Posted on June 13, 2018
Demand Drives Definition
As many states continue to deal with budget deficits and seek expansion of the reach of the sales tax as a means of increasing revenue, how states define nexus is evolving. Nexus can be defined as a connection with a state. Typically, we think of this connection as established through people or property physically located within a state. Its impact on state taxes becomes ever more cumbersome and technical as states look to expand the physical definition and morph it into that of an economical one as well. With economic nexus, physical presence is not required; a business may simply have nexus through a specified number or dollar threshold of sales delivered into that state.
The more taxpayers collecting and remitting sales tax to the state, the higher the state’s revenue from sales taxes. It is no wonder that states wish to maximize their reach in expanding the tax base.
Historically, the definition of nexus as defined by the courts hinges on a limited number of tax cases held by the U.S. Supreme Court. Two such U.S. Supreme Court cases are cornerstones: National Bellas Hess, Inc. v. Department of Revenue of Illinois and Quill Corp. v. North Dakota.
In National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967), the U.S. Supreme Court held that the imposition of a use tax collection responsibility on mail order companies that did not have tangible (physical) presence in the state is unconstitutional.
National Bellas Hess was an out-of-state mail order company with its principal place of business in Missouri. National Bellas Hess only had a connection with Illinois (in-state) customers through common carrier or U.S. mail. National Bellas Hess had no tangible property in Illinois, had no sales outlets, representatives, or even telephone listing or advertising in Illinois. Twice a year, catalogues were sent to customers throughout the U.S. and supplemental occasional flyers were sent. All orders were mailed to the Missouri location where goods were then sent to customer by mail or common carrier.
The Illinois Supreme Court issued a judgment requiring National Bellas Hess to collect and pay the use tax imposed by Illinois consumers. The U.S. Supreme Court upon hearing the case held that the Commerce Clause prohibits a state from imposing the duty of use tax collection and payment upon a seller whose only connection with customers in the state is by common carrier or by mail.
Citing the 14th Amendments’ Due Process Clause, a definite link or minimum connection is required between a state and the person, property, or transaction which the state wishes to tax. In this case, the Court found that physical presence within a state satisfies the requirement of Due Process.
The other milestone case of notoriety in the tax world is Quill Corp. v. North Dakota, 504 U.S. 298 (1992) in which the State of North Dakota argued that Quill’s (a direct marketer’s), economic presence in the state met both the Due Process Clause and the Commerce Clause requirements as they relate to nexus.
Quill Corporation was an out-of-state mail order house with neither outlets nor sales representatives in the state of North Dakota. North Dakota filed an action in state court requiring Quill to collect and pay use tax on goods purchased for use in the state of North Dakota.
Ruling in Quill’s favor, the trial court found the case indistinguishable from National Bellas Hess and held that a similar Illinois statute violated the 14th Amendment’s Due Process Clause and created an unconstitutional burden on interstate commerce. The state also based its case on commercial and technological innovations which impacted the “bright-line” test of physical presence and stated Bellas Hess was therefore obsolete.
Siding with Quill, the U.S. Supreme Court reaffirmed the physical presence standard for nexus and also further distinguished the Due Process and Commerce Clause nexus standards. They overruled Bellas Hess and stated that a taxpayer’s “purposeful availment” of the marketplace satisfied the minimum contacts requirement, thus affirming economic presence. The Court also determined that the Commerce Clause still requires “substantial nexus,” in other words physical presence, that is not de minimis to avoid an “undue burden” on interstate commerce. The Court closed by calling Congress to action if it wanted a different result.
Fast forward a quarter of century and what has changed since Quill?
The advent of the publicly available World Wide Web August 6, 1991, brought with it a rapidly expanding internet sector of the market that accounts for 6.5 percent (in 2016) of real Gross Domestic Product (GDP).
The Bureau of Economic Analysis estimates show that the digital economy has been a beacon in the U.S. economy as evidenced by an annual growth rate of 5.6% per year from 2006 to 2016 when compared to 1.5% growth in the overall economy during the same period. Accounting for $1.2 billion of current-dollar GDP in 2016, the digital economy ranked just under professional, scientific and technical services.
The world in which we live has changed dramatically since 1991. We are operating in a technologically divergent galaxy when compared to the days of mail-order catalogues, door-to-door salespeople, and traditional brick and mortar stores. If we desire something, all we simply need to do is to turn to our electronic devices to obtain the goods. We physically do not need to leave the confines of our homes to enact a transaction with a seller operating in another state. The economy and consumers rely on digital technology in ways that could not have been imagined decades ago. As technology continues to boom, sales increase and the sales tax transaction grows more complex as each state seeks a portion of its claim.
Federal Proposed Legislation
Since 2005, a number of proposed Acts have surfaced regarding federal legislation aimed at impacting the tax area. They include: Sales Tax Fairness and Simplification Act, Main Street Fairness Act, Marketplace Equity Act, Marketplace Fairness Act, Remote Transactions Parity Act, Online Sales Simplification Act, No Regulation Without Representation Act. None of them have been passed.
Streamlined Sales Tax
With no required uniformity amongst the states, each is left on its own to determine which goods, services and entities it will tax. As a business taxpayer, the differences from state to state require an astute understanding of the collection and reporting mechanisms and methodologies. Sales tax definitions and software used to report taxes to states can be as diverse as the topography of the states themselves. Monthly, the corporate tax professional must interact with a myriad formats, forms, rules, and website styles in order to remit sales tax collected to each state on a timely basis.
In March 2000, the Streamlined Sales Tax Project (SSTP) was formed with the goal of finding solutions for the complexities in state sales tax systems as a result of the U.S. Supreme Court holding in Quill. The resulting Streamlined Sales and Use Tax Agreement (SSUTA) became effective October 1, 2005. To date, 24 states have adopted SSUTA which provides for uniform definitions, administrative simplifications, as well as technology and collection models.
With a movement toward standardized definitions and systems, states are becoming increasingly (although somewhat) more consistent over the years. The tax professional has seen noticeable systems modifications and platform changes of many states in recent years. As an industry, tax is a long way from uniformity amongst all the U.S. states and taxing authorities, but much progress has been made.
Present Day Landmark Decision Awaits
Fast forward to April 17, 2018. The U.S. Supreme Court is making national news as it hears oral arguments in the case of South Dakota v. Wayfair, Inc. et al. Why South Dakota? Let’s back up and summarize the sequence of events leading up to the present-day landmark case.
On March 22, 2016, South Dakota enacted legislation (S.B. 106) effective April 1, 2016, that provided for companies to collect and remit South Dakota use tax on transactions even if they had no physical presence in the state (also known as remote seller registration) and if they had in the current or prior year sales (gross revenue) of $100,000 of tangible personal property, electronic products, or services delivered into the state of South Dakota or had 200 separate transactions of tangible personal property, electronic products, or services delivered into the state. South Dakota effectively stated anyone who had sales into the state at this volume would have nexus and would have to register, collect, and remit tax to South Dakota.
On April 28, 2016, the South Dakota Department of Revenue (SDDOR) filed suit in state court against several large online retailers who did not register to collect and remit South Dakota sales tax. The retailers listed in the suit were Wayfair, Inc.; Systemax, Inc.; Newegg.com, Inc.; and Overstock.com, Inc. As a result, May 25, 2016, the retailers filed a Notice of Removal asking the case to be transferred to federal court due to the assertion that the case questions federal law.
On July 22, 2016, the state filed a Motion to Remand asking for the case to be heard in state court not federal court due to jurisdiction. On Jan. 17, 2017, the federal court granted the state’s remand which brought the case back to the state court.
On March 6, 2017, the South Dakota Sixth Judicial Circuit Court ruled in favor of the online retailers on the grounds of lacking physical presence in South Dakota under Quill. Furthermore, the court held that S.B. 106 failed to satisfy Quill’s physical presence requirement and failed the Commerce Clause application. In the precipice of mounting legal escalation, the South Dakota Supreme Court upheld the lower court’s decision and asserted S.B. 106 unconstitutional under Quill and stated “…Quill has not been overruled.” On Janunary 12, 2018, the U.S. Supreme Court granted South Dakota’s petition for a writ of certiorari.
Oral arguments proceeded April 17, 2018, at the U.S. Supreme Court in South Dakota v. Wayfair, Inc. At the heart of the issue is whether the U.S. Supreme Court should repeal Quill Corp v. North Dakota’s sales tax only physical presence requirement.
Presently, as we await the U.S. Supreme Court’s next steps and opinion in the case of South Dakota v. Wayfair, Inc., et al, much contemplation and speculation has emerged as to the direction and impact of this case. For the last two years, a number of other states have enacted similar legislation as South Dakota and are currently awaiting enforcement of such legislation pending the outcome of Wayfair. Alabama, Colorado, Indiana, Maine, Mississippi, North Dakota, Pennsylvania, Tennessee, Vermont, Washington, and Wyoming hang in the balance of the pending litigation as these states have attempted enact similar nexus laws not requiring physical presence.
Quill has been the foundation upon which remote sellers have been grounded as it requires physical presence as a factor for which states have the ability to tax sales. Quill has also been the limiter that prevents states from taxing this base of online or remote retailers. Quill is the center of attention even today as the U.S. Supreme Court ponders over the oral arguments before arriving at a decision in South Dakota v. Wayfair, Inc., et al. As of June 8, 2018, a decision has not been announced by the U.S. Supreme Court, but one is expected soon.
Impact of Pending U.S. Supreme Court Decision
Since April 2018, speculation among tax professionals is being discussed on the merits of the case and interpretations of those who listened to the oral arguments. A perceived division of opinions of the U.S. Supreme Court justices seems to be the consensus with some tax and legal professionals calling it for South Dakota and some for Wayfair et al. We eagerly await word from the U.S. Supreme Court regarding the outcome of this case.
The impact of the effects of Quill being overturned has great magnitude as it relates to the basis for sales tax registration, collection, and remittance as we know it today. Imagine a U.S. where all transactions are subject to sales tax regardless of where the seller is located (or not), where online sellers will be forced to register in all taxing states and take on the compliance aspect of not only registering but also collecting tax at rates associated with all of the approximately 10,814 (as of October 2017) U.S. state and local taxing authorities and the related administration of filing returns on a monthly basis, making prepayments as required, collecting resale and exemption certificates in all states as applicable, and being subject to sales and use tax audits in potentially all 45 taxing states and 38 states with local sales taxes.
What will the impact be on such a retailer and can such a retailer absorb the administrative burden and cost of such a new tax world? What will the impact be on consumers? Will the imposition of a sales tax for transactions they have typically seen without tax cause their shopping or sourcing habits to change?
Will nexus be defined as physical presence, economic presence or otherwise? Certainly, we have not seen this type of visibility in the sales tax arena since the Quill decision in 1992. These are exciting times, and we will stay tuned to see what transpires. In the meantime, there are steps that a business can take to review its tax situation, prepare and ensure compliance.
Tips for the Taxpayer
Companies who sell products, services, or electronic goods in the United States will need to stay abreast of the U.S. Supreme Court’s next steps. The impact of this case will more seemingly have ramifications for all parties involved: consumer, retailer, tax professional. Stay updated with the latest legislation and related notices by monitoring state and federal legislation and cases. Understand your business’ footprint from a physical presence perspective and potentially an economic nexus perspective. If you have nexus in a state, you must register to collect and remit sales or use tax. Not doing so can have substantial financial consequences that may affect your bottom line. If questions exist, consult a tax professional for clarity and expertise. Perform a nexus review.
The requirements related to sales and use taxes, a primary revenue source for many states, have become more difficult to comply with, and administer, as sales transactions have become more complicated. The U.S. Supreme Court has ruled that the Commerce Clause under the U.S. Constitution requires “substantial nexus” to force a taxpayer to collect sales and use taxes for a state outside (a nonresident state) of their primary residence. The court defined “substantial nexus” in terms of physical contact. Under this requirement, some direct in-state presence creates the nexus that triggers the imposition of sales or use tax collections requirements.
Despite these protections, states vary greatly in determining what particular types of activity performed within their borders might trigger sales and use tax collection requirements.
Even without a decision of the U.S. Supreme Court on the issue, there is a chance that nexus may be created for your business currently and you may be required to collect sales and use tax on sales in the nonresident state if your business:
• employs or sends a sales person to a nonresident state;
• has a local phone number in the nonresident state that is forwarded to your headquarters;
• maintains a P.O. Box in a nonresident state;
• installs or delivers products in a nonresident state;
• attends a trade show in a nonresident state, and has sales in that state; or
• hires independent contractors in the nonresident state to provide warranty services on property sold in that state.
If you are concerned that you may have created sales and use tax nexus, please contact us at your convenience. We can help you determine if you have a sales and use tax collection requirement and, in the event that you do have a requirement, limit potential penalties and interest.
Contributer: Trisha Davidson
How Can We Help?
Allyn offers tax compliance and consulting services for companies doing business in the United States. Allyn has significant tax experience assisting businesses with nexus reviews, research of taxability, registering businesses with states, and performing opportunity reviews of their sales and use tax processes. As tax laws change, we use our experience to help your business improve compliance, minimize costs, reduce liabilities and increase profits.
We can help your business maintain compliance with federal and state tax responsibilities and put procedures in place to ensure future streamlining of processes and increased data accuracy for tax purposes.
Allyn’s tax team is experienced in all aspects of Federal, state, and local tax compliance and consulting for large US and global corporations. We use that expertise to your advantage.
Allyn files state and local sales and use, property, and license tax returns in every U.S. taxing jurisdiction in addition to excise tax filings such as Federal Excise Tax, Heavy Highway Vehicle Use Tax, and International Fuel Tax Agreement returns. We can manage your tax compliance, create a solid tax process, and provide audit defense for your company.
Contact us for help with nexus, registrations or sales tax return filing, and we can provide a customized cost-effective solution to meet your company’s needs. For further information on Allyn Tax services, please contact: email@example.com.
For More Information
If you are interested in learning more about this topic or other tax topics, please visit our Tax Publications under News and Events at www.allynintl.com.
About Allyn International
Allyn International is dedicated to providing high quality, customer centric services and solutions for the global marketplace. Allyn's core products include transportation management, logistics sourcing, freight forwarding, supply chain consulting, tax management and global trade compliance. Allyn clients range from small local businesses to Fortune 500 firms. Allyn conducts business in more than 20 languages and has extensive experience in both developed and emerging markets. Highly trained experts are positioned throughout North and South America, Europe and Asia. Allyn’s regional headquarters are strategically located in Fort Myers, Florida, U.S.A., Shanghai, P.R. China and Prague, Czech Republic. For more information, visit www.allynintl.com.