The Supreme Court Makes A Federal Case Out Of South Dakota's Inability To Collect Taxes From Its Residents And Thus A Big Mess

from the aereo-for-ecommerce dept

In some ways the Supreme Court's decision last week in South Dakota v. Wayfair may seem like a small thing: it simply overturned an earlier decision, Quill Corp v. North Dakota, which had concluded that states could not impose requirements to collect sales tax on businesses with no physical presence in the state. But in dispensing with that rule, the decision invited broader effects that may not be so small, thanks to the alarming reasoning the Court used to justify it.

The Court was prompted to reverse its earlier decision – something that the Supreme Court does but rarely, thanks to the principle of stare decisis that ordinarily discourages the Court from messing with an earlier precedent – for a few reasons. In particular it was concerned that Internet businesses without a physical presence in the state had an advantage over those with one [p.12-13], and it accepted South Dakota's claims that it was losing out on millions of dollars in sales tax revenue when South Dakotans bought things from out-of-state Internet businesses who were not collecting the sales taxes that normally would have been owed [p.2].

These assumptions, if true, would raise reasonable policy concerns. But even if they were valid worries, it doesn't follow that the Supreme Court should be the organ of government to address them, especially not when its doing so threatens to create additional policy concerns of its own.

First, South Dakota may be heavily dependent on sales tax to generate revenue, but that's its choice. If consumption taxes turn out to be an inadequate way of filling its coffers, it could choose to impose other forms of taxation, like an income tax, as many other states have. It is not dependent on the United States Supreme Court to help it balance its budget.

Second, like other states, South Dakota requires its residents to independently submit to the state the sales tax that would have been collected, had they bought their goods from an Internet business with a physical presence there. ("If for some reason the sales tax is not remitted by the seller, then instate consumers are separately responsible for paying a use tax at the same rate." [p.2]). The Court may have been correct in observing that enforcing these sorts of payment requirements may be difficult [p.2], but just because it is difficult does not mean that it should fall to the United States Supreme Court to relieve the state of its enforcement burden – especially not an enforcement burden against parties over whom the state already had undisputed jurisdictional reach. This case essentially seems to boil down to South Dakota complaining, "We can't make our residents, who are clearly subject to our laws, pay their taxes, so please make sure that out-of-state residents, who are not clearly subject to our laws, do instead." And the court was amenable to this plea. [p.13]

As for whether the physical presence rule truly gave an advantage to out-of-state businesses, if the state could manage to get its residents to pay the taxes they owe the answer would be no, since any price advantage an out-of-state business could offer would have been negated by the subsequent payment obligation. But the problem with the Supreme Court having now changed the rule is that it's placed its thumb firmly on the other side of the scale and disadvantaged out-of-state businesses in favor of those with a physical presence.

In terms of sales tax collection, in and of itself it's no small task. States rarely have one tax rate applicable to the whole state, or to all types of goods. True, as the Court notes, South Dakota "is one of more than 20 States that have adopted the Streamlined Sales and Use Tax Agreement."

This system standardizes taxes to reduce administrative and compliance costs: It requires a single, state level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules. It also provides sellers access to sales tax administration software paid for by the State. Sellers who choose to use such software are immune from audit liability. [p.23]

Such an agreement may certainly aid in minimizing compliance costs. So might the reasonably-priced software that the Court glibly assumes may eventually "make it easier for small businesses to cope with these problems." [p.21]. But in the here and now, compliance is still not so simple. This decision will still reach the other 30 states that have not adopted the Streamlined Sales and Use Tax Agreement, and figuring out how to comply will be more feasible for some businesses than others. Larger companies, for instance, will have more resources to manage complex compliance requirements. Companies large enough, or local enough, to have a presence in these states will also be more familiar with the state and its compliance requirements generally, since they will need to comply with the state's other laws as well.

Which leads to a more significant question raised by this decision, whose holding won't be confined to sales tax collection: what about these other state laws? Per the logic of the decision, can states impose other compliance obligations on Internet businesses, in addition to tax collection ones? As we've seen in recent discussions around Section 230, including in the cases involving Airbnb/Homeaway and Armslist, states love to apply local law to the Internet. In fact, even before the Internet states liked to impose local law whenever they could. The "long-arm" reach of states to impose their regulatory power on out-of-state parties has traditionally been limited by the requirement that the foreign party at least have some minimum contact with the state before they can be exposed to its jurisdiction. Which is why the physical presence rule made sense: being physically there suggested there was a significant enough contact between the party being regulated and the state doing the regulating. It also seemed more fair: in-state companies will also likely have in-state employees able to wield political pressure on the state government if the laws it passes to apply to their employers starts threatening their employment. Whereas out-of-state companies have no such political leverage to wield over the regulators they are nonetheless beholden to.

What the Court seems to be saying now is that lesser contact with a state than physical presence may be sufficient to establish minimum contact. In and of itself, such an assertion may not be controversial, and if the decision's rationale had been focused on those indicia it might not be so disquieting. In terms of the South Dakota taxation law itself, the law does incorporate some limitations so that it won't apply to Internet businesses with only incidental connections to South Dakota.

The Act applies only to sellers that, on an annual basis, deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions for the delivery of goods or services into the State."[p.3]

But the Court is not specific as to what sort of lesser contact will be sufficient to subject an Internet business to state jurisdiction for taxation or otherwise, and it is going to be really expensive for out-of-state Internet businesses to find out.

Furthermore, the hostility that the Court showed to these out-of-state businesses is worrying. First, it is unjustifiably dismissive to the utility of the physical presence requirement.

The argument, moreover, that the physical presence rule is clear and easy to apply is unsound. Attempts to apply the physical presence rule to online retail sales are proving unworkable. States are already confronting the complexities of defining physical presence in the Cyber Age. For example, Massachusetts proposed a regulation that would have defined physical presence to include making apps available to be downloaded by in-state residents and placing cookies on in-state residents’ web browsers. Ohio recently adopted a similar standard. Some States have enacted so-called “click through” nexus statutes, which define nexus to include out-of-state sellers that contract with in-state residents who refer customers for compensation. Others still, like Colorado, have imposed notice and reporting requirements on out-of-state retailers that fall just short of actually collecting and remitting the tax. Statutes of this sort are likely to embroil courts in technical and arbitrary disputes about what counts as physical presence. [p. 19-20]

Of course, far from impugning the physical presence rule, these examples demonstrate the wisdom of it, because in all the examples described any dispute that might arise would arise because the states are trying to target businesses that aren't actually physically present in their states.

In fact, in general the Court seems to have an uneasy notion of what constitutes physical presence by an Internet business:

For example, a company with a website accessible in South Dakota may be said to have a physical presence in the State via the customers’ computers. A website may leave cookies saved to the customers’ hard drives, or customers may download the company’s app onto their phones. Or a company may lease data storage that is permanently, or even occasionally, located in South Dakota. Cf. United States v. Microsoft Corp., 584 U. S. ___ (2018). [p.15]

The Court also cannot imagine how limiting a company's physical presence might be of value to it:

But the administrative costs of compliance, especially in the modern economy with its Internet technology, are largely unrelated to whether a company happens to have a physical presence in a State. For example, a business with one salesperson in each State must collect sales taxes in every jurisdiction in which goods are delivered; but a business with 500 salespersons in one central location and a website accessible in every State need not collect sales taxes on otherwise identical nationwide sales. [p. 12]

Worse, to the extent that the Court can imagine why a 500-person company might choose not to have boots on the ground in every state where it might happen to have an online customer, it is inexplicably hostile:

In effect, Quill has come to serve as a judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a State’s consumers—something that has become easier and more prevalent as technology has advanced. [p. 13]

Later it in the decision the Court further describes Quill as allowing out-of-state companies to aid and abet customers in "evad[ing] a lawful tax that unfairly shifts to those consumers who buy from their competitors with a physical presence that satisfies Quill—even one warehouse or one salesperson—an increased share of the taxes." [p. 17]

What is concerning is that in using these pejorative assessments the Court is essentially declaring, "How dare you do something legal to avoid liability." Which is sadly an admonition we've heard the Court make before in trying to substantiate a questionable holding in another case: Aereo.

As the Court continues, the comparison with Aereo becomes even more apt:

"Distortions caused by the desire of businesses to avoid tax collection mean that the market may currently lack storefronts, distribution points, and employment centers that otherwise would be efficient or desirable." [p. 13]

In other words, the Court has concluded, "Our jurisdictional rule is deterring investment in the state, so therefore it's a bad rule."

This sort of contorted reasoning is exactly what happened in Aereo, where the Court looked at who was making money, unilaterally decided it was the wrong people, and then tied itself in knots to write new law, indifferent to how much settled precedent it displaced or the full extent of its likely effects, in order to justify reallocating the financial gains.

Then, as now, it was a decision predicated on a series of questionable assumptions. We can only hope that this latest result won't be as seriously catastrophic for online innovation as Aereo has been.

Filed Under: sales tax, scotus, south dakota, supreme court, taxes


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  1. identicon
    Anonymous Coward, 25 Jun 2018 @ 9:02am

    Re: Sears Catalogue

    yeah, The Court just destroyed 135 years of well-established common law (52-card Pick-Up is such fun)

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