1980’s movie lore can be instructive. The high point in classic ‘80’s movies is often a house party grown to enormous proportions, at the height of which the authorities arrive to break it up. The Quill physical presence rule will likely be remembered by a generation of remote sellers as being great while it lasted until the Wayfair decision came along to break it up. What should be done now? If Congress will not act to impose a semblance of order, such as dusting-off the Marketplace Fairness Act legislation, use tax nexus analyses are now subject to the same nexus standards as any other type of state tax. Regardless of when or if Congress will act, there is, much like the post-party clean-up scene of an ‘80’s movie, work to be done.
Background: The Quill Era
In the “Quill era,” a remote seller was obligated to collect a state’s use tax if it had the required physical presence in that State. National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U. S. 753 (1967); Quill Corp. v. North Dakota, 504 U. S. 298 (1992). The physical presence standard for use tax nexus was a simple national standard for remote sellers to remember, even as the Digital Age brought increasingly clever state workarounds and interpretations to bear on the standard. Except for Public-Law 86-272, applicable only to income-based taxes under certain circumstances (which also has had and still enjoys a long run), use tax was the state tax that had a national nexus standard which the average business person could quickly grasp. With the U.S. Supreme Court decision in South Dakota v. Wayfair, Inc., et al, 585 U.S.__ (2018) on June 21st, the Quill era has ended.
Unless the United States Congress acts, a remote seller’s requirement to collect a state’s use tax remains subject to the standards set forth in Complete Auto Transit, Inc. v. Brady, which govern the Constitutionality of tax - any type of tax - on interstate commerce. Complete Auto held that a tax in interstate commerce will be sustained “so long as 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. Complete Auto Transit, Inc. v. Brady, 97 S. Ct 1076 (1977).
In the Quill era, the “substantial nexus” prong of Complete Auto for use tax nexus purposes was physical presence. For other types of state tax, for example, income/franchise tax, state supreme courts have held that physical presence is not required to reach a finding of substantial nexus and the Supreme Court has declined review. Sellers have long had to analyze their potential for state income/franchise tax nexus without the benefit of a national physical-presence standard.
Going forward, it will not matter that a seller has no physical presence in a state unless Congress chooses to pass a law that says otherwise. The other elements that govern the constitutionality of a tax on interstate commerce will still need to be met for use tax as with any other type of state tax. Since the South Dakota Supreme Court addressed only the physical presence issue, the U.S. Supreme Court has remanded the Wayfair case back to the South Dakota Supreme Court for further proceedings to consider whether the South Dakota statute can be challenged on an alternative basis under the Commerce Clause – most observers believe the South Dakota law will stick now that the physical presence requirement has been removed.
Some say modern-day state sales tax nexus statutes and taxing authority nexus policies have become more rational and fair to remote sellers over the years. That viewpoint notwithstanding, are remote sellers now ready to put their use tax nexus analyses through the more subjective and sometimes complex nexus analyses that have long caused headaches for state income tax and other tax types?
Addressing a Wayfair Hangover
In anticipation of this case, nearly half the states have already passed economic nexus legislation. Possibly Congress will signal an intention to act, but in the meantime, remote sellers with sales to customers in states where the seller is not registered should plan to analyze their potential for use tax nexus in non-registered states right away, and more frequently thereafter. Sellers which already had a routine of regularly re-evaluating their physical presence for use tax nexus purposes are ahead of the game; while other sellers, particularly digital product sellers who don’t always track the location of their customer-users, may be less prepared to address a “Wayfair hangover”.
Here are some key questions every Company with remote sales should be asking right now.
- Is it time for the Company to revisit its ASC 450-20 analysis?
- Does the Company have reliable sales transaction data by customer location, and for those sellers who are digital products sellers or providers, will additional consideration around the seller’s transaction-sourcing methodologies be required?
- Has the Company already considered its state nexus profile for other tax types for which the facts gathered may be useful as a starting point for understanding a Company’s potential use tax nexus in non-registered states?
- Has the company compared its sales transaction data to the sales thresholds in the South Dakota use tax nexus statute and states with similarly designed use tax nexus statutes?
Alvarez & Marsal Taxand Says:
There will be more news to come when South Dakota Supreme Court revisits the Wayfair case on remand, as instructed by the U.S. Supreme Court. If the remanded Wayfair case is ultimately held constitutional, South Dakota’s law would then stand unless Congress acts. In this instance, a possible outcome is that states with similarly designed use tax nexus laws, even if untested by their own state Supreme Courts and the U.S. Supreme Court, may come to be regarded as having acceptable standards for use tax nexus purposes; particularly when such states are Streamlined Sales Tax Agreement member states, as is South Dakota. This issue appeared to be a point in South Dakota’s favor to the U.S. Supreme Court.
Those companies impacted by the Wayfair decision should focus on gathering facts and making plans to address their ASC 450-20 analyses and potentially registering to collect sales tax in new states – just in case Congress does not act or is late in choosing to act.