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US Supreme Court overturns Quill’s physical presence standard

Multistate Tax alert | June 26, 2018

This tax alert summarizes the Court’s decision in Wayfair, addresses potential implications of the Court’s overturning Quill’s physical presence requirement and offers considerations for taxpayers.


On June 21, 2018, the US Supreme Court issued its opinion in South Dakota v. Wayfair, Inc. et al.,1 a case challenging South Dakota’s anti-Quill sales tax nexus law,2 in which it overturned the decades-old physical presence nexus standard3 required in order for a state or locality to impose a sales or use tax collection responsibility upon a remote seller.

In a 5-4 decision,4 the Court overruled its earlier decisions in Quill and National Bellas Hess,5 holding that the physical presence rule promulgated under these decisions was “unsound and incorrect.”6 The Court’s basis for overturning this 50-year-old nexus standard was grounded in a number of significant bases, including:

  • The application of a physical presence requirement is an “incorrect interpretation of the Commerce Clause”7, particularly when measured in a vastly expanded e-commerce marketplace.
  • South Dakota’s law does not violate substantial nexus requirements because remote sellers have the potential to maintain a significant virtual presence in the state.
  • The principle of stare decisis cannot stand when it prohibits states from exercising lawful powers.

“Substantial nexus” for Commerce Clause purposes does not require physical presence

States have the authority to regulate interstate commerce to the extent the state does not discriminate against or unduly burden interstate commerce.8 In its 1967 decision in National Bellas Hess,9 the Court held that the Due Process Clause and the Commerce Clause required physical presence for a state to require a vendor to collect sales or use tax. In its 1977 decision Complete Auto Transit, Inc. v. Brady,10 the Court developed a test sustaining state tax laws under the Commerce Clause if the statute satisfies a four-prong test; the first of which is the tax “applies to an activity with a substantial nexus with the taxing State.”11 In its 1992 decision in Quill,12 the Court overruled its prior determination that physical presence was an element of the Due Process Clause, but reaffirmed that physical presence is necessary to satisfy “substantial nexus” under the Commerce Clause.13

In the majority decision authored by Justice Kennedy, the Court criticized the Quill decision as flawed, finding that physical presence was not a necessary interpretation of the “substantial nexus” requirement, and that such the requirement deprives a factual analysis of the purposes and effects of the state’s nexus law, which “creates rather than resolves market distortions.”14 Noting the hypothetical of a business with one salesperson in every state (required to collect sales tax) relative to a company with 500 salespersons in one central location and a website accessible in every state (not required to collect sales tax in every state), Kennedy commented that Quill has the potential to “equally or more burden”15 a small company with diverse physical presence relative to a large remote seller. In the opinion of the Court, “[t]he physical presence rule is a poor proxy for the compliance costs faced by companies that do business in multiple States.”16

The Court also disputed as “unsound” the contention that the physical presence rule is “clear and easy to apply”17 stating that it is “proving unworkable” to apply to online retail sales”18 as states have recently enacted cookie nexus, click through, and notice and use tax reporting requirements on out of state retailers.19 The court noted, “statutes of this sort are likely to embroil the courts in technical and arbitrary disputes about what counts as the physical presence.”20

“Substantial nexus” for Commerce Clause purposes may be satisfied by a remote seller’s virtual connections

While Quill’s physical presence standard “may have seemed like a ‘clear,’ ‘bright-line tes[t]’…[it] now threatens to compound the arbitrary consequences that should have been apparent from the outset.”21 The Court surmised that it “should not maintain a rule that ignores these substantial virtual connections to the State.”22 The Court observed that an online showroom “can show far more inventory, in far more detail, and with greater opportunities for consumer and seller interaction that might be possible for local stores.”23

The Court also noted that “[a] physical presence requirement for nexus puts retailers with physical presence in the state at a disadvantage to solely online or remote retailers.24 Quill essentially treats “economically identical actors differently, and for arbitrary reasons.”25 The “physical presence rule . . . has limited States’ ability to seek long-term prosperity and has prevented market participants from competing on an even playing field.”26

Stare decisis does not support upholding an “error” in constitutional interpretation

Stating that the judicial doctrine of stare decisis “is not an inexorable command,”27 the Court held that stare decisis can no longer support the “Court’s prohibition of a valid exercise of the States’ sovereign power.”28 The Court “conceded” that while Congress has the authority to change the physical presence rule, Congress cannot change the “constitutional default rule.”29 Noting that the “Internet’s prevalence and power have changed the dynamics of the national economy”30 as well as the massive revenue lost by states, the Court stated, “the physical presence rule as defined by Quill must give way.”31

Other features of South Dakota’s law potentially avoid discrimination and undue burden on interstate commerce
Turning from the nexus issue to the other elements of the Commerce Clause test of the constitutionality of a state tax, the Court noted that the South Dakota law has “several features that appear designed to prevent discrimination against or undue burdens to interstate commerce.”32 First, the South Dakota law applies a safe harbor to those who transact “only limited business in South Dakota”33 (i.e., $100k or less in sales, or less than 200 in-state transactions). Second, the existence of an injunction staying any enforcement of the South Dakota law during the litigation “ensures that no obligation to remit the sales tax may be applied retroactively.”34 Third, South Dakota is one of “more than 20 states”35 that have adopted the Streamlined Sales and Use Tax Agreement requiring certain standardization within the sales and use tax statutes “to reduce administrative and compliance costs” for remote sellers.36

Dissent would have left it to Congress to overrule Quill
In the dissent, Chief Justice Roberts asserted that the Court should have “let Congress decide whether to depart from the physical-presence rule.”37 The dissent suggested that stare decisis has “special force” in dormant Commerce Clause questions considering Congress has final say over regulation of interstate commerce.38 Justice Roberts also opined that the Court’s acting with “inexplicable sense of urgency”39 caused the Court to “breezily disregard the costs that its decision will impose on retailers.”40 Thus, the Court did not adequately consider the burden the cost of compliance may have on all retailers and especially, the burden that may be more heavily borne by small businesses.41 Congress, he noted “may more directly consider the competing interests” and could draft legislation to “provide a nuanced answer to the troubling question whether any change will have retroactive effect.”42

Sales-based economic nexus statutes in other states

The US Supreme Court decision in Wayfair appears to validate South Dakota’s law (pending remand to the South Dakota Supreme Court) and may potentially validate other state’s sales-based economic sales and use tax nexus laws or administrative rules that fit within the South Dakota framework—i.e., provide a safe harbor for small sellers, prevent retroactive collection and remittance responsibility, and are adopted in a state that is a member of the Streamline Sales and Use Tax Agreement. While many of these states have enjoined enforcement (or delayed the effective date) pending the outcome of Wayfair, these statutes are now arguably effective and enforceable or will be shortly after any applicable injunctions are lifted. In addition, states with broadly worded general nexus statutes (e.g., “to the extent permissible under the US Constitution”) may issue regulatory guidance to assert similar sales-based nexus provisions consistent with the South Dakota framework.

For states with sales-based economic sales and use tax nexus laws or administrative rules that fall outside of the South Dakota framework, the Court left open the possibility of future constitutional challenges based on the concerns articulated by the Court and discussed above.

At this time, it is unclear how states may respond to Wayfair though a number of states have already issued statements, generally to the effect that they are aware of the decision and are studying the implications for taxpayers.43

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Potential for congressional response

While previous congressional proposals to address sales and use tax nexus have stalled,44 Congress may now be spurred to act given that the Court has overturned Quill. For example, Congress could act to reverse the Wayfair decision and affirmatively require physical presence as the appropriate nexus standard for sales and use tax purposes. Conversely, Congress could take a more limited approach and require the adoption of the Streamlined Sales and Use Tax Agreement, or similar simplification requirements, for states wishing to impose a tax on remote sellers through the enactment of sales-based nexus standards.

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Now that the US Supreme Court has overturned the physical presence standard required for a state to impose a sales or use tax collection obligation, taxpayers should consider the following as part of their compliance readiness analysis:

  • Is a state’s previously-enacted sales-based nexus provision now effective? If so, is it retroactive?
  • Do the taxpayer’s business activities or virtual connections in the state amount to “substantial nexus”?
  • Does the state’s regime impose any unreasonable burdens to a collection?
  • Will states provide guidance on effective date, registration and compliance assistance and enforcement?
  • Whether IT systems are in place to begin collecting sales tax in states with economic nexus sales and use tax statutes.
  • Whether existing IT systems are compatible with existing service providers or will new IT system implementations be required.
  • Application of the Streamlined Sales and Use Tax Agreement tools and systems.
  • Whether current financial statement positions need to be reconsidered.
  • In states with use tax notification requirements based upon a lower sales threshold amount, whether compliance with notification requirements, voluntarily registration, or another approach is appropriate considering current resources.
  • How sales of products or services would be characterized in relevant states.
  • Whether the required customer data is available to determine how to source sales if a sales and use tax obligation is imposed.
  • Whether the increased compliance burden makes outsourcing sales and uses tax compliance functions to a third-party a cost-effective alternative.

At this time, state approaches to enforcement remain uncertain, but delays in planning to meet these obligations may result in additional compliance costs and interruption to business operations. Companies are encouraged to consult with their indirect tax advisors to review the technical and logistical considerations that should be addressed now that Wayfair has been decided.

This important decision will be the subject of close scrutiny by affected remote sellers as well as states which may seek to adopt sales and use tax nexus provisions similar to those now upheld as constitutional in South Dakota. In this regard, please consider attending our special edition Dbriefs webcast—SCOTUS on Wayfair case: The path forward for sales-and-use tax reportingwhich will be held on June 29 at noon, EST.

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If you have questions regarding the Wayfair decision or other sales and use tax nexus matters, please contact any of the following Deloitte Tax professionals:

Valerie Dickerson, partner, WNTax-MTS, Deloitte Tax LLP, Washington DC, +1 202 220 2693

Michael Bryanmanaging director, WNT-MTS, Deloitte Tax LLP, Philadelphia, +1 215 977 7564

Rick Hellermanaging director, MTS, Deloitte Tax LLP, Parsippany, +1 973 602 4088

Stephanie Csan, managing director, Deloitte Tax LLP, Parsippany, NJ, + 973 602 6435

Galina Philipovitch, managing director, Deloitte Tax LLP, San Jose, CA, +1 408 704 2456

David Welliver, senior manager, Deloitte Tax LLP, Minneapolis, MN, + 1 612 659 2938

Stephanie Gilfeather, manager, Multistate Tax Services, Deloitte Tax LLP, San Francisco, + 415 783 7091

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The Multistate Tax alert archive includes external tax alerts issued by Deloitte Tax LLP's Multistate Tax practice during the last three years. These external alerts highlight selected developments involving state tax legislative, judicial, and administrative matters. The alerts provide a brief summary of specific multistate developments relevant to taxpayers, tax professionals, and other interested persons.

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1 South Dakota v. Wayfair, Inc., et al., No. 17-494 (June 21, 2018) 585 US. Opinion.

2 For additional details on the South Dakota law and the US Supreme Court’s grant of certiorari in South Dakota v. Wayfair, Inc. et al., please see our previously issued MTS tax alert.

3 Quill Corp. v. North Dakota, 504 US 298 (1992).

4 Justices Kennedy with Ginsburg, Alito, Gorsuch, with Justices Gorsuch and Thomas concurring, and Chief Justice Roberts with Justices Breyer, Sotomayor, and Kagan dissenting.

5 Quill Corp., 504 US 298 (1992); 386 US 753; National Bellas Hess v. Dept. of revenue, 386 US 753 (1967).

6 South Dakota v. Wayfair, Inc., et al., 585 US, 22 (2018).

7 Id. at 10.

8 Id. at 5-7.

9 National Bellas Hess, 386 US 753 (1967).

10 Complete Auto Transit, Inc. v. Brady, 430 US 274 (1977).

11 Complete Auto Transit, Inc., 430 US at 279.

12 Quill Corp., 504 US at 298 (1992).

13 Quill at 311.

14 South Dakota v. Wayfair, Inc., et al., 585 US, at 10-14.

15 Id. at 12.

16 Id.

17 Id. at 19.

18 Id.

19 Id. at 19-20.

20 Id. at 20.

21 Id. at 15, citing Quill Corp. v. North Dakota, 504 US 298, 315 (1992).

22 Id.

23 Id.

24 Id. at 12-13.

25 Id. at 13-14.

26 Id. at 17.

27 Id., citing Pearson v. Callahan, 555 US 223, 233 (2009) (quoting State Oil Co. v. Khan, 522 US 3, 20 (1997).

28 Id.

29 Id. at 17-18.

30 Id. at 18.

31 Id.

32 Id. at 23.

33 Id.

34 Id.

35 Id.

36 Id. The Court’s opinion may not foreclose a challenge from small businesses that South Dakota’s Act, or another state’s economic nexus law, discriminates against or is unduly burdensome to interstate commerce in the absence of Quill and National Bellas Hess based on facts and circumstances.

37 South Dakota v. Wayfair, Inc., et al., 585 US, at dissent p. 8.

38 Id. at dissent, p. 2, quoting Quill Corp., 504 US, at 305.

39 Id. at dissent, p. 4.

40 Id. at dissent, p. 5.

41 Id. at dissent, p. 5-6.

42 Id. at dissent, p. 7.

43 For example, the Washington Department of Revenue website has been updated with the following statement: “We are examining the decision and its implications for businesses and taxpayers, and we are working with other states to make the transition as smooth as possible for businesses.”

44 Marketplace Fairness Act of 2013, 113 S. 336 passed the Senate; Marketplace Fairness Act of 2015, S. 698, introduced by Senator Mike Enzi R-Wyo. on March 25, 2015, but stalled after introduction.

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