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Sales Tax

The Future of the Online Sales Tax “Physical Presence” Nexus Standard – Part Four

Accountants are being pulled in to the trend of the online marketplace. The ease offered by online ecommerce platforms means even small clients can suddenly be mired in complexities of multistate tax rules from their very first sale.

In previous parts of this article (Part 1, Part 2, Part 3) we discussed the physical-presence requirement for sales tax nexus, as established by the U.S. Supreme Court in the 1992 case Quill Corp. v. North Dakota, 504 U.S. 298 (1992). We also provided an overview of the Court’s decisions that led to the Quill physical-presence standard, Congress’s inability to change or overrule the decision through legislation, and state efforts to expand or ignore the physical-presence standard, through attributional and agency nexus theories, click-through and affiliate nexus provisions, use tax reporting and notification standards, and most recently, economic nexus standards.

As we provided in previous sections of this article, these economic nexus standards are the most draconian measures taken by states to seize upon the interstate commerce activities of remote sellers. One such state is South Dakota, which, in direct conflict with the Quill physical presence standard, out-of-state sellers to collect its sales tax if a seller’s annual sales volume to South Dakota purchasers meets or exceeds $100,000, or consists of 200 or more separate transactions.

On September 13, 2017, upon challenge by Wayfair, Overstock and NewEgg, the South Dakota Supreme Court ruled the state’s “economic presence” nexus law (SDCL 10-64-1 et seq.) to be unconstitutional as it is contrary to the physical presence requirement for state sales and use taxes reaffirmed by the Supreme Court in Quill. [South Dakota v. Wayfair Inc. et. al., 901 N.W.2d 754 (S.D., September 13, 2017] By design, South Dakota petitioned the United States Supreme Court to hear the case, and the Court granted the state’s petition for writ of certiori.

The United States Supreme Court is set to hear oral arguments on April 17, 2018, in South Dakota v. Wayfair, Inc. et. al. [South Dakota v. Wayfair Inc., et. al., 901 N.W.2d 754 (S.D. September 13, 2017); cert. granted (U.S. January 12, 2018)(No. 17-494)] At issue is whether the Court should abrogate Quill’s sales-tax-only, physical-presence requirement?

As such, now the questions are: (1) Will Quill survive? (2) To the extent the Court changes or overturns Quill, what does this mean for remote sellers, and (3) If the Court overturns Quill, will it apply retroactively? This latter question was one of the reasons the Quill Court upheld the “physical presence” standard set forth in National Bellas Hess, hoping that Congress would take action with a prospective focused legislation. In Part Two of this series, we look at some of the consideration that will impact the answers to these questions.

Will Quill Survive?

It is reasonable to agree that the Quill physical presence standard, whether appropriate or not when decided, no longer respects the nature of the economy today. Quill was decided when retail shopping and mail order shopping were the primary, if not only means of consumer purchasing. Today, mobile devices, the Internet and electronic commerce are the primary means of conducting everything, everywhere, at any time. “According to the US Census Bureau, in 2016 total e-commerce sales in the United States were estimated at $394.9 billion, which accounted for 8.1 percent of total retail sales.

For some perspective: Fifteen years before, in 2001, total e-commerce sales were estimated to be $32.6 billion, which at the time made up about 1 percent of total sales. According to research firm eMarketer, Amazon represents 43.5 percent of all US retail e-commerce sales; eBay accounts for about 6.8 percent.”

We are a borderless, global economy. As such, upholding boundaries that govern state’s ability to impose sales tax collection obligations on a remote seller seems rather arbitrary when such boundaries do not govern other tax or legal obligations. Then there’s the money.

From a purely fiscal standpoint, most readers will agree that the states would gain an increase in sales tax revenue collections from a removal of the sales tax nexus physical presence requirement. According to the U.S. Government Accountability Office (GAO), the GAO estimated that state and local governments could gain from about $8 billion to about $13 billion in 2017 if states were given authority to require sales tax collection from all remote sellers.

These figures are supported by the results of a study conducted by three University of Tennessee professors, who concluded that states’ 2012 revenue shortfall from e-commerce would be $11.4 billion. This 2009 study’s results were updated in 2015 by the National Conference of State Legislature and the International Council of Shopping Centers to estimate that total U.S. uncollected sales and use taxes increased to almost $26 billion annually. But these figures are just estimates, so we have no concrete means of determining with any degree of statistical confidence whether the states will generate such revenue if allowed to tax all remote sales. However, we can all agree that revenue collections will rise.

In Wayfair, the Court could reaffirm Quill and the physical presence standard. This would enable the Court to respect its precedent, particularly when Congress has the authority under the Commerce Clause to overturn that precedent. And you’re saying, “But Mike, Congress has had the opportunity for more than 25 years, and has not done so.” Affirmation of Quill by the Wayfair Court may be just what lobbyists for state and local taxing authorities and large retailers require in order to force Congressional action on such legislation as the Marketplace Fairness Act. Congressional legislation is likely the more appropriate and rational method for addressing states’ inability to require remote sellers to collect sales tax on business generated from customers in the state.

Among other positive attributes, Federal legislation could be prospective only, eliminating seller concerns over the retroactive application of a new nexus standard. It could also address small seller concerns by creating a safe harbor threshold, under which smaller retailers would not have to collect sales tax everywhere. It could require states to simplify and standardize their laws prior to permitting the state to impose sales compliance obligations on remote sellers.

Furthermore, it could provide for subsidized sales tax compliance automation solutions, thereby removing cost of compliance concerns voiced by remote sellers. Lastly, Federal legislation could establish a bright line standard by which states could require remote sellers to collect sales tax on business generated from customers in the state. This would eliminate some – but not all – of the guesswork surrounding remote seller concerns about when they have nexus and a sales tax compliance obligation in a state, and would enhance state budget forecasting capabilities.

Congressional leaders of the effort to pass Federal legislation enabling states to tax remote sales even filed an amicus brief with the Wayfair Court, stating that Congress has been unable to reach a consensus on a legislative solution and that the impasse is the result of “structural advantages and disadvantages created by the Quill decision.” In other words, Quill prevents them from acting, in large part because to pass Federal legislation in the face of Quill would be perceived as imposing a “new” tax on their constituents. [] In their opinion, if the Court overturns Quill, then Congress will step in and provide a solution to the issue of taxing remote sales.

It is more widely agreed that the Wayfair Court will overturn Quill. Many, if not most, State and Local Tax (SALT) professionals agree that the Court would not have taken the case if it did not at least have serious considerations about overturning Quill. The author believes that the Court will overturn Quill, or at least modify the physical presence standard. In a recent internal poll by KPMG’s Washington National Tax practice of its staff, 12 out of 15 SALT professionals “have a decent degree (ranging from 51-100 percent) of confidence that the Court agreed to review the case to change the law and eliminate the physical presence test. Only 3 of the 15 SALT professionals participating believe that the Court will leave Quill standing”. [] What’s more compelling is that 35 states filed an amicus brief with the Wayfair Court, asking the Court to overturn Quill. []

This author does not have a crystal ball with which to see into the future, however, at least three Supreme Court justices seem to support the reversal of Quill. The South Dakota law, on which the Wayfair case is based, was specifically designed to provoke a Supreme Court review of the Quill case, in direct response to Justice Kennedy’s concurring opinion in Direct Marketing Association v. Brohl, [575 U.S. ___ (2015)(considering federal court jurisdiction over a suit to enjoin the enforcement of Colorado’s notice-and-reporting requirements, and not the constitutionality of the statute)]

In his concurrence, addressing these novel state attempts to tax remote sales, Justice Kennedy stated that “Quill now harms states to a degree far greater than could have been anticipated earlier”, and calling for the states to enact legislation that would enable to Court to reconsider Quill.   Justice Thomas has said he would jettison the entire dormant commerce clause, saying “[t]he negative Commerce Clause has no basis in the text of the Constitution, makes little sense, and has proved virtually unworkable in application.” [Hillside Dairy Inc. v. Lyons, 539 U. S. 59, 68 (2003) (opinion concurring in part and dissenting in part)] Justice Gorsuch, the newest Supreme Court justice, has suggested skepticism about Quill as a 10th Circuit judge, calling Quill’s physical presence standard “a ’formalistic’ and ‘artificial’ distinction between sales and use tax collection obligations and other comparable regulatory and tax duties”, noting that it has an “expiration date” and that it would be appropriate to allow Quill to “wash away with the tides of time.”  [Direct Marketing Association v. Brohl, 814 F.3d 1129 (10th Cir. February 22, 2016)]

The Court may be hard-pressed to overturn Quill in the face of stare decisis, which is Latin for “to stand by decided matters,” and tends to be cited by courts when considering an issue with similar facts for which the court has already rendered a decision. However, the principle of stare decisis stands for the notion that cases must be decided the same way when their material facts are the same. Based on what we know about the mail order industry, on which Quill was decided, as compared to the Internet and global e-commerce industry that states seek to tax, the Court should be able to find ample distinguishing facts to overturn Quill, regardless of the principle of stare decisis.

If the Court upholds Quill, this may set the states back in terms of their efforts to enforce sales tax compliance obligations on remote sellers. But do not expect this to eliminate their laws, or their strategic efforts to continue expanding the definition of physical presence.

If the Court overturns Quill, how they do so can dramatically impact states’ and taxpayers’ ability to now understand how and when they have substantial nexus sufficient to require sales tax compliance.

Regardless of whether Quill survives or not, as we discuss in Part 5 of this series, there will remain countless arguments about nexus, only furthering the need for Federal legislation in this area.





Michael Dillon is an attorney, and the founder and President of Dillon Tax Consulting. With more than twenty years of state and local tax experience, Mike has both public accounting expertise leading the State and Local tax department for two of the country’s largest accounting and consulting firms, as well as serving as Tax Director for a publicly traded e-commerce retailer and as a tax attorney in one of the world’s largest communications companies. With his focus primarily on the state and local tax needs of businesses, Mike provides solutions and planning recommendations to clients’ questions regarding sales tax, business license tax, various other state and local tax matters, and other business compliance requirements.