'Wayfair' decision—potential financial reporting implications

Overview

On June 21, 2018, the US Supreme Court decided what is arguably the most important state tax case of the last 25 years in Wayfair et. al.¹ In a 5–4 decision, the majority overruled the sales/use tax nexus standard of physical presence established in National Bellas Hess² and later upheld in Quill³ as it applied to South Dakota’s sales/transaction-based sales/use tax nexus statutes affecting remote seller transactions.

Much of the focus has now turned to those states with enacted statutes that are similar in application to the law in South Dakota and the potential effective date of such provisions.

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Potential effective date varies by state

As of the date of this alert, approximately 20 states have enacted sales and/or transaction-based sales/use tax nexus statutes affecting remote seller transactions. Given the significance of the effective date relative to the potential financial reporting implications, the status of enacted state laws in this area can be generally segregated into the following categories:

• Enacted statute exists with an associated effective date prior to the June 21 decision in Wayfair, and the statute is currently the subject of litigation challenging the constitutionality of the state law.
• Enacted statute exists with an associated effective date prior to the June 21 decision in Wayfair, and the statute provides that collection efforts are enjoined pending the outcome of the Wayfair litigation.
• Enacted statute exists with an associated effective date reliant upon an outcome in Wayfair upholding the South Dakota law.
• Enacted statute exists with an associated effective date scheduled to occur at some date in the future.

Of the remaining states that levy a sales tax, proposals are under consideration as of the date of this alert in a handful of other states which, if enacted, would create similar sales and/or transaction-based sales/use tax nexus provisions affecting remote seller transactions.

Finally, there are also a number of states with provisions that extend nexus to “the extent permissible under the US Constitution.” It is presently unclear the manner in which these states might seek to apply (and if so, the effective date of) the Wayfair decision.

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Financial reporting implications

If it is certain that an entity will be subject to liability for sales/use tax in particular jurisdictions as result of the Wayfair decision, then the liability should be recognized and measured based on the provisions of the applicable laws. Such liability does not represent a loss contingency, but rather represents a contractual obligation pursuant to applicable law.

Derecognition of the liability would be based on the guidance in ASC 405, Liabilities, which requires the debtor to derecognize a liability if and only if it has been extinguished. A liability has been extinguished if either the debtor pays the creditor and is relieved from its obligation for the liability, or the debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor.

If there is uncertainty whether or not an entity will be subject to liability for sales/use tax as result of the Wayfair decision, ASC 450, Contingencies, provides accounting guidance for loss contingencies, which include existing conditions involving uncertainty as to possible loss that will be resolved when one or more future events occur or fails to occur. Uncertainty regarding tax positions not within the scope of ASC 740, Income Taxes, such as sales and use tax should be assessed as a loss contingency pursuant to ASC 450, Contingencies. ASC 450 governs if and when the recognition of a liability for a loss contingency is necessary.

An estimated loss from a loss contingency is accrued if it is probable that a liability has been incurred as of the date of the financial statements and the amount of the loss can be reasonably estimated. If an entity concludes it is probable it will be subject to sales/use tax, then the liability should be recognized and measured based on the provisions of the applicable laws. Derecognition of the liability would be based on the guidance in ASC 405 discussed above which requires the debtor to derecognize a liability if and only if it has been extinguished.

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Financial reporting analysis necessary on a state by state basis

In light of the Court’s unequivocal statement in Wayfair that physical presence is not a necessary element for “substantial nexus,” taxpayers should revisit positions they may have taken for sale and use tax collection purposes regarding the need for a physical presence to establish the substantial nexus. While the facts at issue in Wayfair involved a statute with prospective application, potential retroactive application, and enforcement to the effective date of a state’s applicable statute remains uncertain.

For example, if a company sold taxable goods or services to customers in Georgia, where the enacted sales/transaction-based nexus statute will not become effective until January 1, 2019, a remote seller whose activities into Georgia have been limited to sales would not have an accrual. By contrast, if a company has sold taxable goods or services to customers in Massachusetts, a state where a promulgated sales/transaction-based nexus regulation became effective in October 2017,⁴ a careful evaluation should be performed.

The Massachusetts Department of Revenue indicated in a Wayfair-related notice issued on June 22, 2018, that the “existing regulation which took effect in October 2017, continues to apply and is not impacted by the [Wayfair] decision.”⁵

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Notification and reporting statutes

As of the date of this alert, approximately 10 states have enacted notification statutes which can carry substantial penalties. Such states require remote sellers to provide in-state buyers with information regarding their use tax obligations, as well as provide a report to the state detailing in-state purchases.

Colorado, for example, enacted a penalty regime in conjunction with their notification statute that includes the following penalties for each non-collecting retailer: $5 for each transaction not reported; $10 for each annual purchase summary not provided. While seemingly nominal, these penalties could be substantial depending on the number of transactions.

Note that in Colorado, penalty caps may be available, for example, if the non-collecting retailer “reasonably had no knowledge of the requirement to provide transactional notices and began to provide [them] within 60 days of demand by the Department, [the penalty is limited to] $25,000.”⁶ Amounts associated with penalties would also be accounted for consistent with the financial reporting guidance discussed above.

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Considerations

This landmark decision continues to receive careful consideration by taxpayers and states. Taxpayers should consider the impact of Wayfair on positions they may have taken regarding sales and use taxes, as well as other taxes, fees, and charges typically collected and remitted to states as described above when evaluating the financial reporting implications of the decision.

For further information on the Wayfair decision and the potential implications for remote sellers overall, please see our June 26 tax alert "US Supreme Court overturns Quill’s physical presence standard." For further information on the potential state tax implications of Wayfair for non-US companies with US customers, please see our June 27 tax alert "State tax implications of Wayfair for non-US companies with US customers." For further information on Wayfair’s potential nexus ramifications for income and other taxes, please see our June 28 tax alert "Wayfair—potential nexus ramifications for income and other taxes."

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Multistate Tax alert archive

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.

View the list of archived Multistate Tax alerts.

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References

¹ South Dakota v. Wayfair, Inc., US Supreme Court, Dkt. 17–494, (6/21/2018).

² National Bellas Hess, Inc. v. Department of Revenue, 386 US 753 (1967).

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

⁴ 830 CMR 64H.1.7: Vendors Making Internet Sales available here.

⁵ Massachusetts Department of Revenue Notice dated 6/22/2018.

⁶ CO Rule 39-21-112(3.5) (4)(g)(ii)(A).

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