The US Supreme Court issued an opinion on South Dakota v. Wayfair, Inc. a case brought by South Dakota to force the collection of sales tax from remote sellers (online sellers).
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We asked Scott Peterson, Avalara’s VP of US Tax Policy, for his view on the court’s ruling. Avalara has a unique insight into this issue as they provide sales tax automation software for online retailers subject to various tax jurisdictions.
“First of all, you have to define what you mean by “small business.” The majority of very small businesses will not be impacted at all by this ruling because it establishes a threshold of $100,000 in sales or 200 transactions in South Dakota.
Small businesses that are selling independently or through marketplaces – such as Amazon FBA, eBay, Etsy, and more – may have to go from filing sales tax in the states where they’re currently located to potentially having to file taxes in many states – where they have nexus issues based on their threshold of sales.
It’s challenging to suddenly have to understand the tax requirements and threshold logic across the entire country.
While the ruling won’t go into immediate effect – the ruling has been passed back to the South Dakota State Supreme Court – small businesses should understand the possible future implications.
In the era of eCommerce, the Supreme Court stated that physical presence is no longer a suitable test so small businesses may need to consider where they sell, not where they are, for tax compliance requirements.”
His summation brings up a good point on the thresholds the court accepted and maybe one states now regret has happened.
The court was unanimous in stating that previous opinions on interstate collection were flawed as the court, not legislation, created an artificial barrier for when a retailer was required to collect sales tax from an out-of-state customer.
Previously, retailers were only required to collect sales tax from remote buyers when that buyer was located in a state in which the retailer had a physical presence such as a store, office, warehouse, or sales force.
But in this opinion, the court agreed with the state of South Dakota that the physical presence standard is not relevant in today’s connected commerce world and that nexus (the requirement to collect sales tax), should be based on another method.
Since it is the legislature (Congress) that actually has to make laws in the US, South Dakota (and indirectly all other states) asked the high court to overturn previous opinions on this issue (Quill and National Bellas Hess) and give the states the rights to set new standards for nexus.
Beware of What You Ask For
In simple terms, the case was about state rights and the state’s rights and abilities to control when to enforce sales tax laws on entities located outside of their state.
It’s been obvious the states wanted the court to eliminate the physical location standard as they considered it limiting and just give them full power to determine other methods to enforce tax collection.
Knowing the court cannot legislate, but also understanding the court was going to be sympathetic to issues in the constitution’s Commerce Clause, the states supported the argument by South Dakota that setting a minimum standard before sales tax collection from remote sellers is required, would not create an undue burden on small businesses.
They went so far as to argue that it is even burdensome for states to create laws with very low minimum standards. From the “Friends of The Court” brief by the Multistate Tax Commission:
“…states will, themselves, incur costs to register, track, process returns, and provide notices to small sellers, that, like the fixed costs of compliance, make imposing tax collection obligations on small sellers inefficient from the states’ standpoint.”
So, the states said something to the effect, trust us, we won’t do anything to harm ourselves, but we need the power to set our own standards based on an alternative method that will work better to capture lost sales tax revenue.
However, during the oral arguments before the court, South Dakota acknowledged that if the court overturned the physical presence requirement, a new minimum standard could be based on a requirement as low as one sale.
And apparently, that must have scared the court.
9-0 On Flaw of Previous Decision
In both the majority and the minority opinion, all justices agreed that the previously set threshold by the court was arbitrary and had to be fixed.
But they disagreed on the method and timing, mostly around how to “nudge” Congress to act, which to date, Congress had failed to do so.
So it seems to fix the big problem of undoing the previous “wrong” decisions, the court narrowed the focus of this problem by concentrating on the specifics in this case. Meaning does South Dakota’s law represents an undue burden on small businesses.
Under the Commerce Clause, and without legislation from Congress, states cannot enact laws that negate or reduce the ability of merchants to conduct commerce across state lines.
But since the court can only rule on the laws as they are today, not create legislation that enforces minimum standards not found in the law, it decided on an interesting strategy to agree that it considers South Dakota’s minimum standards a reasonable threshold and does not violate the undue burden provision of the Commerce Clause.
“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, on an annual basis, deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions for the delivery of goods or services into the State. Ibid. The Act also forecloses the retroactive application of this requirement and provides means for the Act to be appropriately stayed until the constitutionality of the law has been clearly established.”
But South Dakota’s law went beyond defining a reasonable standard for the future, it also included language that prohibits retroactive enforcement.
And by including the language in its opinion, it seems the court may have effectively stopped retroactive enforcement actions because states now have guidance from the court on what it considers an acceptable burden on businesses.
The court did not give, nor is it allowed to, provide states guidance on what other minimum thresholds may be acceptable. Therefore, states now have to consider South Dakota’s law a minimum acceptable standard that satisfied the court.
But states have no clue on what other thresholds may be acceptable to the court, therefore, states are now forced to interpret this court’s opinion.
To make matters worse, the court even reminded states that it has the power to effectively null and void unreasonable minimum standards.
“States may not impose undue burdens on interstate commerce. State laws that discriminate against interstate commerce face “a virtually per se rule of invalidity.”
The court was emphatic that only Congress can provide legal changes that would create a single standard for all states.
Absence such legislation, the court only agreed that South Dakota’s specific law is an acceptable minimum standard. But this may have opened up a box of worms.
For example, some states coerced monies from remote retailers on “back taxes,” what happens to those monies? Is retroactive collection an undue burden?
Could a merchant now argue that since in this case, the court accepted that retroactive action was being prohibited by South Dakota’s law, it may consider such action a burden?
The big question here is that while most states supported this case, did states expect the court to tie the South Dakota thresholds and prohibition of retroactive enforcement into a de-facto standard?
It seems the court told states you must look forward and your laws must be reasonable and not create an undue burden or we may just throw them out.
With this narrow ruling, Congress may feel compelled to act to avoid further ambiguity because it has the power to set any standard it sees fit, and that takes this whole situation out of the state’s hands.
Is this really what they wanted because that is what they got!
State legislatures around the country may have to revisit their laws to ensure they meet the “suggested” accepted standard of South Dakota’s law because the court changed the nexus standard from physical location to one of “undue burden.”
So any attempt to deviate to a standard that may be perceived as a lower standard than South Dakota could tie up sales tax legislation for years again before it may land with the high court to determine if another standard is acceptable to them.
Salex Tax Not Really Settled
For those that expected the Supreme Court to settle this issue, this may actually be a blow to clarity. There was so much the court didn’t address and even hinted could be argued in future cases.
Paul Rafelson, Executive Director, Online Merchants Guild, an industry organization that represents the interests of small business online retailers provided us with this analysis.
“This ruling is not a game changer it’s a wake up call that we as a seller community need to take action to protect our constitutional rights as online merchants. The Court removed physical presence from the nexus equation, that’s it.”
“They Court, admittedly, left many questions unanswered, including whether it’s appropriate for small business merchants to have massive multi-state tax collection responsibilities.”
“The Court found the physical presence standard to be unworkable in the context of a large company like Wayfair, but left the door open for further challenge from online merchants whose only connection in the state is via Amazon, eBay, etsy, Walmart, etc.”
One could argue that after a night of celebrating a “victory,” states now find they have more confusion about what this really means for them.
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