Sales Tax Nexus: States Continue to Chip Away at the Physical Presence Requirement

A recent opinion in Colorado and a new law in South Dakota further call into question the future of the physical presence requirement for sales and use tax nexus.

By Jeff Glickman, SALT partner

In our May 2015 newsletter, we discussed United States Supreme Court Justice Kennedy’s dissenting opinion in Direct Marketing Ass’n v. Brohl, Executive Director, Colorado Dep’t of Revenue (the “DMA Case”), in which he stated that due to changes in technology, it was time revisit the Court’s holding in Quill that physical presence is required to establish sales and use tax nexus.

Since then, three developments have raised the issue of Quill’s continuing viability. The first was Alabama’s adoption of a regulation imposing an economic nexus requirement for sales/use taxes, as reported in our October 2015 newsletter. The other two are summarized below: (1) The Tenth Circuit Court of Appeals’ (the “Court of Appeals”) opinion in the DMA Case issued on Feb. 22, 2016, which addressed the issue of whether Colorado’s use tax reporting statute was constitutional, and (2) South Dakota legislation establishing an economic nexus standard for sales/use tax collection. [1]

In 2010, Colorado passed a use tax reporting law to assist the state in collecting use tax from Colorado purchasers. That law required an out-of-state seller that did not have an obligation to collect and remit Colorado use tax (i.e., those sellers that did not have physical presence) and that had at least $100,000 in annual gross sales to Colorado purchasers to (i) send a notice to Colorado purchasers informing them that they may have a Colorado use tax obligation, (ii) send Colorado purchasers who spent more than $500 with the seller an annual report summarizing their purchases (with dates and amounts), including a reminder of their obligation to pay Colorado use tax, and (iii) send to the Colorado Department of Revenue an annual report listing the customers’ names, addresses and total amount spent. [2] The Direct Marketing Association argued that the law was unconstitutional since it applied to sellers who did not have a physical presence in Colorado.

The Court of Appeals disagreed and held that the law was constitutional. In particular, the Court of Appeals concluded that Quill was not applicable in this case because Quill specifically addressed whether or not physical presence was required to obligate an out-of-state seller to collect and remit a state’s sales/use tax. Since the Colorado law at issue in the DMA case imposed only an obligation to report certain tax information and not to collect and remit any tax, the law could be applied to an out-of-state seller who did not have physical presence in Colorado.

On March 22, 2016, South Dakota Governor Dennis Daugaard signed into law S.B. 106 (the “Bill”), effective as of May 1, 2016, establishing sales and use tax nexus for sellers that do not have a physical presence in the state. Specifically, the Bill provides that any seller of tangible personal property, products transferred electronically or services for delivery into South Dakota that does not have a physical presence is subject to the state’s sales and use tax laws as if such seller had a physical presence, provided that either of the following criteria are met for the prior or current calendar year:

  1. The seller’s gross revenue from the sale of tangible personal property, any product transferred electronically or services delivered into South Dakota exceeds one hundred thousand dollars; or
  2. The seller sold tangible personal property, any product transferred electronically or services for delivery into South Dakota in two hundred or more separate transactions.

The legislature made several findings which are set forth in the bill, including a recognition of Justice Kennedy’s opinion that the holding in Quill should be revisited:

Given the urgent need for the Supreme Court of the United States to reconsider this doctrine, it is necessary for this state to pass this law clarifying its immediate intent to require collection of sales taxes by remote sellers, and permitting the most expeditious possible review of the constitutionality of this law…At the same time, the Legislature recognizes that the enactment of this law places remote sellers in a complicated position, precisely because existing constitutional doctrine calls this law into question. Accordingly, the Legislature intends to clarify that the obligations created by this law would be appropriately stayed by the courts until the constitutionality of this law has been clearly established by a binding judgment, including, for example, a decision from the Supreme Court of the United States abrogating its existing doctrine, or a final judgment applicable to a particular taxpayer. [3]

Both of these developments raise the possibility that sometime in the near future, the United States Supreme Court will be called upon to once and for all address the future applicability of Quill’s physical presence nexus requirement.

The Aprio SALT group is experienced in evaluating a company’s nexus profile for both income tax and sales and use tax purposes. We will continue to monitor these and other state tax developments, and we will include significant updates in future issues of the Aprio SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at [email protected] for more information.

This article was featured in the March 2016 SALT Newsletter. To view the newsletter, click here.

[1] Direct Marketing Ass’n v. Brohl, Executive Director, Colorado Dep’t of Revenue, No. 12-1175 (10th Cir. 2/22/16). The United States Supreme Court remanded the DMA case back to the Tenth Circuit.

[2] Colo. Rev. Stat. §39-21-112(3.5).

[3] S.B. 106, Section 8.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding this matter.