Last year, the Connecticut Department of Revenue Services sent requests for information to several large out-of-state internet sellers.
The department invoked its power to request this information under the state’s tax recordkeeping law and offered the sellers the option of providing details about past sales to Connecticut customers or registering to collect tax on sales into Connecticut going forward. Many companies chose to register and collect tax on a prospective basis. Some, including at least one with product listings boasting “no sales tax,” did not.
As tax practitioners know, but the public at large does not, the sales and use tax laws of most states require in-state customers to self-report use tax when an out-of-state seller does not collect the tax on a purchase they make online. In late February, the department sent use tax bills to Connecticut customers of the seemingly “tax free” seller, noting that the tax was due under state law. The surprised customers unleashed a torrent of criticism on Twitter, Facebook, Reddit and other social media platforms. Their fury was directed not at the state or the taxing agency but at the company that, in the view of many, had hung them out to dry. Many said they would never purchase items from the seller again. Ultimately the seller apologized to its customers and agreed to register and collect the tax. The case may be a cautionary example for internet companies continuing not to collect — a practice that until a couple of years ago was the norm online and part of the appeal for bargain shoppers.
Out-of-state internet retailers making sales into a state and not collecting tax on those sales have been relying on the physical-presence standard established in the 1992 case of Quill Corp. v. North Dakota. In Quill, the U.S. Supreme Court ruled that the Commerce Clause of the U.S. Constitution prevents states from imposing sales tax collection duties on out-of-state sellers without some physical presence in the state.
As discussed in our first installment of this “Nexus Considerations” series, several states are in revolt against this standard. A few have enacted economic nexus laws that blatantly contravene Quill and impose sales or use tax collection requirements on large out-of-state sellers making a certain dollar amount of sales to customers in the state. They did this in the hope of pushing the U.S. Supreme Court to grant certiorari in the case of South Dakota v. Wayfair, which revisits the Quill question.
As we noted back in January, the court did agree to hear the case. Since then, attorneys general for 41 states and two U.S. territories filed a joint brief in support of overturning Quill. The Justice Department also urged the court to overturn Quill, on the basis that the earlier court’s “analysis was deeply flawed.” The court has scheduled oral argument for April 17.
We touched in our last installment on the detailed and often cumbersome notice and reporting requirements that some states have enacted instead of, or as an alternative to, the economic nexus schemes. Traditionally these laws were considered, in light of Quill, to be of dubious constitutionality. Critics argued that states lacked the authority, under the U.S. Constitution, to impose such onerous requirements on out-of-state sellers. In 2016, however, the laws got an infusion of legitimacy with the ruling of the Tenth Circuit Court of Appeals in Direct Marketing Association v. Brohl that Colorado’s notice and reporting scheme was constitutional. The U.S. Supreme Court, despite ruling on an injunction in the case a year earlier, declined to review the decision.
Now, a growing number of states, including Colorado, Louisiana, Oklahoma, Pennsylvania, Rhode Island, South Carolina, South Dakota, Texas, Vermont and Washington, require remote sellers making sales of taxable items into the state to comply with notice and/or reporting requirements even when they lack an in-state physical presence. Tax experts writing for Thomson Reuters’ Journal of Multistate Taxation and Incentives last year referred to this gambit as “the passive-aggressive approach” to economic nexus.
Many of these states target remote sellers making a certain dollar amount or number of sales into the state and require these sellers to issue multiple notices to in-state customers concerning the taxability of their purchases, and to provide reports to the state. Colorado, for example, requires “non-collecting retailers” lacking a physical presence in Colorado and making $100,000 or more in total Colorado gross receipts the previous year to issue detailed annual statements to customers informing them of their use tax liability and to provide counterpart statement to the Department of Revenue.
The Nebraska legislature is considering a similar bill that would terminate and be replaced by an economic nexus provision on July 1, 2018, or the first calendar quarter after a court or federal law eliminates the physical presence requirement, whichever is later.
In practice, these laws represent a major whittling away of Quill’s physical-presence requirement. The Pennsylvania, Rhode Island and Washington schemes allow sellers to avoid complying with cumbersome notice and reporting requirements by registering to collect tax going forward. These states impose stiff penalties on companies that opt to follow the notice and reporting schemes but fail to deliver all notices and reports required. All existing state notice and reporting requirements are discussed in detail, and in the broader context of the state’s historical approach to nexus, in Checkpoint Catalyst Topic #1050, Sales and Use Tax: Nexus.
Connecticut’s approach further muddies the waters for online sellers. The state does not have explicit notice and reporting requirements of the kind enacted in these other states. Nonetheless, as we’ve seen, the Connecticut Department of Revenue Services is relying on an existing sales and use tax recordkeeping law and aggressively pursuing historical sales information from vendors. The department is forcing these sellers to decide between registering to collect tax on sales to Connecticut purchasers from now on or putting their customers in the position of receiving large use tax bills for large-ticket items such as computers or televisions that they bought two or three years ago.
In the past, many consumers have excoriated states’ efforts to impose sales tax collection duties on online sellers, seeing these requirements as a new tax. With consumers being billed by the state, however, the public’s perception is changing. In recent years, many large online sellers that traditionally fought sales and use tax collection have begun to agree to register and collect. Connecticut’s tax commissioner argued in a podcast that companies making ostensibly “tax free” sales to people in the state “are very cagey about how they do it, but it’s very clear that the message they give to customers is, ‘if you buy it through us, you don’t have to pay tax.’” A seller that continues in this environment to hold itself out as a venue for “tax free” purchases may find itself fielding inquiries and denunciations from angry consumers.
The shift has been swift, but the landscape is different now. With Wayfair being decided later this year, the physical presence standard is on increasingly shaky ground. Non-collection of tax on taxable online purchasers has become a potential public relations issue that companies must consider and manage carefully, not only in the states that have explicit notice and reporting requirements on the books, but those like Connecticut that choose to take a subtler but equally forceful approach. Internet sellers that do not collect sales and use taxes on remote sales should take great care with recordkeeping practices and may wish to consider informing customers of their use tax obligations even in the absence of action from state revenue departments.
This article originally appeared in State & Local Tax Update, Thomson Reuters Checkpoint, 03/15/2018, and is the second installment in a special series dedicated to recent nexus developments.