Reversing prior precedent that prevented collecting sales tax from Internet retailers that do not have a physical presence in the state, the 5-4 Supreme Court said the case law didn’t reflect the current reality.
The dispute can be traced back to 1967, when the Court in National Bellas Hess, Inc. v. Department of Revenue of Illinois held that a mail-order company whose only connection with customers in the state was by mail or common carrier lacked the requisite minimum contacts to collect sales tax. The justices doubled down on the decision in 1992’s Quill Corp. v. North Dakota, reiterating that the mere shipment of goods into the consumer’s state did not satisfy the physical presence requirement to require a retailer to collect sales tax.
In an effort to work around the Bellas Hess and Quill decisions, the state of South Dakota enacted a new law to increase its collection of sales tax. The 2016 law declared an emergency because the inability to collect sales tax from remote sellers was “seriously eroding the sales tax base” and “causing revenue losses and imminent harm.” The state estimated it loses $48 million to $58 million in tax revenue on an annual basis. In response, S.106 requires out-of-state sellers to collect and remit sales tax “as if the seller had a physical presence in the state.”
Pursuant to the law, sellers that 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 and services into the state must collect the 4.5 percent South Dakota sales tax from purchasers. The South Dakota Act foreclosed the retroactive application of the law and, by its own terms, could be applied only after its validity was judicially upheld.
To test the constitutionality of the act, the state filed a declaratory judgment action against three remote sellers who met the minimum sales or transactions threshold—Newegg, Overstock.com and Wayfair—and asked for a declaration that the requirements of the law are valid and applicable. The defendants moved for summary judgment, arguing the law is unconstitutional.
A trial court sided with the defendants, and the South Dakota Supreme Court affirmed. The Supreme Court granted certiorari and reversed in an opinion authored by Justice Anthony Kennedy.
The physical presence rule has been the target of criticism for many years from many quarters, the Court noted, and each year, the rule “becomes further removed from economic reality and results in significant revenue losses to the States. These critiques underscore that the physical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.”
It is an inescapable fact of modern commercial life that a substantial amount of business is transacted without the need for physical presence within a state, and the rule “is a poor proxy” for the compliance costs faced by companies that do business in multiple states, the justices said.
The precedent puts both local businesses and many interstate businesses with physical presences in a state at a competitive disadvantage compared with remote sellers who can offer lower prices because they are not collecting tax. Wayfair advertised this fact, Justice Kennedy wrote; the company stated that “[o]ne of the best things about buying through Wayfair is that we do not have to charge sales tax.”
“In effect, Quill has come to serve as a judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a State’s consumers—something that has become easier and more prevalent as technology has advanced.”
Time and the rise of the Internet marketplace also provided support to South Dakota’s law. Modern e-commerce does not align analytically with a test that relies on the sort of physical presence defined in Quill, the majority said. “Between targeted advertising and instant access to most consumers via any internet-enabled device, ‘a business may be present in a State in a meaningful way without’ that presence ‘being physical in the traditional sense of the term.’”
Stare decisis is not an inexorable command, the Court said, and could no longer support the Court’s prohibition of a valid exercise of the states’ sovereign power.
Having overruled Bellas Hess and Quill, the justices wasted little ink on whether the South Dakota law was constitutional. The act applied to an activity with a substantial nexus with the taxing state, as the quantity of business required by the law to collect sales tax “could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota,” the Court held.
Further, the act includes several features designed to prevent discrimination against or undue burdens upon interstate commerce, from its forward-looking application to the safe harbor for those sellers who fail to meet the dollar or transactions thresholds, Justice Kennedy said, and South Dakota is one of more than 20 states to adopt the Streamlined Sales and Use Tax Agreement (which standardizes taxes with uniform definitions and rules and provides software that immunizes sellers from liability).
Justice Clarence Thomas authored a concurring opinion to essentially admit he was wrong to join the majority in Quill, while Justice Neil Gorsuch wrote a separate concurrence praising the majority for “correct[ing] the mistake” of Quill.
In a dissent led by Chief Justice John G. Roberts, Justices Stephen Breyer, Sonia Sotomayor and Elena Kagan expressed concern that the majority’s alteration to the rules could disrupt the economy, noting that e-commerce grew into a “significant and vital part of our national economy” against the backdrop of the physical presence rule. Congress should address the issue, the dissenters said, not the Court.
To read the opinion in South Dakota v. Wayfair, Inc., click here.
Why it matters: A sea change for e-commerce, the decision now permits states to require remote sellers to collect sales tax from purchasers despite not having a physical presence in the state. To take advantage of the decision, states will have to amend existing laws or enact new laws similar to the challenged South Dakota Act, which will buy online retailers some time before they begin collecting. Justice Kennedy also took pains to highlight features of the South Dakota law that protect sellers, such as the lack of retroactive application, the high threshold for dollar amount or sales transactions, and the state’s participation in the Streamlined Sales and Use Tax Agreement. States that neglect to include such provisions could face a legal challenge from sellers.