Sales tax accounts for approximately 34 percent of states’ revenue. Due to the growth in e-commerce, however, it is estimated that states lose approximately $23 billion in sales tax annually from online and catalog sales. The prevailing view among states is that the only answer to this revenue loss is to close the loophole over sales tax collection from remote sellers, such as internet retailers, by expanding traditional nexus standards.
The traditional concept of what constitutes sales tax nexus has increasingly been under attack as states struggle for new ways to subject foreign entities to sales tax collection and reporting. For decades, the US Supreme Court decisions in Quill Corp and National Bellas Hess stood as the standard governing sales tax nexus. In Quill and Bellas Hess, the Court held that a business could not be required to collect and remit sales tax without having a physical presence in the state. More recently, though, states have challenged the physical presence requirement through different statutory frameworks, such as click through nexus, affiliate nexus, and factor presence tests, creating a bright line standard to determine when a company has triggered nexus in the state.
The most recent assault on sales tax nexus came from litigation surrounding Colorado’s law requiring remote sellers to notify the state of purchases made by Colorado customers. The notice and reporting law was intended to promote sales and use tax compliance among Colorado purchasers buying from remote sellers. The Direct Marketing Association filed a lawsuit (Direct Marketing Association v. Brohl) seeking to enjoin Colorado from enforcing its notice and reporting law. The Supreme Court issued a unanimous decision in the case which paved the way for Direct Marketing Association to pursue its case against Colorado.
While the case appears to be a victory for the taxpayer, the significance of the decision extends beyond its limited application to notice and reporting requirements. As part of his concurring opinion, Justice Kennedy opened the door for the Court to potentially reexamine its prior opinions in Quill and Bellas Hess requiring physical presence in a state to establish sales tax nexus. Kennedy noted that while there have been “systemic and structural changes in the U.S. economy,” a business can be present in a “meaningful way without that presence being physical in the traditional sense.” Whether Kennedy was swayed by his sympathy for the states’ economic plight and the tremendous revenue loss they are experiencing from the growth in internet retailing, or legal principles, is unclear. However, what is clear is that Kennedy’s comments in his opinion will likely act as a catalyst for states to enact broader sales tax nexus laws.
The outcome of sales tax nexus is not entirely in the hands of the states. There is the possibility that Congress will intervene to end the uncertainty around remote seller nexus by enacting laws that will change the landscape of sales tax nexus. There are currently a number of bills in Congress that would require remote sellers to collect and remit sales tax. Although, the likelihood that one of those bills would pass seems unlikely given Congress’s inability to enact such legislation previously.
The issue of remote seller nexus started out couched as a way to defend main street businesses from competition brought on by major corporations like Amazon. However, it has morphed into an issue affecting all businesses with internet sales. Many main street businesses have had to turn to internet sales as a means of survival. Any change to the physical nexus standard will likely impact them, as well.
For now, physical presence continues to be the nexus standard for sales tax collection and businesses can take some comfort in that reality. Any change to the nexus standard is unlikely to be a speedy one and will probably take place on a state-by-state basis, which will allow remote sellers an opportunity to gradually adapt to these changes.
Thomas M. Frascella can be reached at Email or 215.441.4600.
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