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On June 21, 2018, the U.S. Supreme Court ruled 5-4 in favour of allowing South Dakota to impose an e-commerce sales tax by Wayfair Inc. (“Wayfair”), a large online furniture and décor retailer, to customers located in South Dakota.
Wayfair has no physical presence in South Dakota. It did not have any employees, agents or inventory in the state. It had relied on two earlier Supreme Court cases. The latter of the two cases, Quill vs. North Dakota (“Quill”) decided in 1992, held that the mere shipment of goods into the consumer’s state following an order from a catalog as not satisfying the “physical presence test” necessary to create a state tax nexus (i.e. the ability of the state to tax the company or its sales to customers in the state).
The Supreme Court’s ruling in Wayfair has broad implications to Canadian companies selling goods and, possibly, services into the U.S. In order to explain the impact of the law, the following Frequently Asked Questions are answered below.
What was the U.S. Supreme Court’s rationale in overturning Quill in the Wayfair decision?
Does this ruling mean that all e-commerce sales will require the collection of sales tax?
Does the ruling only impact e-commerce or will it have more far-reaching effects?
Will the new rules apply in all states that have a sales or use tax?
Will states be able to retroactively apply the sales tax to any or all years prior to the ruling?
Does the ruling apply to sales of goods used in a manufacturing process or to goods for resale?
Will companies have to file multiple sales tax returns in various jurisdictions?
How do the states hope to enforce the new rules?
What was the U.S. Supreme Court’s rationale in overturning Quill in the Wayfair decision?
The Court believed that the proliferation of electronic commerce has made “the physical presence rule…further removed from reality and results in significant revenue losses to the state”. It believed that the ruling in Quill “creates rather than resolves market distortions”.
Statistics were quoted stating that the “physical presence” standard causes states to lose between $8 billion and $33 billion in much needed revenue every year. The court partially attributed the decline in “bricks and mortar” retailing to the sales tax advantage provided to internet shoppers.
Does this ruling mean that all e-commerce sales will require the collection of sales tax?
Justice Kennedy, in drafting his opinion, did not give states an unrestricted ability to tax internet sales. The opinion specifically endorsed the South Dakota system as not providing “undue burdens on interstate commerce.” Under the South Dakota rules, a seller needed to have at least 200 separate transactions or $100,000 in revenue from the state in the current or previous tax year for the rules to apply.
The Court also felt the ruling is appropriate, as South Dakota legislation precluded the imposition of a retroactive sales tax.
Finally, the issue which weighed in favour of South Dakota, is that, it is one of more than 20 states that have adopted the Streamline Sales and Use Tax Agreement, which standardizes rules and rates and provides a single level of tax administration. The approach reduces sellers’ burdens which would otherwise provide a significant impediment to interstate commerce, which is a constitutional right under the Commerce Clause.
Does the ruling only impact e-commerce or will it have more far-reaching effects?
The ruling specifically overturned Quill and an earlier ruling called the National Bellas Hess case, which imposed the physical presence standard. Therefore, it is reasonable to conclude that various states may look to tax high volume sellers in their states, whether or not sales are made over the internet.
Will the new rules apply in all states that have a sales or use tax?
Currently, a handful of states already have rules taxing e-commerce on the books, a heightened enforcement initiative should be anticipated.
Certain states that tax electronic commerce, have rules which do not conform to the three criteria set forth in the answer to question number 2 above. For example, Virginia does not have a quantitative threshold for the rules to apply.
The Court was clear that it did not want the decision to adversely impact start-ups and small businesses. Additionally, the Court did not want the ruling to create unreasonable barriers for interstate commerce.
One would reasonably expect that states which have e-commerce laws, to attempt to align those rules with the criteria established by the Supreme Court in its narrow decision. Failure to align with the criteria could lead to further expensive legal challenges.
States which are not currently taxing internet sales will almost certainly pass legislation to create this new source of revenue and will likely conform to the Court’s criteria.
Will states be able to retroactively apply the sales tax to any or all years prior to the ruling?
It is anticipated that states with internet sales tax rules will enforce the rules immediately. One expects that many of these states will enact a “tax amnesty” period for taxpayers to voluntary disclose tax information, followed with an enhanced penalty regimen for those subject to the tax who have not complied.
The Court’s ruling implicitly suggested that states should not be able to legislate a retroactive tax on internet sales.
Does the ruling apply to sales of goods used in a manufacturing process or to goods for resale?
As previously noted, the elimination of the “physical presence” test increases the number of taxpayers subject to sales compliance and remittance to a state. Exempted sales, such as sales for resale and sales of goods used in a manufacturing process, in states which allow the latter exemption, may not require the collection of sales tax.
However, sales tax returns reporting no liability are required to be filed periodically, failing which states can assess nuisance statutory penalties.
In the last few years, Florida has begun imposing a $400 annual penalty for late filed corporation income tax returns and using this penalty as a revenue source. States desperate for revenue will look towards noncompliance penalties as a robust source of revenue. Therefore, compliance should be considered even in the absence of taxability.
Will companies have to file multiple sales tax returns in various jurisdictions?
Possibly. However, if there is a silver lining in this cloud of a decision, it is that the court specifically endorsed the simplification of filing through South Dakota’s adoption of the Streamlined Sales and Use Tax (“SST”) Agreement, as a favourable factor in determining that the ruling did not create unreasonable compliance barriers in contravention of the Commerce Clause.
The SST standardizes rules and rates, and provides a single level of tax administration for all states to adopt. It would make sense for any state wishing to check all of the Supreme Court boxes, for having a fair tax on internet sales to adopt the SST. Failure to do so could subject the tax to a costly and risky challenge. However, relinquishing a state’s sovereign rights is an anathema to many Americans. Therefore, time will tell.
How do the states hope to enforce the new rules?
The likely first mode of attack, will be to get records for online payment processors, such as PayPal. Vendors who do not use traditional payment processors, should not believe that they are beyond enforcement. Traditionally, states have been extremely creative and successful in identifying out-of-state noncompliance.
How can Zeifmans help?
Your Zeifmans advisor can provide guidance navigating the tax rules and help with the required compliance.
For more information, please contact your Zeifmans advisor today or Stanley Abraham, U.S. Tax Partner at 647.256.7551 or sa@zeifmans.ca.
