INSIGHT: <em>Wayfair</em>: Analysis of the Opinion and Dissent—An Exercise in Tax Policy

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By Mark L. Nachbar

The U.S. Supreme Court handed down its eagerly awaited decision in South Dakota v. Wayfair, Inc., (138 S. Ct. 2080 (2018), on June 21, 2018. Since that point in time, many states have been analyzing the implications of the case and positioning existing statutes, or proposing new legislation, to capitalize on the elimination of the physical presence nexus standard. Some states have called it a windfall and plan on using the proceeds for extraordinary expenditures. The question is whether it is appropriate for the states to enact remote seller use tax collection rules or, as the dissent argued, if Congress should address the issue.

Congress has the right to regulate commerce between the states under the commerce clause of the Constitution. It was invited to address the nexus for tax collection issue by the Court in Quill (Quill Corp. v. North Dakota, 504 U.S. 298 (1992) at 318) more than 25 years ago. While, to date, Congress has not passed a statute regulating this issue, in recent years it would appear they are more inclined to do so. Congress has considered several proposals in the 115th Session (2017–2018): the Remote Transactions Parity Act, HR 2193; the No Regulation Without Representation Act, HR 2887; and the Marketplace Fairness Act, S 976. None passed their respective bodies. The Marketplace Fairness Act passed the Senate in 2013 but failed to advance in the House.

In the past, House Judiciary Committee Chair Bob Goodlatte (R-Va.) has supposedly stated that he won’t hold a vote on federal remote sales tax collection legislation because it will overwhelmingly pass the committee and the floor of the House. Others have postulated that federal legislation has stalled to await the outcome of Wayfair, which seems to be the case. Sen. Jon Tester (D-Mont.) introduced the Stop Taxing Our Potential Act of 2018, (Stop Taxing Our Potential Act, S 3180, introduced June 28, 2018) just one week after the Wayfair opinion was released. It appears Congress is eager to weigh in on this issue based on the Senate’s previous approval of the Marketplace Fairness Act in 2013 and the introduction of the legislation this year. Goodlatte will not be running for office, which also bodes well for Congressional action. Most recently, the House Judiciary Committee held hearings on Wayfair.

Sales Taxes to Fund Government

Let’s start with an analysis of the majority opinion. Justice Kennedy, in his opening paragraph, clearly points out the issue with the tax. It is not whether it is due to the state, it is whether the out-of-state seller has the responsibility to collect and remit the tax when the state cannot rely on its residents to pay the use tax owed. The majority goes on to discuss how important this revenue is to the state, saying that “[i]n South Dakota alone, the Department of Revenue estimates revenue loss at $48 to $58 million annually. Particularly because South Dakota has no state income tax, it must put substantial reliance on its sales and use taxes for the revenue necessary to fund essential services. Those taxes account for over 60 percent of its general fund.”

Because South Dakota has chosen to fund its government primarily through a sales and use tax system that it can’t enforce with its residents has now become a problem for remote retailers? Five states have chosen to run their governments without a sales and use tax. Alaska, Delaware, Montana, New Hampshire, and Oregon all have functioning state governments and revenue streams without relying on sales and use taxes. Notably, Oregon, Montana, and New Hampshire supplement their heavy reliance on property taxes with a reliance on income taxes. South Dakota has chosen not to implement an income tax. Unsurprisingly, it is the senior senator from Montana that introduced the Stop Taxing Our Potential Act, and the Governor of New Hampshire has vowed to fight the collection of use taxes based on Wayfair for New Hampshire-based retailers.

On July 19, 2018, a committee of New Hampshire lawmakers put the finishing touches on legislation to be presented to the full Legislature in a special session at the end of July. That legislation would require any state to register with the New Hampshire Attorney General and pay a fee before they go to any New Hampshire business to collect a use tax. Secondly, the Attorney General’s office must determine that the laws of the state attempting to collect the tax are constitutional. If the tax is found to be constitutional, the business that collects and remits the tax will be able to recoup all costs associated with collecting the tax, even if that includes buying software to calculate, collect, and remit the tax due. One term that was discussed, but was not included in the legislation, was a provision that would require the taxing state to show that it had made an effort to collect the tax from the consumer before approaching the New Hampshire business for the tax. The legislation passed in the Senate but was stripped in the House, leaving only a commission to study the matter. In the end, the special session ended without enacting any proposal.

In addition, Sen. Ron Wyden (D-Ore.) stated: “I’ll do everything I can as the top Democrat on the Finance Committee to protect Oregonians—and small businesses everywhere—from being harmed by this catastrophic [Wayfair] decision” (“Supreme Court allows states to collect sales taxes on more online transactions,” USA Today, June 21, 2018, Richard Wolf). Clearly, there is a concern to protect small businesses. In addition, there are many unanswered questions that result from the opinion, as well as judicial concerns about the doctrine of stare decisis.

Stare Decisis

Both the majority and the dissenters in Wayfair agree that to require physical presence to create a collection obligation on the part of the seller was a bad decision, but that was the decision of the Court going back to 1967 with National Bellas Hess (National Bellas Hess, Inc. v. Department of Revenue of Ill., 360 U.S. 753 (1967)). That brings into play the doctrine of stare decisis, Latin for “to stand by things decided.” The majority opinion acknowledges that it does not overturn an earlier decision lightly, at Section IV. However, they find that since it is the Court’s error, which prohibits a state from exercising its authority to collect legally due taxes, it is the Court, not Congress, that must change the law. The dissent argues that there is a higher standard in overruling a previous decision, especially when it was relied on in a subsequent decision. (Quill upheld the physical presence standard found in Bellas Hess based on stare decisis.)

The Court has overruled its commerce clause decisions in only six instances. All but one (United States v. Darby Lumber Co., 312 U.S. 100 (1941)) came after the landmark decision in Complete Auto v. Brady, (430 U.S. 274 (1977)) which itself overturned a prior Supreme Court decision, Spector Motor Service v. O’Connor (340 U.S. 602 (1951). It would seem that the appropriate time to overturn the physical presence nexus standard would have been in the Quill decision. Quill was decided after Complete Auto, and thus it would seem logical that the first opportunity to overturn the burden created by National Bellas Hess would be in Quill. However, the Court let this physical presence standard prevail for another 26 years. With more than 50 years of reliance on a physical presence test, the dissent suggests, the Court should have “applied a heightened form of stare decisis in the dormant commerce clause context.”

Physical Presence Test

The issue the justices discuss is whether it is appropriate to saddle the first prong of the Complete Auto test, substantial nexus, with the burden of requiring a physical presence. They spend a significant amount of time distinguishing between in-state and out-of-state retailers and bemoan the fact that the Court created a “tax shelter.”

The majority asserts that the physical presence rule becomes further removed from economic reality as time progresses. While this may be true, the dissent points out that the rate of collection of tax has increased over time. “States and local governments are already able to collect approximately 80 percent of the tax revenue that would be available if there were no physical presence rule . . . . Among the top Internet retailers, that rate is between 87 and 96 percent.” As was predicted after Quill, market forces encourage retailers to create an in-state presence to satisfy consumer demand and provide greater customer service. As online retailers grow, same-day delivery, local pick-up locations, and more responsive customer service have forced online retailers to establish a physical presence in many locations. As both the majority and dissent point out, the physical presence rule established in Bellas Hess, fostered the growth of the online economy. The decision to completely eliminate the rule, without providing some concrete standard for tax collection responsibilities, may have the opposite effect on small businesses, stifling their growth by burdening them with the costs of determining the appropriate tax, and collecting and remitting the payments.

Sufficiency Test

The majority has replaced a bright line test of physical presence with an amorphous “sufficiency test” to determine whether substantial nexus exists. The test basically states that selling into a state is “sufficient” to create substantial nexus. While the Court does not eliminate the distinction of nexus as analyzed under the “due process” and “commerce” clauses, it has merged these two principles into the sufficiency test. The dissent notes that to meet the due process clause, there must have been a purposeful direction of the sales efforts into a particular jurisdiction. The majority does not confine substantial nexus to this principle; the seller only needs to have the requisite number of transactions into the taxing jurisdiction.

The new “sufficiency test” solely relates to the first prong of Complete Auto. The majority fails to address whether the collection responsibility is discriminatory or if it is fairly related to the services provided by the state, the second and fourth prongs of Complete Auto. The Wayfair case is currently on remand to the South Dakota Supreme Court to address these issues, but it looks like the case will settle before the court can answer these questions, according to South Dakota Department of Revenue Secretary Andy Gerlach.

Current Activity Based on ‘Wayfair’

Not only are these commerce clause questions unanswered, the tax community has focused on several other issues that remain outstanding after this decision. Those include whether the tax or collection obligation is burdensome or discriminatory, and whether it is fairly related to the services rendered by the state. With the majority’s acceptance and focus on the South Dakota law, which was not retroactive and contained a small business exception, and the fact that South Dakota adopted the Streamlined Sales and Use Tax Agreement, it would appear that the Court has blessed these elements to satisfy the burdensome and discriminatory elements. However, both lawmakers and retailers have expressed their concern with the vagaries left after the Wayfair decision. These issues include retroactivity, cost, foreign retailers, and the implications to taxes other than sales tax collection obligations.

The Streamlined Sales Tax Governing Board Inc. held emergency meetings on July 19th and 20th to address the implementation of remote sales tax collection authority. Some of the questions presented at that meeting were 1) when should states start enforcing the remote seller collection obligation; 2) how to enforce the collection obligations on alien sellers; and 3) when, if ever, nexus could be terminated.

The House Judiciary Committee also held a hearing on the ramifications of the Wayfair decision on July 24th. Seven witnesses were heard. The first presentation was made by Grover Norquist from Americans for Tax Reform. One of the more interesting issues he brought up during his presentation was the concept of taxation without representation. This echoes the No Regulation Without Representation Act, H.R. 2887, in the 2017-2018 Congress. He points out that the South Dakota tax provision is part of a growing trend to assess out-of-state entities to shift the cost of government to nonresidents, in effect pushing the tax burden to those that do not receive a direct benefit from the state. Question: does this violate the “fairly related” clause of Complete Auto?

Mr. Norquist went on to note that Wayfair not only affects sales and use tax collection but other taxes as well. As an example, he pointed out that Wells Fargo has increased its state income tax reserves by $481 million as a response to the Wayfair decision. He encouraged Congress to take action in response to the Supreme Court’s ruling.

The next witness was Chad White, owner of Class-Tech Cars, an online small business retailer. He also urged Congress to act to protect small business owners, based on the cost of compliance. This testimony was countered by Lary Sinewitz, EVP of BrandsMart USA, testifying on behalf of the National Retail Federation. While the Small Business Retail Council wanted the federal government to enact legislation to ensure a low cost of compliance, his experience in meeting with software providers was that the cost to implement a system was modest. He indicated that putting all retailers on the same playing field will ensure their viability. However, he failed to take into consideration the lack of enforcement mechanisms available to put alien sellers on that same basis.

Next up was Utah Sen. Curtis Bramble (R). He also served as the past president of the National Conference of State Legislatures (NCSL) and submitted a statement on behalf of that group. The notable quote from his testimony was: “I ask that Congress continue to do what it always has done in regards to sales tax—not act.” While the NCSL does not believe that Congress should intervene with respect to the sale of tangible personal property over the internet, five days after Bramble made his statement, the NCSL task force on state and local taxation approved a resolution supporting federal legislation to set standards for the taxation of digital goods and services. It is confusing that the NCSL does not think Congress needs to act with respect to physical goods, but would like to see it intercede with respect to digital goods and services.

Andrew Moylan of the National Taxpayers Union Foundation and National Taxpayers Union was the next presenter. He is the director of the Interstate Commerce Initiative (the Initiative) for the National Taxpayers Union. The goal of the Initiative is to protect taxpayers from overreaching states trying to exercise power over taxpayers outside of their borders. Mr. Moylan asked Congress to act to clarify what the parameters of evaluating a nexus standard are when the tests used in South Dakota are not adopted by another state. One of his interesting observations was whether a large state should use the same sales thresholds as a small state for establishing nexus. For example, selling $100,000 worth of goods into California is likely to occur far more often than selling the same amount of goods into South Dakota. He urged Congress to enact a moratorium on state’s responses to Wayfair until all questions that have been presented are settled. He would like to see H.R. 2887 “No Regulation Without Representation Act” pass congress to “bring clarity to sales tax, income tax, and regulatory issues in interstate commerce.”

The testimony of the CEO of MultiState Associates Inc., Joe Crosby, was next on the agenda. MultiState Associates is a state and local government relations firm with the objective of helping businesses coordinate their activities with government. Mr. Crosby addressed the Committee with one point: Congress need not respond with legislation to the decision in Wayfair. He pointed to the interstate cooperation through national bodies, discussed in many of the testimonies, trying to set model nexus standards as sufficient to addressing outstanding issues. He also noted that Overstock.com, another large internet retailer and a respondent in the case, will start collecting sales tax on a national basis. He also observed that Overstock.com will begin to expand its physical presence, as it will not create additional tax obligations in light of the new “substantial nexus” standard.

The final presentation was made by Andrew Pincus, a partner at the law firm Mayer Brown LLP. He represented eBay Inc. and independent small businesses that operate on eBay’s marketplace platform as amici curiae in Wayfair. He said that the Wayfair decision replaces clear rules with tremendous uncertainty, not only for sales tax but for other taxes as well. His first observation was that the Court did not address the discrimination and undue burden questions regarding the application of the Commerce Clause, nor did the Wayfair court opine on the constitutional protections found in the Due Process clause, particularly with respect to the purposeful availment requirement. He also expanded upon the consequences of Wayfair beyond sales and use tax collection obligations. In addition, he postulated that states may use this increased authority to collect taxes by expanding the base of items taxed, particularly services such as professional, educational, and software services as well as digital products. Mr. Pincus also elaborated on the current issues created by the lack of conformity for income tax apportionment, if the nexus standard does not include an in-state presence, stating that it can lead to double taxation and remarking that the “elimination of the physical presence standard is likely to lead States to become more aggressive in asserting the power to collect income taxes.”

Other Unanswered Issues

The elimination of the physical presence rule by the Court, without a bright line replacement, leaves much uncertainty whether a taxpayer’s responsibilities under a state’s economic nexus rules represent an undue or discriminatory burden under the Commerce Clause. What exists after this ruling is a balancing analysis akin to the decision in Pike (Pike v. Bruce Church, Inc., 397 U.S. 137 (1970)). Most certainly, these decisions will be made at the state court level, resulting in disparate decisions across the country.

Several questions remain for future courts to decide after Wayfair. Certainly, the purposeful availment premise of the Due Process clause will be one contested area in establishing nexus. Another has already found its way to court according to Mayer Brown’s Leah Robinson. Her team has recently drafted a petition to challenge nexus in a state in which her client has physical presence, but it does not meet the “substantial nexus” requirements outlined in Wayfair. In other words, do you have “substantial nexus” when the potential taxpayer has physical presence in the state but does not meet the sales or transaction test, and the physical presence does not help establish and maintain a market in the state?

While the Court seems to have blessed states that have adopted the Streamlined Sales and Use Tax Agreement, as one element that would indicate that the collection responsibility does not create an undue burden on interstate commerce, that agreement has undergone numerous changes. The governing board has repeatedly de-simplified the agreement to entice additional states to adopt its provisions. To date, only 24 states representing only 33 percent of the population have enacted conforming legislation, despite the almost 20 years that the agreement has been in place. Question: without the intervention of Congress, will we really be dealing with sales and use tax collection obligations that do not offend the ease of selling goods and services in more than one state? Attempts to create uniformity for tax collection by remote sellers were initiated by George Isaacson, the attorney who represented Wayfair, with the Multistate Tax Commission (MTC) prior to the Supreme Court decision in the case. However, the Multistate Tax Compact, an attempt to unify income tax apportionment provisions developed by the MTC, is now only considered an “advisory” compact. To further compound the decrease in influence, in recent years several member states have repealed the compact and resigned their membership in the organization. Currently, there are only 16 states that are members of the compact. Will the MTC really be able to make an impact in the simplification of sales and use tax collection?

The issue of whether the tax requirement is “fairly related” to the services provided by the state may seem to be answered by the majority which finds that the establishment of an organized marketplace is, in and of itself, enough of a benefit to impose collection responsibilities on the seller for a tax otherwise due to the state. However, will this be enough of a benefit to impose a direct tax on an out-of-state business’s income? Other remaining questions include: does an economic nexus standard apply to alien entities, and will an economic nexus standard create an income tax liability for alien entities that do not have a “permanent establishment” in the U.S.? Moreover, how will a state enforce these obligations on alien companies that do not have a physical presence in the U.S.?

While many question Congress’ desire and willingness to act with respect to these issues, the Court may have inadvertently given them a compelling reason to act by issuing an opinion that some consider to be vague and certainly leaves many unanswered questions. In addition, the effect of the ruling actually favors states with a sales tax over states without a sales tax. The Court has determined that South Dakota can properly force nonresident taxpayers to collect tax on the state’s behalf from sellers in jurisdictions that do not have a sales tax. One can infer that the Court is saying, “it is ok for South Dakota to rely on a sales tax to fund government, and require a New Hampshire retailer to collect tax on their behalf.” But the New Hampshire retailer that may have chosen to locate in New Hampshire due to its lack of a sales tax, and where the government relies on income and property taxes to fund government, can be forced to collect use tax on its sales to South Dakota residents. Of course, the New Hampshire retailer has no say in the funding of government in South Dakota. Additionally, the decision may favor non-U.S. retailers over domestic retailers to the extent there is no way to enforce the collection laws against alien retailers.

Congress is the only body that has representatives from all states and can properly address these competing agendas of the states and their constituents with input from all sides. They have taken the appropriate steps by holding hearings on the issues presented by Wayfair. Only time will tell if they act and how they will resolve these issues.

Author Information

Mark L. Nachbar is a Principal at Ryan LLC. He has over 35 years of experience delivering multistate tax services to corporate enterprises. Mark focuses on minimizing corporate tax liabilities and limiting corporate tax exposures. In addition, Mark has provided state credit and incentive services to many corporate enterprises.

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