The United States Supreme Court is set to hear oral arguments on April 17, 2018, in South Dakota v. Wayfair, Inc. et. al. [South Dakota v. Wayfair Inc., et. al., 901 N.W.2d 754 (S.D. September 13, 2017); cert. granted (U.S. January 12, 2018)(No. 17-494)] At issue is whether the Court should abrogate Quill's sales-tax-only, physical-presence requirement?
The Future of the Quill Sales Tax “Physical Presence” Nexus Standard – Part One
To understand the significance of this issue, it is important to understand the Court’s decisions that led to the Quill sales-tax-only, physical-presence requirement. In 1967, the U.S. Supreme Court held that both the Due Process Clause and the dormant Commerce Clause prohibit a State from requiring catalog retailers to collect sales taxes on sales into the State unless the retailer is "physically present" there. [Nat'l Bellas Hess v. Dep't of Rev. of Ill., 386 U.S. 753 (1967)] The Court stated that "the Court has never held that a State may impose the duty of use tax collection and payment upon a seller whose only connection with customers in the State is by common carrier or the United States mail." [386 U.S. at 758]
The operative issues in most cases involving remote sellers (e.g., e-commerce retailers) concerns the the “substantial nexus” between the taxing State and the activity taxed. As such, for sales tax nexus purposes, the requisite “substantial nexus” requires physical presence.
The Commerce Clause of U.S. Constitution reserves to Congress the power to regulate commerce among the states, with foreign nations, and with Indian tribes. [U.S. Const. Sec. 8, Cl. 3, Art. I]. The dormant Commerce Clause, also known as the nagative Commerce Clause, refers to the authority judicially inferred to Congress by virtue of the exclusive power of Congress to regulate interstate commerce. This dormant authority is a restriction prohibiting a state from passing legislation that improperly discriminates against interstate commerce. In Complete Auto Transit, Inc. v. Brady, the U.S. Supreme Court established the following four-part test to determine the constitutionality of a tax on multistate transactions:
(1) the tax is applied to an activity having substantial nexus with the taxing state,
(2) the tax is fairly apportioned,
(3) the tax does not discriminate against interstate commerce, and
(4) the tax is fairly related to services provided by the taxing state.
[430 US 274 (1977)] The purpose of the four-part test established by the U.S. Supreme Court in Complete Auto Transit, Inc. v. Brady is to determine when non-resident businesses conducting interstate commerce in a State may be asked to contribute their “‘just share’” to collecting that State’s taxes. The operative issues in most cases involving remote sellers (e.g., e-commerce retailers) concerns the first part of the test: the “substantial nexus” between the taxing State and the activity taxed. As such, for sales tax nexus purposes, the requisite “substantial nexus” required physical presence.
In Quill Corp. v. North Dakota, the Court was asked to address a similar set of facts previously considered in National Bellas Hess. [504 U.S. 298 (1992)] The Court determined that its “substantial nexus” standard set forth in Complete Auto Transit, Inc. did not limit or undo the National Bellas Hess “physical presence” rule. However, the Court reversed, in part, its decision in National Bellas Hess pertaining to the Due Process clause, noting that an out-of-state seller may have the minimum contacts required by the Due Process clause, and still fall short of the “physical presence” substantial nexus required by the dormant Commerce Clause. Notably, the Court indicated that in light of Complete Auto Transit, Inc. v. Brady, “contemporary Commerce Clause jurisprudence might not dictate the concurring same result” as the Court had reached in Bellas Hess. [504 U. S., at 311] However, believing that it was bound by principles of stare decisis (respecting the precedent established in National Bellas Hess) the Court noted that the bright-line rule of National Bellas Hess "furthers the ends" of the dormant Commerce Clause.
the Court in Quill explicitly stated that Congress can overrule the decision through legislation. . . Obviously, despite numerous efforts of federal legislators to put forth legislation that might enable states to impose sales tax collection obligations on remote sellers, none of these measures have passed.
Since Quill, it has been clear that a business must have a physical presence in a state for that state to require it to collect sales taxes. However, the Court in Quill explicitly stated that Congress can overrule the decision through legislation. Furthermore, the Court did not indicate a clear set of guidelines for what activities, and what level of activities, may establish the “physical presence” substantial nexus required by the dormant Commerce Clause. Obviously, despite numerous efforts of federal legislators to put forth legislation that might enable states to impose sales tax collection obligations on remote sellers, none of these measures have passed. [see most recently, Marketplace Fairness Act (S.976); Remote Transaction Parity Act (HR 2193)]
As such, for the past 25 years, states, sellers and practitioners have been left to argue amongst one another and/or determine for themselves what types of activities, or what level of activities creates a physical presence for sales tax nexus. Legal and practical interpretations of this standard over the past 25 years make it clear that physical presence sufficient to create sales tax nexus can be created by employees, as well as by offices, inventory, equipment or other assets in a state (owned or leased). It is widely agreed among sales tax practitioners that nexus and sales tax compliance obligations are established for retailers as a result of storing inventory in a state. As such, for remote sellers that store inventory in a third-party warehouse in a state, it is widely understood that this creates a physical presence for sales tax nexus purposes. What remains to be determined, and is not currently before the U.S. Supreme Court, is whether remote sellers that use third-party fulfillment services, such as Fulfillment By Amazon, are actually the "seller of record" or a "retailer" under state sales tax laws, given that such remote sellers lose all but legal title to the inventory once it is in the hands of the third-party fulfillment service provider.
In light of declining sales tax revenues, as more commerce involves remote sellers and electronic commerce, states continue to adopt novel theories for attributing the nexus ... to an out-of-state retailer.
Over the course of many years worth of audit adjudication and litigation, states have developed “attributional nexus” theories, through which nexus is imposed on an out-of-state seller based not on its activities, but rather on the activities of an in-state representative, or an in-state affiliate. In the sales tax context, these so-called “attributional nexus” standards have been based on theories of agency. As such, nexus can also be established by independent contractors or third parties that are deemed to represent the remote seller. All states consider that in-state solicitation, either by employees or independent contractors, will establish sales tax nexus. Many states – in particular the most populous and aggressive states, from a sales tax nexus perspective – will assert that any third party activities conducted “on behalf of” an out-of-state seller that are associated with the ability of the out-of-state seller to “establish and maintain a marketplace” will create sales tax nexus, regardless of the third party’s activities or their purpose. [Tyler Pipe Indus. Inc. v. Wash. State Dep’t of Revenue, 483 U.S. 232 (1987)(quoting the Washington Supreme Court decision on appeal, 715 P.2d 123, 126 (Wash. 1986)); Standard Pressed Steel Co. v. Dep’t of Revenue of Washington, 419 U.S. 560, 562 (1975); Scripto v. Carson, 362 U.S. 207 (1960); State v. Dell Intern., Inc., 922 So. 2d 1257 (La. Ct. App. 2006) reh’g denied, No. 2004 CA 1702, 2006 La. App. LEXIS 867 (2006)] The implication of these decisions and their judicial offspring is that an out-of-state seller will have nexus by attribution of a third party's in-state activities when the third party is acting "on behalf of" the out-of-state seller, and the third party's activities are "significantly associated with the taxpayer's ability to establish and maintain a market in this state for the sales." [Tyler Pipe, 483 U.S. 232, 250 (1987) (quoting the Washington Supreme Court decision on appeal, 715 P.2d 123, 126 (Wash. 1986)); Scripto, 362 U.S. 207, 211 (1960).] As such, a company who doesn’t have a physical presence in a state may still be found to have a substantial nexus if its connection with an in-state third party meets these requirements. For example, having an employee or a third party (even if considered an independent contractor) provide marketing, training, installation, support services, picking up or delivering inventory, meeting with suppliers, are all activities that can and have established nexus for an out-of-state seller. In addition, if a company or its representatives are conducting certain activities in a state, even if the presence is only for a few days, it may be deemed to have nexus and be "engaged in business" or “doing business” in that state for purposes of sales tax.
The more recent and growing trend in this area are the affiliate nexus and click-through nexus standards, .... [and] economic nexus standards, through which nexus is attributed to a remote seller ..., despite the lack of physical presence.
In light of declining sales tax revenues, as more commerce involves remote sellers and electronic commerce, states continue to adopt novel theories for attributing the nexus of an unrelated entity, or third party, to an out-of-state retailer. As noted above, the oldest and most adjudicated theories involve the nexus-creating activities of one party being attributed to an out-of-state seller, through agency nexus theories. The more recent and growing trend in this area are the affiliate nexus and click-through nexus standards, which have been adopted in some shape or form by nearly every state that imposes a sales tax. Most recently, several states have enacted or adopted economic nexus standards, through which nexus is attributed to a remote seller whose sales exceed a certain threshold, despite the lack of physical presence, direct or attributed. These theories demonstrate the lengths to which states will go to assert jurisdiction over out-of-state businesses for sales tax purposes.
Click-Through and Affiliate Nexus Laws: Since New York initiated the trend in 2008, states have begun changing their laws, regulations and even tax policies to address Internet linking agreements and affiliated entities, and their impact on a retailer’s nexus in a state. These laws and rules are commonly known as Amazon-type Click-Through Nexus laws, named for the company targeted by such measures. The objective of these standards is to create a presumption of nexus for remote sellers that have Internet linking agreements with in-state sellers, whereby the in-state sellers receives a commission for “click-through” sales on their linked websites, on the premise that they are an agent of the remote seller. Similar laws attributing nexus to an out-of-state company based on the in-state activities of an affiliated entity, commonly referred to as Affiliate Nexus Laws, have taken effect in several dozen other states. [Click-Through Nexus states include: AR, CA, CO, CT, GA, IL, KS, LA, ME, MI, MN, MO, NV, NJ, NY, NC, OH, PA, RI, TN, VT, WA; Affiliate Nexus states include: AR, CA, CO, DC, FL, GA, ID, IL, IA, KS, MD, ME, MO, NE, NY, ND, OK, PA, SC, SD, TX, UT, VA, WV, WA]
Remote Seller Standard: Several states have effected a Remote Seller Standard: District of Columbia, Louisiana, Maryland, New Mexico, North Dakota, Pennsylvania, South Carolina, Tennessee and Washington State. This standard would take effect upon enactment of any Federal legislation establishing a new nexus or sales tax compliance obligation for remote sellers that otherwise lack a traditional “physical presence” in a state.
Use Tax Reporting & Notification Requirements: Yet another novel attempt to force compliance on remote seller’s is Colorado’s use tax reporting regime requires sellers (i.e., those that lack a physical presence nexus in Colorado) that did not collect Colorado sales tax on taxable purchases by Colorado customers to notify customers on their website and on each invoice of the customer’s use tax reporting obligation, and to provide annual information to each customer and to the Colorado Department of Revenue regarding all sales customers in the state. Failure to do so results in penalties that typically are larger than the remote sellers sales in that state. In considering a challenge to the constitutionality of the Colorado law by Direct Marketing Association, the federal Appeals Court for the 10th Circuit stated that the state law "does not violate the dormant Commerce Clause because it does not discriminate against or unduly burden interstate commerce". As such, this standard has been upheld on challenge, at least for states in the 10th Circuit. [Direct Marketing Association v. Brohl, 12 F.3d 1175 (10th Cir. February 22, 2016)]
Similarly, other states, including Pennsylvania and Washington, have enacted notification laws to combat use tax avoidance by their residents. The reality of these reporting and notification requirements, when combined with economic nexus standards (explained below), is to create an untenable position for remote sellers, under which they must concede nexus and register to collect sales tax, comply with the more onerous notification standards, or face financially crippling penalties for non-compliance. These laws in Pennsylvania and Washington have resulted in negotiated agreements between Amazon and the respective taxing authorities, under which Amazon will collect and remit sales tax on behalf of remote sellers selling on the Amazon platform. Of course, this also means that Amazon will be handing over the names of every seller on whose behalf they are collecting sales tax, enabling the respective taxing authorities to then contact and audit each seller for prior period sales.
Prior to the 10th Circuit’s decision in Direct Marketing Association v. Brohl, the U.S. Supreme Court granted a petition to review whether, simply put, a federal court had jurisdiction to hear the case. [Direct Marketing Association v. Brohl, 575 U.S. ___ (2015)] The Supreme Court unanimously determined that the Tax Injunction Act did not bar federal court jurisdiction over a suit brought by non-taxpayers to enjoin the enforcement of Colorado’s notice-and-reporting requirements. [Id.] What was truly impactful about the decision, however, was Justice Kennedy’s concurring opinion, in which he wrote about the “tenuous nature” of the Court’s decision in Quill, noting that the Internet and mobile devices now mean that “a business may be present in a State in a meaningful way without that presence being physical in the traditional sense of the term.” [Id.] Kennedy went on to state that “Quill now harm states to a greater degree than could have been anticipated” and that “the legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess” in light of the Internet and changes in technology. These words marked the first overture by the Supreme Court indicating that it may entertain a sales tax nexus case.
Economic Nexus: Despite the Supreme Court’s long-standing and binding requirement that there must be a substantial nexus, meaning physical presence, between a taxpayer and a state before the state can require sales tax compliance, several states have recently enacted economic nexus, or sales factor presence, standards for sales tax purposes. For example, South Dakota’s economic nexus law requires sales tax collection and remittance for any entity exceeding, in the previous or current calendar year: (1) an annual sales threshold of $100,000; or (2) 200 separate sales transactions into South Dakota. (S.B. 106, Laws 2016). Similarly, Alabama, Colorado, Connecticut, Indiana, Massachusetts, Oklahoma, Vermont, Washington State and Wyoming have adopted similar economic presence rules. These laws are commonly referred to as “Kill Quill” laws, given that their intent is to respond to Justice Kennedy’s perceived invitation to provide “an appropriate case for this Court to reexamine Quill and Bellas Hess”.
...now the questions are: (1) Will Quill survive? and (2) If the Court overturns Quill, will it apply retroactively?
On September 13, 2017, upon challenge by Wayfair, Overstock and NewEgg, the South Dakota Supreme Court ruled the state’s “economic presence” nexus law (SDCL 10-64-1 et seq.) to be unconstitutional as it is contrary to the physical presence requirement for state sales and use taxes reaffirmed by the Supreme Court in Quill Corp v. North Dakota, 504 U.S. 298 (1992). [South Dakota v. Wayfair et. al., Inc., 901 N.W.2d 754 (S.D., September 13, 2017)] The Court concluded that "[h]owever persuasive the State’s arguments on the merits of revisiting the issue, Quill has not been overruled." [Id.] In turn, the state of South Dakota petitioned the U.S. Supreme Court for writ of certiorari, presenting the single question of whether the US Supreme Court should “abrogate Quill’s sales-tax-only, physical-presence requirement." [Petition for Writ of Certiorari, South Dakota v. Wayfair, Inc., 901 N.W.2d 754 (S.D. 2017), cert. granted (U.S. January 12, 2018) (No. 17-494)]
The United States Supreme Court agreed to hear the case in January 2018, with arguments to be heard in April 17, 2018, and a ruling expected by June at the end of the Court's current session. [South Dakota v. Wayfair, Inc., et.al., Docket No. 17-494 (January 12, 2018)] The debate regarding the outcome of this case, as well as active involvement in the case by both the tax and business community, according to Bloomberg BNA, has “captivated” the State and Local tax community.
As such, now the questions are: (1) Will Quill survive? and (2) If the Court overturns Quill, will it apply retroactively? This latter question was one of the reasons the Quill Court upheld the “physical presence” standard set forth in National Bellas Hess, hoping that Congress would take action with a prospective focused legislation. In Part Two of this series, we will look at some of the considerations that will impact the answers to these questions.