On April 17, 2018, the U.S. Supreme Court considered oral arguments in South Dakota v. Wayfair
, a case that may have groundbreaking implications with respect to sales and use tax nexus standards.1
Last year, the South Dakota Supreme Court unanimously affirmed a circuit court’s decision that a law requiring certain remote sellers that do not have a physical presence in South Dakota to collect sales tax on sales made in the state is unconstitutional.2
In affirming the circuit court, the South Dakota Supreme Court agreed that the law violates the physical presence requirement for sales and use taxes under Quill v. North Dakota3 Contacts:
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Jamie C. Yesnowitz
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Priya D. Nair
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and its application of the Commerce Clause. The U.S. Supreme Court decided to consider the case and recently heard oral arguments. Mark Arrigo, Matthew Melinson, Jamie Yesnowitz and Jeremy Jester from Grant Thornton LLP attended the hearing and provide their observations in this Alert.
Under the contested legislation, certain remote sellers that sell tangible personal property, products transferred electronically, or services for delivery into South Dakota are subject to the state’s provisions governing the retail sales and service tax and uniform municipal non-ad valorem tax, and are required to remit sales tax as if they had a physical presence in the state.4
Remote sellers are subject to these provisions if they meet one of two thresholds in either the previous calendar year or the current calendar year:
- The seller’s gross revenue from the sale of tangible personal property, any product transferred electronically, or services delivered into South Dakota exceeds $100,000
- The seller sold tangible personal property, any product transferred electronically, or services for delivery into South Dakota in 200 or more separate transactions5
The legislation explains that it is intended to directly challenge Quill
and provides expedited court procedures for litigating this matter. Although the legislation was scheduled to take effect on May 1, 2016, it was enjoined prior to its effective date. A circuit court granted the remote sellers’ motion for summary judgment, holding that the legislation “fails as a matter of law to satisfy the physical presence requirement that remains applicable to state sales and use taxes under Quill
and its application of the Commerce Clause.”6
The legislation provides that any appeal goes directly to the South Dakota Supreme Court and must “be heard as expeditiously as possible.”7
Based on the U.S. Supreme Court’s holdings in Bellas Hess8
, the South Dakota Supreme Court held that the contested law, S.B. 106, could not impose an obligation on the sellers to collect and remit sales tax because none of them had a physical presence in the state. The South Dakota Supreme Court did not find a “distinction between the collection obligations invalidated in Quill
and those imposed by Senate Bill 106, and [held] that the circuit court correctly applied the law when it granted Sellers’ motion for summary judgment.”
Before the South Dakota Supreme Court, the state argued that the U.S. Supreme Court should reconsider Bellas Hess
because changes in circumstances and technology have made these decisions outdated. The South Dakota Supreme Court acknowledged that Justice Kennedy, in his concurrence in Direct Marketing Association (DMA)
recognized many of the state’s arguments supporting reconsideration of these cases. In affirming the circuit court, the South Dakota Supreme Court explained that “[h]owever persuasive the State’s arguments on the merits of revisiting the issue, Quill
has not been overruled.” The South Dakota Supreme Court was required to follow Quill
because it “remains the controlling precedent on the issue of Commerce Clause limitations on interstate collection of sales and use taxes.” On January 12, 2018, the U.S. Supreme Court agreed to consider this case.10
Preliminary observations of hearing
On April 17, 2018, several representatives from Grant Thornton LLP attended the South Dakota v. Wayfair
hearing at the U.S. Supreme Court. We provide our preliminary observations on a hearing that reflected potentially deep divisions between the Justices’ views on these issues.
South Dakota’s ‘one sale’ position
South Dakota’s attorney general, and the U.S. deputy solicitor general who argued on behalf of South Dakota, claimed that merely having one sale in a jurisdiction would be enough to require a business to collect and remit sales tax in a jurisdiction that does not have a threshold-based nexus standard at issue in this case. This argument effectively endorsed overturning Quill
to allow any state to impose sales tax collection and remittance responsibilities without any types of transactional or sales thresholds, going well beyond the thresholds established by the South Dakota statute in question.
Justice Sotomayor’s early challenge to South Dakota
Within the first minute of the argument, Justice Sotomayor strongly criticized South Dakota’s attorney general’s position on a number of fronts, noting that the impact of the physical presence standard on state revenues was not caused by Quill
itself, but by the fact that states did not have an adequate mechanism to collect tax from consumers. Leaning on the Quill precedent, she raised numerous complicating issues, including the potential for retroactive application of a new sales tax nexus standard, the uncertain threshold at which sales tax nexus should arise, the line of case law that should be used to determine whether the sales tax nexus obligation is constitutional, and numerous compliance difficulties, burdens and costs to small businesses that would have to follow the new standards.
Justice Alito’s options, and potential congressional intervention
During South Dakota’s time for argument, Justice Alito gave South Dakota’s attorney general the option of eliminating Quill
and allowing the states significant flexibility in the area of sales and use tax nexus (option A), or the option of having Congress act in this area (option B). The attorney general chose option A, basing that choice on Congressional failure to address the issue for 26 years. That led to Justice Kagan noting that Congress consciously chose not to address this issue, and by doing so, implying that Congress had addressed the issue by not adopting legislation and leaving it to the states to decide. In fact, throughout the hearing, there were numerous references to Congressional intervention and why that has not happened to date. Several of the Justices seemed hesitant to encourage Congress to act in this area given the length of time in which it could have crafted legislation, as well as viewing such task as beyond what the Justices are empowered to do.
Chief Justice Roberts’ comments on economic impact
In many oral arguments, the Justices and the parties engage in very technical discussions involving construction of statutes and legal precedents. This oral argument was exceptional in that much of the argument revolved around the practical effect of Quill
, including the economic impact on the states. For example, at the end of the South Dakota attorney general’s argument, Chief Justice Roberts alluded to the perception that states were figuring a way to resolve the revenue problem despite the presence of Quill
, and that as a result, Quill
could be preserved. The South Dakota attorney general did not agree with that assessment, claiming that the expansion of e-commerce would have a $100 billion negative impact to the states over the next ten years with a physical presence rule in place.
Justices Ginsburg and Gorsuch team up
In many cases before the Supreme Court, decisions are reached along ideological lines, with conservative and liberal Justices pitched on opposite sides. While the policy implications of the Quill
rule were in full display here, it was interesting to see that the traditional ideological split may not apply here. Particularly striking was Justices Ginsburg and Gorsuch appearing to side with South Dakota. During Wayfair’s argument, Justice Ginsburg emphasized that in her view, a policy that required all who exploited a state’s market should be subject to that market’s tax, and such policy would be considered “equalizing” rather than “discriminating.” Wayfair’s counsel responded that requiring such a blanket rule would be problematic in no small part because of the number of sales tax jurisdictions that exist. Justice Gorsuch noted that Justice Ginsburg’s question had not been answered, in that the Supreme Court wanted to know why they should favor a particular business model over others. Justice Gorsuch did not appear to find satisfaction in Wayfair’s counsel’s response, which referenced the fact that most Internet retailers do collect and remit sales tax due to their move to increase their physical presence.
Justice Kagan’s recognition of unintended consequences of Quill
During Wayfair’s argument, an interesting exchange occurred where Justice Kagan noted the irony in an overturn of Quill
possibly resulting in large Internet marketplace providers performing sales tax compliance functions for small retailers for a fee, resulting in a benefit for these providers that historically had tried to maintain the Quill
physical presence standard. Wayfair’s counsel responded by saying that a number of the functions needed to comply with sales tax collection and remittance responsibilities, including hard-copy exemption certificates and audit defense services cannot be performed by software, whether provided by large marketplace providers or anyone else.
Justice Breyer’s need for more information
Justice Breyer notably claimed that both briefs made valid points, at one point exclaiming that after reading the briefs, he thought both sides were absolutely right, yet he knew that both sides could not actually be absolutely right. He appeared to genuinely struggle with the case, ultimately believing he did not have enough actionable information to affirmatively rule on the case, and asking questions designed to elicit more information that could help him make a decision.
Justice Kennedy, almost as silent as Justice Thomas
Justice Kennedy, who inspired the legislation that spurred this litigation through his desire to see a challenge to Quill
reflected in his concurrence in the Colorado DMA litigation involving notice and reporting provisions in lieu of sales tax collection and remittance, only raised one brief issue throughout the hearing.11
His relative silence was somewhat notable given his seemingly solid support to revisit and potentially overturn Quill
under the right set of circumstances. Less surprisingly, Justice Thomas did not break from his preference to remain silent at hearings. His disdain for the dormant Commerce Clause, an implication that state legislation which discriminates against interstate commerce is unconstitutional, makes it particularly unlikely that he would find against a state effort to regulate commerce through the imposition of a sales tax collection and remittance obligation.
Notice and reporting provisions: Not so burdensome?
Wayfair’s counsel noted that the Colorado notice and reporting provisions endorsed in DMA
were not overly burdensome to businesses, a curious point to make given that these provisions are considered to be voluminous, may cause privacy issues given the amount of data required to be shared with state tax authorities, and often force affected businesses to collect and remit sales tax in states that have adopted these provisions. In addition, Wayfair’s counsel stated that “all of the players that are involved in this issue” were inclined to support Congressional legislation.
In 2016, South Dakota became the first state to enact legislation that directly challenges Quill
’s physical presence requirement. In Quill
, the U.S. Supreme Court held that, for Commerce Clause nexus purposes, out-of-state retailers must have a physical presence in a state before a state can require the retailer to collect sales tax. Due to the rapid expansion of the Internet since Quill was decided in 1992, the way that consumers purchase items has changed tremendously. As a result, sales tax revenues are substantially declining because tax is not collected on many purchases through the Internet. Other states have followed South Dakota’s lead and now have laws or regulations that challenge Quill
’s physical presence requirement. As a result, this case is being closely followed by the state tax community, retailers and consumers.
Based on prior knowledge of the Justices’ opinions and the lines of questioning pursued by the Justices at the hearing, we believe that Justices Sotomayor, Alito and Roberts are most likely to support Wayfair, while Justices Thomas, Ginsburg, Gorsuch and Kennedy are most likely to support South Dakota. Justices Kagan and Breyer look to be “on the fence,” raising the possibility that they, and possibly other Justices, may want a more complete record in the lower courts before proceeding.
While at first blush, the count would appear to favor the state given four Justices that seem poised to abandon Quill
, we note that several paths remain for the Quill
rule to survive. In cases where the Justices do not feel they have enough information to decide a matter, relying on stare decisis as well as decisions rendered by lower courts is often the safest way to proceed. This would be good news for Wayfair, given that reliance on stare decisis would uphold Quill
, and the South Dakota decisions on this case all favored Wayfair. In addition, there is a distinct possibility that a majority decision may not be possible given the litany of positions that may be taken by the Justices, in which case the judgment of the South Dakota Supreme Court in favor of Wayfair could stand. As a potential example, four Justices might want to keep Quill
based on stare decisis, counterbalancing the four Justices that likely want to get rid of Quill
. If the ninth Justice wants to return the case to the lower courts for further development of the record without opining on Quill
would stand. Finally, the U.S. Supreme Court conceivably could decide on an extremely narrow basis that the South Dakota statute is valid while providing that the ruling only applies to the facts at issue, without completely disturbing the Quill
standard. Based on all of these potential options, it is becoming
increasingly likely that the U.S. Supreme Court’s decision, expected in June, will reflect a deeply divided body with several concurring and dissenting opinions possible, if not likely.
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