In a 5–4 split decision, the Supreme Court today overturned decades-old precedents that stood in the way of states that want to require online “e-tailers” and other remote sellers without a physical presence in their borders to collects sales tax on transactions with the states’ residents.
Both the majority and the dissenters agreed that the precedents were wrongly decided by past courts, but the dissenters held that changing such a long-standing holding should be left to Congress, where legislation has repeatedly been introduced in recent years to create a path for states to impose tax-collection obligations on remote sellers.
“South Dakota v. Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc.” (case 17-494) came to the U.S. Supreme Court from the South Dakota Supreme Court, which followed U.S. Supreme Court precedent in a decades-old ruling that states cannot require online retailers and other remote sellers that do not have a physical presence in a state to collect sales taxes on transactions with their residents. The 1992 Supreme Court decision “Quill v. North Dakota” reaffirmed in the context of catalog sales the ruling first articulated in the 1967 decision “National Bellas Hess v. Department of Revenue of Illinois” that sellers can't be forced to collect sales taxes for states in which they have no physical presence.
Justice Anthony M. Kennedy wrote the majority opinion, in which he was joined by Justices Clarence Thomas, Ruth Bader Ginsburg, Samuel A. Alito Jr., and Neil M. Gorsuch.
Justice Kennedy noted that in the 1992 “Quill” decision, Justices Scalia, Kennedy, and Thomas “based their decision to uphold the physical presence rule on stare decisis alone,” that is, on deference to established precedent.
Today, he was joined by one of the other two remaining justices who took that view in saying that “Quill is flawed on its own terms. First, the physical presence rule is not a necessary interpretation of the requirement that a state tax must be ‘applied to an activity with a substantial nexus with the taxing State.’ … Second, Quill creates rather than resolves market distortions. And third, Quill imposes the sort of arbitrary, formalistic distinction that the Court’s modern Commerce Clause precedents disavow.”
Justice Kennedy noted that the question is not whether a state can tax a purchase by one of its residents but whether it can compel a company that does not maintain a physical presence within its borders to collect the tax on its behalf.
“The Quill majority expressed concern that without the physical presence rule ‘a state tax might unduly burden interstate commerce’ by subjecting retailers to taxcollection obligations in thousands of different taxing jurisdictions. … 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. In other words, under Quill, a small company with diverse physical presence might be equally or more burdened by compliance costs than a large remote seller. The physical presence rule is a poor proxy for the compliance costs faced by companies that do business in multiple States. Other aspects of the Court’s doctrine can better and more accurately address any potential burdens on interstate commerce, whether or not Quill’s physical presence rule is satisfied,” Justice Kennedy wrote.
He added that “the rule produces an incentive to avoid physical presence in multiple States. 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. The Commerce Clause must not prefer interstate commerce only to the point where a merchant physically crosses state borders. Rejecting the physical presence rule is necessary to ensure that artificial competitive advantages are not created by this Court’s precedents. This Court should not prevent States from collecting lawful taxes through a physical presence rule that can be satisfied only if there is an employee or a building in the State.”
Justice Kennedy also said, “In the name of federalism and free markets, Quill does harm to both. The physical presence rule it defines has limited States’ ability to seek long-term prosperity and has prevented market participants from competing on an even playing field.”
He also cited changes in the marketplace since the 1992 “Quill” decision. “The Quill Court did not have before it the present realities of the interstate marketplace. In 1992, less than 2 percent of Americans had Internet access. … Today that number is about 89 percent. … When it decided Quill, the Court could not have envisioned a world in which the world’s largest retailer would be a remote seller,” he said.
In response to concerns about the administrative burden faced by small businesses with low levels of Internet sales spread across many states, Justice Kennedy said, “Eventually, software that is available at a reasonable cost may make it easier for small businesses to cope with these problems. Indeed, as the physical presence rule no longer controls, those systems may well become available in a short period of time, either from private providers or from state taxing agencies themselves. And in all events, Congress may legislate to address these problems if it deems it necessary and fit to do so.
“In this case, however, South Dakota affords small merchants a reasonable degree of protection. The law at issue requires a merchant to collect the tax only if it does a considerable amount of business in the State; the law is not retroactive; and South Dakota is a party to the Streamlined Sales and Use Tax Agreement,” he added.
“Finally, other aspects of the Court’s Commerce Clause doctrine can protect against any undue burden on interstate commerce, taking into consideration the small businesses, startups, or others who engage in commerce across state lines. For example, the United States argues that tax-collection requirements should be analyzed under the balancing framework of Pike v. Bruce Church, Inc., 397 U. S. 137. Others have argued that retroactive liability risks a double tax burden in violation of the Court’s apportionment jurisprudence because it would make both the buyer and the seller legally liable for collecting and remitting the tax on a transaction intended to be taxed only once. … Complex state tax systems could have the effect of discriminating against interstate commerce. Concerns that complex state tax systems could be a burden on small business are answered in part by noting that, as discussed below, there are various plans already in place to simplify collection; and since in-state businesses pay the taxes as well, the risk of discrimination against out-of-state sellers is avoided. And, if some small businesses with only de minimis contacts seek relief from collection systems thought to be a burden, those entities may still do so under other theories. These issues are not before the Court in the instant case; but their potential to arise in some later case cannot justify retaining this artificial, anachronistic rule that deprives States of vast revenues from major businesses,” Justice Kennedy wrote.
In a dissenting opinion joined by Justices Stephen Breyer, Sonia Sotomayor, and Elena Kagan, Chief Justice John G. Roberts Jr. wrote that although he agreed that “Bellas Hess” was wrongly decided, he opposes discarding the physical-presence because, as the majority noted, “the ‘Internet’s prevalence and power have changed the dynamics of the national economy.’”
“E-commerce has grown into a significant and vibrant part of our national economy against the backdrop of established rules, including the physical-presence rule. Any alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress. The Court should not act on this important question of current economic policy, solely to expiate a mistake it made over 50 years ago,” Chief Justice Roberts wrote.
He added, “This is neither the first, nor the second, but the third time this Court has been asked whether a State may obligate sellers with no physical presence within its borders to collect tax on sales to residents. Whatever salience the adage ‘third time’s a charm’ has in daily life, it is a poor guide to Supreme Court decision-making. If stare decisis applied with special force in Quill, it should be an even greater impediment to overruling precedent now, particularly since this Court in Quill ‘tossed [the ball] into Congress’s court, for acceptance or not as that branch elects.’”
Bipartisan criticism of the court’s decision was swift in coming from Congress.
In a joint statement, House Judiciary Committee Chairman Bob Goodlatte (D., Va.), Rep. Anna G. Eshoo (D., Calif.), and Rep. Jim Sensenbrenner (R., Wis.) said, “The Court’s reversal of Quill’s physical presence principle is a nightmare for American businesses and small online sellers, who will now have to comply with the different tax rates and rules of, and be subject to audits by, over 10,000 taxing jurisdictions across the U.S. in which they have no say at the ballot box or representation in state and local government.
“This decision will have broad ramifications well beyond the sales tax arena. The physical presence rule the Court overturned today preserved the political accountability that is essential to deter complex compliance burdens for small businesses. Today’s decision will stifle online commerce, close businesses, and ultimately harm consumers,” the three senior lawmakers added.
“The dominant issues under debate in this case involved policy, not law. The briefs filed with the Court were filled with discussions of economics, the efficacy of software, trends in the retail industry, and myriad other non-legal questions. Congress is the appropriate institution to resolve these policy questions, not the Supreme Court,” they said.
Sen. Ron Wyden (D., Ore.) said, “The Supreme Court has given the green light for states to establish an underground, nationwide, privatized tax-collecting bureaucracy. With this ruling sellers from other countries won’t have to collect tax, which will give them a big leg up over American producers and sellers.”
Sen. Wyden added, “Oregonians selling their goods online will now be extorted by a litany of software providers and their allies in state governments. They’ll need to pay multinational corporations a pretty penny to comply with an endless web of new tax jurisdictions. Then small business will be forced to carry the financial burden of other states’ taxes. That’s because local politicians desperate to find money to improve schools, roads and law enforcement will look for outside their borders to find it. I’ll do everything I can as the top Democrat on the Finance Committee to protect Oregonians — and small business everywhere — from being harmed by this catastrophic decision.”
Sen. Wyden noted that “earlier this year, the Government Accountability Office (GAO) estimated that state and local governments can already collect 75 to 80 percent of taxes that would be owed if all sellers were required to collect tax on all remote sales at current rates.”
Sen. Steve Daines (R., Mont.) said, “Today’s Supreme Court decision means unnecessary and complex burdens on small businesses, as well as a tax increase on consumers across the country. We must act to protect small businesses in Montana and across the country from this overregulation.”
There was also criticism from the tech sector.
Computer & Communications Industry Association President and Chief Executive Officer Ed Black said, “Today’s decision promises to subject small businesses reliant on e-commerce to new and burdensome tax obligations in states across the nation. As we approach the celebration of our nation’s independence, we should recall that taxation by a remote government was an injustice that animated the founding of our nation. CCIA has serious concerns about the future implications for e-commerce if governments are empowered to tax those who reside beyond their borders.”
CCIA had filed an amicus brief in the case argued that allowing states “to engage in extraterritorial taxation would burden internet services, and the startups and small businesses that rely on them.”
TechFreedom President Berin Szóka predicted, “Today’s decision is merely the beginning of years of costly litigation over states’ ability to tax online sales.” He added, “The majority insists that software will fix the problem of calculating the correct state and local sales tax for every transaction, but with over 10,000 jurisdictions taxing similar products differently, the problem is nightmarishly complicated. The majority acknowledges that this burden might be large enough to make laws like South Dakota’s unconstitutional as applied to some small businesses or startups. Yet the majority offers no guidance as to where to draw that line.”
Mr. Szóka continued, “There is only one alternative to waiting years for the courts to resolve these questions: federal legislation. The majority invites Congress to resolve these questions, while the Chief Justice repeatedly implores Congress to act, correctly noting that Congress is far more capable of resolving highly fact-dependent policy questions than the courts. Unfortunately, he may also be correct that, ‘by suddenly changing the ground rules, the Court may have waylaid Congress’s consideration of the issue.’ But lawmakers must not wait for the courts. They should reiterate what bipartisan Congressional majorities have said repeatedly by extending ITFA [the Internet Tax Freedom Act] multiple times since 1998: states should not be allowed to burden activity that affects them only incidentally. The very borderlessness that has made the Internet so successful is in jeopardy.”
There was also some praise for the decision.
Sen. Lamar Alexander (R., Tenn.), a co-sponsor with Sens. Mike Enzi (R., Wyo.), Dick Durbin (D., Ill.), and Heidi Heitkamp (D., N.D.) of the Marketplace Fairness Act, which would authorize states to require remote sellers to collect sales tax for them, said, “The Court’s decision is good news for Main Street business and for states. It correctly leaves to states decisions about who should pay state sales and use taxes and how they should be collected. It stops the federal government from forcing states to prefer out-of-state businesses over Main Street. There still may be a need for Congress to act to adopt the simplified collection of sales tax procedures in the Marketplace Fairness Act that 69 United States senators voted for in 2013.”
In a joint statement, the Council of State Governments, the International City/County Management Association, the National Association of Counties, the National Conference of State Legislatures, the National Governors Association, the National League of Cities, the U.S. Conference of Mayors, and the Government Finance Officers Association said, “State and local organizations applaud the U.S. Supreme Court’s decision recognizing that the 1992 Quill ruling put Main Street retailers at a competitive disadvantage to remote sellers and the efforts by states to simplify the sales tax collection process and giving those states remote sales tax collection authority. For 26 years Congress has failed to act and through the efforts of Justice Anthony Kennedy, the federal government has finally recognized the changing nature of commerce and state efforts to simplify the collection process.”
Information Technology and Innovation Foundation Vice President Daniel Castro said that “Congress has had many chances to address this issue, but it has failed to act decisively to resolve this problem. During this time, states have struggled to collect sales tax revenue from many online businesses and consumers even as these states have worked together to simplify and harmonize their sales tax systems. Today, the Supreme Court has ruled that states may require out-of-state businesses to collect sales tax on consumers even if they do not have a physical presence. This ruling ensures that major online businesses cannot operate as virtual sales tax havens, allowing consumers to avoid paying their fair share of sales taxes and unfairly competing with other online and brick-and-mortar retailers. The ruling is the right step forward for the digital economy. E-commerce has grown up.”
Mr. Castro added that “not all states have participated in the efforts to streamline their sales taxes systems. Moreover, states have a history of enacting laws and regulations that discriminate against online businesses to boost local businesses. Congress should continue to monitor and resist any attempts by states to place undue burdens on e-commerce, and policymakers should encourage states to streamline their sales tax systems before requiring out-of-state sellers to collect sales taxes so as to minimize compliance costs, which will ultimately be passed on to consumers.” —Lynn Stanton, [email protected]
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