The recent story of Wayfair Inc. is one which is becoming very commonplace in the U.S. due to the increase of e-shoppers which goes hand in hand with the increase in ‘e-retailers’. The crux of this case pertains to the question:
Should out of state retailers who do not have a physical presence in the state they sell in, be obligated to collect and remit taxes ?
This question is so relevant on a national level and so hard to decide on due to judicial precedent that it has made it all the way to The Supreme Court.
The ruling overturned Quill Vs. North Dakota (1992) as well as the Bella Hess case (1967) which have served as judicial precedent for decades when deciding on eCommerce taxation issues.
Needless to say this decision has far reaching implications for online sellers the nation over. The legal system can have a huge economic impact on your online retail business which is why it is important to stay informed about these issues.
Taking notice of the large revenue stream that eCommerce has provided, coupled with the fact that a large portion of that came at the expense of traditional revenue (ie bricks and mortar commerce), The State of South Dakota decided to pass legislation and collect taxes from remote sellers (Senate Bill 106) if they meet one of two conditions:
- Goods or services provided in South Dakota exceed $100,000Or:
- Goods and services were provided in state in excess of 200 transactions
At first, this bill was contested in South Dakota itself where it made it to the state supreme court which actually upheld the original Quill Vs. North Dakota ruling. The legal reasoning of that case was based mainly on the Dormant Commerce Clause.
What exactly is the Dormant Commerce Clause (DCC)?
Not all of us are constitutional scholars (myself included) so this is an opportunity to understand a very important aspect of the US constitution. The Commerce Clause refers to Article 1, Section 8, clause 3 of The United States Constitution affording congress the power to:
“Regulate commerce with foreign nations, and among the several states, and with Indian tribes”
Here the constitution grants a ‘positive’ power allowing congress to regulate commerce but The Supreme Court has traditionally attributed a ‘negative’ command which came to be known as the Dormant Commerce Clause which does not allow states to impose taxation even when congress fails to pass legislation (ie is dormant). One key principle which is outline in this clause is that states are prohibited from:
“…imposing excessive burdens on interstate commerce without congressional approval.”
Which major cases impacted the court’s interpretation of DCC?
In recent history, besides South Dakota Vs. Wayfair, there were 3 major cases which had the Dormant Commerce Clause at the heart of their case:
- The Bella Hess case (1967) – The court ruled that although goods were being sold in the state of Illinois, the remote retailer did not have a sufficient connection to the state under Due Process and DDC based on the fact that the company lacked a physical instate presence.
- Complete Auto Transit Vs. Brady (1977) – Ultimately this case gave birth to a 4 prong ‘test’ in which all four parts need to be upheld when deciding state taxation as it pertains to DDC:
- There needs to be a substantial connection between the taxpayer and the state
- Taxes must be fairly appropriated
- Taxes do not discriminate against interstate commerce
- The need to be fair and proportionate in relation to services that the state provides
- Quill Vs. North Dakota (1992) – In this case the court threw out the Due Process clause holding but upheld DCC in order to prevent undue burdens on interstate commerce. This was based largely on the Auto Transit case and Bella Hess using the legal principle known as ‘stare decisis’ (ie when litigation is determined based on precedent).
The court said that “Quill is flawed on its own terms” and decided to move away from judicial precedent for 3 main reasons:
- Embracing public criticism that the physical presence requirement is no longer relevant due to recent technological and economic developments
- Quill, according to the court’s decision causes market distortions instead of solving them
- The precedents in Quill are arbitrary and go against The Supreme Court’s modern Commerce Clause precedents
The court wrote that it believes that operating costs or physical presence have very little to do with a company’s connection (or nexus) with a state in modern times and thus its ability to be taxed. The court further explained that the DDC was meant to prevent interstate commerce discrimination and that in this case it was actually having the opposite effect. The reasoning is that out-of-state retailers without a physical presence were gaining the upper hand on local retailers with a physical presence. This ultimately helped create an artificial competitive advantage for those companies and encouraged companies to not establish an in-state physical presence which does nothing for the local economy.
“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.”
Furthermore the court said that it does not see a building or employees as a more substantial connection to the state than it does a ‘digital nexus’ for example and that it would not ignore virtual state connections – this conclusion is revolutionary specifically for eCommerce but also as a precedent for the American economy as a whole.
But what about the little guys ?
In the Wayfair decision the court discussed the burden of their legislation on small eCommerce retailers and said that separate legislation may be passed in the near future in this regard. Additionally the judgement mentioned three things that may very well put many small retailer’s mind at ease:
- There is software available which can make this process seamless as far as the court claims though hey make no mention of anything specific.
- The Wayfair Vs. South Dakota case as per the state’s legislation only requires taxation remittance from a pretty high threshold as I mentioned above ($100,000 and up or over 200 transactions) so small retailers need not be concerned
- The law is not retroactive and is part of the Streamlined Sales and Use Tax Agreement (October 1, 2005)
What is the Streamlined Sales and Use Tax Agreement?
The goal of the Agreement is to simplify sales tax administrative aspects in an attempt to considerably mitigate the burden of tax compliance. The Agreement Puts an emphasis on simplifying sales and use tax administrative structures for all sellers by:
- Making state and local tax bases more homogeneous
- Creating a centralized computerized registration system for all member states
- Simplifying state and local tax rates
- Creating uniform sourcing rules for all taxable transactions
- Simplifying administration of exemptions
- Simplifying tax returns
- Simplifying tax remittances
Currently 24 states representing 30% of the U.S. population have adopted the agreement and more states are moving to join and adopt it.
What does the future hold and is the Wayfair decision final ?
Some people are positive about the future and believe that the fight is not over yet. Two main things may yet change the tides:
- The litigation is still ongoing despite The Supreme Court’s decision. Wayfair or other litigants may choose to challenge the court’s decision using other arguments than the ‘substantial nexus’ (ie physical presence) and in that case the injunction against the South Dakota legislation may be valid for some time
- Many parties including The Supreme Court itself have invited congress to weigh in on this issue. Lobbying interests as well as varying state tax rates and legislation may force congress to take swift action and make concrete decisions on this matter. This may include deciding on uniform interstate remittance rates for example.
Here is a list of things you can do to start preparing yourself and your eCommerce business for a post Wayfair tax policy:
- Conduct an in-depth review of your activities in states where you do business but do not have a physical presence.
- Try and understand if and when the states you are currently doing business in plan on adopting legislation similar to South Dakota and if so, what level of business will be taxable?
- Consider shifting your selling strategy to states which seem less inclined to require tax remittances. For instance you can offer free shipping to people who live in these states in order to try and attract more business specifically from there.
- Consider the pros and cons of early compliance with tax remittance versus waiting till the last minute
- For retailers who have this possibility and after consulting a tax attorney, consider officially moving your eCommerce business to a foreign country which has a more comfortable tax agreement with the U.S.
The 42 states, 2 territories as well as The District of Columbia who all petitioned The Supreme court to reject the Physical presence rule, see South Dakota Vs. Wayfair as a historic decision and as progress in the digital age of commerce and economics. I am sure that local retailers too, who have suffered from an uneven playing field caused by out-of-state competition are also breathing a sigh of relief and praising the greatness of American democracy right around Independence Day. But for most retailers who do sell out-of-state, this legislation is problematic to say the least and raises many questions as to what the future holds such as:
- Should I move my operations overseas?
- Is interstate eCommerce still profitable for me ?
These questions are relevant today as ever and I would appreciate you sharing your opinion of The Supreme Court’s ruling and how you plan on facing these new challenges.