Tennessee Sales Tax Rule Continues Economic Nexus Trend

This article was co-authored by Paul A. Zee-Cheng.

On October 3, 2016, Tennessee issued a proposed rule making it the third state to impose a sales tax collection obligation on certain out-of-state sellers with no physical presence in a State (Rule 1320-05-01-.129). Under the new rules, out-of-state sellers who make over $500,000 in sales to consumers in Tennessee during the previous twelve-month period automatically have substantial nexus with the state, and are obligated to collect and remit Tennessee sales tax.

The new rule requires out-of-state sellers meeting the sales threshold to register with the state by March 1, 2017, and begin collecting sales tax on July 1, 2017. If a taxpayer meets the threshold after the March deadline, then they must register with the state and begin collecting sales tax on the first day of the third month after the month that they meet the threshold. Taxpayers that do not comply with the new rule will be subject to penalties.

Tennessee’s economic nexus provision for sales tax, which is similar to recently adopted rules in Alabama and South Dakota, is in direct contradiction to the nexus standard established by the U.S. Supreme Court in the 1992 case of Quill Corporation v. North Dakota. In Quill, the Court held that a retailer must have a physical presence within a state to be obligated to collect sales tax. The new economic nexus rules that states are adopting attempt to pave the way for Quill to be revisited by the Court, through a challenge to one of the new rules. Justice Kennedy recently invited such a challenge in his concurring opinion in Direct Marketing Association v. Brohl. With pending litigation in Alabama and South Dakota, the physical presence nexus standard could be revisited sooner rather than later.

The Tennessee Department of Revenue did acknowledge the conflict with Quill in its response to public comments regarding the new rules. Despite the conflict, the Department maintains that the rule does not restrict interstate commerce for three reasons. First, as the Court observed in Brohl, the economy has experienced significant structural changes in the past 24 years. The use of online shopping means that a business may now be present in a state without a traditional physical presence. Second, the burden of tax compliance on out-of-state sellers has decreased with sophisticated new tax software. Third, despite pressure from Tennessee and other states, so far Congress has come up short in creating an alternative legislative solution for sales tax collection by remote sellers.

Tennessee’s new rule is still subject to review under the state congress Government Operations Rule Review Committee. This committee could theoretically vote to request the agency repeal, amend, or withdraw the rule. Retailers potentially impacted by Tennessee’s new nexus provision should plan on registering by March of next year, as well as monitor whether any challenges to the provision result in delayed enforcement.

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