Supreme Court Overrules Prior Decisions Requiring Physical Presence to Subject Out-of-State Sellers to Sales Tax
On June 21, 2018, in South Dakota v. Wayfair, Inc., ET Al (No. 17-494), the Supreme Court of the United States held that physical presence is no longer required to subject out-of-state sellers to a state’s sales tax laws. The Court’s decision in Wayfair overruled prior Supreme Court decisions in Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and National Bellas Hess, v. Department of Revenue of Ill., 386 U.S. 753 (1967), which provided that the U.S. Constitution requires that a seller maintain a physical presence in a state in order for the state to require the seller to collect sales or use tax on sales to consumers in that state.
Wayfair involved a lawsuit by South Dakota in which the state wanted to compel two national retailers (with no employees or property in South Dakota) to register and collect sales tax in the state. The South Dakota sales tax law in question was one requiring sellers to collect and remit sales tax “as if the seller had physical presence in the state.” This law applied only to sellers that annually delivered more than $100,000 of goods or services into the state or engaged in more than 200 sales transactions.
In arriving at its holding, the Court reiterated the four elements that a state tax must possess in order for the tax to be sustained as valid:
- It must apply to an activity with a substantial nexus with the taxing state;
- It must be fairly apportioned;
- It may not discriminate against interstate commerce; and
- It must be fairly related to the services the state provides.
The Court stated that the “physical presence” rule, as previously set forth in Quill, is not a necessary interpretation of the substantial nexus requirement; and, rather, that through widely-accessible modern technology, a seller can be virtually present in a state without being physically present in the state (in the traditional sense of the term). Further, the Court stated that “each year the physical presence rule becomes farther removed from economic reality and results in significant revenue losses to the States.” Consequently, the Court concluded that ”the physical presence rule, both as first formulated and applied today, is an incorrect interpretation of the Commerce Clause.” The Court did not, however, provide a rule to determine when exactly substantial nexus with a taxing state exists, and remanded the case to the lower courts to address any further claims under the Commerce Clause.
The Court acknowledged that the elimination of the physical presence rule could potentially pose a significant compliance burden on small businesses that make small volume sales to customers in many states; and it noted that software may soon be available to assist these small retailers (and that Congress can legislate to address these problems if it so chooses). The Court further noted that South Dakota offers small retailers a reasonable degree of protection in that there is a threshold of annual sales volume, or frequency of sales, that must be met before law is applicable.
POTENTIAL EFFECT ON NEW YORK STATE LAW
It will be interesting to see how the New York State (“NYS”) legislature reacts to this recent Wayfair decision. Most of the existing NYS statutory provisions require some degree of physical presence in the state either from the seller, its employees, independent contractors, sales referral sources or affiliates, along with the conduct of certain activities before a seller becomes subject to its sales tax laws. There is, however, an existing statutory provision under the NYS laws governing Sales & Use Taxes, similar to the statute at issue in South Dakota that is based upon economic nexus, under which a seller can be deemed to have sales tax nexus without acquiring any degree of physical presence in the state. This provision applies to any person who regularly and systematically solicits business in NYS by distributing—without regard to the original location from which the distribution came—catalogues, ad flyers or letters to people in the state, and who makes sales of tangible personal property to people in the state (if such solicitation satisfies the nexus requirement of the U.S. Constitution). The current NYS “Vendor” regulations provide that a person is presumed to be “regularly and systematically soliciting business” in the state if, for the immediately preceding four quarters, the cumulative gross receipts from sales of property delivered in NYS exceed $300,000; and such person had more than 100 sales of property delivered in the state.
While “physical presence” may no longer be required to establish substantial nexus with a taxing state, it is unclear at this time what level of activity would establish nexus. For example, would the mere existence of a website without further advertising in a state, electronic or otherwise, give rise to nexus? While the parameters of establishing nexus remain unclear, New York State could decide that its existing statutory scheme is sufficient for the time being, in that its ability to subject large retailers who solicit business in the state to its sales tax laws will be upheld. It may make sense for the legislature to wait for additional guidance from the courts or Congress before strengthening the nexus laws, as it should be mindful of the Constitutional requirement that compliance with its laws not unduly burden interstate commerce.
It is highly recommended for businesses selling tangible personal property or taxable services in NYS, or any other state, to discuss any such planned activities with their tax advisors. Our experienced team here at FF&F is well-equipped to provide you with guidance on the various nuances of sales tax liabilities and requirements, and we welcome you to contact us for any such advisement. For more information on this topic, or our services, please contact us at firstname.lastname@example.org or (212) 245-5900.
Click here to read the full South Dakota v. Wayfair, Inc. case.
Hunter Norton, J.D.L., LL.M., CPA, is an accomplished Tax Director with FF&F. Prior to joining the firm, he spent 7 years as an attorney at Withers Bergman LLP, a tax-oriented law firm, and 8 years in the Tax practice with Deloitte. His areas of expertise include business and investment partnerships, cross-border tax matters, high net worth individuals, and family offices. Hunter’s experience also allows him to advise clients in income tax matters related to trusts, estates and grantors, and taxable gifts, as well as estate planning.