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Death of a Sales Tax Rule: Wayfair's Implications for Virginia

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Death of a Sales Tax Rule: Wayfair's Implications for Virginia Virginia Legislative Issue Brief Death of a Sales Tax Rule: Wayfair's Implications for Virginia Number 60 July 2018 Connor Garstka, DLS Attorney 2013 transportation funding bill's enactment Introduction clauses, as well as possible future congressional action. The brief identifies the On June 21, 2018, the Supreme likely need for authorizing state legislation Court of the United States reversed 50 years for Virginia to begin collecting revenues of Supreme Court precedent when it decided from remote sellers, options for the future, South Dakota v. Wayfair, Inc.1 Its ruling and potential revenue gains. overturned the physical-presence rule that had applied to collecting sales tax on interstate sales. Under the old rule, if an out- 1: Physical-presence rule of-state seller lacked physical presence in- Previously, as stated in the 1992 case state, a state could not require it to collect Quill Corp. v. North Dakota, a seller without sales tax from the purchaser. In most states, an in-state physical presence lacked including Virginia, buyers already are sufficient "nexus" for the state to require it obligated to report purchases from these to collect sales tax.3 Under Quill, requiring sellers on their state income tax return and collection from this kind of seller would pay a use tax,2 but in practice, few do. impose an "undue burden" on interstate After Wayfair, a state may require an commerce and thus violate the Dormant out-of-state seller—even one with no Commerce Clause (DCC). physical presence—to collect sales tax, so Dormant Commerce Clause long as the state can demonstrate a connection based on something else, such as The DCC is a judicial doctrine, volume of in-state sales. The ruling will derived from the federal Constitution's make it easier for states to collect sales tax Commerce Clause. The Commerce Clause from out-of-state sellers. However, because gives Congress the power "[t]o regulate of the structure of current state law, it likely Commerce . among the several States."4 will not increase Virginia's revenues Since 1824, the Supreme Court has immediately. interpreted this clause to imply a further "dormant" aspect: States may not enact laws This issue brief covers the old that interfere with interstate commerce.5 physical-presence rule, its roots in the Generally, the DCC prohibits states from (i) Commerce Clause, and criticism of the rule; discriminating against interstate commerce describes the South Dakota statute or (ii) imposing an undue burden on challenging the rule and the Wayfair interstate commerce. decision overturning the rule; and explains Wayfair's implications for Virginia, At first, the Court interpreted the including Wayfair's interaction with the DCC to impose an absolute bar on state Virginia Division of Legislative Services 1 taxation of interstate commerce. In the 1888 company's sole connection to Illinois was case Leloup v. Port of Mobile, it said, "[N]o through the mail. It had no property or state has the right to lay a tax on interstate solicitors in the state. 6 commerce in any form." The Court reasoned that allowing Gradually, the Court relaxed this rule Illinois and other states to impose a and allowed some state taxation of interstate collection obligation would impede commerce. However, it struggled to interstate commerce and thus violate the establish a consistent rule. It held that a state DCC. According to the Court, interstate tax on a multistate business was permissible sellers would be put at a disadvantage so long as the state did not tax interstate compared with in-state sellers. Unlike a commerce "directly."7 Later, the Court store in Illinois, which only had to deal with rephrased the rule as prohibiting a tax on state and local taxes, interstate sellers would "the privilege of doing interstate business."8 face different requirements in every state— But states easily circumvented these different rates, different exempt products, arbitrary, formalist distinctions. In 1959, and different recordkeeping requirements. Virginia convinced the Court to uphold a tax The Court's holding was narrow and that it had struck down five years earlier confined to the case facts; it did not actually simply by renaming it from a tax on the use the phrase "physical presence" that later "privilege of doing business in Virginia" to a appeared in Quill. "franchise tax" measured by Virginia gross 9 Twenty-five years later, the Court receipts. considered a fact pattern similar to Bellas Hess. Quill, an office supply company, had Bellas Hess and Quill physical locations in Illinois, California, and In 1967, the Court attempted to bring Georgia. It was the sixth-largest office some order to its chaotic DCC doctrine. It supply seller in North Dakota, but it did not considered the case of an out-of-state seller have any in-state property or salespeople. in National Bellas Hess v. Department of Like Bellas Hess, Quill made all of its Revenue.10 Bellas Hess was a retailer deliveries into the state by mail. headquartered in Missouri that sold clothes through the mail to customers in other states. North Dakota's statute asserted nexus based on advertising activity; the statute The general law that applied to a required a business to collect sales tax if it brick-and-mortar retailer in Illinois was that, advertised in North Dakota at least three when the brick-and-mortar retailer sold times in a year. Despite the fact that Quill clothes to an Illinois person, it had to collect had no physical presence, North Dakota sales tax from the purchaser and remit it to asked the Court to overrule Bellas Hess. the Illinois Department of Revenue. Bellas Hess, however, was selling from Missouri The Court refused, reiterating its tax-free. position from Bellas Hess: Out-of-state sellers without physical presence did not When the Illinois Department of have nexus with a state, so requiring them to Revenue directed Bellas Hess to collect, the collect sales tax would impose an undue company sued Illinois. The Court held that burden under the DCC.11 The Court Bellas Hess did not have sufficient observed that there were more than 6,000 connection with Illinois for the state to taxing jurisdictions nationally and that if an impose the collection obligation, because the interstate business had to collect in every Virginia Division of Legislative Services 2 one, the burden would crush any hope of purchases, states likely would need to raise interstate businesses competing with in-state sales tax rates, thus giving customers an businesses.12 even bigger incentive to avoid taxes by 23 The Court acknowledged the buying online. artificiality of the physical-presence rule, but The Quill rule also encouraged e- said the benefits were worth it because the retailers not to invest in in-state capital such rule provided clear guidelines for businesses as employees or property because to do so and states to follow.13 The Court also cited would establish physical presence and stare decisis, or the weight of precedent, as trigger the sales tax collection obligation.24 another reason for upholding the physical- For instance, before Amazon agreed to presence rule.14 The rule might not be the collect sales tax, it carefully avoided best rule, the Court said, but businesses activities that would establish physical relied on it.15 presence. It gave color-coded maps to its employees containing detailed travel routes 2: Criticism of the physical- that avoided certain states.25 presence rule The disincentive to establish physical The Quill Court anticipated presence exacerbated the negative effect on criticism: it acknowledged that it might have states. Not only did they lose sales tax decided differently if not for precedent.16 revenue, but they also lost potential And the criticism was immediate. Justice investments that remote sellers might Byron White dissented, calling for the Court otherwise make in local jobs. to give the physical-presence rule "the complete burial it justly deserves."17 Legal 3: South Dakota's statute academics, too, strongly criticized the Heeding Justice Kennedy's public 18 decision. disapproval of Quill, states again sought to In the more recent past, Justice challenge the physical-presence rule. A task Anthony Kennedy explicitly invited a force from the National Conference of State challenge to Quill,19 and Justice Neil Legislatures sent state legislators a draft of a Gorsuch, then a circuit court judge, called it law designed to challenge Quill, which "wrong" and hoped it would "wash away South Dakota ultimately enacted.26 Under with the tides of time."20 In recent years, South Dakota's law: Congress also attempted to address the • Remote sellers are required to collect sales issue. Congressmen have introduced four tax if they have at least $100,000 in sales or bills that would allow states to tax e- more than 200 transactions in South Dakota; retailers, but none have passed.21 • The obligation does not apply Commentators argued that the retroactively; physical-presence rule created an unfair playing field. It allowed e-retailers to charge • South Dakota conforms to multistate lower prices than brick-and-mortar stores standards on sales tax collection; because Internet customers could escape • South Dakota provides remote sellers free paying sales tax.22 access to sales tax collection software; and Others have argued the advantage • Sellers that use that software are immune would grow even more imbalanced over from audit.27 time. To make up revenue lost on online Virginia Division of Legislative Services 3 Wayfair, an e-commerce company mortar stores under Quill, but they also that sells home décor, challenged the law. advertise their products as tax-free. Since South Dakota conceded that the law was state law requires buyers to report tax from unconstitutional under the physical-presence purchases from remote sellers, Kennedy rule; instead, it argued that the Court should chided companies like Wayfair for their overturn Quill.
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