New Tax Burdens on App, Software Sellers After ‘Wayfair’

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By Ryan Prete

The landmark U.S. Supreme Court decision involving Wayfair and states’ ability to tax online sales could present new challenges to the digital goods and services industry, according to tax lawyers.

“Below the e-commerce giants like Amazon, you have the real affected parties, which are those selling software on various platforms and app developers,” Mark Nebergall, president of the Software Finance & Tax Executives Council (SoFTEC), told Bloomberg Tax. “I ask does the Wayfair decision add pollution to the app-developer ecosystem? And I think it certainly does.”

In South Dakota v. Wayfair, decided June 21, Justice Anthony Kennedy led a 5-4 majority in throwing out its 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.

Third-party developers and vendors make up a significant part of the digital goods and services sector, which includes software, downloaded media content, and mobile applications, said Nebergall, a co-author of a Bloomberg Tax portfolio on cloud computing. And some of these services can be tendered and sold from a remote location without the need for distributions centers.

As a result, these services once benefited from the now-deceased Quill physical presence rule and could be vulnerable as states are expected to extend their tax authority over online sales in the wake of Wayfair.

By contrast, Nebergall said providers of digital goods that already can be taxed in all states that impose a sales tax, such as Microsoft Corp., won’t face as much of a change because of Wayfair, because they are likely already collecting and remitting sales tax on purchases. That is also true of e-commerce giant Amazon.com, Inc., which has collected sales tax in every relevant state since early last year.

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 observers project that states will flock to copy South Dakota’s model as soon as the state Supreme Court presumably does that. The state court’s decision is expected in mid-August.

Compliance Challenges for Three Groups

Nebergall said app developers who sell their products through an online marketplace and qualify for a state’s economic nexus regime—which imposes sales tax collection duties on retailers that rise above a specified sales threshold—will now be forced to collect and remit sales tax. Connecticut, Minnesota, Oklahoma, Pennsylvania, Rhode Island, and Washington already require the marketplace to collect that tax.

The problem facing these smaller developers and retailers, according to Jeffrey Friedman, a tax partner at Eversheds Sutherland (US) LLP in Washington, is that many of them don’t know the locations of their customers.

Friedman told Bloomberg Tax that when it comes to heightened compliance challenges in the digital goods realm, three categories of sellers come to mind: non-U.S. sellers, sellers who don’t know the locations of their customers, and start-ups.

“Non-U.S. sellers that do not have U.S. operations have been able to largely ignore sales and use taxes under the physical presence regime. These sellers now must get up to speed quickly and, in some cases, put in place sales tax compliance systems,” Friedman said. “Also, we have worked with other clients who sell to customers that do not provide reliable location information. These sellers will be forced to put in place reasonable assumptions about how best to determine the sourcing of a particular sale.”

Friedman said vendors who sell sales tax software and systems are aggressively marketing to all three parties, but especially to start-ups.

“Start-up companies that sell digital goods but do not have the resources or time to put in place a sales tax compliance system are feeling the impact of the court’s decision,” he said.

State Implementation Dates

Many states with South Dakota “copycat” laws are either moving ahead or already consider them to be in place. Along with Hawaii, Oklahoma, and Kentucky, Connecticut, Illinois, and Vermont are set to have economic nexus laws take effect before 2019.

A few that were contingent on Wayfair will have to wait for the South Dakota Supreme Court to issue an opinion on remand. Below are specifics of those South Dakota-esque regimes, including effective dates:

  •  Alabama (Jan. 1, 2016), $250,000 in in-state sales;
  •  Connecticut (Dec. 1, 2018), 200 transactions or $250,000 in in-state sales;
  •  Georgia (Jan. 1, 2019), 200 transactions or $250,000 in in-state sales;
  •  Hawaii (July 1, 2018), 200 transactions or $100,000 in in-state sales;
  •  Illinois (Oct. 1, 2018), 200 transactions or $100,000 in in-state sales;
  •  Indiana (July 1, 2017), 200 transactions or $100,000 in in-state sales;
  •  Iowa (Jan. 1, 2019), 200 transactions or $100,000 in in-state sales;
  •  Kentucky (July 1, 2018), 200 transactions or $100,000 in in-state sales;
  •  Louisiana (contingent on Wayfair ruling), 200 transactions or $100,000 in in-state sales;
  •  Maine (Oct. 1, 2017), 200 transactions or $100,000 in in-state sales;
  •  Minnesota (contingent on Wayfair ruling), 100 transactions or $100,000 in in-state sales in at least 10 transactions;
  •  Mississippi (Dec. 1, 2017), $250,000 in in-state sales;
  •  North Dakota (Oct. 1, 2018, or 60 days after a remote retailers meets the state’s threshold—whichever is later), 200 transactions or $100,000 in in-state sales;
  •  Oklahoma (July 1, 2018), $10,000 in in-state sales;
  •  Pennsylvania (March 1, 2018), $10,000 in in-state sales;
  •  Rhode Island (Aug. 17, 2017), 200 transactions or $100,000 in in-state sales;
  •  South Dakota (contingent on state Supreme Court’s approval, on remand from high court’s Wayfair decision), 200 transactions or $100,000 in in-state sales;
  •  Tennessee (currently on hold due to litigation), $500,000 in in-state sales;
  •  Vermont (July 1, 2018), 200 transactions or $100,000 in in-state sales;
  •  Washington (July 1, 2017), $10,000 in in-state sales;
  •  Wyoming (July 1, 2017), 200 transactions or $100,000 in in-state sales.

To contact the reporter on this story: Ryan Prete in Washington at rprete@bloombergtax.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bloombergtax.com

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