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Supreme Court Rejects Precedents in State Sales Tax Case; Quill and Bellas Hess Overruled

(Parker Tax Publishing June 2018)

The Supreme Court vacated a North Dakota Supreme Court decision in which that court held that a state law requiring out-of-state sellers to collect and remit sales tax as if the sellers had a physical presence in the state was unconstitutional. In so doing, the Supreme Court overruled its prior decisions in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967). South Dakota v. Wayfair, Inc., 2018 PTC 183 (S. Ct. 2018).

South Dakota, like many states, taxes the retail sales of goods and services in the state. Sellers are required to collect and remit the tax to the state, but if they do not, then in-state consumers are responsible for paying a use tax at the same rate. Under National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967), and Quill Corp. v. North Dakota, 504 U.S. 298 (1992), South Dakota may not require a business that has no physical presence in the state to collect its sales tax. Consumer compliance rates are notoriously low, however, and it is estimated that Bellas Hess and Quill cause South Dakota to lose between $48 and $58 million annually.

Concerned about the erosion of its sales tax base and corresponding loss of critical funding for state and local services, the South Dakota Legislature enacted a law (the Act) requiring out-of-state sellers to collect and remit sales tax as if the seller had a physical presence in the state. The Act covers only sellers that, on an annual basis, deliver more than $100,000 of goods or services into the state or engage in 200 or more separate transactions for the delivery of goods or services into the state.

A group of top online retailers with no employees or real estate in South Dakota each meet the Act's minimum sales or transactions requirement, but do not collect the state's sales tax. South Dakota filed suit in state court, seeking a declaration that the Act's requirements are valid and applicable to the online retailers and an injunction requiring the retailers to register for licenses to collect and remit the sales tax. The retailers sought summary judgment, arguing that the Act is unconstitutional. A trial court granted their motion and the State Supreme Court affirmed on the ground that Quill is controlling precedent. North Dakota appealed to the Supreme Court.

On June 21, in a 5-4 decision, the Supreme Court vacated the lower court decisions and overruled the decisions in Quill and National Bellas Hess after concluding that the physical presence rule of Quill is unsound and incorrect. The Court began its analysis by reviewing the Court's Commerce Clause principles and their application to state taxes and noting that two primary principles mark the boundaries of a state's authority to regulate interstate commerce: (1) state regulations may not discriminate against interstate commerce; and (2) states may not impose undue burdens on interstate commerce.

Those principles, the Court said, also animate Commerce Clause precedents addressing the validity of state taxes, which will be sustained so long as they (1) apply to an activity with a substantial nexus with the taxing state, (2) are fairly apportioned, (3) do not discriminate against interstate commerce, and (4) are fairly related to the services the state provides.

The Court noted that the physical presence rule has long been criticized as giving out-of-state sellers an advantage. Each year, the Court said, it becomes further removed from economic reality and results in significant revenue losses to the states. According to the Court, when the day-to-day functions of marketing and distribution in the modern economy are considered, it becomes evident that Quill's physical presence rule is artificial, not just at its edges, but in its entirety.

Modern e-commerce, the Court observed, does not align analytically with a test that relies on the sort of physical presence defined in Quill. As a result, the Court felt that it should not maintain a rule that ignores substantial virtual connections to the state.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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