The Supreme Court, in a 5-4 decision, has erased decades of reliance on the physical presence test to determine remote seller nexus – while also creating more work for state courts. Associate Justice Anthony Kennedy wrote the majority opinion, while Chief Justice John Roberts wrote a dissent.
At issue was the Supreme Court’s 1992 decision in Quill, which established the physical presence test for sales and use tax nexus. In Quill, the Supreme Court concluded that a state could not require an out-of-state seller to collect sales tax on a sale to a resident of the state. That was before the surge of online sales, and states have been seeking since then to find constitutional ways to collect tax revenue from remote sellers into their state.
In 2016, South Dakota enacted legislation that was clearly unconstitutional by Quill standards. Implementing an economic nexus test that requires remote sellers without a physical presence in the state to collect sales tax if certain gross revenue or transaction thresholds were met – more than $100,000 of goods sold or 200 transactions. The state supreme court held the legislation to be unconstitutional, and the U.S. Supreme Court granted South Dakota’s petition asking for a writ of certiorari (asking for a rehearing).
“At the end, the Supreme Court vacated and remanded the case to the state court,” said Jamie Yesnowitz, principal and SALT National Tax Office leader at Grant Thornton. “The sole issue the Supreme Court decided was whether the physical presence test could stand. Eliminating the physical presence rule doesn’t decide whether South Dakota’s law passes the entire Commerce Clause test. There’s still work to be done in the lower courts.”
“Having said that, the court’s decision implies that South Dakota’s statute is likely to pass constitutional muster,” Yesnowitz said. “This would lead other states to quickly pass legislation that is consistent with South Dakota’s legislation.”
Of course, Congress could always act legislatively to set a uniform set of standards, Yesnowitz observed. “Will a Supreme Court decision that says that states can do what they want result in Congress saying, ‘We don’t want that?’ In the coming weeks and months you’ll see states come out with legislation either consistent with South Dakota’s economic nexus standards or perhaps more aggressive, and the question is, will Congress want a uniform standard to make it consistent throughout the U.S.? The dissent from Justice Roberts said that they – Congress – should be the actor here and the Court should follow stare decisis.”
“Everyone needs to take a deep breath, because they remanded the case back to South Dakota,” Scott Peterson, vice president of U.S. Tax Policy and Government Relations at Avalara. “The South Dakota law is not going into effect this afternoon. It still has to be evaluated on the four prongs of the Complete Auto case. This was a U.S. Supreme Court case where the court ruled in favor of the state, and laid out four prongs to test whether the Commerce Clause was violated. The prongs are substantial nexus, nondiscrimination, fair apportionment and a fair relationship to services provided by the state.”
“Online retailers should be calling their CPA and seeking professional advice,” he said. “They will need to stop thinking about where they have employees and other potential physical presence, and start thinking about where they’re making sales.”
Surprisingly to some, the majority opinion stated that Quill’s physical presence test is unsound and incorrect.
“They had to use that kind of language,” said Brian Kirkell, lead SALT principal at RSM US’s Washington National Tax Group. ”Physical presence has long been considered the law of the land, and they had to use that kind of language to overcome stare decisis. At the time Quill was decided, no one could have predicted what modern technology would lead to.”
“They sent it back to the South Dakota Supreme Court, which will rule based on instructions from the Supreme Court,” he continued. “Ultimately what will happen is that the South Dakota Supreme Court will uphold the lower court decision that this tax is valid. They’ll send it back for fact finding, at which point Wayfair will settle.”
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