By Craig A. Becker, Annie H. Huang, Carley A. Roberts, Marc A. Simonetti, Jeffrey M. Vesely, Andrew D. Appleby, Michael J. Cataldo, Eric J. Coffill, Timothy A. Gustafson, Richard E. Nielsen, Breann E. Robowski, Jessica N. Allen, Nicole D. Boutros, Aruna Chittiappa, Dmitrii Gabrielov, Evan M. Hamme, Mike Le, Robert P. Merten III,
The Supreme Court in South Dakota v. Wayfair, Inc. overruled the “physical presence” requirement as “unsound and incorrect” and ruled that “substantial nexus” is satisfied when an out-of-state seller has sufficient “economic and virtual contacts” with the state. The prior Supreme Court precedent in National Bellas Hess, Inc. v. Department of Revenue of Illinois and Quill Corp. v. North Dakota required out-of-state sellers to collect and remit sales/use tax on retail sales of certain tangible personal property and services only if the seller had “physical presence” with the state.
The South Dakota sales tax statute at issue challenged the “physical presence requirement,” requiring out-of-state sellers to collect and remit sales tax if the sellers annually deliver more than $100,000 of, or 200 or more separate transactions for the delivery of, goods or services into the state. The statute does not apply retroactively. The Court reversed the South Dakota Supreme Court’s finding that the South Dakota statute violated the “substantial nexus” prong of the Commerce Clause analysis from Complete Auto Transit, Inc. v. Brady.
Nexus – The Court holds that the South Dakota law satisfies the Commerce Clause “substantial nexus” requirement based on the “economic and virtual contacts” with the State. As a result, the Court’s newly expressed standard is the only standard for Commerce Clause limitation on state taxation based on “substantial nexus.” However, the decision does not resolve whether any presence less than the $100,000 of receipts, or 200 transactions for goods or services into a state, survives Commerce Clause “substantial nexus” scrutiny. The Court’s decision may have far reaching consequences in the state and local tax landscape (i.e., income, franchise, excise, etc.)
The Court held that Quill was wrongly decided for three reasons: (1) the Quill Court upheld National Bellas Hess because of stare decisis and that the physical presence rule was not a “necessary interpretation” of the substantial nexus requirement; (2) the “physical presence” requirement is arbitrary and formalistic, and overlooks current economic realities (i.e., the explosion of online retail commerce); and (3) Quill has caused “market distortions” and what the Court perceived to be “judicially created tax shelter[s].” The Court spent significant time underscoring the inequitable results achieved by the “physical presence” rule, articulated in National Bellas Hess and Quill. The Court anchored its analysis in its desire to eradicate “artificial competitive advantages” it created for online retailers.
Retroactivity – The Wayfair decision does not prohibit the retroactive application of this new standard for Commerce Clause “substantial nexus.” Further, the Court expressly states that the issue of retroactivity is not resolved by the decision (not litigated or briefed) and may be addressed on remand. The Court, in fact, appears to acknowledge that retroactivity is a concern that may result in unfair apportionment because of double taxation. The Wayfair proceedings, on remand, likely will not have to address this issue because the South Dakota law is not retroactive.
Remand – The Court remands the case for trial on the remaining three prongs of the Commerce Clause analysis from Complete Auto, which requires that a tax (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. The Court states that the taxpayer may, on remand, challenge whether the South Dakota law results in unfair apportionment, discriminates against interstate commerce, or imposes an undue burden on interstate commerce. However, the Court proceeds to describe the features of the South Dakota law that are designed to prevent any possible violation – no retroactivity, small business safe harbor, and compliance with the Streamlined Sales and Use Tax Agreement.
The dissent, penned by Chief Justice Roberts, argued that overturning Quill’s physical presence standard requires congressional and not judicial action. The dissent notes that the majority’s disregard for stare decisis contradicts decades of case law that dictates its application in this instance. That is, while the Court may depart from stare decisis in cases where only the Court may act, a higher standard applies to depart from stare decisis in cases where Congress may legislate, like in Commerce Clause cases. Instead, the majority’s departure from stare decisis may have a (1) chilling effect on congressional action, including three pending bills; and (2) dampening effect on commerce in new markets. Further, Chief Justice Roberts reasoned that Congress is the right place for the debate and analysis because it “has the flexibility to address these questions in a wide variety of ways.” Finally, the dissent notes that the Court’s decision will disproportionately burden small businesses that could be subject to collection obligations in over 10,000 jurisdictions.
Rule of Law - The decision strikes a blow to the U.S. Supreme Court’s stare decisis jurisprudence. As the authority cited by the dissent makes clear, the Court should have abided by stare decisis because Congress was able to correct any mistake in Commerce Clause jurisprudence (if necessary). The decision seems to create an additional basis for overturning prior precedent that is not clearly defined.