United States: U.S. Supreme Court Overturns Physical Presence Test Giving States Authority To Collect Sales Tax From Remote Sellers

On June 21, 2018, the Supreme Court rendered its long awaited decision in South Dakota v. Wayfair and overturned the Court's 50-year old physical presence nexus standard arising from Quill Corp. v. North Dakota (1992) and National Bellas Hess v. Department of Revenue of Illinois (1967). That rule prevented a state from requiring a business with no physical presence to collect that state's sales/use tax.

The South Dakota v. Wayfair case originated after the South Dakota Legislature enacted an economic nexus law requiring remote sellers to collect and remit sales tax if they deliver more than $100,000 of goods or services into South Dakota or engage in 200 or more separate transactions of goods or services into the state (the "Act").  Following the enactment of the Act, South Dakota filed suit against Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc. (the "Respondents"), seeking to require each Respondent to register to collect and remit South Dakota sales tax.

The Respondents sought summary judgment, arguing that the economic nexus test imposed by the Act was unconstitutional due to the physical presence standard set forth in Quill.  The trial court granted their motion and the South Dakota Supreme Court affirmed.  The U.S. Supreme Court granted certiorari in January of this year and heard oral arguments in April, all culminating in its decision to overturn Quill.

In a 5-4 decision, the Supreme Court held that the physical presence rule of Quill is "unsound and incorrect".  It is important to note that the four justices joining Chief Justice Roberts in his dissenting opinion also recognized that Bellas Hess was "wrongly decided", but submitted that Congress should decide whether to depart from the physical presence rule. The majority opinion, written by Justice Anthony M. Kennedy, provides that the physical presence rule is not necessary to determine what activity has a substantial nexus with a state, that it creates rather than solves market distortions, and that it treats economically identical actors differently for arbitrary reasons.  The opinion further states that:

In effect, Quill has come to serve as a judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a State's consumers – something that has become easier and more prevalent as technology has advanced.

For these reasons and others enumerated in the opinion, the Supreme Court overruled Quill.

After overruling the physical presence rule of Quill in the opinion, the Supreme Court shifted its attention to the Respondents' sales in South Dakota and determined that the Respondents had substantial nexus in South Dakota "based on both the economic and virtual contacts respondents have with the State."  Interestingly, the Supreme Court held that the Respondents had substantial nexus even though it did not render a final decision as to the validity of the Act.  Since the physical presence rule of Quill invalidated the Act on the front end, the Respondents will have the opportunity to make any additional claims as to the validity of the Act on remand.  However, the Supreme Court appeared to support the Act, stating:

South Dakota's tax system includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce.  First, the Act applies a safe harbor to those who transact only limited business in South Dakota.  Second, the Act ensures that no obligation to remit the sales tax may be applied retroactively . . . . Third, South Dakota is one of more than 20 States that have adopted the Streamlined Sales and Use Tax Agreement.  This system standardizes taxes to reduce administrative and compliance costs: It requires a single, state level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules.  It also provides sellers access to sales tax administration software paid for by the State.  Sellers who choose to use such software are immune from audit liability.

So, what's next after the Supreme Court's decision in South Dakota v. Wayfair?

  • Economic Nexus is Here to Stay. Wayfair overturned the physical presence test of Quill in favor of applying an economic nexus standard to determine whether South Dakota may require a remote seller to collect and remit South Dakota sales tax on sales to South Dakota customers. To that end, sellers of taxable goods and services should, if they have not done so already in anticipation of the Supreme Court's ruling in Wayfair, quantify the amount of sales and number of transactions to customers located in states that have enacted economic nexus standards in which such sellers do not have physical presence to determine whether such amount exceeds any "safe harbors" that the applicable state may have adopted in its economic nexus statute.
  • Expect States to React Quickly. While the Supreme Court approved of South Dakota's Act and reasoned that delivering $100,000 of goods into South Dakota or engaging in 200 or more separate transactions is sufficient to establish nexus, it did not provide any other details as to whether the Act is the new bright-line test to establish substantial nexus. If a state adopts an economic nexus law requiring sellers with less than $100,000 of sales or less than 200 separate transactions to collect and remit sales tax to such state, will such law be valid?  Does a state have to adopt the Streamlined Sales and Use Tax Agreement in order for its economic nexus law to be valid?  Does a state have to copy the South Dakota law precisely in order for its economic nexus law to be valid?

The Supreme Court's decision does not answer these questions and it is unclear how states will proceed in light of this decision.  Only time will tell.  In the coming days and weeks, we expect that states that have an economic nexus law will publish guidance regarding how their particular state will apply the Wayfair decision. Those states that do not have an economic nexus law may begin to take the steps necessary to enact one.

In the meantime, clients should prepare to begin collecting and remitting sales tax in more jurisdictions than before.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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