US Supreme Court landmark decision reverses longstanding rule on physical presence and sales tax which could have far reaching consequences for online businesses
Elizabeth Wilson 1 July 2018 No comments
In the South Dakota vs. Wayfair ruling of 21st June 2018, the Supreme Court of the United States has overturned a previous Supreme Court decision dating back to the 1960s stipulating that only businesses with a physical presence in a state were liable to collect sales tax on purchases by the state’s residents.
The ruling opens the way for all US states to pass laws requiring remote retailers with no property or employees in the state, to charge local taxes on sales to US consumers.
This major Supreme Court decision is anticipated to have a significant impact on US retailers’ online interstate sales, as well as overseas retailers’ online sales, neither of which are currently subject to US state sales tax under the physical presence standard.
South Dakota, like many states, taxes the retail sales of goods and services by businesses with a physical presence in the state. Sellers are required to collect and remit the tax to the state, but if they do not, then in-state consumers are responsible for paying a “use tax” at the same rate.
South Dakota has no income tax and so relies heavily on sales and use taxes to fund its state and local services. However, consumer compliance rates are notoriously low and the physical presence rule is causing South Dakota to lose an estimated USD 48 million to USD 58 million a year.
In 2016, South Dakota passed a law introducing an economic presence standard requiring sales tax collection for any entity exceeding an annual sales threshold of USD 100,000 or engaging in 200 or more separate transactions in South Dakota. The state subsequently sued four sites for non-compliance, including Wayfair.
Initially a lower court ruled against South Dakota’s law due to the 1992 Quill vs. North Dakota judgment. In the 1992 case, North Dakota argued that Quill Corporation, an office supply retailer, should be considered a North Dakota company and collect the local tax due to the number of customers it had in the state. The Supreme Court ruled however that the case was indistinguishable from the 1967 National Bellas Hess, Inc. vs. Department of Revenue of Illinois, and that as Quill’s sales were through mail and telephone orders, and the company had no physical presence in North Dakota, it could avoid the local taxes.
A subsequent appeal by the state, in South Dakota vs. Wayfair, to the South Dakota Supreme Court resulted in an affirmation of the judgement. However, in April 2018, with the support of 40 other states, the case made its way up to the US Supreme Court, with South Dakota arguing that e-commerce has completely changed the retail landscape and that US states were losing out on billions of dollars’ worth of sales tax.
In a reversal of the National Bellas Hess and the Quill rulings, the US Supreme Court overturned the physical presence rule for charging US sales tax, finding that it was “unsound and incorrect”.
The Court added that the physical presence standard created, rather than resolved, market distortions and created arbitrary distinctions that do not apply to the modern age where e-commerce is the norm.
In its decision, the Court commented that “the Quill Court did not have before it the present realities of the interstate marketplace, where the internet’s prevalence and power have changed the dynamics of the national economy”.
The Court also acknowledged that South Dakota’s tax system has several preventative features to ensure that it does not discriminate against, or place undue burdens upon, interstate commerce, which include no obligation to retroactively remit sales tax.
The Court remanded the case to the South Dakota Supreme Court to address the matter in-line with the US Supreme Court’s opinion.
Impact on businesses
Following the ruling, other states may now start requiring remote sellers in the US and overseas, to register, collect and remit local sales tax regardless of the seller’s physical presence.
This would create a more level playing field, as businesses that sell online into US states where they do not have a physical presence, will no longer have a price advantage over local businesses or interstate retailers with a national presence who already charge sales tax in most states.
However, many states have more complex laws than South Dakota and, in-line with the US Constitution, will need to address this to ensure that their tax systems would not discriminate against or impose undue burdens on interstate commerce following any local tax changes on remote sales.
There are still many areas of uncertainty as to how each state will respond in the light of this ruling, and legislation will need to be passed before new laws can be implemented.
Furthermore, the Court did not resolve the question of whether a state may retroactively impose a sales tax obligation on a remote seller with no physical presence. Demands for retrospective tax collection could have a huge financial and administrative impact on businesses, and could even lead to the demise of many small businesses.
Congress may also be influenced to take action to provide a federal solution on the issue.
Until all states have clarified their position following this landmark ruling, remote sellers who have not previously collected local taxes on e-commerce sales into the states would be advised to revisit their sales tax obligations and assess the potential tax risk as soon as possible.
In order to mitigate liabilities, businesses could also consider approaching the relevant US states under their voluntary disclosure or amnesty programmes.
Once a state has confirmed it will apply local taxes retroactively, impacted businesses should also analyse historical tax obligations that would have been owed over the period of retroactivity.
Going forward, companies operating online will need a process in place to track US sales, in order to calculate whether they meet the specific economic presence standards of each state.
Given the potential far reaching consequences, e-commerce businesses that sell to US customers should closely monitor this issue.
We will keep you updated with further developments as they arise.