Supreme Court: States can require online retailers to collect sales tax

The U.S. Supreme Court has handed down its long-awaited decision regarding online sales tax collection — and digital-only retailers are not on the winning side.

In a 5-to-4 ruling in the South Dakota vs. Wayfair case, the court ruled that Internet retailers can be required to collect sales taxes in states where they have no physical presence. The ruling overturned the court’s 1992 decision in Quill Corp. v. North Dakota, which had affirmed the “physical presence” test for state sales-and-use tax collections (allowing states to collect sales taxes only on sales if the retailer has a "bricks and mortar" presence in that state.)

“Each year the physical presence test becomes further removed from economic reality and results in significant revenue losses to the States,” wrote Justice Kennedy in the majority decision. “These critiques underscore that the physical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the commerce clause.”

According to Justice Kennedy, the physical presence test was estimated to cost the states between $8 billion and $33 billion annually.

Online home furnishings retailer Wayfair and several other digital marketers had argued that overturning the Quill ruling would expose them to a host of burdensome rules related to retroactive tax obligations in thousands of municipalities nationwide. While the decision acknowledged as much, it also noted that, given technological advances, there may alternatives in place to reduce the load.

Retail analyst Neil Saunders noted that while large retailers will be able to cope with compliance, it will still impose an initial burden on them “which may further increase costs that could be passed on to consumers.”

“The challenge for smaller players will be significant and the concern here is that complexity could stymie innovation and entrepreneurialism,” Saunders said. (For more, click here.)

Small online-only players, however, may have some breathing room. Justice Kennedy said the decision left open the possibility that some transactions were so small and scattered that no taxes should be collected. The court also did not decide whether states may seek sales taxes retroactively.

Justice Kennedy was joined in the majority decision by Justices Clarence Thomas, Ruth Bader Ginsburg, Samuel Alito and Neil Gorsuch. Chief Justice John Roberts dissented, and said the decision should be left to Congress. He was joined by Justices Stephen Breyer, Sonia Sotomayor and Elena Kagan.

“E-commerce has grown into a significant and vibrant part of our national economy against the backdrop of established rules, including the physical presence rule,” Roberts said. “Any alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress.”

The ruling was hailed by the nation’s leading retail associations, which had long argued for a ‘fair and level’ playing field.

"The retail industry is changing, and the Supreme Court has acted correctly in recognizing that it's time for outdated sales tax policies to change as well,” stated Matthew Shay, president and CEO of the National Retail Federation. "This ruling clears the way for a fair and level playing field where all retailers compete under the same sales tax rules whether they sell merchandise online, in-store or both."

The Retail Industry Leaders Association and sister organization the Retail Litigation Center also praised the ruling.

“Today’s decision culminates years of tireless work by the retail community to reverse a pre-Internet era rule that distorts free markets and puts local brick and mortar stores at a competitive disadvantage with their online-only counterparts," said Deborah White, general counsel for RILA and president of the Retail Litigation Center. “This was the right case and the right time for the Court to act, and we couldn’t be more pleased with the outcome.”

White also addressed the suggestion that new collection requirements would be a burden to start-ups and small online retailers. She pointed to the dramatic changes in network computing and e-commerce in the last quarter century.

“The Court clearly didn’t buy the argument made by the Respondents in this case that remote sales tax compliance represented the same burden today that it did in 1992,” said White. “Through its decision, the Court has acknowledged that the same computing sophistication that has fueled exponential growth in e-commerce has also dramatically simplified remote sales tax collection.”

Given the court’s ruling, White said she expects the forty-five states with a sales tax to work expeditiously on legislative and regulatory solutions to close the online loophole in their states.