Supreme Court overturns Quill’s physical presence requirement

Whether it is because of the convenience, low prices, or wide selection we’ve been seeing more and more of online shopping in recent years. Online purchases can have another characteristic: online purchase can be sales tax free. This may now change after the Supreme Court ruled in South Dakota vs. Wayfair, Inc. on June 21, 2018.

Under previous rulings (*1), states may not require businesses to collect sales tax unless they have a physical presence to the state. Instead, in-state consumers are responsible for paying use tax at the same rate; but compliance with the use tax is low. This could provide more savings for customers and hence better operating environment for sellers, but this also means loss of revenue for states.

South Dakota, like many states, taxes only the businesses with physical presence in the state and it is estimated that the state loses between $48 and $58 million sales tax revenue annually. Concerned about the erosion of its sales tax base and corresponding loss of critical funding for the state and local services, South Dakota enacted a law requiring certain out-of-state sellers to collect and remit sales tax. The act only applies to sellers that, on an annual basis, i) deliver more than $100,000 of goods or services into the state or ii) engage in 200 or more separate transactions for the delivery of goods or services into the state.

South Dakota’s Legislature knew that its new act would be considered unconstitutional unless previous rulings were overturned. South Dakota filed a declaratory judgment action in state court against Wayfair Inc., Overstock.com, and Newegg Inc., all of which are large internet merchants that have no physical presence in South Dakota and do not collect sales tax. The law was first declared unconstitutional by South Dakota courts, then the Supreme Court granted certiorari.

In deciding to overrule the prior ruling, the U.S. Supreme Court stated that Quill banning sales tax collection when businesses lack “physical presence” in a state was an incorrect interpretation of the Commerce Clause. First, the Court criticized that the physical presence rule is not a necessary interpretation of the “closely related” nexus requirement. Second, the Court found that the prior ruling creates, rather than resolves, market distortions, calling it a “judicially created tax shelter for businesses that decide to limit their physical presence”. Third, the Court found that Quill imposes “arbitrary, formalistic” distinctions that run counter to the Court’s modern precedents under the Commerce Clause. The Court also provides an example: a business that has a warehouse, even though the warehouse has nothing to do with the sales, would be required to collect sales tax, while an online retailer with pervasive internet sales cannot be subject to the same tax for the sales of the same items. The Court states “this distinction simply makes no sense”.

In dissenting opinion, Chief Justice John Roberts, with whom Justices Breyer, Sotomayor, and Kagan joined, wrote that, although he agreed that previous ruling was wrongly decided, and that the internet commerce has improved the economy greatly, any alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress. Which may have put some pressure on congress to move ahead with legislation on this issue to provide a national standard for e-commerce. Also, it is expected that other states will now change their laws to take advantage of the decision.

Companies with remote sales should closely monitor current and potential state and federal legislation and related sales tax exposures. Before Wayfair, even though some states require sales tax responsibilities to remote sellers without physical presence in the jurisdictions, some companies chose not to comply with the regulations since they have favorable previous rulings. This position needs to be re-analyzed as the previous rulings were overturned. Companies should consult with sales tax experts.

Please refer to the Supreme Court Opinion: https://www.supremecourt.gov/opinions/17pdf/17-494_j4el.pdf

*1: National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967), and Quill Corp. v. North Dakota, 504 U.S. 298 (1992)