The U.S. Supreme Court issued a ruling in South Dakota v. Wayfair that could transform the e-commerce industry by allowing states and local governments to force online retailers to collect sales taxes.

The U.S. Supreme Court on Thursday issued a landmark ruling in South Dakota v. Wayfair Inc. that could transform the e-commerce industry by allowing states and local governments to force online retailers to collect sales taxes even if they don’t have a physical presence, or nexus, in the state.

In doing so, the court overruled the decision in Quill Corp. v. North Dakota, which stated that Quill, a catalog retailer, did not have to collect sales tax in North Dakota because it had no physical presence in the state. The court’s decision, which five justices signed on to, states that the Quill decision was “unsound and incorrect.”

The case had centered on a South Dakota law that would require retailers with more than $100,000 in annual sales, or 200 transactions in the state, to pay a 4.5% tax on purchases. In an opinion written by Justice Anthony Kennedy, the court agreed with the state’s argument that the state is losing sales tax revenues needed for education, healthcare and infrastructure. Quill, it said, harms small retail businesses because out-of-state sellers, which are mostly e-commerce merchants, can offer a price advantage on their goods.

“The Quill Court did not have before it the present realities of the interstate marketplace, where the internet’s prevalence and power have changed the dynamics of the national economy,” Kennedy wrote. “The expansion of e-commerce has also increased the revenue shortfall faced by states seeking to collect their sales and use taxes, leading the South Dakota legislature to declare an emergency. The argument, moreover, that the physical presence rule is clear and easy to apply is unsound, as attempts to apply the physical presence rule to online retail sales have proved unworkable.”

While the decision left open the possibility that other arguments could be pressed against the South Dakota law, Kennedy’s opinion argued that the law is constitutional, in part, because of its $100,000 threshold and the fact that it doesn’t try to impose retroactive taxation.

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“South Dakota’s tax system includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce,” Kennedy wrote.

The decision means that that retailers will no longer be shielded from tax-collection duties if they don’t have a physical presence in a state, as long as that merchant has what the court calls a “substantial nexus” in that state.

 

Andy Pincus, a lawyer at Mayer Brown who filed a brief on behalf of eBay Inc. and a group of small businesses, says the decision was narrow and other states may have to meet some additional constitutional tests before they can begin collecting sales tax from remote sellers.

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“The court said that physical presence isn’t necessary to create substantial nexus,” he says. “But that certainly doesn’t mean that every remote seller can be required to collect taxes.”

About 16 states already have laws similar to South Dakota’s that could enable them require tax collection by internet retailers in the coming months—and more could follow quickly. Other states would have to revise their tax laws. As states “push the envelope,” Pincus expects a number of cases will end up in litigation to iron out a firm definition of substantial nexus.

In the near-term, Deborah White, general counsel for the Retail Industry Leaders Association and president of the Retail Litigation Center, expects the 45 states with a sales tax to quickly begin working on legislative and regulatory solutions to collect online sales tax in their states.

“States had this authority taken from them decades ago,” she says. “Most will work quickly and judiciously to reclaim their authority and create a level playing field for all retailers selling to customers in their states.”

Those moves could introduce complications, says Nancy Manzano, tax director at Vertex Inc., a tax technology company. “There are different taxability rules that make it difficult for retailers to navigate,” she says. For instance, Illinois categorizes Twix as “food” and Snickers bars as “candy” because Twix are made with flour and Snickers are not, while many other states consider both “candy.”

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Industry response

Reactions in the industry were mixed.

“Retailers have been waiting for this day for more than two decades,” says Matthew Shay, president and CEO of the National Retail Federation. “The retail industry is changing, and the Supreme Court has acted correctly in recognizing that it’s time for outdated sales tax policies to change as well. This ruling clears the way for a fair and level playing field where all retailers compete under the same sales tax rules whether they sell merchandise online, in-store or both.”

However, he noted that there’s more work to be done to put the decision into action. “Congress must now follow the court’s lead and pass legislation implementing uniform national rules that provide consistency and clarity for retailers across the country,” he says.

 

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Steve DelBianco, president and CEO of e-commerce advocacy group NetChoice, says the court’s decision puts a burden on online retailers. “While a fraction of online commerce was free of sales tax before this ruling, the Supreme Court has now created an even greater imbalance by placing far greater burdens on internet shopping compared to its offline counterparts. A brick-and-mortar business won’t have to comply with the differing rules of over 12,000 tax jurisdictions, or integrate costly and complex tax software into its operations. But small web businesses will, eating away at their already razor-thin profit margins,” he says.

Wayfair Inc., the lead respondent in the case decided today, said it appreciates the clarity the decision provides. In a statement to Internet Retailer, the retailer said: “Wayfair already collects and remits sales tax on approximately 80% of our orders in the United States, a number that continues to grow as we expand our logistics footprint. As a result, we do not expect today’s decision to have any noticeable impact on our business, as it may on other retailers who do not currently collect and remit sales tax. Wayfair has long supported a legislative solution that would establish a level playing field for brick-and-mortar and online retailers by permitting states to collect sales tax on online sales. While we believe the Court was not the ideal venue for creating this level playing field, we expect that today’s decision will bring clarity and certainty to this issue.”

Wayfair, No. 13 in the Internet Retailer Top 1000, currently collects sales tax in 22 states, according to Internet Retailer research.

Overstock.com Inc., another of the e-retailers named in the South Dakota case, on Thursday said it is ready to comply with the court’s decision; however, it voiced concern that the ruling may inhibit innovation in e-retailing and encouraged Congress to act. “Today, the U.S. Supreme Court has reshaped the interstate commerce landscape in a move that could impact small business innovation on the internet, which has been a driving force behind our nation’s economy for the last 15 years,” says Jonathan Johnson, a director at Overstock.com, No. 32 in the Internet Retailer Top 1000. “To lessen the potential impact of today’s ruling on internet innovation, Congress can, and should, pass sound legislation allowing states to accomplish their aims while still permitting small internet business to thrive.”

Overstock currently collects sales tax in five states, according to Internet Retailer research.

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The Supreme Court’s ruling in the immediate term will force online retailers to comply with the law in South Dakota, a state with a population of 870,000, which is about 0.26% of the U.S. population. Given the South Dakota law requirements, if consumers in South Dakota buy online at the same rate as the rest of the country, the ruling would mean that any e-retailer selling about $43 million annually in the United States would have to comply with the law. That would equate to 726 of the retailers ranked in the  Internet Retailer 2018 Top 1000.

Currently, 163 of the Internet Retailer Top 500 e-retailers collect sales tax on purchases made by South Dakota residents.

Find the Supreme Court’s complete opinion here.

 

Bloomberg contributed to this article. 

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