New Sales Tax Law Fast-Tracks Constitutional Challenge in South Dakota

Protecting Americans from Tax Hikes (PATH) Act
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On March 22, 2016, South Dakota enacted legislation (SB 106) that requires certain out-of-state sellers with no physical presence in the state to collect and remit the state’s sales tax on sales to South Dakota customers. Beginning on May 1, 2016, the obligation to collect the state’s sales tax for out-of-state sellers is based solely on having greater than $100,000 in sales or 200 separate sales transactions to South Dakota customers. In anticipation of a challenge to the law’s constitutionality, the legislation includes a fast-track judicial review procedure that can take place without an audit or assessment against a taxpayer. South Dakota has attempted to pave the way for the U.S. Supreme Court to finally readdress the “nexus” standard for sales and use tax, a task that Congress has argued in recent years.

A retailer’s sales tax collection obligations under South Dakota’s new law stem from the fact that it’s inefficient for states to audit their residents for the use taxes they have not remitted to the state – for example, on their purchases from certain online retailers. Clearly, it’s more effective to have retailers collect and remit the tax to the respective states where they make sales. Still, this can be unduly burdensome on small retailers. Collection of the sales tax is especially important in South Dakota, a state that does not impose an income tax. There is just one minor roadblock in the way of South Dakota’s law remaining intact – the Constitution. In 1992, the U.S. Supreme Court held in Quill Corporation v. North Dakota that a state cannot require a retailer to collect its sales tax unless the retailer has a physical presence in the state. The Quill decision is yet to be overturned. Thus, the physical presence nexus standard is still good law today.

For a number of years, states have passed laws that clarify their position on what constitutes a physical presence, many of which are arguably consistent with the decision in Quill. For example, many states’ sales tax laws specifically provide that having an out-of-state retailer with an in-state affiliate results in a presumption that the out-of-state affiliate has a physical presence in the state. This largely addresses businesses attempting to avoid the collection of sales tax for online sales by setting up their brick-and-mortar stores in one legal entity and their online seller in another.

However, the South Dakota law is clearly at odds with the decision in Quill, as it bases the requirement to collect state’s sales tax solely on a retailer meeting a certain threshold of sales to South Dakota customers. Thus, instead of having a “physical presence” nexus standard, the law establishes an “economic” nexus standard. In recent years, a handful of states have adopted “economic” nexus laws for income tax purposes on the basis the Quill decision does not apply to income tax, but the South Dakota law is the first of its kind applicable to sales tax. Alabama is the only other state with a similar rule, but theirs is in the form of a regulation.

The judicial review procedure established in the new law reflects South Dakota’s awareness of the significance of the requirements that it is attempting to impose on remote sellers. During a review, which can be initiated by the state itself through a request for a declaratory judgement, the state is prohibited from enforcing the collection obligations in the law until its constitutionality has been determined. Thus, despite the May 1, effective date, it could be quite some time, if ever, before the law can be enforced, especially if the U.S. Supreme Court eventually hears the case. Still, South Dakota has boldly gone where no other state has, which could finally result in the reconsideration of the “physical presence” nexus standard.

If you have questions about your company’s sales tax collection obligations, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301-231-6200.

About Michael Colavito, Jr.

Michael Colavito, Jr. has written 55 post in this blog.

Michael L. Colavito, Jr. is a senior manager in Aronson LLC’s Tax Services Group, where he provides multi-state taxation services pertaining to income, franchise, sales and use, and property taxes. Michael’s experience also includes representing clients at all stages of tax controversy, from audit through appellate litigation, and advising them on restructurings, state tax refund and planning opportunities.

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