By: Ed Zimmerman, Partner & Chair, The Tech Group at Lowenstein Sandler & Brian Silikovitz, Partner & Chair, Tax Group at Lowenstein Sandler
Got a letter from the IRS
Saying your tax return is a terrible mess
We want our money, We don’t like to wait
Please come in and see us on such and such a date
Right now, Right away
Well I ain’t got nothing to send you today
But I’m gonna give you all your money
Soon as I get paid
“Soon As I Get Paid,” by Keb Mo (from his Grammy Award-winning 1998 Slow Down)
Retailers have taken note of the dramatic shift in state sales tax law emerging from one of Justice Anthony Kennedy’s last Supreme Court decisions. As different states announce legislative and regulatory changes throughout the summer, retailers are scrambling and we’re now seeing the impact in venture capital, private equity, and merger and acquisition transactions involving commerce companies.
On June 21, 2018 the U.S. Supreme Court decided South Dakota v. Wayfair, Inc. , in which it upheld a South Dakota law that requires certain sellers to collect sales tax even if those sellers lack “physical presence” in the State. The South Dakota law challenged prior Supreme Court precedent because it required a minimum annual amount of sales to South Dakota customers rather than requiring a seller’s physical presence in South Dakota. As a result, the Supreme Court’s decision reverses longstanding precedent and has sweeping repercussions for online sales and old style mail order sales. In the two months following the Wayfair decision, numerous States have been reacting, including enacting legislation very similar to South Dakota’s, and they’re doing so with an eye toward enhancing their collections of sales tax revenues. Consumers will pay and retailers, especially but not solely, online retailers, are concerned that the Wayfair case will adversely impact sales and/or price.
As background, for the quarter century preceding the Wayfair decision (basically the entire E-commerce era), taxing authorities have operated under Supreme Court precedent mandating that for a seller to have sufficient “nexus” with a state for sales tax purposes, the Commerce Clause of the Constitution required that the seller must have physical presence in that State. (Quill Corp. v. North Dakota (1992)). Physical presence, for example, might come from having employees or property in the state. Without that physical presence, a retailer solely located in New York wouldn’t expect to collect sales tax on sales shipped to its New Mexico-based customers.
The Supreme Court reversed its 1992 Quill decision, concluding “that the physical presence rule of Quill is unsound and incorrect.” The June 2018 decision held that while the U.S. Constitution still requires nexus for collecting sales tax, nexus itself need not solely arise from physical presence. In Wayfair, the South Dakota law at issue requires sales tax collection if a seller has meaningful economic nexus. Specifically, the law requires collection of South Dakota sales tax if the seller delivers more than $100,000 of goods or services into the state or engages in 200 or more transactions with in-state buyers in a year.
Many states had aspirationally already enacted statutes with a minimum level of contact needed to impose sales tax, as they waited for the law to shift toward the holding in Wayfair. Following the June 2018 Supreme Court decision, the state taxing authorities and other courts will likely read those statutes to require sales tax collection. As BNA reported in the aftermath of the decision:
Twenty-one states have an economic nexus model in place like South Dakota’s regime, which the Wayfair suggested was constitutionally valid. Of these, many already have announced plans to start enforcing their laws or will do so as soon as July 1.
Other States are enacting or contemplating enacting similar laws. For example, Texas has announced that it plans to implement Wayfair and that changes should apply starting in 2019. Similarly, the New Jersey legislature has already passed a bill mirroring South Dakota’s, and its Division of Taxation announced that it “will apply the Supreme Court’s ruling in the Wayfair decision on a prospective basis for remote sellers that do not have a physical presence in New Jersey.” Other states have also moved to a September 1 or October 1, 2018 go effective date for Wayfair-style sales tax laws. See, for instance, BNA’s August 15 article.
While South Dakota’s law was not retroactive, observers (and retailers) are concerned that various states could seek to apply their statutes retroactively or even enact retroactive legislation so that, for instance, retailers would be on the hook to calculate, collect, and remit sales tax for 2017, 2016, or perhaps even further back. An amicus brief filed in the Wayfair case on behalf of 41 states (supporting South Dakota), however, contained assurances that the states would not apply these Wayfair laws retroactively, at least to any significant extent, yet there’s no assurance that will be the case. In BNA’s Daily Tax Report, other commentators have weighed in on the retroactive application of Wayfair, “that retroactive application of any new decision would be unlikely and limited.”
Hawaii may be a case in point. As KPMG reported (as of July 2, 2018) that:
The Hawaii Department of Taxation on June 27, 2018, announced how it plans to implement the state’s recently enacted ‘general excise tax’ (GET) economic nexus provisions. This law has an effective date of July 1, 2018, and applies to tax years beginning after December 31, 2017.
Hawaii expected to collect sales tax under its Wayfair-style law from the start of calendar 2018, despite that law’s July 1 date. In other words, Hawaii wanted to “retroactively apply Wayfair” by reaching back to the beginning of the tax year during which it had implemented the legislation.
A mere two weeks later (July 13), the BondBuyer reported that Hawaii had walked that back and abandoned plans to apply the law retroactively:
Thursday evening the spokeswoman [for Hawaii] updated that information with a copy of a Tuesday announcement from the state’s Department of Taxation that essentially withdrew the plan to retroactively collect the tax.
‘To avoid any constitutional concerns, the department will not retroactively administer Act 41,’ the announcement said. ‘Accordingly, taxpayers who lacked physical presence in Hawaii prior to July 1, 2018, but who met the $100,000 or 200 transaction threshold in 2017 or 2018, will not be required to remit GET for the period from Jan. 1, 2018 to June 30, 2018.’
Hawaii, like South Dakota, is a perfect example of how Wayfair makes sense for less populous states, as online retailers are less likely to have physical presence in those states, but triggering sales tax based on a small number or dollar volume of sales could meaningfully help boost state sales tax revenues from out of state retailers.
Needless to say, retailers are wincing at the prospect of either contacting customers for back taxes or watching their own profit margins erode as the retailers themselves foot the bill. Wayfair’s ripple effect might also create interesting issues on mergers and acquisitions (M&A), venture capital, or private equity deals involving retailers where investors or acquirors seek to obtain insurance to cover the representations and warranties in those M&A or investment deals, including representations relating to compliance with state sales tax obligations.
While many have already enacted analogs to the South Dakota law at issue in Wayfair, we expect that others may seek to stretch or shrink the limits (If $100,000 sufficed in Wayfair, would $50,000 work? If retroactive to a prior year might not work, what about retroactive to the start of the current tax year, Hawaii’s example notwithstanding?) of this new precedent, and other states will likely adjust their legislation along the way.
While we expect more clarity to emerge in coming months, Wayfair will have significant implications for retailers and the companies and investment funds that buy or invest in retailers. We expect to see investors and acquirors carefully review how retailers handle compliance and customer relations in a shifting market and price pressure arising from the Wayfair case’s impact on sales tax. Whether this will boost sales at local malls as Wayfair attempts to level the playing field for out of state sales, remains to be seen.