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States Can Require Out-of-State Sellers To Collect State Sales Taxes

On Behalf of | Oct 8, 2018 | Business Litigation

South Dakota v. Wayfair, Inc., ___ U.S. ___, No. 17-494 (21 June 2018)

When a consumer purchases goods or services, the consumer’s State often imposes a sales tax.  The question before the Court was whether a State can require an out-of-state seller to collect and remit the tax.  Previously, the Supreme Court held that a State can require an out-of-state seller to collect and remit sales tax only if the seller has a physical presence in the State.  The mere shipment of goods into the consumer’s State following an order from a catalog did not satisfy the physical presence requirement.  National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967); Quill Corp. v. North Dakota, 504 U.S. 298 (1992).  That rule was applied to sales made over the Internet.  It has been estimated that Bellas Hess and Quill cause the States to lose between $8 and $33 billion every year.

Like most States, South Dakota has a sales tax that requires sellers to collect and remit the tax to the State’s Department of Revenue.  In 2016, South Dakota enacted a law requiring certain remote sellers to collect the sales tax.  The legislature found that the inability to collect sales tax from remote sellers was seriously eroding the sales tax base and causing revenue losses and imminent harm through the loss of critical funding for state and local services.  South Dakota’s law requires out-of-state sellers to collect and remit the sales tax as if the seller had a physical presence in the state.  The Act applies only to sellers annually delivering more than $100,000 of goods or services into the State or engaging in more than 200 separate transactions for delivery of goods or services into the State. 

The respondents are three, out-of-state, online sellers having no employees or real estate in South Dakota who sell and deliver substantial amounts of goods and services into South Dakota.  These out-of-state sellers do not collect or remit the state sales tax.  South Dakota sued the sellers in state court seeking a declaratory judgment and an injunction requiring the sellers to register for licenses to collect and remit the sales tax.  The sellers moved for summary judgment based on Bellas Hess and Quill, and the trial court granted summary judgment to the sellers.  The South Dakota Supreme Court affirmed. 

The result was different in the U.S. Supreme Court.  The Supreme Court overruled Bellas Hess and Quill, vacated the South Dakota judgment, and remanded for further proceedings to address any remaining claims regarding application of the Commerce Clause in the absence of Bellas Hess and Quill.

The Constitution grants Congress the power to regulate commerce among the several States. Art. I, §8, cl. 3.  If Congress exercises its power to regulate commerce by enacting legislation, then the legislation controls. Southern Pacific Co. v. Arizona ex rel. Sullivan, 325 U.S. 761, 769 (1945).  In some instances, the Commerce Clause limits State regulation of interstate commerce even in the absence of federal legislation; but not always.  Absent federal legislation preempting the States, the Supreme Court has said that in some circumstances the States and Congress have concurrent power to regulate commerce.  This interpretation of concurrent regulatory power can be traced to Gibbons v. Ogden, 9 Wheat. 1 (1824) and Wilson v. Black Bird Creek Marsh Co., 2 Pet. 245 (1829).  If a subject by its nature imperatively demands a single, national, uniform rule, then only Congress can regulate Commerce; but if the subject permits diversity that can only be met by local necessities, then the states can regulate. 

The Court’s precedents rest upon two primary principles.  First, state regulations may not discriminate against interstate commerce; and second, States may not impose undue burdens on interstate commerce. Grenholm v. Heald, 544 U.S. 460, 476 (2005); Pike v. Bruce Church, Inc., 397 U.S. 137, 142 (1970).  The Court will sustain a state tax if 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 that the State provides. Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977).

In this case, the Court said that physical presence is not necessary for an out-of-state seller to have a sufficient “nexus” with the taxing state.  It has long been settled that the sale of goods or services has a sufficient nexus to the State in which the sale is consummated to be treated as a local transaction taxable by the State. Oklahoma Tax Comm’n v. Jefferson Lines, Inc., 514 U.S. 175, 184 (1995).  The imposition on the seller of the duty to insure collection of the tax from the purchaser does not violate the Commerce Clause.  McGoldrick v. Berwind-White Coal Mining Co., 309 U.S. 33, 50, n. 9 (1940).  There just must be a substantial nexus with the taxing state. Complete Auto, supra, at 279.  Moreover, it is settled law that a business need not have a physical presence in a State to satisfy the demands of due process. Burger King Corp. v. Rudzwicz, 471 U.S. 462, 476 (1985).  Physical presence is not necessary to create a substantial nexus.

The physical presence rule of Quill and Bellas Hess puts both local businesses and many interstate businesses with physical presence in the State at a competitive disadvantage relative to remote sellers.  The Court said that “when the day-to-day functions of marketing and distribution in the modern economy are considered, it is all the more evident that the physical presence rule is artificial in its entirety . . . . Between targeted advertising and instant access to most consumers via and an internet-enable 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.”  Today, online businesses often have “substantial virtual connections to the State.”  The Court concluded that Quill and Bellas Hess “must give way to the far-reaching systemic and structural changes in the economy and in many other societal dimensions caused by the Cyber Age . . . . The Internet’s prevalence and power have changed the dynamics of the national economy.”

This was a five-to-four decision but with a different division of the Justices than the usual political split.  Justice Kennedy wrote the majority opinion, joined by Justices Thomas, Alito, Gorsuch and Ginsburg.  Chief Justice Roberts wrote a dissenting opinion joined by Justices Breyer, Sotomayor and Kagan.  It was like the king and queen changing sides on the chessboard.

John Polk is a Special Counsel at Berenzweig Leonard, LLP. John can be reached at [email protected].