On June 21, 2018, the US Supreme Court, in the South Dakota v. Wayfair case, overruled Quill Corp v. North Dakota (1992) and National Bellas Hess v. Department of Revenue of Ill. (1967), and thus erased long standing precedent in the area of sales and use tax collection.
Let’s first start with outlining the issues: Under the Quill and Bellas Hess cases, a state could not compel a business to collect sales tax if that business had no physical presence in the state. Instead, consumers paid a use tax that is equivalent to the sales tax. However, as noted by the Supreme Court, “Consumer compliance rates are notoriously low” and South Dakota lost “between $48 and $58 million annually.” Moreover, the physical presence rule has been seen to give out of state sellers an unfair advantage. As such, the Supreme Court found that the rule has become “further removed from economic reality and results in significant revenue losses to the States. These critiques underscore that the rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.” E-commerce has made this issue particularly difficult in regards to the physical presence rule as it “ignores substantial virtual connections to the State.” It should be noted that like Tennessee, South Dakota has no income tax and must rely heavily on the sales tax, and therefore had a strong incentive to seek a change in the precedent. In fact, according to the Supreme Court, “Forty-one States, two Territories, and the District of Columbia have asked the Court to reject Quill’s test.”
Next, let's discuss the underlying legal principal at stake, i.e. the Commerce Clause contained within the U.S. Constitution: According to the Supreme Court in Wayfair, “Two primary principles mark the boundaries of a State’s authority to regulate interstate commerce; State regulations may not discriminate against interstate commerce; and States may not impose undue burdens on interstate commerce. These principles guide the courts in adjudicating challenges to state laws under the Commerce Clause." The Supreme Court did note that if the U.S. Congress actually passed legislation in this area it would be controlling, but it remains to be seen if any such legislation will be passed, at least in the near term.
Next, let’s look at the South Dakota Act itself. First, it only applies to sellers that annually deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions that deliver goods or services into the State. Secondly, it does not impose a retroactive sales tax. Third, South Dakota adopted the Streamlined Sales and Use Tax Agreement. The state provides free sales tax administration software to businesses.
The Supreme Court decided that the nexus requirements of the Commerce Clause were satisfied since the Act only applied to sellers that delivered substantial goods or services into the State. It found that South Dakota’s system “includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce” since the South Dakota law has a safe harbor for those that conduct limited businesses, the law isn’t retroactively applied, the Streamlined Sales and Use Tax Agreement was utilized, and free software provided.
As for the effect of this decision, it is likely that many states will work to quickly enact compliant legislation in order to expand their sales tax collection, and will likely model their statutes after South Dakota to avoid undue burden issues. It will be interesting to see if the Supreme Court is correct that the elimination of the physical presence rule will encourage more physical “storefronts, distribution points, and employment centers,” since sales tax collection will not be able to be so easily avoided (by not having a physical presence) for larger sellers in states that adopt statutes in compliance with this decision.