South Dakota Digital Tax Case Puts Retailers in ‘Tricky Spot’

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

By Ryan Prete

The South Dakota Supreme Court’s decision to strike a state statute requiring out-of-state sellers to collect sales tax has created confusion over remote retailers’ sales tax collection obligations while they await potential U.S. Supreme Court action.

“Companies with no South Dakota physical presence are in a tricky spot,” Jamie Yesnowitz, state and local tax practice and National Tax Office leader for Grant Thornton LLP, told Bloomberg BNA.

The confusion for remote retailers comes from the South Dakota Supreme Court’s Sept. 13 affirmation of a lower circuit court decision that found the state’s “economic nexus” law, S.B. 106 (codified as S.D. Codified Laws Chapter 10-64), unconstitutional under Quill Corp. v. North Dakota—the 1992 U.S. Supreme Court decision that prohibits states from imposing sales and use tax collection obligations on vendors without a physical presence in-state. The statute would require out-of-state sellers with annual in-state sales exceeding $100,000 or 200 separate transactions to collect and remit sales tax ( South Dakota v. Wayfair, Inc. , S.D., No. 28160, 9/13/17 ).

Yesnowitz said companies that started collecting and remitting to South Dakota in anticipation of the legislation being upheld could cease doing so, in line with the court’s decision. However, Yesnowitz said that he “can’t imagine the state would be happy with that outcome.”

Yesnowitz said he would counsel sellers to continue with their current approach.

“Given the possibility of U.S. Supreme Court action in this area, perhaps the more cautious strategy for those remote sellers is to wait and see whether the court takes the case,” Yesnowitz said.

The South Dakota litigation is furthest along among several state lawsuits intended to undo Quill, including cases pending in Alabama, Indiana, Tennessee and Wyoming. South Dakota officials have indicated they will appeal to the U.S. Supreme Court, which sets a deadline for a petition for review within 90 days after entry of the judgment.

Pros and Cons

Remote retailers should weigh potential risks before deciding whether to cease sales tax collections for South Dakota, according to practitioners.

“The risk for remote sellers that are collecting the tax and want to stop is that it puts them on the radar screen of the state,” Yesnowitz said. “For example, the state could question whether the remote seller truly is remote, or whether the seller may have other ties with the state that lead to a conclusion of actual or de facto physical presence.”

Yesnowitz and other tax practitioners have mentioned that the South Dakota law provides for an injunction during the legal challenge, “prohibiting any state entity from enforcing the obligation in section 1 of this Act against any taxpayer who does not affirmatively consent or otherwise remit the sales tax on a voluntary basis.” Accordingly, practitioners have said there shouldn’t be a risk of retroactive application to prior transactions, even if the U.S. Supreme Court accepts the case and rules in favor of South Dakota.

Joe Henchman, executive vice president at the Tax Foundation, said that “South Dakota’s law is very clear that retroactive collection is off the table, even if it is ultimately upheld. Online retailers ought to facilitate use tax payments, but that’s only voluntary right now, not mandatory.”

Out-of-state sellers that keep collecting sales tax could face an angry and confused consumer base that may question the legitimacy of the applied sales tax, according to Jon Maddison, state tax attorney at Reed Smith LLP.

Maddison told Bloomberg BNA he would “counsel sellers on a case-by-case scenario, and would push for competitive advantage, meaning that companies should collect or not collect based on the best outcome for the individual entity.”

“Overall, this is a frustrating situation for all involved,” he added.

Alternative Approaches

Jeff Friedman, a tax partner at Eversheds Sutherland (US) LLP, told Bloomberg BNA that the South Dakota decision makes clear that South Dakota courts will respect the physical presence nexus standard for sales and use taxation, and that “taxpayers who do not have a physical presence, on their own or through others, cannot be required to collect their tax.”

Friedman highlighted two points that sellers should remember while awaiting the U.S. Supreme Court’s decision to take the case.

“First, state taxing authorities pursue various nexus theories that purportedly satisfy the physical presence standard, including attributional nexus and the presence of software and use of servers in a state, and we should expect states to continue to pursue these positions,” Friedman said. “Second, we also know that some states will not follow this South Dakota decision and will seek to impose a sales tax collection obligation irrespective of whether a taxpayer established a physical presence.”

For example, several states—including Minnesota, Rhode Island, and Washington—have pursued taxing third-party marketplace sales. Minnesota and Washington this year became the first states to enact laws requiring marketplace providers to collect tax on third-party marketplace transactions.

“It will be interesting to see if other state courts come to a different decision than the South Dakota Supreme Court,” Friedman said. “A split among state supreme courts will lead to an extremely high likelihood that the U.S. Supreme Court will grant a certiorari petition and resolve this issue.”

Several Considerations

Friedman said he would counsel sellers based upon individual circumstances and facts.

“Specific considerations would include the client’s risk tolerances, its willingness to litigate, its business plans and growth expectations, whether it’s a public company or not, whether it collects taxes in other states, whether it’s registered to file and pay the state’s other taxes, and, of course, whether it does in fact have a no physical presence position,” Friedman said.

Joe W. Garrett Jr., deputy commissioner of revenue with the Alabama Department of Revenue, told Bloomberg BNA there is “zero question over whether the tax is due, the only question is who has to remit the tax—the seller or the seller’s customer.”

“‘Have to’ or not, we think collecting and remitting on behalf of your customers is the right thing for a seller to do. Failing to collect is creating a burden for the customer and the state,” Garrett said in an email.

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

To contact the editor responsible for this story: Jennifer McLoughlin at jmcloughlin@bna.com

Copyright © 2017 Tax Management Inc. All Rights Reserved.

Request Daily Tax Report: State