The Supreme Court’s 5-4 decision last month in the case South Dakota v. Wayfair, Inc., allows states to require out-of-state retailers to collect sales tax from customers, even if they don’t have a physical store or warehouse in the state, clearing the way for more sales tax revenue from internet purchases.
The court held that the physical presence rule established by the Quill Corp. v. North Dakota decision is incorrect, with Justice Anthony Kennedy pointing out that the court didn’t write the 1992 opinion with the realities of today’s internet market in mind.
“Quill creates rather than resolves market distortions,” wrote Kennedy, who announced his retirement last month. “In effect, it is a judicially created tax shelter for businesses that limit their physical presence in a State but sell their goods and services to the State’s consumers, something that has become easier and more prevalent as technology has advanced. The rule also produces an incentive to avoid physical presence in multiple States, affecting development that might be efficient or desirable.”
James Brockway, a tax attorney and partner at the law firm Withers Bergman in New Haven, Connecticut, believes the Wayfair decision could have far-reaching tax implications for retailers both online and offline.
“I think it is going to be a significant burden on the e-commerce industry,” he told Accounting Today. “Unless states basically rationalize their sales and use taxes so that there’s really a single type of a tax in terms of exemptions and things like that, the e-commerce retailers are going to have their work cut out for them in terms of data collection, payments and things like that. What is likely going to happen is more standardization in how the taxes are enforced and what transfers are subject to the tax.”
States may now feel free to levy taxes on services and software in the wake of the decision. “The biggest issues that I see, quite frankly, are not in the goods transfers, but service transfers,” said Brockway. “In other words, what do you do with software downloads and those kinds of things? Every state has a very, very different concept if they have a sales tax with respect to the imposition of the tax on services. I think that the e-commerce retailers are going to have a big burden. And coincidentally, the larger ones probably will be able to do it more easily just because of the volume so that the smaller e-commerce retailers are going to get hurt the most.”
South Dakota set a model that other states may now follow. “What it means for out-of-state retailers is that sales tax nexus is no longer solely based on a physical presence standard,” wrote Shane M. Finn, who directs HBK CPAs & Consultants’ state and local tax practice. “Out-of-state sellers that meet minimum standards can be required to charge, collect and remit sales tax. Each state sets its own standards. In South Dakota, the minimum standards are $100,000 in sales or more than 200 transactions over a 12-month period. The winners are local brick-and-mortar businesses, which will be able to compete price-wise with online retail giants. States and municipalities stand to gain billions of dollars in annual revenue. The losers are small online retailers who could be devastated by new compliance costs.”
Many states are likely to respond to the ruling this year. “The U.S. Supreme Court’s decision on Wayfair is unequivocal: the physical presence nexus standard for sales and use tax purposes is dead,” said Steve Wlodychak, EY principal and state tax leader for the EY Center for Tax Policy. “With this ruling, the court affirms that Congress still has the most important power and can still impose uniform limits. Until then, every state is free to come up with their own standards. Expect states to respond immediately. No retroactive protection is provided to companies and states can go back to an indefinite period to collect unpaid taxes. Remote retailers need to ensure they implement and follow updated compliance practices on sales tax collections. Foreign retailers have to be especially careful. Nexus is not permanent establishment and U.S. international tax treaties do not protect them from a state’s assertion of sales tax nexus.”
The decision could add considerable complications for small e-commerce companies and is likely to prompt more of them to use sales tax software such as Avalara, Vertex or TaxCloud to automate the process.
“If I am a relatively small e-commerce retailer, but I still pay whatever minimum thresholds the state set up for the imposition of the sales tax, I could be dealing with 20 different states in terms of calculation of the tax, obtaining exemptions under resale certificates or exemptions for sales to tax exempts,” said Brockway. “And that will be a large burden on the smaller retailers because they’re going to have to have a dedicated person compiling the data, making sure that the forms get filed and that the taxes get paid. It’s a big imposition on e-commerce but you almost had to see it coming.”
Up to now, relatively few people have been declaring and paying sales taxes on their online purchases on their tax forms. “The use tax is a very inefficient way to do it because it places the burden on the consumer, and but for the big-ticket items that people do pay attention to, nobody paid any attention to the mail order and e-commerce deliveries, they just didn’t know,” said Brockway. “They just didn’t pay the use tax. It will be an enormous revenue boon for the states that have sales taxes, in the billions.”
The court ruling could have far-reaching implications across corporate America. “The impact of the court’s ruling on companies in terms of time, technology and expense is likely going to be substantial,” said Jeffrey C. LeSage, Americas vice chairman of tax at KPMG. “Businesses will now need to prepare to closely examine and retrofit their operations to determine where they have to collect tax, whether their goods are taxable, and how they are going to handle the new tax computation, filing and remittance obligations.”
The Supreme Court decision could put brick-and-mortar retailers on more of an even playing field with some of the online e-commerce leaders, although the online space will still enjoy some advantages.
“I think it will certainly put them on a more level playing field,” said Brockway. “They’re still at a disadvantage because you know they're paying overhead for storage space that is more expensive than the warehouse space, but with sales taxes in many states above 5 to 6 percent, if people are smart consumers and they were getting either subsidized delivery or no-cost delivery, why wouldn't you go and have it delivered to your door rather than going out to a brick-and-mortar store and paying the sales tax?”
Brockway pointed out that the Wayfair case itself isn’t entirely settled, though. “Remember, the case was remanded,” he said. “It’s not over yet. But I think that what the Supreme Court has basically said is what South Dakota did will pass constitutional muster.”
He believes many states will now follow South Dakota’s lead. “I think a lot of states are going to mimic South Dakota’s minimum presence thresholds, and I think a lot of states will be very reluctant to try to go after retailers retroactively,” said Brockway. “If you look at the Supreme Court decision, the keys to their upholding it was there was a reasonable minimum threshold and they’re party to a multi-state convention [the Streamlined Sales and Use Tax Agreement]. They have software that can be downloaded that will make it easier for the smaller e-commerce retailers to be able to get to it, and South Dakota wasn’t going to go after people retroactively. All those things were in their favor and I think you're going to see a lot of states just mimic that tax.”
Brockway did find the Supreme Court ruling surprising in some respects. “I think that everybody kind of agrees with the principle, but my expectation was that they were to going to leave it up to Congress,” said Brockway. “But Congress has proven to be pretty impotent in terms of being able to deal with this. Things have changed so much in the last 30 years with regard to the volume of e-commerce and catalog shopping and things like that, they had to be able to level the playing field. I have a hunch that within this year you’re going to see a tremendous influx of new legislation in the states because it’s a big revenue raiser.”
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