The Texas Comptroller (the “Comptroller”) has circulated a draft of proposed amendments to Comptroller’s Rule 3.286 (the “Draft Regulation”) that provides a further look into how the Comptroller will respond to the decision of the U.S. Supreme Court in South Dakota v. Wayfair. In Wayfair, the Court overruled its long-standing rule established in the National Bellas Hess and Quill cases that a state is precluded from imposing a use tax collection obligation on a remote seller with respect to sales it makes to residents of a state unless the seller has a physical presence in the state. In general, the Draft Regulation proposes a fairly robust sales-based safe harbor for out-of-state sellers and a generous prospective effective date for collection and reporting obligations for such sellers. The Draft Regulations were distributed to the Comptroller’s Business Advisory Group and Tax Advisory Group and, once the Comptroller receives comments from these two groups, the Draft Regulation will be published in the Texas Register, which will begin the 30-day comment period. A link to the Draft Regulations is here.
Prior Comptroller Statement Regarding Wayfair
In a memorandum dated July 5, 2018, the Comptroller stated that it was “proceeding carefully and deliberately to fully understand” the Wayfair decision, “while seeking input in order to implement the new law in a way that best serves the state of Texas, our citizens and the businesses already operating here.” More specifically, the Comptroller’s memo stated:
“We are reviewing agency rules that need amending to, for example, explain the amount of economic nexus in sales and/or transactions required to create a safe harbor for small sellers. We intend to adopt new rules under our current legal authority in early 2019, but this could change depending on issues that arise during the rulemaking process.
We will not apply the new law retroactively to remote sellers that have no physical presence in Texas; we want a smooth transition and a successful partnership with remote sellers who start collecting and remitting Texas taxes. We will provide ample notice to remote sellers as to when they need to start collecting and remitting.”
The July 5th memo also noted that the Comptroller was reviewing statutes that the Texas Legislature may consider updating when it convenes in 2019. Among the actions the Comptroller suggested the Legislature consider taking in an effort to address the legal requirement (that was emphasized in Wayfair) that states not impose undue burdens on remote sellers was:
“Amend Tax Code § 151.059 (Fee Imposed in Lieu of Local Sales and Use Taxes), which currently allows a nonresident (remote) seller to pay a fee based on a weighted average local sales and use tax rate in lieu of collecting local sales and use tax based on actual local tax rates. This statute currently only applies to a change in collection responsibilities based on the passage of federal legislation, not to changes in federal law based on a court case such as Wayfair.”
The Draft Regulation
Expansion of Comptroller’s Rule 3.286 to Include “Remote Sellers”
Consistent with Wayfair, the Draft Regulation amends the definition of “engaged in business” to include the “engaged in business” activities listed in Texas Tax Code § 151.107 (Retailer Engaged in Business in This State) that do not require a physical presence in Texas. Thus, the provisions of Texas Tax Code §§ 151.107(a)(4) and (a)(5) providing that a person is engaged in business in Texas if it systematically solicits sales in Texas through various types of communication systems or solicits orders from Texas customers by mail or other media would be listed among the activities set forth in Comptroller’s Rule 3.286(a)(4) as constituting “engaged in business” in Texas. Sellers whose activities are limited to these activities are defined as “remote sellers” in the Draft Regulation. These activities are currently omitted from Comptroller’s Rule 3.286(a)(4) due to the physical presence rule of Quill.
New Gross Revenue Safe Harbor to Determine Remote Seller Nexus
The Draft Regulation deletes the current generic provisions of Comptroller’s Rule 3.286(b)(2) regarding the determination of whether an “out-of-state seller” has nexus with Texas and replaces it with an annual gross revenue-based safe harbor for “remote sellers.” The preamble to the Draft Regulation sets forth the factors underlying the safe harbor that the Comptroller has proposed, and it is clear that those factors are based on the Wayfair opinion and the response of other states to that opinion.
“In devising a safe harbor, the comptroller has considered whether the statutory ‘engaged in business’ activities constitute substantial nexus based on availment of the substantial privilege of carrying on business in Texas; whether the statutory ‘engaged in business’ activities might constitute an undue burden on interstate commerce; the safe harbor thresholds established to date by other states that are implementing the Wayfair opinion; and the extent to which the failure to enforce the obligations associated with the statutory ‘engaged in business’ activities might thwart the use tax statute purpose of leveling the playing field between in-state and out-of-state vendors.”
The proposed safe harbor provides that the Comptroller will not impose the statutory permit and collection responsibilities on remote sellers whose total revenue from Texas sales in the preceding twelve calendar months is less than $500,000. A remote seller whose total revenue exceeds that threshold amount will be required to obtain a sales and use tax permit and begin collecting sales and use tax no later than the first day of the fourth month after the month in which a remote seller exceeds the safe harbor amount. The initial twelve-month period for determining whether a remote seller’s total revenue from Texas sales exceeds the safe harbor threshold amount will be July 1, 2018 through June 30, 2019, and the permitting and collection obligations would not begin until October 1, 2019. The preamble states that the delayed effective date for permitting and collection is to provide additional time for remote sellers to prepare for their collection and reporting obligations.
Termination of Reporting and Collection Obligations
The Draft Regulation also provides that a remote seller who has become permitted and subject to collection and reporting obligations may terminate those obligations after twelve consecutive months in which its total revenue from Texas sales falls below the safe harbor threshold. The remote seller must submit a form prescribed by the Comptroller in order to terminate its reporting and collection obligations. These obligations again become effective for such a remote seller on the first day of the month following any twelve calendar months in which the seller’s total revenue from Texas sales exceeds the safe harbor amount. In addition, the Draft Regulation provides procedures that allow a permitted remote seller to withdraw from Texas if it no longer intends to make sales of taxable items in Texas.
Conformity with Wayfair
As noted, the Draft Regulation represents a concerted effort by the Comptroller to bring the nexus provisions of Comptroller’s Rule 3.286 into conformity with Wayfair. In explaining the proposed safe harbor amount, the Comptroller noted in the Preamble that:
“The comptroller will not impose the statutory permit and collection responsibilities on remote sellers whose Texas sales are below the safe harbor amount. The comptroller intends the safe harbor amount to simplify tax administration for both the agency and taxpayers by eliminating the need to litigate on a case-by-case basis whether the statutory collection obligation is unduly burdensome.
The safe harbor amount uses historical sales, as was the case with the tax legislation in Wayfair. Because the safe harbor uses historical sales, it is conceivable that taxpayers with similar current sales below the safe harbor amount will have different collection obligations. The comptroller has determined that there are rational, legitimate reasons for this treatment. Among other reasons, a seller with historically higher sales has enjoyed a greater benefit from the Texas market. Also, the courts have upheld the use of historical data in other similar contexts, specifically the Texas franchise tax, which bases the current privilege of doing business on prior year activity in the State. [citations omitted]”
This language, together with the previously cited language from the preamble, is clearly intended to demonstrate that the Comptroller believes that the Draft Regulation both conforms to the substantial nexus test announced in Wayfair (i.e., has the taxpayer availed itself of the substantial privilege of carrying on business in the State) and the Supreme Court’s pronouncement that, notwithstanding its elimination of the Quill physical presence test for establishing nexus, the law must not discriminate against or constitute an undue burden upon interstate commerce. In Wayfair, the Supreme Court pointed to three features of the South Dakota statute at issue that “appear designed to prevent discrimination against or undue burdens on interstate commerce.” Those features were (1) a safe harbor for those who transact only limited business in South Dakota, (2) no retroactive application of the new law, and (3) South Dakota had adopted the Streamlined Sales and Use Tax Agreement (“SSUTA”), which standardizes taxes to reduce administrative and compliance costs.
Safe Harbor Annual Revenue Threshold and No Retroactive Effective Date
The first two features of the South Dakota law are clearly features of the Draft Regulation. The $500,000 safe harbor threshold exceeds the $100,000 safe harbor in the South Dakota law. Interestingly, many commentators have questioned whether simply adopting the safe harbor levels of the South Dakota statute would suffice under Wayfair irrespective of the size of the State. Some have wondered whether a higher safe harbor amount would be necessary for states such as California, New York, and Texas to establish that a remote seller had availed itself of the privilege of carrying on business in the state or to establish that smaller sellers would not be unduly burdened by the imposition of reporting and collection obligations. One would think that the $500,000 safe harbor should pass constitutional muster. And not only does the Draft Regulation not have a retroactive effective date, it provides for a generous prospective effective date.
Compliance Burden: How Important is SSUTA Adoption
The obvious question that remains unanswered by the Draft Regulation is what effect will the fact that Texas has not adopted the SSUTA have on its ability to subject remote sellers to Texas sales and use tax reporting and collection obligations. Only twenty-four states have adopted the SSUTA, and those states do not include the largest states with about two-thirds of the U.S. population. Did Wayfair make adoption of SSUTA a constitutional requirement for a State to impose sales and use tax reporting obligations on remote sellers? No. The importance of South Dakota’s adoption of SSUTA was that it reduced the administrative and compliance costs on remote sellers and led the Supreme Court to strongly suggest that, on remand, the South Dakota act will likely be found to not constitute an undue burden on interstate commerce. What steps, therefore, must Texas take (short of the unlikely adoption of SSUTA) to ensure that the Draft Regulation not impose unduly burdensome administrative and compliance costs? The features of the SSUTA that the Supreme Court listed in Wayfair were:
- It requires a single, state level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules;
- It provides sellers access to sales tax administration software paid for by the State; and
- It provides sellers who choose to use such software with immunity from audit liability.
Must Texas adopt rules that duplicate some or all of these features? Will market forces result in compliance software becoming more available, reliable, and inexpensive as a result of Wayfair? If Texas does not (or is not required to) provide cost-free access to software, should it (or must it) nevertheless designate software, the use of which will provide users with immunity from audit liability?
The compliance issue sure to raise the most concern for remote sellers is how to comply with the vast number of local sales and use tax jurisdictions in Texas and their varying rates. The Comptroller noted this concern in its July 5th memo where, as set forth above, it recommended that the Legislature consider amending Tax Code § 151.059, which allows a nonresident (remote) seller to pay a fee based on a weighted average local sales and use tax rate in lieu of collecting local sales and use tax based on actual local tax rates. The Comptroller noted that this statute currently only applies to a change in collection responsibilities based on the passage of federal legislation, not to changes in federal law based on a court case such as Wayfair. Resolution of the local sales and use tax collection responsibilities of remote sellers will be necessary if the Comptroller is to fully achieve its desire of “eliminating the need to litigate on a case-by-case basis whether the statutory collection obligation is unduly burdensome.”