South Dakota v Wayfair: A Level Playing Field for Some, an Uphill Battle for Others
Written by Stan Adams
The Supreme Court issued an opinion today that will fundamentally change the nature of ecommerce in America, and allow states to charge sales tax on purchases made online. In South Dakota v. Wayfair, the Supreme Court sided with 42 states, two territories, and the District of Columbia, and overturned Quill Corp. v. North Dakota and National Bellas Hess, Inc. v. Department of Revenue of Illinois, under which retailers were not responsible for collecting state sales tax unless they had a physical presence in a state. Quill (the most recent of the two overturned decisions) was decided in 1992, a time when only a small fraction of Americans had internet access. Since then, as Justice Kennedy notes, the internet’s “prevalence and power have changed the dynamics of the national economy.” This means that states may now require online retailers to collect (and remit to the states) taxes on goods sold to their residents regardless of where the retailer is physically located. This decision is a major victory for states, but may make ecommerce more difficult, especially for small and mid-sized businesses selling products outside their home states.
In one aspect, Wayfair ushers in a more equal application of state tax laws to online retailers. Under Quill’s physical presence doctrine, a large business selling goods all over the country but physically located in a single state would only be obligated to collect sales tax on goods delivered in that state. Meanwhile, a smaller business with an office in each state would be responsible for collecting and remitting sales tax in every state to which it delivered goods. As Justice Kennedy notes, “[e]ach year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the States.”
This rule favored a more centralized business structure (with a distributed customer base) in two ways. First, it limited the costs associated with collection and remission of sales tax to only those states in which a retailer physically resided. Second, it allowed those retailers to offer a lower price on goods by omitting the portion otherwise collected as sales tax. (Important side note: buyers were, and still are, responsible for paying sales tax on goods purchased from out-of-state retailers. However, almost no one actually does this.) The combination of these two factors may have helped many businesses compete in the online marketplace, but potentially put local businesses offering similar products at a disadvantage due to the relative price differences. Likewise, states were deprived of revenue because neither the seller nor the buyer paid sales tax, or as Justice Kennedy observes, “the tax distortion created by Quill exists in large part because consumers regularly fail to comply with lawful use taxes.”
As a result of today’s decision, both centralized and distributed online retailers share the same responsibilities as local businesses for collecting sales tax according to the laws of any state in which they do business. This additional tax revenue will benefit states, who had been missing out on billions dollars each year under the Quill doctrine, and will also level the playing field in some ways between remote and local retailers.
The justices dissenting from today’s opinion note the case creates a new burden on retailers who may have difficulty navigating the legal intricacies of 10,000 different jurisdictions’ tax laws. CDT Board member and Mayer Brown partner Andrew Pincus points out that many of the largest online retailers already have a physical presence in most states and are therefore already in the practice of navigating these complex legal responsibilities. The new responsibilities to which online businesses will be exposed, then, will fall primarily on small and medium-sized entities who will need to invest in legal compliance. Although the extent and impacts of these compliance costs is difficult to estimate, they will almost certainly have a more significant impact on all but the largest retailers. As Chief Justice Roberts notes in the dissent, “People starting a business selling their embroidered pillowcases or carved decoys can offer their wares throughout the country—but probably not if they have to figure out the tax due on every sale.”
If Wayfair represents an advantage for the largest online retailers, whether because they are already geared for state-by-state compliance or because they can more easily absorb the costs of adapting to a new set of tax laws, overall competition in the online retail economy may be diminished. Roberts notes that “[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.” Granted, Roberts’ concern for internet retail may have roots in a reluctance to overturn past decisions, but his observation does put Wayfair in perspective. At the very least, Wayfair could help cement the advantage large companies already have. At worst, it may drive smaller competitors out.
In time, new products and services will probably arise to fill the compliance needs of smaller ecommerce retailers. Or Congress may step in with legislation to limit or balance states’ interests with those of online businesses. Although it is unclear what effects Wayfair may have, either in the short or the long run, those effects will reshape the online marketplace for years to come.