David Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Worldwide Tax Daily. This week: The post-Wayfair landscape. In its June decision, the Supreme Court upended much of what we knew about state authority to force the collection of sales taxes. As we continue to sort through what that might mean for the future, we're joined by State Tax Today legal reporter, Jad Chamseddine, and we're joined on the phone by State Tax Today senior reporter, Paul Jones. Jad, Paul, welcome back to the podcast.
Jad Chamseddine: Thanks, it's good to be here.
Paul Jones: Thanks.
David Stewart: I should note before we get started that this episode is a follow-up to episodes we posted on June 26th and September 14th. Listeners interested in more of the background here should go back to those episodes, and we'll post links to them in the show notes. Paul, over the last few months, we've started to get a sense of the scope of this decision's effects. What's coming next?
Paul Jones: Well, obviously most states are now moving forward and preparing to enforce, or have actually begun in some cases, seeking compliance with their sales tax rules from remote sellers. However, notably, South Dakota's case recently was settled, so people are waiting to see if there's going to be further litigation that might clarify some lingering questions about the Wayfair decision with respect to states’ taxing authority in the context of sales taxes. Particularly, there's some question as to how far a state can stray from South Dakota's specific circumstances in the Wayfair case before a court might decide that it's overburdening remote sellers and potentially violating the dormant commerce clause. But even beyond sales tax, I think we're also looking at the possibility that the decision's effects will sort of trickle over and affect other business taxes, and potentially even affect tax policies outside of the U.S.
David Stewart: Now, on the authority to collect sales taxes from remote sellers, what are some of the questions that might still be addressed?
Paul Jones: Well, for one thing, it's not clear if every state can simply copy South Dakota's law, which a lot of them are trying to do. South Dakota obviously set a threshold of $100,000 in sales into the state, or 200 distinct transactions into the state, and asserted that that created substantial nexus. And other states have been adopting that as well, but it's not clear if all of them will be successful in doing that ultimately. For example, I've been following California's process for implementing Wayfair, and late in their last legislative session, they actually had draft legislation that suggested potentially a higher threshold of $500,000 in annual sales before the state would assert that a remote seller had an obligation to collect sales taxes. Now, they ultimately didn't adopt that, and currently they're talking about using South Dakota's thresholds as well. But sources have told me that it's possible that larger states, or states with more complex sales tax regimes, or that don't accommodate remote sellers the way that South Dakota and other Streamlined Sales and Use Tax Agreement states do, they might want to look at larger thresholds to protect them against court challenges and being found to have run afoul of the “Pike balancing.” Regarding thresholds, actually one thing that's interesting is I've heard some sources suggest that South Dakota's approach of either such a value of annual sales or certain number of sales might not be the best approach, particularly because there are some sellers perhaps that sell a very small number of high-value items. And then conversely, some remote sellers that sell a high volume of very low-value items. And I've heard some sources suggest that potentially there should be a combined minimum dollar value and a minimum transaction quantity threshold, which would protect smaller and potentially less sophisticated businesses from excessive compliance burden.
David Stewart: Jad, on the question of thresholds, does it follow that the bigger states will have to impose, or at least adopt, higher thresholds?
Jad Chamseddine: Possibly. It's certainly something that could be brought up in litigation. I was recently at a streamlined Governing Board meeting in St. Louis where the NetChoice President Steve DelBianco, whose organization has been involved in litigation around the country to quell these South Dakota-style bills, and he said it wasn't fair that a state like New Jersey, for instance, would adopt similar thresholds as South Dakota because of the amount of business New Jersey generates and the population it has compared to a state like South Dakota. He said that New Jersey's GDP perhaps would be a measuring stick and suggested a number closer to $1.2 million worth of sales into the state rather than $100,000.
David Stewart: With South Dakota's case settled, where might we see litigation that will answer the questions for other state systems?
Paul Jones: One state that some sources have said could potentially provide an opportunity to litigate the Wayfair decision further is Colorado, which has, it's put out its rules, its proposed rules. And a lot of sources have said that Colorado sort of got a complex sale tax regime that could prove burdensome, particularly to smaller sellers and generate litigation. I think Jad can speak a little bit more to that.
Jad Chamseddine: Paul is right. Colorado is one of those states that has a complicated sales tax regime, mainly because of its home rule cities. It recently released emergency regulations requiring remote vendors to collect and remit by December 1st. And the reason why it is so complicated is because these home rule cities will also require the remote sellers to collect or remit to their own jurisdictions. So essentially, a remote seller will have to collect and remit to the state and then also to the home rule city, which will open them up to multiple audit investigations possibly. The emergency rules actually took people by surprise over there. Some of my sources have told me that even the local jurisdictions didn't know that the emergency rules were coming out until the press release. Another state that you could possibly see some litigation in is Louisiana, which has a similar type of complex sales tax regime with their parishes. One way these states could avoid lawsuits is to adopt Alabama-style reporting requirements by creating one rate for all remote vendors. One of the problems, though, created by that, according to its deputy commissioner Joe Garrett, is that it creates a dual system in which an Alabama company pays different rates than a remote vendor. Texas has actually just released legislation that it may follow a similar route as Alabama.
Paul Jones: Also, regarding local taxing jurisdictions, sort of interesting I should note, in California, this has cropped up recently. Tax officials there have suggested that it's possible, I guess under California law specifically, that because counties are identified as taxing authorities in the state's sales and use tax law, that they may actually have to establish their own economic nexus threshold, how it was satisfied. They'd have to have their own economic nexus threshold and then have a remote seller actually make enough sales into the specific jurisdiction to meet that threshold before they could require a collection and remittance of their local sales taxes. So even if a remote seller had a sufficient nexus with the state to need to collect and remit the state sales tax, it might not be enough for counties in California. So that could be another wrinkle with respect to the state-local issues in Wayfair that need to be clarified.
David Stewart: Beyond these threshold issues and complexity issues, what else is out there that needs to be addressed and might end up in future litigation?
Paul Jones: Yeah, there are a lot of other issues that are going to have to be addressed. Sources have said that they expect there may be a little bit more attention paid to how states tackle the taxation of digital goods and services, which can be subject to sales tax. And that would obviously present some challenging sourcing issues when you deal with more and more remote vendors. And sources have also suggested that complying with state sales tax regimes could create some new liability risks for remote sellers, such as lawsuits regarding improper or overcollection of sales tax, or class action suits by taxpayers. So those are issues that people have said might come up.
One thing that could also be interesting to watch, in my opinion, is what's going to happen to some of these old laws that were passed prior to the Wayfair decision that were created to assert that an online seller had some form of physical presence in a state, such as click-through and affiliate nexus and even cookie nexus laws. The sources I've spoken with have suggested that some of them may end up sort of defunct because states will be able to rely on the holding in Wayfair and economic nexus through sales to require remote sales tax compliance. But I've also heard from people that some of these older laws could serve as a sort of backup authority that would help states continue to seek compliance, and not just sales taxes from before Wayfair, but also serve a use going forward. I've also heard, this is sort of an interesting wrinkle, I don't know if this will go anywhere, but at least a couple sources have said that if the argument post-Wayfair is that physical presence isn't a bright-line test for substantial nexus, and sales are, what happens in a case where you have a seller in a state with marginal physical presence, not a real big footprint, and also very low sales, very low retail sales into the state that would actually be below the state's economic presence threshold for remote sellers. I've heard some people suggest they might have an argument then under those circumstances a seller with some minimal physical presence in the state could claim it doesn't really have substantial nexus anymore because of Wayfair. But I guess we'll have to see if that comes up and where it goes.
David Stewart: Now, the Supreme Court's decision didn't limit this ability to force the collection of sales taxes to U.S. companies. What does this mean for foreign vendors that sell into the U.S.?
Jad Chamseddine: Yeah, look, the law is quite clear. Foreign vendors have to comply with U.S. law, and they have to collect and remit when they're selling into a state and they reach the threshold. Now, the issue is obviously whether they can go after foreign companies that are not abiding by the law and are not collecting and remitting. States simply don't have the ability to go after a foreign vendor that doesn't have a physical presence in the United States and is selling into the United States, but never ever enters the U.S. Some of the sources suggested that states could use the full faith and credit clause to go after companies that have assets in the U.S. if they're not located in the state in which they owe sales taxes. For instance, a bank account in New York, but that could prove problematic if they don't have enough assets in those bank accounts. And it could prove burdensome for the states to do that and engage in all that litigation. But not complying could also prove to be a short-term benefit for the company essentially, especially if the company is being acquired by a larger company, or it has ambitions to grow in the future. The U.S. has something known as successor liability for sales taxes. And so, if there's an outstanding assessment, the acquiring company could be on the hook for the acquirer's debts in that sense. Some of the more novel ideas would conscript the customs authority to do the taxman's job, like they do in some European countries. But these measures would be too complex and too time consuming for the federal government to do the state's job and tax certain items coming into the country. Another interesting idea would be using real time taxation to help collect taxes, such as using credit card companies whenever a point of purchase. They would be able to register what is being acquired, and then source the correct taxes to the local jurisdiction and to the states. But again, credit card companies will likely push back on measures to make them responsible for collecting and remitting at the end of the day.
David Stewart: Alright, now, I've actually heard folks from outside the U.S. talking about Wayfair and its implications beyond sales taxes. What implications do you see for Wayfair on other business taxes?
Paul Jones: Sources have told me the main impact of the ruling beyond sales taxes is that by eliminating the physical presence test, the court's decision really bolsters states’ use of economic nexus. The physical presence requirement, that bright-line test, only applied to states’ sales taxes. But it was something that stood sort of in contrast to the broader premise of economic nexus. So by removing that, that sort of implies that economic nexus really is sufficient probably for most forms of business tax. Already, we've seen the growth of factor presence nexus. That includes asserting nexus for business activity taxes based on a business's sales into the state. And I've had some sources suggest that the Wayfair ruling might encourage other states to feel confident to pursue that. I will add also that there was apparently some lingering question as to whether the physical presence standard might apply to business taxes. Most of the legal experts I spoke with said that they didn't think, prior to Wayfair, that there was much reason to suspect that it did. And there had been a number of state court cases in which courts had ruled that it did not. But it was pointed out to me that Wells Fargo had adjusted its earnings down in anticipation of having a higher state income tax liability after the Wayfair decision. So there appears to have been some in the business community that had been taking the view that the physical presence standard could offer them some protection in the context of business taxes. I'm going to mention this as sort of a side note, one other sort of potential implication of the Wayfair decision, sort of a very specific one, has to do with Public Law 86-272. Of course, that protects retailers of tangible personal property from having to pay income tax to a state where they limit their operations to sales and solicitation. I had a couple sources say that now that you've got remote sales tax compliance obligations for other sellers, you might see sellers of digital goods and services trying to see if they can get that law's protections expanded to apply to them as well so that any remote seller, including those that are not selling tangible personal property, that is going to have to register and collect and remit sales tax, is potentially protected from having to face bigger income tax as well.
David Stewart: Jad, do you see this decision having some effect on the larger discussion happening overseas about the taxation of the digital economy?
Jad Chamseddine: Possibly. Internationally, there's a concept similar to the physical presence rule known as permanent establishment. Many foreign jurisdictions like the U.K. and France have long struggled to collect from the digital economy. Some of the biggest players in that domain are U.S. companies from Silicon Valley. And the U.S. so far has resisted any attempts at taxing them if there is no permanent establishment in the taxing jurisdiction. And while the Wayfair decision may have come at the right time for countries looking to tax U.S. multinational companies in that space, European countries have struggled with this concept long before the Wayfair case came about. At the end of the day, Wayfair is a U.S. Supreme Court decision dealing with U.S. sales taxes and not digital taxes. So the Supreme Court decision won't do France any good in leveling a strong argument to tax the Facebooks of this world.
David Stewart: Is there anything the U.S. should take from the Wayfair decision when negotiating with its foreign counterparts?
Jad Chamseddine: Definitely. Just as states took matters into their own hands to create novel approaches to tax remote vendors by introducing concepts such as click-through nexus and cookie nexus when Congress failed to act after the Quill decision, the European Union is also going down the same path. It has proposed rules to implement a revenue-based digital service tax on companies with a significant digital presence. A company would be taxed if revenue from digital service exceeds €7 million, it has more than 100,000 users, or it has more than 3,000 online business contracts. By couching it as a tax on gross revenue as opposed to income, income tax treaties still apply and they don't have to worry about renegotiating them. I think the main lesson to learn is that countries, just like states, won't let revenue slip out of their hands. As an attorney told me, everybody will have to come to terms with the new digitizing economy and how that gets taxed.
David Stewart: Well, gentlemen, this has been great. Paul, I understand you're not on Twitter, but Jad, you are. So Jad, where can listeners find you online?
Jad Chamseddine: You can find me on Twitter @jchamseddine10.
David Stewart: Excellent. Gentlemen, thank you for being here.
Jad Chamseddine: Thank you.
Paul Jones: Thanks, our pleasure.
David Stewart: And now, Coming Attractions. Each week we preview commentary that will be appearing in the next issue of the Tax Notes magazines. We're joined by executive editor for commentary, Jasper Smith. Jasper, what will you have for us?
Jasper Smith: In Tax Notes, Professors J. Clifton Fleming Jr., Robert Peroni, and Stephen Shay consider the effect of the TCJA's international provisions on taxation of foreign-source active business income, while Scott Swartz examines the questions used to evaluate whether an investment is considered a trade or a business.
In State Tax Notes, Carley Roberts and Jessica Allen launch a new column from Pillsbury Winthrop. The first article examines the underpinnings of the exhaustion doctrine, and the de novo review standard. Also, Michael Fatale discusses the aftermath of Wayfair and the processes that should allay the constitutional concerns raised by the decision.
And in Tax Notes International, Torsten Fensby reviews the new foreign derived intangible income regime. While Frans Vanistendael discusses the EU Council Directive addressing automatic exchange of information regarding reportable cross-border arrangements.
David Stewart: You can read all that and a lot more in the December 3rd editions of Tax Notes, State Tax Notes, and Tax Notes International. That's it for this week. You can follow me on Twitter @TaxStew, that's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a review on wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.
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