It just won’t stop.
While attending a tax conference, you stroll into a panel on recent international developments. The prepared talking points focus squarely on corporate taxation. You expect a robust discussion about the OECD’s base erosion and profit-shifting project and the ongoing efforts to tax the digital economy. There’s absolutely no reason for attendees to mention consumption taxes, state and local tax litigation, or the commerce clause of the U.S. Constitution.
Then it happens. Before you know what hit you, everyone in the room is harping on the spillover effects from the Supreme Court’s South Dakota v. Wayfair, Inc. decision from last summer. This shouldn’t occur, but it does — and with surprising regularity.
It happened at the recent American Bar Association Section of Taxation meeting in Washington. Colleagues have been asking me about it since shortly after the decision was released. And trust me, it’s happened all over the world. We’ve seen it occur in Seoul, Mumbai, and Vienna — places that seem far removed from a spat over South Dakota’s sales tax regime. Most foreign policymakers probably can’t locate Pierre, South Dakota, on a map; but we can be darn sure they’re well versed in key aspects of Justice Anthony M. Kennedy’s majority opinion. Particularly the bit when Kennedy explains that physical presence — as a juridical basis for constraining taxing rights — has outlived its useful life and deserves to be relegated to history’s dustbin.
Wherever we find market jurisdictions seeking to expand their taxing authority — which is pretty much everywhere — someone is invoking Kennedy’s language in support of the desired conclusion: The permanent establishment concept is dead, and we’re patiently waiting for the OECD to bury the corpse. This must be the case — the Supreme Court said so. But how accurate is this narrative?
Here, some Latin comes in handy. Per Black’s Law Dictionary:
Dictum: … generally used as an abbreviated form of obiter dictum, “a remark by the way;” that is, an observation or remark made by a judge in pronouncing an opinion upon a cause, concerning some rule, principle, or application of law, or the solution of a question suggested by the case at bar, but not necessarily involved in the case or essential to its determination; any statement of the law enunciated by the court merely by way of illustration, argument, analogy, or suggestion.
At no point in the Wayfair opinion did Kennedy mention stateless income or the various maladies that the BEPS project sought to cure. In fact, Wayfair isn't about income taxes at all. The facts of the case involved South Dakota’s attempt to apply its sales tax to remote vendors — that is, companies with sales to customers in South Dakota, but without any property or employees in the state.
Understandably, those firms don’t want to deal with the pesky sales tax obligations of states in which they lack a physical presence. Wayfair challenged South Dakota’s actions on constitutional grounds. They had federal case law on their side. In 1967 and 1992 the Supreme Court gave us decisions that confirmed that a physical presence standard applied to these situations.
Without some form of boots on the ground (i.e., property or people), state tax authorities couldn’t reach out-of-state firms — at least not in the consumption tax context. The idea bears a striking resemblance to the PE concept: Just swap international borders for state borders, and corporate income taxes for the retail sales tax.
Wayfair set critical new precedent. I happen to agree with the decision point for point — but only as applied to state and local consumption taxation. To extend the Court’s rejection of the physical presence standard to other fields of taxation is a creative use of dictum. It pushes the Court’s reasoning to places it was never intended to go.
Most fundamentally, Wayfair hinged on a reading of the commerce clause. This renders the judgment a uniquely American form of jurisprudence and, accordingly, limits its scope. There’s no parallel source of law that applies extraterritorially. For better or worse, the world lacks a universally applicable commerce clause that purports to constrain the reach of a sovereign nation’s taxing authority. But governments voluntarily enter bilateral tax treaty relationships with their key trade partners, and those treaties divvy up taxing rights in a mutually acceptable manner, with the stated objective of avoiding double taxation. The PE concept resides in those treaty networks. There isn’t even a parallel provision to the PE concept in the Internal Revenue Code.
In short, other countries are being opportunistic when they invoke Wayfair to underscore the deficiencies of the PE concept. Those efforts make the U.S. Treasury Department look hypocritical when it opposes alternative nexus concepts, such as the “significant economic presence” standard proposed by India and other G-24 nations. This hints at a tax policy disconnect, suggesting that Treasury is cherry-picking when it embraces a physical presence standard — as between nations — and when it repudiates the same — as between the U.S. states. The optics are admittedly awkward.
In terms of strict jurisprudence, Wayfair should have nothing to do with how we tax multinational corporations on their foreign profits. That said, the serendipitous timing of the Supreme Court docket and the aftermath of BEPS make such comparisons inevitable. Dictum is punching above its weight.