In Wayfair, Supreme Court Overturns Quill "Physical Presence" Sales Tax Rule
On June 21, 2018, a 5-4 majority of the US Supreme Court in South Dakota v. Wayfair, Inc. overturned the physical presence sales tax rule set forth in Quill Corp. v. North Dakota. In a decision by Justice Kennedy, the Court applied the standard set forth in Complete Auto Transit, Inc. v. Brady, concluding that a state tax will be sustained under the Commerce Clause of the US Constitution so long as it (1) applies to an activity with a substantial nexus with the taxing state, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the state provides. Notably, the Court held that physical presence is not necessary to create substantial nexus, stating that the Quill rule is "unsound and incorrect."
Prior to being overturned in Wayfair, the Quill rule prohibited a state from requiring a business to collect sales tax with respect to sales to customers in the state unless the business had a physical presence in the state. In a direct challenge to the Quill rule, South Dakota enacted S.B. 106, which requires certain businesses without a physical presence in the state to collect and remit state sales tax. S.B. 106 applies only to sellers that deliver more than $100,000 of goods or services to customers in South Dakota, or engage in 200 or more separate transactions for the delivery of goods or services to customers in South Dakota, in each case in the current and/or prior calendar year. S.B. 106 does not apply on a retroactive basis.
In Wayfair, the Court determined that the economic and virtual contacts that the retailers in question have with South Dakota rise to a sufficient level of nexus with the state. The Court noted that "South Dakota's tax system includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce." The Court emphasized S.B. 106's threshold requirement of delivering more than $100,000 of goods or services or engaging in 200 or more separate transactions for the delivery of goods or services into the state in determining whether the substantial nexus requirement was met, stating that, "[t]his quantity of business could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota."
In overturning Quill, Wayfair may embolden states to implement more aggressive and expansive regimes to require out-of-state vendors to collect and remit sales tax. However, Wayfair leaves many questions unanswered. Namely, the Court did not issue a ruling as to whether South Dakota's S.B. 106 satisfies all four prongs of the Complete Auto test, remanding the case to the South Dakota Supreme Court to decide that issue. Nonetheless, considering that the Court determined the substantial nexus requirement of Complete Auto was satisfied in Wayfair, S.B. 106 may serve as a model for other states that intend to expand the reach of their sales tax nexus in a post-Quill world. Another question left unanswered by the Court is whether a state could successfully enforce a post-Quill sales tax nexus retroactively. The majority opinion in Wayfair emphasizes that S.B. 106 does not have retroactive effect but ultimately does not resolve whether a retroactive rule would pass constitutional muster. Even if such post-Quill laws are not made retroactive, Wayfair will impose a significant compliance burden on retailers that now may be tasked with determining their sales tax liability in states in which they do not have a physical presence.
Ultimately Congress may address these issues, but unless and until it does so, the courts will be left to resolve the key question as to whether a given state's sales tax laws comply with the post-Quill substantial nexus requirement and the other prongs of the Complete Auto test. As such, businesses should consult with their tax advisors regarding the potential impact of Wayfair on their sales tax obligations and should continue to monitor the development of post-Quill sales tax laws.
© Arnold & Porter Kaye Scholer LLP 2018 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.