Everyone is by now likely familiar with the recent Wayfair decision and its central holding. Prior to Wayfair, businesses had some degree of comfort that they would not be required to collect and remit sales or use taxes to states in which those businesses did not have physical presence. Now that the physical presence test is gone, state legislation must be reviewed on a case-by-case basis to determine whether it will survive Commerce Clause scrutiny. Rather than go over every detail of the case, we at Horwood Marcus & Berk Chtd. thought it would be helpful for each attorney to give a takeaway or two from the case. For our recent discussion on Wayfair generally and its impact on Illinois' recently adopted legislation, click here.
All Businesses should Consider Wayfair's Impact
The Wayfair holding has an impact on all businesses. Most obviously, the holding will trigger businesses who previously did not collect in jurisdictions which it did not have a physical presence to start collecting applicable sales and use tax. Additionally however, businesses that had established nexus everywhere prior to the holding of Wayfair should not fall into the trap that this holding is inapplicable to its business. These businesses should review their use tax accruals, direct pay permits, and vendors' invoices. Their inaction to review these processes will likely result in the double payment of tax as their vendors who did not previously collect sales or use tax, will likely begin to do so in light of the Wayfair ruling.
What will Wayfair mean for Future State Legislation?
Although the Supreme Court remanded Wayfair to the Supreme Court of South Dakota on the basis that the Court's decision was limited solely to the question of whether the Quill physical presence standard was fatal to SB 106, the Court provided a number of characteristics of South Dakota's law that counseled in favor of upholding the law on remand. These factors include:
- By asserting nexus only over sellers who deliver either $100,000 of goods or services or 200 or more separate transactions into the state, the act applies a "safe harbor to those who transact only limited business in South Dakota";
- The act ensures that no obligation to remit the sales tax may be applied retroactively;
- South Dakota is one of more than 20 states that have adopted the Streamlined Sales and Use Tax Agreement, or SSUTA; and
- South Dakota also provided sellers access to sales tax administration software paid for by the state that immunizes sellers from audit liability regarding their reliance on the software.
But the Wayfair Court did not provide any bright line rules to assist in determining whether a state statute satisfies the requirements of the Commerce Clause. Thus, when assessing the constitutionality of a state's assertion of nexus prospectively, courts will review the facts on a case by case basis, undoubtedly aided by the four factors identified by the Supreme Court in South Dakota's law which indicate a tax does not burden interstate commerce. A pivotal issue moving forward is whether the four factors were meant to be a leash for future legislation, restricting the constitutionality of a law to these requirements, or whether they should merely be considered and potentially ignored in a Commerce Clause analysis. The likelihood is the latter, but taxpayers should not be surprised when litigation arises surrounding this issue.
Safe-Harbor or Red Herring?
The South Dakota law at issue in South Dakota v. Wayfair requires remote sellers to collect sales tax if they deliver more than $100,000 of goods or services into South Dakota or engage in 200 or more transactions in the state. The US Supreme Court referred to this requirement as a "safe harbor" for sellers who only transact limited business in South Dakota. But is the amount of business that a seller conducts in a state really constitutionally relevant? The Wayfair court goes to great lengths to emphasize that the Commerce Clause test is about burdens or, more precisely, eliminating or reducing burdens on interstate commerce. Indeed, this was one of the reasons that the Court abandoned the physical presence test. Physical presence, by itself, is a "poor proxy" (Justice Kennedy's term) for the compliance costs faced by companies that do business in multiple states. A remote seller's degree of physical presence in a state tells us little about the compliance burdens faced by the seller in that state. Is a company's sales or transactions in the state really a better proxy? Is a company with $50,000 of sales in South Dakota more burdened by having to file a sales tax return than a company with $150,000 of sales? Not necessarily, at least for sellers whose sales and transactions exceed a truly nominal number (one or two sales into the state). This is especially true for indirect taxes such as a sales/use tax collection obligation.
The Commerce Clause burdens test should focus on a state's tax system, a point emphasized by the Supreme Court when it noted that South Dakota was a member of the Streamlined Sales and Use Tax Agreement. Streamlined member states are required to have a single, state level tax administration; uniform definitions of products and services; simplified tax rate structures; and access to software provided by the state. These criteria are arguably a better measure of the burden on interstate commerce than a simplistic sales/transactions threshold. While the sales/transactions threshold has political appeal because it shows concern for the small sellers of the world, the threshold is arguably just a red herring in evaluating the burdens on interstate commerce.
When does a Business Cross the Safe-Harbor Threshold?
Illinois, in anticipation of a favorable Supreme Court decision, has amended its statute to adopt what the Court has characterized as a safe harbor. Beginning October 1, 2018, a remote retailer making sales of tangible personal property to Illinois purchasers will be subject to a use tax collection obligation if (i) its cumulative gross receipts from sales of tangible personal property to Illinois purchasers are $100,000 or more or (ii) the remote retailer enters into 200 or more separate transactions (sales of tangible personal property to Illinois purchasers).
Unanswered by the Court was the question of when a remote seller crosses the threshold. If, during the course of a 12-month period, the remote seller hits the $100,000 mark or has engaged in its 200th transaction, is the remote seller now obligated to collect tax and if so, for how long. Illinois has attempted to answer this question by requiring the remote seller to determine on a quarterly basis ending on the last day of March, June, September and December, whether the remote seller has hit the $100,000 mark or has made 200 separate sales to Illinois purchasers. If the remote seller has met either of the statutory criteria for a 12-month period, the remote seller is required to collect and remit use tax. At the end of the 1-year period, the remote seller is required to determine if it has met either criteria during the preceding 12-month period. If the remote seller has met either criteria for the preceding 12-month period, the remote seller is required to collect and remit use tax for the subsequent year. If at the end of a 1-year period a remote seller that was required to collect and remit tax determines that it no longer meets either of the criteria, the remote seller must once again determine on a quarterly basis whether it meets either of the statutory criteria.
Whether this is a workable solution to the question of when a remote seller crosses the statutory threshold and is required to begin collecting and remitting tax remains to be seen. Another concern is what other states may adopt. This is only one of the many problems facing remote sellers as they now attempt to comply with what the individual states may adopt in this new and unchartered era.
The Supreme Court and Stare Decisis
Putting aside the obvious sales tax implications of the Wayfair decision, what I found most profound was the Court's about-face turn in regard to the long-respected and followed concept of stare decisis. Quill was originally decided in large part due to Court's hesitance to overturn Bellas Hess, its established legal precedent dealing with nexus. The term stare decisis has its origin from Latin that means "to stand by things decided," and over the years the Court has done so unless the decision was found to be both (1) wrongly decided; and (2) harmful to society "and causing a lot of trouble?" (Summarizing a Justice Breyer interview with students). Justice Breyer, writing for the Court in Randall v. Sorrell, the Vermont campaign finance reform decision, 2006, stated:
"The Court has often recognized the 'fundamental importance of stare decisis, the basic legal principle that commands judicial respect for a court's earlier decisions and the rules of law they embody. The court has pointed out that stare decisis 'promotes the evenhanded, predictable and consistent development of legal principles, fosters reliance on judicial decisions, and contributes to the actual and perceived integrity of the judicial process.' Stare decisis thereby avoids the instability and unfairness that accompany disruption of settled legal expectations. For this reason, the rule of law demands that adhering to our prior case law be the norm. Departure from precedent is exceptional and requires special justification."
In the matter of two short weeks the Court has dealt two significant blows to stare decisis with not only its decision in Wayfair, but most recently in Janus v. American Federation of State, County and Municipal Employees, No. 16-1466, in which the majority overruled a 40-year-old precedent in holding that government workers who choose not to join unions may not be required to help pay for collective bargaining.
Thomas, for his part in the Wayfair decision, put pen to paper to renounce his own past views in the 1992 Quill case, noting that "a quarter century of experience" had convinced him that the physical-presence requirement "can no longer be rationally justified." Without explaining how he changed his mind, he acknowledged that "it is never too late to surrender former views to a better considered position." We, as a society, have obviously benefited from the Court's past "surrendering of former views to a better considered position," (See Brown v. Bd. of Education, 347 U.S. 483 (1954)); however, historically the Court has only strayed from its well-established precedent in rare and sometimes extreme situations. Justice Scalia made his feelings toward it clear when in its Planned Parenthood v. Casey dissent he argued that, "?it seems to me that stare decisis ought to be applied even to the doctrine of stare decisis, and I confess never to have heard of this new, keep-what-you-want-and-throw-away-the-rest version." 505 U.S. (1992)(dissenting).
Immediately after the Wayfair decision was issued, I joked that my favorite part of the decision was Justice Thomas' dissent because of his blatant jab at the dormant commerce clause. Justice Thomas' inability to withhold his disdain of the dormant commerce clause from a short, concise one-paragraph dissent was greatly entertaining to me. However, this short dissent has much great implications than the humorous ones that I initially pointed out. What are the broader implications that it will have on stare decisis? In recent weeks the Supreme Court has dealt a significant blow to its long-standing adherence to judicial precedent in general and now we have Justice Kennedy retiring from the Court. What will this all mean? If one thing is for certain now, it is that we cannot rely on precedent to tell us.
Wayfair and Foreign Sellers
The Wayfair decision has given us clarity in that the physical presence test created in National Bellas Hess and confirmed in Quill is no longer the test when determining what constitutes substantial nexus under Complete Auto v. Brady. But the Wayfair decision has left us with many unanswered questions. One of the many questions I have been asked is about the impact of Wayfair on foreign sellers. In other words, does the elimination of the physical presence test impact a foreign seller's obligation to collect use tax on sales into the United States? In a word, in my opinion, YES.
Prior to the Wayfair decision, foreign sellers, similar to remote sellers, did not have an obligation to collect use tax on sales that they were not physically present. The removal of the physical presence test and the substitution of the 200 sales or $100,000 of sales test puts the same burden on foreign sellers as it does other remote sellers. Remember, states are not bound by treaties between the United States and a foreign country. Also, use tax collection imposed on a foreign seller is most likely not a violation of either the foreign commerce clause or the import/export clause.
The only real issue is in the case of a state assessing a foreign seller is a matter of collecting the unpaid tax. That can be a real time consuming and difficult task for the states.
Applying Wayfair Prospectively
Be careful what you wish for as you may get it is a fitting adage for the Wayfair decision. In the prophetic words of Justice White in his concurrence/dissent in Quill the "vagaries of 'physical presence' were tested" and the concept was laid to rest. The Wayfair decision harmonized the Commerce Clause substantial nexus requirements with the evolution of electronic commerce and technology. In reaching its conclusion the Court accepted the South Dakota standards of 200 transactions and $100,000 of sales as sufficient to pass constitutional muster particularly when coupled with the prohibition against retroactive application. It certainly could be argued that this is floor for any collection requirements. The Court also in reaching its decision rejected the administrative compliance burden argument that swayed the Court in Quill pointing out there are other doctrines that may be invoked to handle the situation should it arise. Although providing some guidance around the collection requirement the Court did not provide the bright line guidance that many had hoped for. So, what are the take ways from the decision: (1) Substantial nexus does not equate to physical presence and substantial virtual presence will meet the standard; (2) A bright line test that creates market distortion when it treats two economically identical entities differently for an arbitrary reason will not pass constitutional muster; and (3) There are other doctrines that may be used to address the issue of substantial burdens should the issue arise. As the states review the decision and begin to contemplate implementation not only should these three factors be taken into consideration but also a prospective approach to any collection requirements.
What Case Law do we Look to Now?
In support of the Supreme Court's new Commerce Clause nexus standard, the Court referred to Polar Tankers. That case addressed whether an Alaskan city was entitled to impose a personal property tax on the value of ships traveling through the city. Although the tax was struck down on other grounds, the Court noted that a "[n]ondomiciliary jurisdiction may constitutionally tax property when that property has a 'substantial nexus' with that jurisdiction, and such a nexus is established when the taxpayer 'avails itself of the substantial privilege of carrying on business' in that jurisdiction." The taxpayer in that case had at least twenty-eight ships that were in port in the city, a substantial physical presence in the taxing jurisdiction.
Polar Tankers quoted Mobil Oil Corp. v. Comm'r of Taxes. That case hinged on whether Vermont could constitutionally tax the Vermont taxpayer's net dividends from subsidiaries and affiliates operating abroad. The Mobil Oil Court's characterization of nexus was focused on whether the state could constitutionally include the net dividends in apportionable income, and was not really focused at all on whether the taxpayer, which was engaged in the production, refining, transportation, and distribution and sale of petroleum and petroleum products in many states, including Vermont, was subject to tax.
In light of Wayfair's citation to Polar Tankers, which quoted Mobil Oil, the Supreme Court may have unwittingly conflated apportionment case law with nexus jurisprudence. Only time will tell, but this highlights the need for taxpayers to think about their contacts with taxing jurisdictions with a fresh perspective.
Although the Supreme Court remanded the case to the South Dakota Supreme Court for further analysis regarding whether SB 106 conflicts with the Commerce Clause, the central holding in the case, that physical presence is no longer a requirement under the Commerce Clause, has been established. Both states and businesses should critically assess the relevant factors for Commerce Clause analysis and consider how those apply to businesses on a case by case basis.
Polar Tankers, Inc., 557 U.S. at 1.
 445 U.S. 425 (1980).
Id. at 427.