Can State Force Online Retailers To Collect Sales Tax?

By January 7, 2018 Tax Strategy

The US Supreme Court is being asked to review its 1992 sales tax ruling that allows retailers without any physical connection with a state to avoid collecting sales tax in that state.  Remote sellers enjoy an exception, as “physical presence” is the only criteria to collect and deposit sales tax in a state. South Dakota has become one of the first states to mount a challenge to this exclusivity of brick-mortar presence for sales tax collection through a legislative action. The final ruling is sure to have a bearing on Wayfair, Overstock, NewEgg, and other big online retailers that lead the challenge to the legislation.

The Background of Debate on Sales Tax Remittance by Online Retailers

In 2016, the South Dakota Senate passed the Bill 106 that made economic nexus as a prerequisite for sales and use tax remittance.  With effective from May 1 of that year, the law mandates a remote seller to collect and pay 4.5% sales and use tax if its gross sales revenue is more than $100,000 or has at least 200 sales transactions in the state.

The law brought into the ambit of sales tax most out-of-state and major e-commerce retailers that electronically deliver products and services to the state residents. Online furniture retailer Wayfair challenged the law arguing this as a violation of the 1992 judgment in Quill Corp vs North Dakota. At that time, the federal court laid down physical presence in a state as the only condition for sales tax collection in that state.

However, a 2015 ruling by Justice Anthony Kennedy in the DMA case underlined a willingness on the part of the highest federal court to review its decision that predates the e-commerce era. South Dakota saw this an opportunity to force a revision by the US Supreme court and boost its tax collection from the burgeoning internet commerce. The state Congress passed the law knowing that it contradicted the ruling of the court that defined physical presence, not economic nexus as the very basis of sales tax remittance to the state.

As expected the law was overruled by the South Dakota Supreme Court paving the way for the state government to approach the US Supreme Court. The decision is expected in early January 2018.

What States Say on Sales Tax Remittance by Online Retailers

South Dakota’s petition has support from 35 states that reel under increasing budgetary deficits and eager to cash in on e-commerce’s popularity to augment the state revenue. The Quill judgment dates back to an era when online retail was in its infancy. However, after a quarter century, sales tax revenue from the internet trade is too big to be ignored now by governments at all levels.

In 2018, the states are expected to lose $34 billion in sales and use tax unless the federal Supreme Court rules in their favor. The sales tax revenue from e-commerce is expected to exceed $50 billion in 2022.

The petition also highlights the discrimination faced by bricks-and-mortar sellers. With exemption granted to online retailers from tax collection and payments, bricks-and-mortar sellers are at a disadvantage. It is supported by the National Retail Federation, the nationwide representative body of physical retailers, and the Multistate Tax Commission.

Meanwhile, Wyoming has also adopted a bill eliminating the physical presence clause as the sole basis to collect and pass on sales and use taxes.

The Online Retailers’ Point on Sales Tax Remittance

Wayfair seeks a national legislation passed by the Congress to resolve the issue. It fears that state-level laws may lead to problems affecting the operation of online retailers.

NetChoice wants protection for e-commerce and online businesses “from overbearing tax compliance burdens” in states where such firms have no physical presence.

The Way Ahead

It has been more than 25 years since the Quil ruling. The e-commerce sector has grown big enough to become an important part of the national economy. With depleting coffers, governments have to cut spending on public services. When they are looking to increase their tax base, it is hard to ignore billions of dollars missed due to exemptions.

Simultaneously, it is essential to protect the national character of e-commerce. While the Internet brings in an excellent prospect for the future of trade and commerce, it is in the national interest to protect retailers from unnecessary compliance burdens.

Major online retailers, such as Amazon, have already started to collect and pass on sales tax to states. If the tax ambiance is made fair, simple, and convenient, remote sellers would have no qualms to comply. The need is to redefine the physical presence clause and make a national system making tax collection and payment easier for such retailers.

There are three bills under consideration in the Congress to regulate and control interstate commerce and facilitate sales tax remittance by retailers who have no physical presence in a state.

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