Earlier today, in the case of South Dakota v. Wayfair, the Supreme Court overturned the decades-old Quill physical presence nexus standard first established in 1967 in National Bellas Hess, Inc. v. Department of Revenue of Illinois. In doing so, the majority opinion delivered by Justice Kennedy has put its imprimatur on states’ ability to tax online and catalog retailers with no physical presence in the state.
The Court also reaffirmed its four-prong Commerce Clause test under Complete Auto Transit, Inc. v. Brady. Under that 1977 case, a tax will withstand Commerce Clause scrutiny if it: “(1) applies to an activity with a substantial nexus with the taxing State, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the State provides.” At issue in Quill and Wayfair was the first prong of the test. Under Quill, some physical presence within a state was necessary to satisfy the first prong of this test and require an out-of-state retailer to collect and remit sales and use tax. Having overturned this bright-line rule, the Court will now look instead to whether a taxpayer “‘avails itself of the substantial privilege of carrying on business’” in a state.
The issue of whether this standard has been met for Wayfair, Overstock, and Newegg, the respondents in this case, will officially be decided on remand. However, the Court suggested that this standard has been satisfied, based on the fact that the respondents carry on a significant quantity of business in the state and have an extensive virtual presence. Under South Dakota’s economic nexus statute, retailers lacking a physical presence in the state are required to collect and remit sales and use tax when they have more than $100,000 of sales or 200 separate sales into the state annually. Referring to Quill as a “judicially created tax shelter,” and noting the distortionary effects that it may have on market actors, the Court acknowledged that its overturning of Quill may necessitate a “‘case-by-case analysis of purposes and effects’” in making the substantial nexus determination. Regardless of what this may mean in other cases, when a retailer has more than $100,000 of sales or 200 separate transactions in a state, substantial nexus appears to be established.
Addressing the issue of stare decisis, the Court intimated that it “did not have before it the present realities of the interstate marketplace” when Quill was decided. With the benefit of hindsight, the Court concluded that the physical presence rule was not only artificial “at its edges” when created, as it had acknowledged in Quill, but “artificial in its entirety.” In his dissenting opinion, Chief Justice Roberts, joined by Justices Breyer, Sotomayor, and Kagan, agreed that the physical presence rule was wrong when initially created in Bellas Hess. However, he favored upholding the rule on stare decisis grounds, leaving it to Congress to address the issue.
The Court spoke briefly in dicta about the concerns of small businesses and the barrier to market entry presented by sales and use tax compliance. Addressing South Dakota’s economic nexus law, the Court noted that it “requires a merchant to collect the tax only if it does a considerable amount of business [and] is not retroactive.” Further, it suggested that the fact that South Dakota is a Streamlined Sales Tax state would reduce the compliance burden and that certain small out-of-state retailers will still be able to claim that they do not have substantial nexus, even without the protections of Quill.
Do you expect a wave of states to adopt economic nexus statues modeled after South Dakota’s? Continue the discussion on Bloomberg Tax’s State Tax Group on LinkedIn.
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