Tax Strat­egy: What’s at stake for re­tail­ers from Wayfair

Accounting Today - - Contents - BY MARK FRIEDLICH

De­spite the Supreme Court’s de­ci­sion in Wayfair, state sales and use tax nexus un­cer­tainty con­tin­ues even as the ink is barely dry on the ruling that over­turns the long-stand­ing manda­tory Quill re­quire­ment that only phys­i­cal pres­ence meets the con­sti­tu­tional sub­stan­tial nexus test.

With omni-chan­nel com­merce and dig­i­tal dis­rup­tion, sales tax obli­ga­tions for the re­tail sec­tor have never been more com­plex and dy­namic.

And with the re­cent de­ci­sion by the Supreme Court in Wayfair to over­turn the decades-old phys­i­cal pres­ence nexus stan­dard of Quill, states can now fol­low in South Dakota’s foot­steps or may take their own paths to im­ple­ment sales tax on the bil­lions of dol­lars spent an­nu­ally on on­line sales.

The court’s de­ci­sion has sig­nif­i­cant im­pact on states, busi­nesses and con­sumers alike. It is crit­i­cal for busi­nesses to stay cur­rent and if they haven’t al­ready done so, to es­tab­lish pro­cesses and so­lu­tions to meet their tax obli­ga­tions as nexus laws and reg­u­la­tions will con­tinue to evolve at a fever­ish pace.

Ma­jor fac­tors

What were the key de­vel­op­ments lead­ing up to the Wayfair case?

1. State rev­enue short­falls. In 1992, when the Supreme Court de­cided Quill, it was es­ti­mated that the states were los­ing be­tween $694 mil­lion and $3 bil­lion per year in sales tax rev­enues as a re­sult of the phys­i­cal pres­ence rule. Now es­ti­mates range from $8 bil­lion to $33 bil­lion.

2. Growth of U.S. sales tax ju­ris­dic­tions and com­plex­ity.

Na­tion­ally, there are a to­tal of 10,708 ju­ris­dic­tions in the United States that im­pose a sales tax, as of June 30, 2017, rang­ing by state on the high end from 1,277 in Mis­souri, 1,153 in Texas, 908 in Iowa, and 800 in Alabama, to just one each in the states of Con­necti­cut, In­di­ana, Ken­tucky, Maine, Mary­land, Mass­a­chu­setts and Michi­gan.

The num­ber of sales tax ju­ris­dic­tions has grown each year and is up from about 6,000 at the time of the Quill de­ci­sion. That’s al­most dou­ble, and ex­pect that rate of growth to con­tinue at least at a sim­i­lar rate as states face the prospect of in­creas­ing rev­enue short­falls, par­tic­u­larly as the re­sult of fed­eral tax re­form leg­is­la­tion passed at the end of 2017.

3. Nexus al­ter­na­tives to phys­i­cal pres­ence.

Par­tic­u­larly since Quill, many states have ag­gres­sively tested the lim­its of the mean­ing of “phys­i­cal pres­ence,” adding new nexus laws un­der a num­ber of ap­proaches, in­clud­ing:

Eco­nomic nexus (the Wayfair case);

Click-through nexus;

Af­fil­i­ate nexus;

Mar­ket­place nexus;

Cookie nexus; and,

Use tax no­tice/re­port­ing.

Even a brief re­view of the cre­ative and ag­gres­sive ac­tions by the var­i­ous states to in­tro­duce al­ter­na­tive nexus stan­dards prior to the Wayfair de­ci­sion il­lus­trates the re­tailer’s chal­lenges in sales tax com­pli­ance, with many states in­tro­duc­ing two or even three new types of nexus.

4. Stream­lined sales and use tax agree­ment. An­other state-in­spired ap­proach has been the adop­tion of a stream­lined sales and use tax agree­ment, the goal of which was to find so­lu­tions for the com­plex­ity in state sales tax sys­tems that re­sulted in the U.S. Supreme Court hold­ing in Quill. The agree­ment fo­cuses on im­prov­ing sales and use tax ad­min­is­tra­tion sys­tems for all sell­ers and for all types of com­merce. How­ever, be­fore Wayfair, only 23 states had adopted it in some form or an­other.

In­side the ruling

What did the Wayfair court say and not say about state sales and use tax nexus?

The South Dakota law at is­sue is S.B. 106, ef­fec­tive May 1, 2016, which re­quires that any en­tity ex­ceed­ing an an­nual sales thresh­old of $100,000 or 200 sep­a­rate trans­ac­tions in South Dakota col­lect and re­mit South Dakota sales tax. This is often re­ferred to as “eco­nomic nexus,” rather than “phys­i­cal pres­ence nexus,” be­cause it is based en­tirely on eco­nomic pres­ence, not phys­i­cal pres­ence.

This placed the statute clearly and in­ten­tion­ally at odds with Quill for the spe­cific pur­pose of get­ting the Supreme Court to re­view it — and the court’s ruling over­turned the Quill phys­i­cal pres­ence test as “un­sound and in­cor­rect.”

To many, the Wayfair case can be con­fus­ing be­cause the court re­manded the case back to South Dakota. Here is why it is im­por­tant: The Wayfair court used the four­prong test of Com­plete Auto to test the va­lid­ity of the South Dakota nexus statute. That test has been the ap­pro­pri­ate test for decades — state taxes are valid so long as they:

Ap­ply to an ac­tiv­ity with a sub­stan­tial nexus with the tax­ing state;

Are fairly ap­por­tioned;

Do not dis­crim­i­nate against in­ter­state com­merce; and,

Are fairly re­lated to the ser­vices the state pro­vides.

In Quill, the court held that only phys­i­cal pres­ence meets the first prong of the above test — “sub­stan­tial nexus.” In Wayfair, the court said that phys­i­cal pres­ence is not the only way to es­tab­lish the first prong of the four-prong test — sub­stan­tial nexus. For ex­am­ple, eco­nomic pres­ence in this case did just that. How­ever, since the other three prongs of the Com­plete Auto test must also be met, the case was re­manded back to South Dakota — to re­con­sider the South Dakota nexus statute in light of all four prongs of the test, but this time with­out the manda­tory phys­i­cal pres­ence stan­dard for the first prong of the test — sub­stan­tial nexus.

In over­turn­ing Quill as un­sound and in­cor­rect, it opened the door for states to en­act nexus laws that do not re­quire phys­i­cal pres­ence.

So, what did the court mean by call­ing Quill nexus “un­sound and in­cor­rect?” Here is what the court said:

“The phys­i­cal pres­ence rule has long been crit­i­cized as giv­ing out-of-state sell­ers an ad­van­tage. Each year, it be­comes fur­ther re­moved from eco­nomic re­al­ity and re­sults in sig­nif­i­cant rev­enue losses to the states. These cri­tiques un­der­score that the rule is an in­cor­rect in­ter­pre­ta­tion of the Com­merce Clause.”

“The phys­i­cal pres­ence rule of Quill is also an ex­tra­or­di­nary im­po­si­tion by the ju­di­ciary on states’ au­thor­ity to col­lect taxes and per­form crit­i­cal pub­lic func­tions.”

In the ab­sence of Quill, the test sim­ply asks “whether the tax ap­plies to an ac­tiv­ity with a sub­stan­tial nexus with the tax­ing state.” In the South Dakota law, “the nexus is clearly suf­fi­cient. It ap­plies only to sell­ers who en­gage in a sig­nif­i­cant quan­tity of busi­ness in the state, and [com­pa­nies like Wayfair] are large, na­tional com­pa­nies that un­doubt­edly main­tain an ex­ten­sive vir­tual pres­ence.”

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