The Wayfair Story: Expansion of U.S. State Sales Tax Rules

The Wayfair Story: Expansion of U.S. State Sales Tax RulesOn June 21st, 2018, the U.S. Supreme Court issued its Wayfair opinion which was decided by 5-4 in favour of the State of South Dakota. This case is important due to the “disruptive technologies” which are permeating the current business environment. Presently there are 45 states which impose sales tax on the sale of tangible personal property, subject to various exemptions.

A trip down memory lane….

Once upon a time there was a corner store with bricks and mortar operations in state X. It was readily apparent that the corner store had a physical presence1 in the state and as such it was required to collect sales tax on sales to customers and remit these sales taxes to State X. As a result, most states relied on a physical presence test to determine if a vendor was required to collect and remit sales tax in a specific state.

This was all fine, good, and straightforward and then came the internet. Wayfair, Amazon, Overstock and other online retailers didn’t have a physical presence in State X, but sold goods over the internet to customers in State X. As the sellers didn’t have a physical presence in State X, they were not required to collect/remit state sales tax. This was the judicial law which had been decided by various decisions such as Quill and National Bellas Hess which provided that a seller was required to have a physical presence in a state before it was required to collect sales and use tax.

Question in the back of the room ….”So let me get this straight, as a consumer I could buy goods from my corner store and pay additional sales tax or I could buy the goods online and not pay sales tax? Sounds like the consumer is saving money! Where do I sign up?” Answer: That’s correct, but technically the consumer should self-assess use tax in that situation….

As a result of losing out on sales tax revenue in the new economy, various states while maintaining their physical presence standards added economic nexus standards. Although these standards varied on a state-by-state basis, they typically provided that a seller had economic nexus in State X if it sold more than a fixed dollar amount (e.g., US$100,000) of product within the state during the year. Sellers who meet the economic nexus standards would be subject to sales tax withholding and remittance requirements.

In 2016, South Dakota became the first state to adopt a pure economic nexus standard. Its rules provided that if a seller had South Dakota sales in excess of US$100,000 or had more than 200 separate sales transactions in the state, then the seller was required to collect and remit South Dakota sales tax. In 2017, The South Dakota economic nexus standards were litigated by Wayfair and ultimately the South Dakota Supreme Court found that these economic nexus rules were inconsistent with the physical presence case law which had been established by the U.S. Supreme Court decades earlier in Quill and National Bellas Hess. As a result of the South Dakota Supreme Court ruling, out-of-state sellers were not required to collect tax on sales to South Dakota customers.

The plot thickens…

The State of South Dakota, unhappy with this result, appealed the case to the U.S. Supreme Court. The U.S. Supreme Court in its 5-4 opinion, overruled Quill and National Bellas Hess as unsound and incorrect and struck down the physical presence standards. Notwithstanding that this was a close decision, based on the 5-4 opinion, no Supreme Court justice defended the physical presence standard.

The Court concluded that while there is still a substantial nexus requirement for sales tax purposes, this requirement may be met with physical or economic nexus.

Where do we go from here?

The U.S. Supreme Court has remanded this case to the State of South Dakota to ensure that the U.S. Supreme Court’s ruling is constitutional under South Dakota law. There will be a bit of wait and see while the SD Supreme Court rules on this matter.

Many companies will not be selling to South Dakota customers due to the small population in the state. The bigger issue is that 15 additional states have adopted economic nexus standards and many of these states have been waiting for resolution of Wayfair prior to enforcing these standards. In addition, it is expected that additional states will also adopt economic nexus rules.

While Wayfair is a sales tax case, it has implications for state corporate income taxes as well. Many companies will have economic nexus in various states, but currently take the position that they are not subject to income tax within a specific state as the company does not have a substantial presence. In light of Wayfair, companies may want to consider whether economic presence in a specific state is sufficient to require the company to file a state income tax return.

Implications to Canadian Sellers

Many Canadian companies which have sold tangible property to U.S. purchasers have taken the long-held position that sales tax is not required to be collected from customers nor remitted to the respective state tax authorities in situations where the Canadian seller does not have a physical presence within the state in question. The Wayfair ruling disrupts this position.
While it may be possible for a foreign seller to argue that this ruling discriminates against them and creates an undue burden, it will be difficult for a “small” Canadian seller to litigate this issue.

Furthermore, the ruling in this case provides an opportune moment in time for a Canadian seller to also reassess whether it has state income tax filing requirements in light of the repeal of the physical presence standards.

In summary, state sales tax nexus rules are evolving in a manner similar to that of the corner store. While the physical presence rules still apply, these rules are being expanded by economic nexus rules in the face of the digital economy.

Companies who have taken the position that they did not have nexus within a specific state due to a lack of physical presence should reconsider this position in light of the economic nexus standards imposed by Wayfair.

1 Nexus

The concept of nexus represents the minimum contacts that a business must have within a state in order to subject the business to sales and/or income tax within that state. It is determined on a state-by-state basis and the nexus criteria differs for sales tax versus income tax purposes. As noted in this blog, these nexus rules have typically focused on physical presence in a specific state, but the “new economy” economic nexus ruling from Wayfair may subject a seller to sales tax collection and remittance requirements in the absence of a physical presence within a state.

Author

Alan Tippett, CPA (Indiana)
Director of U.S. Tax Advisory Services
atippett@welchllp.com
613-236-9191 #254