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By Ryan Prete
Serious repercussions to international commerce are possible, but unlikely from the recent U.S. Supreme Court ruling that eased the ability of states to tax online sales, state tax lawyers told Bloomberg Tax.
“The issue of foreign purchased goods is a huge unknown,” said Richard D. Pomp, the Alva P. Loiselle Professor of Law at the University of Connecticut School of Law.
Pomp’s concern stems from the high court’s June 21 ruling in South Dakota v. Wayfair, in which Justice Anthony Kennedy led a 5-4 majority in throwing out the court’s divisive 1992 rule in Quill Corp. v. North Dakota. Quill , which states like the petitioning South Dakota for years have tried to “kill” through lawsuits and regulation, prohibited states from imposing sales tax collection obligations on vendors lacking an in-state physical presence.
What the opinion didn’t address is how foreign countries would collect sales tax on purchases made by customers in the U.S.
Pomp said states can issue “state judgments” against another jurisdiction when sales tax goes uncollected, but this process doesn’t work when it comes to foreign entities.
“There’s currently no treaty between any foreign country and the U.S. to collect sales tax based on a state judgment,” Pomp told Bloomberg Tax. “So really our country would have to put pressure on a foreign country to collect the tax—and good luck with that.”
The majority in Wayfair suggested strongly that South Dakota’s law would pass constitutional muster; the state’s model imposes the tax collection threshold at 200 separate transactions or $100,000 in in-state sales. But the court stopped short of formally declaring that South Dakota’s law, which dozens of states have mimicked already, was valid in the absence of Quill. The court just made clear that Quill was no longer part of any commerce clause test for when states may impose taxes.
The South Dakota Supreme Court still has to bless the state’s economic nexus model before it can become effective. Still, many project that states will flock to copy South Dakota’s model.
It would be a insurmountable struggle to force another country to collect taxes on a purchase from someone in the U.S., and this isn’t a new concept, according to Brian Kirkell, a Washington-based principal at RSM US LLP.
“Our country follows a hundred-year-old ‘revenue rule’ which says that U.S. courts will not enforce the tax laws of another country, and vice versa,” he said. “While Wayfair in many ways equalized ‘main street’ and ‘e-street’ businesses, it bettered the ‘foreign e-street.’”
Kirkell said if a foreign company owned property in the U.S., it would be easier to force the business to collect and remit sales tax, but this scenario is rare.
“For example, if a Singaporean company is selling to people in the U.S. and has no intention of settling a storefront into the U.S., then the sales tax liability is useless,” Kirkell said.
When it comes to the sale of digital goods versus tangible goods, there’s really nothing a state or the federal government can do, he said.
“Short of taking counter-terrorism measures, the federal government wouldn’t be able to stop the download of foreign-purchased digital goods because of constitutional matters, and blocking foreign e-commerce websites would be a First Amendment issue,” Kirkell said.
Kirkell said the Wayfair ruling gives companies that solely sell digital goods little incentive to remain in the U.S.
“Digital goods and cloud-computing software are taxable products in our country, but there’s no reality to them, they aren’t palpable goods,” he said. “It doesn’t mean there isn’t a liability, but there’s just no way of enforcing it.”
While the Wayfair ruling didn’t address how state-side tax rules could impact a foreign seller, the Supreme Court has previously given guidance on how to resolve conflicts regarding taxation of foreign parties. And the conditions are stricter than interstate taxation issues involving U.S.-only citizens.
The court’s 1979 ruling in Japan Line, Ltd. v. County of Los Angeles stated that with respect to a foreign party, the court should apply the high court’s four-part test from the 1977 ruling in Complete Auto Transit, Inc. v. Brady just as with any commerce clause disputes over interstate matters—but with two additions, said Jamie Yesnowitz, a principal and state and local tax practice and national tax office leader at Grant Thornton LLP.
Under the Complete Auto test, a tax regime affecting interstate commerce is valid if it: (1) applies to an activity with a substantial nexus with the taxing state; (2) is fairly apportioned; (3) doesn’t discriminate against interstate commerce; and (4) is fairly related to the services the state provides.
The two additional conditions under the Japan Line case are (1) whether the regime would result in a substantial risk of multiple taxation and (2) would prevent the U.S. from speaking with one voice when regulating commercial relations with foreign governments.
“It is somewhat uncertain whether the economic nexus provisions endorsed in Wayfair can survive constitutional scrutiny with respect to foreign sellers when looking at the Japan Line conditions,” Yesnowitz said. “This might be an issue ripe for further litigation.”
How can the foreign sales tax issue be fixed?
Both Kirkell and Pomp said that the U.S. Customs and Border Protection agency could take charge, forcing foreign retailers to add stamps (similar to those used on cigarette boxes when traveling across state lines) to shipments entering the country.
However, Pomp said this would be a daunting task for the CBP workforce, and Kirkell said it wouldn’t make sense to have the agency enforce state tax collections.
Congress could be the body to alleviate the issue, Pomp said.
“If Congress acts to address the Wayfair ruling in some way, they could tack on a foreign transactions provision to whatever legislation they might draft,” Pomp said. “I do think Congress will act, and I hope that something on foreign vendors would be a priority.”
Pomp said that any congressional action would be months from now at the earliest, mostly because of the upcoming November midterm elections.
Kirkell said he doubts Congress would act to address Wayfair at all, much less address the issue of foreign retailers.
“There’s a very slim chance; I think it’s really unlikely,” he said.
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