On June 21, 2018, in South Dakota v. Wayfair ("Wayfair"),1 the United States Supreme Court (the "Court") reversed its decades-old ban on states imposing a sales tax collection obligation on out-of-state vendors without an in-state physical presence.2 As discussed below, the Wayfair decision has the most relevance to non-U.S. sellers of goods and services to retail customers located in the U.S.

In this note, we briefly review the U.S. sales-and-use tax regime, its application to non-U.S. businesses, and the impact, if any, the Wayfair decision may have on the sales tax collection obligations of non-U.S. businesses.

U.S. Sales-and-Use Tax Regime

In the United States, there is no national-level value-added or consumption tax. Instead, most states (45 of the 50), Washington, DC, and, to the extent permitted by the states, their political subdivisions, such as counties and cities, have their own consumption taxes, colloquially known as "sales and use taxes." Official names of the taxes, taxable purchases, and tax rates vary quite a bit among jurisdictions. Within a single state, multiple levels of tax (for example, state, county, and city) can apply to the same transaction.

Despite variations among jurisdictions, the sales and use tax regimes share certain common traits, such as the following: (i) the taxes are imposed on the retail purchasers of tangible personal property and, to the extent specified by law, intangible personal property and services; (ii) the taxes are levied on the "retail" purchaser as a percentage of the gross sales price of the taxable property or service; (iii) the sales tax is imposed by the jurisdiction where the sale takes place (i.e., where the goods and services are "used" or "consumed" by the retail purchaser (generally, where the good or service is "received" by (or delivered to) the purchaser)); (iv) if the sale occurs within the jurisdiction of use or consumption, the vendor is required to collect sales tax at the point of retail sale and remit the tax to taxing authorities and no use tax becomes due; and (v) if the sale is made by a remote vendor such that the sales transaction does not occur within the jurisdiction of use or consumption, the remote vendor is obligated to collect and remit the sales tax only if it shares a "substantial nexus" with the taxing jurisdiction.

It is important to note that the concept of sale at "retail" is not limited to the sale of consumer items and services to individuals. In many states, retail sale includes the sale of goods and services that are not for resale or other exempt purposes. Therefore, the sales and use taxes often has a far broader application than one expects.

Use tax generally serves as a backup for the sales tax. It is levied on purchasers when sales tax is not collected on taxable sales of goods and services. For example, if a resident of one state purchases a laptop computer, and the seller does not collect the sales tax for any reason, the purchaser is required to pay the use tax. When the purchaser pays use tax, the related sales tax liability generally is deemed satisfied. Use tax, however, relies on self-reporting and payment and, as a result, has historically suffered from low rates of compliance. Moreover, it is difficult to enforce because of the large number of purchasers who are pursued for relatively small amounts of taxes, compared to the number of sellers, and the potential adverse public opinion that may ensue from a strict enforcement.

U.S. Sales and Use Tax Application to Non-U.S. Businesses

Sales and use taxes generally apply to the taxable sales of goods and services by non-U.S. sellers in the same manner as they apply to U.S. sellers resident in states other than the state where the goods or services are consumed. There is no special or disparate state-level tax treatment available to non-U.S. businesses, except that they not be discriminated against based on their non-U.S. status, based on the "nondiscrimination clause" of many U.S. tax treaties.

In addition, it is important to note that this tax collection obligation is independent of the same business's obligation to pay income tax to the same state or the U.S. federal government. In the U.S., out-of-state businesses generally are subject to income taxation in a state if they meet a substantial nexus requirement (with its own criteria) for paying income tax for that particular state. This is a crucial point that is further discussed below. This is further complicated by the fact that a state income tax obligation is independent of whether a non-U.S. business is subject to U.S. federal income taxation under the statutory "U.S. trade or business" standard, or the "permanent establishment" standard under U.S. tax treaties. Therefore, it often is the case that a non-U.S. business meets the requisite "substantial nexus" requirement for sales tax purposes in one state while not meeting the same test for that state's income tax purposes, or vice versa.

Wayfair

Wayfair dealt with the question of whether physical presence (for example, no personnel, stores, offices, or warehouses) is a prerequisite for establishing the substantial nexus for purposes of imposing the sales tax collection obligation on an out-of-state vendor. Specifically, Wayfair looked at whether online retailers without a physical presence in a state can be required to collect that state's sales tax on consumer goods sold and delivered to that state's residents via common carriers (for example, via the U.S. Postal Service).

As discussed above, in most states, the taxable sale of goods and services is subject to sales tax when the goods and services are used or consumed by the purchaser in the taxing state. Before Wayfair, however, if a vendor had no physical presence in the taxing state (for example, personnel, store, office, or warehouse), states could not require the vendor to collect and remit sales tax under the then existing Court's view that such an obligation resulted in an undue burden on the vendor's ability to engage in businesses across U.S. state lines, in violation of the Commerce Clause of the U.S. Constitution.

In Wayfair, given the development of the online retail industry and the physical presence requirement's unintended and undesirable side effects on interstate commerce, the Court reversed the existing rule by holding that the physical presence rule no longer was the prerequisite for the states to be able to impose the sales tax collection obligation on out-of-state vendors. The Court instead determined that the states could satisfy the "substantial nexus" standard under the Commerce Clause of the U.S. Constitution, based on a remote vendor having "economic nexus" with the taxing state.

The Court held that South Dakota's economic nexus law satisfies the Commerce Clause requirements because it imposes reasonable minimum thresholds of economic activity connecting the remote vendor with South Dakota. Under South Dakota law, this economic nexus is established if a vendor delivers more than U.S. $100,000 of goods or services into the state or engages in 200 or more separate transactions for the delivery of goods or services into the state on an annual basis. However, the Court did not provide a bright-line test for the economic nexus, creating a level of ambiguity on the part of the states and the vendors. Many U.S. states have adopted or are in the process of adopting an economic nexus requirement similar to that of South Dakota, while others are experimenting with other forms of economic nexus.

Wayfair's Impact on Non-U.S. Businesses

In our view, the most critical fallouts of Wayfair can be summarized as follows: (i) non-U.S. businesses selling goods and services to purchasers in the U.S. may be subject to sales tax collection obligation of states where they meet the applicable economic nexus; (ii) the sales tax liability may not be limited to non-U.S. businesses selling consumer goods and services, as this liability applies to sale at retail, which often is broader than the sale of consumer goods and services; and (iii) the economic nexus standard will bring the sales tax collection obligation closer to that for state income tax paying obligations.

For point (iii) above, it is interesting to note that, for state income tax purposes, physical presence was not a prerequisite even before Wayfair, creating a gulf between the two tax regimes for years, which now is just beginning to be bridged. It remains to be seen whether states will adopt a uniform economic nexus for both sales and income tax purposes.

Further, many challenges to non-U.S businesses resulting from Wayfair that will be similar to or the same as those to U.S. domestic vendors merit mention. For example, how does a remote vendor implement its tracking of sales by dollar amount and number of transactions into a given state? Does it develop its own internal procedures or software to do the tracking, or retain an outside software vendor to provide it assistance with the tracking? What does it mean to have "a sale" within a given state? That is, do three shipments of goods that are invoiced on one invoice count as one sale or three sales? And now, much like the sourcing of income issues that arise for income tax purposes, the sourcing of sales for sales and use tax purposes takes on greater significance. For example, assume that a software vendor licenses its product to a customer for use in five states, each of which would subject the license to its sales/use tax. If the license enables use by varying numbers of the customer's staff in the five states, how is the licensing price allocated among the five states? This is a relatively simple example. Fact situations involving vendors of taxable intangible products and services (e.g., downloadable and streaming content, data processing services, etc.) can be much more difficult to analyze for state sales tax sourcing purposes.

These questions will take years to resolve as states, some on their own and others collectively, develop the rules needed to implement the newly available economic nexus. As a result, vendors will be left with much uncertainty and required to make business judgments as to how to proceed.

And most significant are the business judgments required at the margins. When does a remote vendor choose to begin complying with a state's sales and use tax rules? For example, if the state threshold is 200 sales into the state trigger nexus, and the remote vendor has around 200 sales at year's end, does it begin compliance immediately? Or does it wait to see what its sales volume looks like for the next year? Or try to figure out if its competitors are complying before beginning to comply itself? And does it take into account perceptions of how aggressive the state is likely to be in auditing and penalizing remote vendors as part of its analysis of when and whether to begin compliance?

In looking ahead, prudent non-U.S. businesses will want to review and confirm that their existing business practices do not raise sales and use tax compliance issues going forward. In doing so, they will want to consult with their accounting and/or legal professionals to assess how best to comply with these evolving standards, given the particular facts and circumstances of their business and its U.S. sales activities.

[1] South Dakota v. Wayfair, Inc., Dkt. No. 17-494 (U.S. S. Ct. June 21, 2018).

[2] In this discussion, "state" refers to a state of the United States, a political subdivision of the United States, and not a sovereign country.

Articles

On June 21, 2018, in South Dakota v. Wayfair ("Wayfair"),1 the United States Supreme Court (the "Court") reversed its decades-old ban on states imposing a sales tax collection obligation on out-of-state vendors without an in-state physical presence.2 As discussed below, the Wayfair decision has the most relevance to non-U.S. sellers of goods and services to retail customers located in the U.S.

In this note, we briefly review the U.S. sales-and-use tax regime, its application to non-U.S. businesses, and the impact, if any, the Wayfair decision may have on the sales tax collection obligations of non-U.S. businesses.

U.S. Sales-and-Use Tax Regime

In the United States, there is no national-level value-added or consumption tax. Instead, most states (45 of the 50), Washington, DC, and, to the extent permitted by the states, their political subdivisions, such as counties and cities, have their own consumption taxes, colloquially known as "sales and use taxes." Official names of the taxes, taxable purchases, and tax rates vary quite a bit among jurisdictions. Within a single state, multiple levels of tax (for example, state, county, and city) can apply to the same transaction.

Despite variations among jurisdictions, the sales and use tax regimes share certain common traits, such as the following: (i) the taxes are imposed on the retail purchasers of tangible personal property and, to the extent specified by law, intangible personal property and services; (ii) the taxes are levied on the "retail" purchaser as a percentage of the gross sales price of the taxable property or service; (iii) the sales tax is imposed by the jurisdiction where the sale takes place (i.e., where the goods and services are "used" or "consumed" by the retail purchaser (generally, where the good or service is "received" by (or delivered to) the purchaser)); (iv) if the sale occurs within the jurisdiction of use or consumption, the vendor is required to collect sales tax at the point of retail sale and remit the tax to taxing authorities and no use tax becomes due; and (v) if the sale is made by a remote vendor such that the sales transaction does not occur within the jurisdiction of use or consumption, the remote vendor is obligated to collect and remit the sales tax only if it shares a "substantial nexus" with the taxing jurisdiction.

It is important to note that the concept of sale at "retail" is not limited to the sale of consumer items and services to individuals. In many states, retail sale includes the sale of goods and services that are not for resale or other exempt purposes. Therefore, the sales and use taxes often has a far broader application than one expects.

Use tax generally serves as a backup for the sales tax. It is levied on purchasers when sales tax is not collected on taxable sales of goods and services. For example, if a resident of one state purchases a laptop computer, and the seller does not collect the sales tax for any reason, the purchaser is required to pay the use tax. When the purchaser pays use tax, the related sales tax liability generally is deemed satisfied. Use tax, however, relies on self-reporting and payment and, as a result, has historically suffered from low rates of compliance. Moreover, it is difficult to enforce because of the large number of purchasers who are pursued for relatively small amounts of taxes, compared to the number of sellers, and the potential adverse public opinion that may ensue from a strict enforcement.

U.S. Sales and Use Tax Application to Non-U.S. Businesses

Sales and use taxes generally apply to the taxable sales of goods and services by non-U.S. sellers in the same manner as they apply to U.S. sellers resident in states other than the state where the goods or services are consumed. There is no special or disparate state-level tax treatment available to non-U.S. businesses, except that they not be discriminated against based on their non-U.S. status, based on the "nondiscrimination clause" of many U.S. tax treaties.

In addition, it is important to note that this tax collection obligation is independent of the same business's obligation to pay income tax to the same state or the U.S. federal government. In the U.S., out-of-state businesses generally are subject to income taxation in a state if they meet a substantial nexus requirement (with its own criteria) for paying income tax for that particular state. This is a crucial point that is further discussed below. This is further complicated by the fact that a state income tax obligation is independent of whether a non-U.S. business is subject to U.S. federal income taxation under the statutory "U.S. trade or business" standard, or the "permanent establishment" standard under U.S. tax treaties. Therefore, it often is the case that a non-U.S. business meets the requisite "substantial nexus" requirement for sales tax purposes in one state while not meeting the same test for that state's income tax purposes, or vice versa.

Wayfair

Wayfair dealt with the question of whether physical presence (for example, no personnel, stores, offices, or warehouses) is a prerequisite for establishing the substantial nexus for purposes of imposing the sales tax collection obligation on an out-of-state vendor. Specifically, Wayfair looked at whether online retailers without a physical presence in a state can be required to collect that state's sales tax on consumer goods sold and delivered to that state's residents via common carriers (for example, via the U.S. Postal Service).

As discussed above, in most states, the taxable sale of goods and services is subject to sales tax when the goods and services are used or consumed by the purchaser in the taxing state. Before Wayfair, however, if a vendor had no physical presence in the taxing state (for example, personnel, store, office, or warehouse), states could not require the vendor to collect and remit sales tax under the then existing Court's view that such an obligation resulted in an undue burden on the vendor's ability to engage in businesses across U.S. state lines, in violation of the Commerce Clause of the U.S. Constitution.

In Wayfair, given the development of the online retail industry and the physical presence requirement's unintended and undesirable side effects on interstate commerce, the Court reversed the existing rule by holding that the physical presence rule no longer was the prerequisite for the states to be able to impose the sales tax collection obligation on out-of-state vendors. The Court instead determined that the states could satisfy the "substantial nexus" standard under the Commerce Clause of the U.S. Constitution, based on a remote vendor having "economic nexus" with the taxing state.

The Court held that South Dakota's economic nexus law satisfies the Commerce Clause requirements because it imposes reasonable minimum thresholds of economic activity connecting the remote vendor with South Dakota. Under South Dakota law, this economic nexus is established if a vendor delivers more than U.S. $100,000 of goods or services into the state or engages in 200 or more separate transactions for the delivery of goods or services into the state on an annual basis. However, the Court did not provide a bright-line test for the economic nexus, creating a level of ambiguity on the part of the states and the vendors. Many U.S. states have adopted or are in the process of adopting an economic nexus requirement similar to that of South Dakota, while others are experimenting with other forms of economic nexus.

Wayfair's Impact on Non-U.S. Businesses

In our view, the most critical fallouts of Wayfair can be summarized as follows: (i) non-U.S. businesses selling goods and services to purchasers in the U.S. may be subject to sales tax collection obligation of states where they meet the applicable economic nexus; (ii) the sales tax liability may not be limited to non-U.S. businesses selling consumer goods and services, as this liability applies to sale at retail, which often is broader than the sale of consumer goods and services; and (iii) the economic nexus standard will bring the sales tax collection obligation closer to that for state income tax paying obligations.

For point (iii) above, it is interesting to note that, for state income tax purposes, physical presence was not a prerequisite even before Wayfair, creating a gulf between the two tax regimes for years, which now is just beginning to be bridged. It remains to be seen whether states will adopt a uniform economic nexus for both sales and income tax purposes.

Further, many challenges to non-U.S businesses resulting from Wayfair that will be similar to or the same as those to U.S. domestic vendors merit mention. For example, how does a remote vendor implement its tracking of sales by dollar amount and number of transactions into a given state? Does it develop its own internal procedures or software to do the tracking, or retain an outside software vendor to provide it assistance with the tracking? What does it mean to have "a sale" within a given state? That is, do three shipments of goods that are invoiced on one invoice count as one sale or three sales? And now, much like the sourcing of income issues that arise for income tax purposes, the sourcing of sales for sales and use tax purposes takes on greater significance. For example, assume that a software vendor licenses its product to a customer for use in five states, each of which would subject the license to its sales/use tax. If the license enables use by varying numbers of the customer's staff in the five states, how is the licensing price allocated among the five states? This is a relatively simple example. Fact situations involving vendors of taxable intangible products and services (e.g., downloadable and streaming content, data processing services, etc.) can be much more difficult to analyze for state sales tax sourcing purposes.

These questions will take years to resolve as states, some on their own and others collectively, develop the rules needed to implement the newly available economic nexus. As a result, vendors will be left with much uncertainty and required to make business judgments as to how to proceed.

And most significant are the business judgments required at the margins. When does a remote vendor choose to begin complying with a state's sales and use tax rules? For example, if the state threshold is 200 sales into the state trigger nexus, and the remote vendor has around 200 sales at year's end, does it begin compliance immediately? Or does it wait to see what its sales volume looks like for the next year? Or try to figure out if its competitors are complying before beginning to comply itself? And does it take into account perceptions of how aggressive the state is likely to be in auditing and penalizing remote vendors as part of its analysis of when and whether to begin compliance?

In looking ahead, prudent non-U.S. businesses will want to review and confirm that their existing business practices do not raise sales and use tax compliance issues going forward. In doing so, they will want to consult with their accounting and/or legal professionals to assess how best to comply with these evolving standards, given the particular facts and circumstances of their business and its U.S. sales activities.