17 September 2021 - Article
Possible alternatives for resolution on state sales and use tax nexus
On April 17, 2018 the Supreme Court heard oral arguments in South Dakota v. Wayfair Inc. to consider whether the Court should overturn the dormant Commerce Clause holding of Quill Corp. v. North Dakota, 504 US 298 (1992).1
The Justices focused on three major issues during oral argument including: (1) retroactivity, (2) how much contact is necessary to justify placing the obligation of collecting and remitting state sales tax on retailers, and (3) the concern that Congress, and not the judiciary, is the proper government branch to address this issue.
South Dakota argued that Quill results in (1) a large loss of sales tax revenue from online retailers who lack physical presence within the state, and (2) small businesses within the state, the local brick and mortar businesses, “being harmed because of the un-level playing field created by Quill, where out-of-state remote sellers are given a price advantage.”2
The Court may of course uphold or overturn Quill in its entirety, but we note it may take an intermediary approach such as limiting any new rule to future application (i.e., retroactive application). While the Court could try to throw the issue back to Congress, one could wonder whether this is an indirect overruling of Quill and reversion to the earlier pre Quill tax regimes.3 The Court hopefully, keeps its opinion limited as Quill is guiding precedent in constitutional jurisdictional issues more broadly and is not merely a “tax” case.
Quill Corp. v. North Dakota (1992)
Quill, a 1992 Supreme Court decision, provides that the Constitution's Commerce Clause prohibits states from requiring out-of-state retailers without a physical presence within the state to collect and remit sales tax for goods sold or shipped into the state.
Under Quill, a state can only require a vendor to collect the state's sales tax if the vendor has some physical presence within its boundaries. However, the world of commerce has changed significantly since the Supreme Court expressed concern about the effect of taxation on the mail order industry a quarter century ago. The Quill Court did not foresee the meteoric rise of online retail and e-commerce in the age of millennials and Gen. Z. E-commerce is now approximately 9% of the market and as estimated in the South Dakota's brief, the states will lose approximately US$33.9 billion in tax revenue in 2018, though it should be noted that the figure is hotly debated.4
Since Quill, states have attempted to chip away the Court's decision, employing “aggressive moves to bring taxation within Quill in some way.”5 Recently, Justice Kennedy's concurrence in Direct Marketing Association v. Brohl, invited states to issue new challenges to Quill by questioning whether the physical presence requirement of Quill has been rendered obsolete by the Internet's far reaching systematic and structural changes to the economy.6
In 2016, the South Dakota Legislature passed a law directly challenging Quill by requiring out-of-state retailers to collect and remit sales tax if they sell over US$100,000 of goods or engage in 200 or more separate transactions within a year.7 The law applies to all retailers, including those that do not have a physical presence in the state. The South Dakota law seeks to subject out-of-state sellers to sales tax liability based on an economic presence within the state rather than the physical presence required by Quill.
During the oral argument, it appeared as if the issue of primary importance to the Supreme Court Justices was the retroactivity of a potential decision overturning Quill. Justice Sotomayor quickly raised concerns that the “many unanswered questions that overturning precedents will create a massive amount of lawsuits.”8 One such unanswered question is what retroactive liability sellers may have if the court overturns the physical presence requirement. While South Dakota has specifically ruled out retroactivity in its 2016 legislation, other states could potentially seek retroactive liability. South Dakota provided that “when it comes to retroactivity, the states don't want to address this [issue] retroactively…in the briefing, 38 other states have indicated their laws would prevent retroactivity.”9
The Justices were also concerned about the level of contact a seller would need in order for a state to impose an obligation to collect and remit sales tax, and the standard to review such cases.10 South Dakota indicated that under SDCL § 10-64-2, a single sale was enough to trigger such tax obligations and encouraged the Justices to use the doctrines defined by Complete Auto when it comes to tax assessment: to look for discrimination, apportionment issues, and substantial nexus.11
In particular, Chief Justice Roberts asked the US Deputy Solicitor General, Malcolm Stewart if, as a constitutional matter, there should be a minimum number of sales before a business is subject to the burdens of collecting sales tax for a state's taxing authority.12 Deputy Solicitor Stewart, arguing on behalf of the United States and in support of South Dakota, explained that “there is no constitutional minimum.”13 Specifically, if there is “an out of state retailer who is deliberately selling a particular physical good within the state, shipping the good into the state for delivery to the customer and transfer of title, that is a sufficient basis for subjecting that retailer to the tax collection obligation in the same way that if that single good turned out to be defective, the retailer could be subject to regulatory burdens imposed by the state.”14
Justice Ginsburg followed Stewart's response by asking “isn't that the very kind of question that Congress would be equipped to deal with, establishing a minimum?”15
The Justices repeatedly raised the issue of a Congressional solution during the course of oral argument. For example, Justice Alito posed the following question to South Dakota Attorney General Jackley: “if there are two options, let's say option A is to eliminate Quill and states can do whatever they want with respect to retroactive liability and with respect to the minimum number of sales that are required in the state in order for the sales to be taxed, and option B is a Congressional scheme that deals with all of these problems. If those are the only two options, which is preferable?”16
Jackley responded that option A was better because “Congress has had 26 years to address this issue. And it's not Congress but it's this court's decision, that is striking down our state statutes.”17 Justice Kagan responded that Jackley's answer “gives us pause because Congress could have addressed the issue and Congress chose not to.”18 Further, it is clear that Congress has been aware of this “very prominent issue” for years and has chosen not to do something about that.” As such, the question becomes whether the fact that Congress is aware of the issue and yet has chosen not to act “makes the state's bar higher to surmount.”19
Jackley replied that since Quill involved interpretation of a constitutional provision, the court needs to act and opined that although “sometimes the activity of this court will spur Congress to act, in this instance, it hasn't.”20 Justice Breyer shot back “no, no, but the word 'constitutional' is not magic. The reason that we say we are more willing to overturn a constitutional case is because Congress can't act. But, here, they can act.”21 Justice Breyer further stated that “You are 50 states, if you do not have the power to get Congress to do something, I don't know who would.”22
Justice Ginsburg stepped in and noted that “Quill was this Court's decision and if time has, and changing conditions, have rendered it obsolete, why should the Court which created the doctrine say, well, we'll let Congress fix up what turns out to be our obsolete precedent.”23 Jackley took the argument a step further by suggesting that “Congress doesn't have an incentive in this instance to take action in something that could be perceived as a tax when yet they don’t get the opportunity to use the revenue.”24
As Justice Sotomayor stated “the problem [is] not Quill but the fact that [the states] don't have a mechanism to collect from consumers?”25 Generally, it is not the merchants who pay the sales tax; it is the consumer. The merchants collect the sales tax for the states. If consumers purchase goods outside of the state or from an online vendor without physical presence in the state, the consumer is obligated to pay use tax. However, it is clear that states are struggling with collection of use taxes on the items purchased out of the state or from online retailers without a physical presence in the state. States have yet to “find a way to collect from [consumers].”26
It appears as if the Court has before it, four options:
- first, uphold the decision in Quill;
- second, uphold Quill but request Congress to act;
- third, overturn Quill in its entirety; or
- fourth, overturn Quill but limit retroactivity.
Uphold Quill Entirely.
First, if the Court upholds Quill, the current rule requiring vendors to have some physical presence within a state in order to establish sufficient nexus for a state to require such vendor to collect sales tax will stand. Vendors such as Wayfair or Newegg will not be required to collect sales tax in most states. However, as Chief Justice Robert points out, the “bigger e-commerce companies find themselves with physical presence in all 50 states.” Thanks to Amazon Prime's two day shipping, Amazon's fulfillment centers are located in almost all 50 states, and thus Amazon is required to (and does) collect sales tax in those states. States will also likely continue to develop and employ work-arounds to bring in more [sales tax revenue].27
Uphold Quill But Suggest Congress Act.
Second, if the Court upholds Quill but requests Congress to act it is unclear what may occur. In an amicus brief submitted by Senators Heitkamp, Alexander, Durbin, and Enzi, the Senators argued that Congress is fully prepared to act if Quill is overturned and various state and local tax systems impose a significant burden on interstate commerce. The Senators provided that Congress is the appropriate source of relief as it has the means to collect evidence and craft narrow solutions.28 The Senators claimed that “once freed from the shackles of Quill, Congress is fully prepared to step in when needed” and “broadly restore the power of the states to collect use taxes from out-of-state sellers.” However, the Court has suggested that Congress act in prior state sales and use tax cases, including Quill, and Congress has yet to act in the quarter century since Quill was decided.29
Overturn Quill Entirely.
Third, if the Court decides to overturn Quill in its entirety, the states argue that the new standard under which sales taxes should be determined is a balancing test as established under Pike v. Bruce Church.30 Pike stands for the proposition that where a statute regulates even handedly to effectuate a legitimate public interest, and its effects on interstate commerce are only incidental, it will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits. If a legitimate local purpose is found, then the question becomes one of degree. The extent of the burden that will be tolerated depends on the nature of the local interest involved, and whether it could be promoted as well with a lesser impact on interstate activities. Such a balancing test is rather vague and will likely favor the states and their interests. Further, not all of the states have agreed to limit such a decision on a prospective basis. Some states may attempt to require vendors to collect and turn over sales tax revenue retroactively. It is unclear if such state action would be able reach back to 1992 when Quill was first decided. Therefore, if Quill is completely overturned and the Pike balancing test becomes the new standard, it is likely that a new wave of litigation will begin to determine the limits of state action.
Overturn Quill But Limit Retroactivity.
Fourth, if the Court decides to overturn Quill but limits the application of the holding of the Wayfair case prospectively, then states will likely still attempt to apply the Pike balancing test to determine the constitutionality of their sales tax statutes. While this option is unlikely as it would arguably be an instance of judicial legislation, given the issue of vagueness and lack of certainty discussed above, further litigation will likely arise in an attempt to determine the application and limits of the Pike balancing test.
After an hour of oral arguments, a number of the Justices appeared to be concerned about the potential fallout of a decision overruling Quill and the physical presence requirement. The oral argument seemed to raise more questions than answers about whether such a ruling will upset the settled expectations of businesses across the country and open the floodgates of sales and use tax litigation. An opinion is expected likely on June 28.