Business Tax Update – The Rapidly Changing Landscape of Sales Tax Liability: 5 Things You Should Know
By , , Business Taxation
On June 21, 2018, the Supreme Court of the United States in South Dakota v. Wayfairchanged the rules on sales tax registration and payment. By rejecting the long-standing “physical presence” requirement, the Supreme Court potentially opened the door to substantial sales tax reporting and payment requirements that did not previously exist and that may require your company to pay sales tax in states where the requirement never applied before.
Life Before South Dakota v. Wayfair
Generally, the constitution prevents any particular state from imposing requirements on a company unless the company has a “substantial nexus” with the state. So, for example, South Dakota could not require a company based in Alaska with no connections to South Dakota to comply with South Dakota’s rules and regulations. The question becomes trickier, however, when the Alaskan company has some dealings that involve South Dakota for example, when it sells products to customers located in South Dakota. In those circumstances, the question is whether the activities of the Alaskan company are sufficient to count as having established a “substantial nexus” with South Dakota.
In the sales tax context, prior to the Wayfair decision, the Supreme Court had ruled that for a company to have a “substantial nexus” with a state sufficient to require registration and payment of sales tax, the company had to have a “physical presence” in the state this could include things like having an office in the state or having sales agents resident in the state. Of course, every state had its own rules on what would generally be required to establish substantial nexus for sales tax registration purposes but every state had to at the very least include some physical presence element in their law. If your company did not have a physical presence in a certain state, you did not have to inquire further because that was the threshold level beneath which no state could reach.
Recently, a number of states had begun to test the boundaries of the physical presence requirement in light of e-commerce retailers who were not required to pay sales tax even where there were substantial sales into a state. Several states had begun to develop concepts such as economic nexus or click-through nexus to collect taxes from out-of-state companies. Generally, click-through nexus laws provide that if an out-of-state seller enters into an agreement to receive in-state customer referrals, often through hyperlinks directing customers to the seller’s website, and if the seller pays an in-state person for such referrals on the basis of sales, the seller is presumed to have sufficient nexus with the state.
But all of these efforts were still laboring under the fact that physical presence remained the constitutional law governing any nexus analysis. Wayfair arose out of those circumstances.
The Supreme Court’s Decision
In 2016, South Dakota passed a law that did not require a physical presence but rather required sales tax registration and reporting if a company did $100,000 or more annually in sales to South Dakota customers or completed 200 or more individual transactions with South Dakota customers. South Dakota also provided software to companies and other miscellaneous steps to assist companies in compliance. The lower court struck down South Dakota’s law because it did not have a physical presence element. In light of Supreme Court precedent, the lower court did not have a choice physical presence was a requirement imposed by the highest court in the country.
On appeal, the Supreme Court reversed the lower court on a 5-4 vote. It expressly rejected its longstanding physical presence test, and held that in today’s modern world, physical presence is not the only method by which a company could establish a substantial nexus with a state requiring registration and payment of sales tax. The Court did not specify what would be necessary to establish nexus, but it found South Dakota’s requirements sufficient – $100,000 or more in annual sales within the state or 200 or more transactions within the state.
In ruling on whether the South Dakota law’s requirements were sufficient to establish a substantial nexus with the state, the opinion states:
“Here, the nexus is clearly sufficient based on both the economic and virtual contacts respondents have with the State. The Act applies only to sellers that deliver more than $100,000 of goods or services into South Dakota or engage in 200 or more separate transactions for the delivery of goods and services into the State on an annual basis. S. B. 106, 1. This quantity of business could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota. And respondents are large, national companies that undoubtedly maintain an extensive virtual presence.
“… South Dakota’s tax system includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce. First, the Act applies a safe harbor to those who transact only limited business in South Dakota. Second, the Act ensures that no obligation to remit the sales tax may be applied retroactively. S. B. 106, 5. Third, South Dakota is one of more than 20 States that have adopted the Streamlined Sales and Use Tax Agreement.”
Five Things You Should Know
What should companies do now? The answers will be unclear for some period of time as states adopt new legislation in light of this decision and as Congress decides whether and how to respond. But here are five things you should know:
- It seems unlikely that there will be retroactive liability. While some states may attempt to collect taxes retroactively, the Supreme Court expressly recognized the fact that South Dakota’s law was not retroactive in affirming its provisions as reasonable protections against abuse.
- Rules will be established on a state by state basis. Each state will be reviewing its sales tax requirements and tweaking them in light of South Dakota v. Wayfair. It will be important to keep track of the number and amount of your sales into each state and to know (and comply with) the reporting and registration requirements in those states.
- It is possible that Congress will act. Prior to the decision, there had been widespread support for action by Congress. Hopefully, this decision will spur Congress to adopt legislation that will provide some uniformity to the patchwork of state regulations and requirements.
- The Streamlined Sales and Use Tax Agreement may provide some relief. More than 20 states had signed onto the SSUTA as of the date of the decision. Unfortunately, some of the larger states had not (e.g., Florida, California). To the extent that states in which your companies do business are part of the SSUTA, its uniform provisions will assist you in ensuring that you comply with your sales tax obligations.
- Kaufman & Canoles’ Business Tax Group can assist. K&C’s business tax professionals can answer your questions and help guide you through the maze. Keep an eye out for further legal updates as matters progress in this evolving field.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.