In The Wake Of Wayfair: It’s Déjà Vu All Over Again

In the years after the U.S. Supreme Court upheld the physical presence nexus standard for state authority to impose a sales and use tax collection duty on remote sellers in Quill v. North Dakota, sales by remote sellers exploded, due almost entirely to the deployment of the world wide web not long thereafter.

The Quill Court declined to overrule National Bellas Hess v. Illinois Department of Revenue, in which the physical presence nexus standard had been announced. In the Court’s view, the necessity of retaining the standard for establishing commerce clause nexus was based on concerns of stare decisis, the general interest in the stability of the law, as well as the reliance interests of a large industry whose growth was enabled by that law.

Although the Quill Court did not explicitly say, its decision in Bellas Hess — which raised the specter of remote sellers having to comply with the wild variations in the tax laws of myriad taxing jurisdictions at both the state and local level, thus requiring a remote seller to keep track of different tax bases, rates, and other peculiarities — lurked in the background of reasoning.

This, the Bellas Hess Court said, and the Quill Court affirmed, was a burden on interstate commerce that the commerce clause would not permit.

A few years after Quill was decided, the online retail market gathered steam. More and more households were gaining internet access every year, and consumers were discovering the convenience and privacy of online shopping.

For merchants large and small, all that was needed to make sales was a web page showcasing their products and a means of taking payments.

In 1995 AuctionWeb, the predecessor to eBay, pioneered the person-to-person online transaction model, where consumers could interact directly with many different merchants without the need for a merchant to have its own website, thereby providing a user-friendly interface for consumer shopping. Other companies imitated eBay, and in the years thereafter, online retailing experienced explosive growth.

As consumers made ever-increasing numbers of their purchases online, revenue estimators’ yearly forecasts saw sales tax collections steadily dropping. As there was no practical way for states to collect the full contingent of use taxes legally due from consumers, they could only watch as their sales tax revenues declined.

State attempts to force Congress into acting, which began not long after Bellas Hess was decided and continued post-Quill, were unsuccessful.

In 2000 a few state tax policy experts seized upon the idea that if states drastically reduced, or even eliminated, the tax collection burden on remote sellers, the commerce clause hurdle might be overcome. They took their proposal to government and business stakeholders, and the Streamlined Sales Tax Project commenced.

In 2002 after much hard work and tearing of hair, the Streamlined Sales and Use Tax Agreement was launched, and today has 24 member states. For commerce clause purposes, SSUTA eliminated the burden argument in several ways, some of which include state-level sales and use tax administration; uniform definitions of goods and services; central, electronic seller registration; uniform sourcing rules for all taxable transactions; and simplified tax returns.

SSUTA established a cadre of certified service providers that keep track of all tax data for SSUTA states and remit the taxes collected on behalf of the online retailer to the appropriate state, thereby taking the retailer out of the equation. 

Citing Quill, companies operating online sales platforms consisting of third-party sellers, either in whole or in part, refused to participate — one, out of concern for third-party sellers on its platforms, and two, because they were not legally required to collect the tax, even though at least one online retailing behemoth was collecting tax on its direct sales to consumers.

A sea change occurred in 2018 when the Supreme Court released its decision in South Dakota v. Wayfair

W
. Overturning Quill’s physical presence standard, the ruling removed the barrier that had protected remote sellers from the duty to collect taxes on interstate sales for 51 years.

In the wake of Wayfair, sales tax states rushed to enact laws requiring person-to-person transaction platforms — referred to as “marketplace facilitators” or “marketplace providers” — to collect sales tax on behalf of those who sold their products on the platform, or “marketplace sellers.” Some states had already enacted such laws even before Wayfair, to become effective if and when Quill was overruled.

And therein lies the problem. In the charge to bring marketplace facilitators into the sales tax collection fold, states seem to have spared little or no thought to the realities of collecting sales taxes for so many jurisdictions, both state and local.

Of the 45 states that levy sales tax, 42 have enacted marketplace facilitator sales tax collection statutes, as well as the District of Columbia. Several states have implemented volume or transaction thresholds that trigger the collection requirement, while others use a volume threshold only.

Commendably, of the states that implemented the volume or transaction threshold, 20 are aligned with the threshold established by South Dakota before the Wayfair litigation. Notably, almost all are SSUTA members.

Some states employ a narrow definition of marketplace facilitator, while others have established a broad definition. It has been pointed out that these broad definitions could include those businesses that are decidedly not market facilitators.

There are more inconsistencies, but the thrust is that, while arguably not of the same magnitude, this is the same kind of patchwork system that led the Court to establish the physical presence standard in 1967.

While it is true that technological progress since Quill has alleviated many of the difficulties remote sellers faced in 1992, technology alone cannot solve every issue.

The Multistate Tax Commission White Paper

In July the MTC released its white paper on the problems engendered by the states’ various marketplace facilitator statutes, an update of a paper released in 2018.

Reminiscent of the earliest days of the Streamlined Sales Tax Project, the MTC’s paper carefully outlines and examines the problems faced by marketplace facilitators in the face of these inconsistent statutes. Aside from the narrow vs. broad definition of marketplace facilitator, there are inconsistent provisions concerning audit exposure for market facilitators and sellers.

In some states, only the marketplace facilitator is subject to audit, whereas other states subject marketplace facilitators and sellers to audit. Also of concern is when and if liability for erroneously collected taxes should shift from the marketplace facilitator to the seller.

Another problem is some states — that otherwise include sales of tangible personal property, services, and digital products in the tax base — have nevertheless carved out services and digital goods from the marketplace facilitator statutes, leaving the statute applicable only to sales of tangible personal property. It is difficult to understand the policy reasons for providing such carveouts.

For remote sellers, there is the question of — in calculating the sales volume to determine if the economic threshold has been met — whether to include gross sales or limit the calculation to taxable sales. Several states limit the calculations to taxable sales, which could prove difficult because it requires a remote seller to know the tax laws of the market state in question.

There are many more issues presented by the inconsistencies in the marketplace facilitator statutes, but the standout for me is the treatment of foreign sellers.

According to the MTC paper, a foreign seller without a permanent establishment in the United States runs into trouble trying to register with the states because it lacks a federal employer identification number (FEIN), which can only be obtained by creating a permanent establishment. Or a state may require the equivalent of a Social Security number from a responsible party.

There seem to be better and easier ways of registering a foreign seller. What is needed is verifiable, official proof that the foreign seller is a legitimate entity. A tax identification number from the seller’s home country would be best, yet it is possible the seller’s home country will refuse to release this information.

In that case, a state could allow the seller to register using its business license number issued by the home country. Interestingly, SSUTA’s centralized registration system allows a foreign seller to register without a FEIN, and the registration number assigned is valid in all SSUTA states.

If a business license number is not acceptable, perhaps a non-SSUTA party state could accept the foreign seller’s SSUTA registration number. Or perhaps non-SSUTA states could develop a system of their own, similar to the SSUTA central registration model.

Thus, a foreign seller’s registration in one non-SSUTA state would be valid in the rest of the non-SSUTA states. For the foreign seller to sell in SSUTA states would require coordination with SSUTA governing board, but this should not present an obstacle if all states are willing to work together.

Enforcement is a problem with foreign sellers and, in some cases, may be insurmountable. Generally, a state has no recourse against a foreign seller if the sales taxes are not paid. The so-called revenue rule holds that no nation is required to take cognizance of another’s revenue laws. Thus, a state cannot bring a tax suit in the United States against a foreign seller and expect a court in the seller’s home country to enforce the judgment.

If a foreign entity is retailing via a marketplace facilitator, in general, there will be no issue because the facilitator will collect the tax on behalf of the foreign seller. In instances when the tax is not collected and the market facilitator is not liable, states may obtain purchase information from the Customs and Border Patrol agency and deduct the tax due from a customer’s state income tax refund, although it must be acknowledged that this is not an option for a state without an income tax.

Other avenues that may be available include intercepting payments to the foreign seller while in the hands of a payment processor, or bringing a nontax civil suit against the foreign seller.

In the end, states should not throw up statutory barriers in the way of marketplace facilitators or marketplace sellers, whether domestic or foreign, to do business.

It is not necessarily a question of a state ceding its sovereignty to another entity, but a matter of coordination between states to help the entire system flow more smoothly, so to facilitate taxpayer compliance at reasonable cost.

Conclusion

The National Bellas Hess physical presence standard, deeply flawed and ultimately unworkable, nevertheless had a sound rationale — encourage the free flow of interstate commerce.

Given 1967 technology — or the lack thereof — the seemingly endless variations of state and local tax laws regarding tax bases, product definitions, compliance schedules, and more, would have forced interstate retailers to shoulder an impossible burden. Perhaps the standard should have been overturned in 1992 in Quill, but it was not.

In the years since, technology has progressed to where much of the burden that would have swamped an interstate retailer trying to comply with the welter of state and local tax laws in 1967 is bearable today. When the physical presence standard was overturned in Wayfair, states rushed to enact tax laws that would impose a sales tax collection duty on marketplace facilitators.

Unfortunately, the states’ actions resulted in the same problem, though perhaps not to the same extent, as existed in 1967: The variety of tax laws again place a difficult compliance burden on those businesses charged with collecting the states’ sales taxes.

Fortunately, states are more cognizant of these problems than they were in 1967 and in 1992, and have acted much faster to address the issues. What it will take to make the system work is for states to look beyond their own borders and coordinate with each other to produce a tax structure that will serve government and businesses alike.

Let’s hope the states will work to fix their mistakes with the same enthusiasm and speed they showed in making them.