Paul L. Caron

Friday, June 22, 2018

Holderness: South Dakota v. Wayfair — The More Things Change

Holderness (2017)Following up on yesterday's post, Law Profs Weigh In On Supreme Court's Wayfair Decision Clearing The Way For Sales Tax Collections From Out Of State Online Retailers:  TaxProf Blog op-ed:  South Dakota v. Wayfair: The More Things Change, by Hayes Holderness (Richmond):

After the better end of fifty years, the physical presence rule is out. That rule, originally established in the 1967 National Bellas Hess case, prevented a state from compelling a vendor not physically present in the state to collect the state’s sales and use taxes. Though the Court reaffirmed the physical presence rule in its 1992 Quill decision (largely on stare decisis grounds), the rule had been constantly derided by commentators, states, and Main Street retailers as failing to achieve the goals of the Commerce Clause and as providing an unfair advantage to mail order and internet vendors. Yesterday, the Supreme Court issued its decision in South Dakota v. Wayfair and made clear that those critics had been heard.

Justice Kennedy—who originally invited South Dakota’s challenge to the rule—pounded the physical presence rule relentlessly, firmly establishing that it has no place in modern dormant Commerce Clause jurisprudence. And in this way, the Wayfair decision represents a big shift for state taxation. No longer should states feel the need to enact click-thru nexus, attributional nexus, and cookie nexus rules designed to assign some scintilla of physical presence to digital actors in order to cross an arbitrary line. Or should they? After its powerful takedown of the physical presence rule, the Court found itself a bit at sea. The Court barely took on the task of articulating the Commerce Clause nexus standard despite hinting at times that Pike balancing might apply or that the standard is closer to due process nexus standards. Instead, the Court opted to establish a safe harbor based on the South Dakota model before claiming that the dormant Commerce Clause is satisfied when the vendor “‘avails itself of the substantial privilege of carrying on business’ in [the taxing] jurisdiction.” Future litigation is surely in store as states venture out of the South Dakota safe harbor, which appears to require not only the South Dakota statute’s sales thresholds and retroactivity prohibitions but also membership in the uniformity-seeking Streamlined Sales and Use Tax Agreement and reduced audit risk for vendors making good faith compliance efforts. Look for states with large consumer bases (e.g., New York, California, Texas) as those most likely not to port in the South Dakota safe harbor. Physical presence won’t be the end goal, but perhaps cookie nexus won’t crumble away just yet.

Discarding bad law is a noble venture, but what does the Wayfair decision mean on the ground? It is not a panacea for the states. The uncollected tax revenue under the physical presence rule was never all that much—around 3 to 4 percent of total state revenues by some measures—and appeared to be declining as states adopted their new nexus laws and bigger vendors like Amazon began collecting in more states. That said, 3 to 4 percent isn’t nothing, so hopefully states will find their legislated tax policies less frustrated as this revenue comes in. If consumers really care about the tax bump they will see on some online purchases, they can lobby their state or federal legislators to exempt those sales from taxation.

The real force of the decision is on the doctrinal side, and it leaves a lot of room for state tax practitioners to earn their keep. As noted, the floor for Commerce Clause nexus is now quite vague and at least some states should be expected to venture out of the South Dakota safe harbor in search of that floor. Also, the Court seems to have casually discarded old rules about state nexus with the activity taxed (as opposed to with the taxpayer or collector) in claiming that “[a]ll concede that taxing the sales in question here is lawful.” When, where, and why did “all” concede this point? It is far from established that sales consummated outside of the state can be lawfully taxed; traditionally, the mere delivery of a sold product into a state by common carrier has not met that nexus standard. The future scope of this “transactional nexus” is important; requiring that nexus has been one of the main ways that states’ taxing powers are limited to their borders and casting it aside may place significant pressure on ill-prepared apportionment rules. From a broader view, this case shows that the Court can be convinced to overturn bad dormant Commerce Clause precedent rather than wait indefinitely for Congress to act. This should embolden states to challenge judicial rules they don’t like; even so, it took fifty years to get the Court to discard the physical presence rule, so Congress may still be the better avenue on most issues.

Wayfair is undoubtedly an important decision, but in light of recent state laws chipping away at the physical presence rule and the relatively small amounts of revenue in play, the decision will likely come to be viewed more as a correction of an archaic legal rule rather than as fundamentally changing the world of state taxation. Remote vendors and state revenue agencies will still fight over nexus, states will continue to adopt innovative (sometimes too innovative) tax collection laws, and consumers won’t pay their use taxes when purchasing from vendors with no collection obligations. The more things change, the more they stay the same.

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Kennedy's opinion is puzzling, and perhaps derives from some sloppiness in the SD statute. That statute seems to impose a sales tax on a sale from an out-of-state seller, rather than a use tax obligation on that seller, and it is that statute that the Court sustained. A use is not a transaction at all, and a use tax is not imposed on a transaction. This is not necessarily a distinction without a difference.

Posted by: Mike Petrik | Jun 29, 2018 4:21:28 AM

Right, there is a distinction, but Kennedy is saying both a sales tax and a use tax are a tax on the transaction. Everyone (including Wayfair) agrees the use tax is constitutional, so everyone (including Wayfair) agrees the transaction is taxable (via a use tax).

Posted by: Anonymous | Jun 28, 2018 7:53:21 AM

Yes, use taxes are clearly constitutional, but the South Dakota law only requires the collection of sales taxes, which--if you take the old doctrine at its word--means that even though Wayfair lost on physical presence, South Dakota still can't collect anything because it lacks transactional nexus with the out-of-state sales. (That assumes that Wayfair was delivering using a common carrier.) That is why it is strange that Wayfair would concede the sales were taxable, if it did. I recognize this relies on a highly formalistic distinction between sales and use taxes, but that distinction exists in the case law. Of course, this issue is easily fixed for South Dakota by expanding its law to cover use taxes as well. For more on this argument, please see an article I co-authored before cert was granted in Wayfair:

Posted by: Hayes Holderness | Jun 26, 2018 3:10:20 PM

In the middle of the penultimate paragraph, where you ask when, where, and why "all" concede that the transaction is taxable, it sounds like you are saying the use tax, and not just the sales tax, is potentially unconstitutional. Is that what you're saying? Because certainly no one argued that in the case (which is Kennedy's point: the use tax is unchallenged, so the only issue is the sales tax).

Posted by: Anonymous | Jun 25, 2018 6:18:39 AM

I dunno. This is the same sort of thing that people said after International Shoe, which had a similar effect on the physical presence rule in personal jurisdiction.

Posted by: Anonymous | Jun 23, 2018 6:04:35 AM