Physical presence: Wayfair

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Publication August 9, 2018

A physical presence is no longer required for companies making sales to have to collect sales taxes, the US Supreme Court said in late June.

The internet is making it hard for brick-and-mortar stores to compete. South Dakota, which does not have an income tax and relies on sales taxes for roughly 60% of its revenue, adopted a new law in 2016 requiring out-of-state sellers to collect and remit sales taxes as if they have a physical presence in the state. The new law applies only to sellers with more than $100,000 in annual sales in the state or more than 200 separate transactions.

The state then sued three out-of-state retailers in an effort to get a decision on whether the new law is constitutional.

The case reached the US Supreme Court as South Dakota v. Wayfair.

States are not allowed under the US constitution to erect barriers to interstate commerce. The US Supreme Court held in a case called National Bellas Hess in 1967 that a mail-order company could not be required to collect sales taxes for Illinois where it had no physical presence. It reached the same conclusion in another case in 1992 involving a mail-order business making sales in North Dakota in a case called Quill Corp.

In between the two decisions, the court offered a set of guidelines in another case called Complete Auto Transit for when states may tax interstate commerce. Interstate commerce can be required to bear its fair share of taxes, but the taxes must be tied to an activity with a substantial nexus with the state, they must be fairly apportioned and they cannot discriminate against interstate commerce. They should also be fairly related to the services the state provides.

Justice Anthony Kennedy, who is stepping down, wrote the majority decision. Kennedy said the requirement for a physical presence in the state before a company can be required to collect sales taxes “becomes further removed from economic reality” with each passing year. Forty one states, the District of Columbia and two US territories asked the court to drop the physical presence requirement. Kennedy said sparing internet sellers and mail order houses from having to collect taxes lets them undercut local businesses on prices.

The decision was 5-4.

Chief Justice John Roberts wrote a dissent joined by three liberal justices: Breyer, Sotomayor and Kagan. Roberts said that any change in whether e-commerce must collect sales tax should be made by Congress since there is the “potential to disrupt a critical segment of the US economy.” Roberts said the burden to collect sales taxes is significant. More than 10,000 state and local jurisdictions impose sales taxes, each with “different tax rates, different rules governing tax-exempt goods and services, different product category definitions, and different standards for determining whether an out-of-state seller has a substantial presence,” Roberts said, quoting from a 2017 Government Accountability Office report to Congress. Software to facilitate compliance is in its infancy.

Congress has been unable to reach consensus on the issues. Four Democratic Senators from Montana, Oregon and New Hampshire, which do not have sales taxes, introduced a bill in the Senate on June 28 to reinstate the physical presence test. Several other bills have been pending in the current Congress. New Hampshire Governor Chris Sununu, a Republican, vowed to protect New Hampshire-based companies from having to collect sales taxes for other states.

New Jersey promptly passed a remote sellers bill with the same standards as South Dakota. A number of other states had passed similar bills before the Supreme Court decision with plans to put them into effect after a positive decision. Lawsuits involving online sales taxes in five states are still pending in the courts.

A similar concept to physical presence comes up in a cross-border context. It is called a “permanent establishment.” More than 3,000 tax treaties bar countries from taxing remote investors or sellers who lack a permanent establishment in the country. A draft European Union directive would treat digital service providers as having a “virtual” permanent establishment if sales proceeds exceed €7 million in a tax period. The US has opposed any change in this direction because of the effect on large US internet companies.


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