In 1992, the U.S. Supreme Court ruled in Quill Corp. v. North Dakota that the Constitution’s commerce clause prohibits the states from imposing a sales tax on out-of-state retailers that do not have a physical presence in the state, such as a store, warehouse or sales representative. Next Tuesday, the justices will hear oral argument in South Dakota v. Wayfair Inc., which could result in overruling Quill and could significantly affect sales-tax collection in the digital age. In Quill, the justices closely weighed an earlier decision that had articulated the physical-presence rule. In 1967, in National Bellas Hess, Inc. v. Illinois Department of Revenue, which also involved mail-order sales, the court ruled that a “seller whose only connection with customers in the state is by common carrier or the United States mail” lacked the requisite minimum contacts with the state to justify “impos[ing] the burdens” of collecting taxes on interstate sales.
The North Dakota Supreme Court, in upholding that state’s law imposing a sales tax on out-of-state retailers such as Quill Corp., a mail-order office-supply provider, had declined to apply Bellas Hess to the North Dakota law. The North Dakota court held that the physical-presence rule was no longer appropriate because of “wholesale changes” in the law and the economy, including that mail-order sales had gone from being a niche enterprise to a sales “goliath.”
The U.S. Supreme Court, in considering the appeal in Quill, questioned the validity of the physical-presence test based on several of its intervening commerce clause rulings. But, citing principles of stare decisis, the justices declined to overrule Bellas Hess. The court in Quill also expressed concern that mail-order retailers faced difficulties in complying with tax obligations from some 6,000 separate state and local taxing jurisdictions nationwide.
Not long after the 1992 Quill decision, the “wholesale changes” in out-of-state sales took on new meaning. The onset of the world wide web brought a revolution in commerce, with internet-based retailers such as Amazon.com becoming popular choices for shoppers. Based on the physical-presence rule, many web-commerce sites declined to collect sales tax, giving them an end-price advantage at the transaction stage. (Consumers who do not pay a sales tax are supposed to pay a use tax in most states, but compliance levels are low.) States and local governments, who say they lost out on $26 billion in sales and use tax just in one recent year (2015), have urged Congress to act, but to no avail.
In 2015, however, the states got a boost from Justice Anthony Kennedy. In a concurrence in Direct Marketing Association v. Brohl, a Colorado case related to state sales and use taxes, Kennedy called for the court to re-examine Bellas Hess and Quill. “There is a powerful case to be made that a retailer doing extensive business within a state has a sufficiently ‘substantial nexus’ to justify imposing some minor tax-collection duty, even if that business is done through mail or the internet,” Kennedy wrote. “This argument has grown stronger, and the cause more urgent, with time.”
Kennedy, who had joined the result in Quill, noted that e-commerce sales were totaling more than $3 trillion per year in the United States. “Because of Quill and Bellas Hess, states have been unable to collect many of the taxes due on these purchases,” Kennedy continued. “States’ education systems, health care services and infrastructure are weakened as a result.” “The legal system should find an appropriate case for this court to re-examine Quill and Bellas Hess,” Kennedy concluded.
South Dakota responded in 2016 by passing a measure known as Senate Bill 106, which looks to a retailer’s economic presence rather than its physical presence within the state. Retailers must collect sales taxes if they have more than $100,000 in sales or more than 200 transactions in South Dakota. The measure also sought to protect retailers from retroactive liability.
The state sued four web-based retailers under the new law. One opted not to assert a Quill defense, while the three others — Wayfair Inc., Overstock.com Inc., and Newegg Inc. —challenged the law. (Amazon is not part of the case, nor has it filed or joined an amicus brief. The giant retailer agreed in 2017 to start collecting sales tax in every state that has one, although it does not do so on sales by its “Amazon Marketplace” partners.)
The retailers moved for summary judgment on the ground that under Quill, they do not meet the physical-presence test and cannot be compelled to collect the state’s sales tax. The state conceded that it cannot enforce SB 106 without the Supreme Court’s overruling Quill, and the South Dakota courts agreed.
In its merits brief in the Supreme Court, the state stresses that “times have changed” in the retail world and that “in the digital age where ubiquitous e-commerce is projected into our homes and smartphones over the internet, traditional ‘physical’ presence is an increasingly poor proxy for a company’s ‘nexus’ with any given market or state.” The state argues that abrogating the physical-presence requirement is now essential to eliminate arbitrary and unclear results, promote interstate commerce, and avoid important, ongoing, and unjustifiable harms to the states.
The state says that 25 years after Quill was decided, it remains “surprisingly unclear” why a seller’s physical presence is significant for sales-tax collection requirements but not for other tax or regulatory burdens of “comparable severity.” Retailing on the internet has made the physical-presence rule more arbitrary and unclear, the brief contends, as “the internet now makes it possible for out-of-state sellers to reach consumers with engaging, interactive virtual storefronts in our homes or on our smartphones at any hour of the day.”
The physical-presence rule is also reshaping American communities and distorting the national economy, South Dakota argues. “Changing conditions mean that Quill no longer props up a retail niche but rather provides a further advantage to companies like respondents on a playing-field already tipped against small, local businesses,” the brief says.
The state also resists the retailers’ claims that compliance with sales-tax obligations remains cumbersome, maintaining that technological advancements have made such collections much simpler and more streamlined. “Rate calculation … is now as easy as typing a shipping address into a search bar” of tax-calculation software, the brief says.
Finally, among other arguments, South Dakota contends that there are no concerns about retroactive tax liability for retailers should the physical-presence rule be eliminated, because SB 106 expressly bars any such retroactive taxation. And if the high court were worried that other states might seek retroactive application, there are significant legal and political barriers to that happening, the brief says.
South Dakota has amicus briefs on its side from the U.S. solicitor general, 41 other states, an association of shopping centers, an association of South Dakota retailers, and numerous law professors and economists.
For their part, the retailers argue primarily that despite efforts to simplify sales-tax collection, “state sales and use tax systems remain inordinately complex and burdensome during the Internet era, just as they were before it began.”
The retailers rely heavily on a U.S. Government Accountability Office report from November 2017, which concluded that state and local governments may, under current law, require remote sellers to collect about 75 to 80 percent of the taxes that would be owed if the physical-presence rule were eliminated. In contrast to the South Dakota brief’s citation of estimate of $33.9 billion in lost sales-tax revenue annually to all states because of Quill, the GAO report estimated a revenue gain of between $8 billion to $13 billion if all states and local taxing authorities had the power to collect sales tax from all remote sellers.
“The GAO Report is consistent with other market trends that indicate the level of uncollected sales tax is steadily declining, not increasing,” the retailers argue. According to the retailers, the GAO report undercuts South Dakota’s “erroneous claim that sales tax collection software is the ‘silver bullet’ to eliminate the burdens of multi-state compliance.” “The non-partisan GAO found … that the costs of sales tax compliance are manifold and significant,” the retailers assert, including software installation, implementation, and integration; mapping of thousands of products to software categories; per-transaction software licensing fees; administrative costs; legal fees in connection with assessments and audits; and the costs of keeping up to date on changes in the laws of thousands of taxing jurisdictions.
The retailers say their fears of retroactive tax liability in states other than South Dakota are not overblown, as some 30 states have laws on their books that might qualify. They point out that the amicus brief filed on South Dakota’s side by Colorado and 40 other states informs the court that the states may choose to “apply their laws retroactively.” (That brief generally contends, though, that there would be multiple factors that would limit any retroactivity.)
The retailers stress in their brief that Congress “is the institution best-suited to resolve the competing interests in remote sales tax collection and to select the proper policy outcome.” If the physical-presence requirement were removed, the states would no longer have the incentive to participate in a political solution, the brief says. “It is only Congress, and not the states or the courts, that has the institutional expertise to weigh the national implications of expanded state taxing authority and to craft legislation that will ensure state tax obligations do not unduly burden interstate commerce,” the retailers argue.
Support for the retailers comes from some of their fellow e-commerce companies (including eBay Inc., Etsy Inc., and America’s Collectibles Network Inc.), as well as the American Catalog Mailers Association, the Cato Institute, and two states that do not collect statewide sales taxes — Montana and New Hampshire.
Despite the wide-ranging estimates of how much sales tax is at stake, there is little doubt that the outcome of the case will be felt across the country. The GAO says that 45 states and the District of Columbia levy sales taxes, and 37 of the states authorize further levies by local governments such as cities and school districts.
[Disclosure: Goldstein & Russell, P.C., whose attorneys contribute to this blog in various capacities, is among the counsel to the petitioner in this case. The author of this post is not affiliated with the firm.]
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