A recent decision by the United States Supreme Court (“Court”) could have significant implications for Canadian organizations making sales to customers in the United States, including new sales and use tax registration and collection requirements.
Historically, Canadian and other out-of-state suppliers with no physical presence in a particular state or other tax jurisdiction in the United States could not be compelled to register for and collect that jurisdiction’s sales or use tax. However, on June 21, 2018, the United States Supreme Court issued its long-awaited decision in South Dakota v. Wayfair [585 U.S. (2018)] – a test case to invalidate the physical presence test established by National Bellas Hess v. Department of Revenue [386 U.S. 753 (1967)] and affirmed by Quill Corp. v. North Dakota [504 U.S. 298 (1992)]. In its decision, the Court expressly overruled those precedents, making South Dakota’s law imposing sales tax collection obligations on certain remote sellers with no physical presence in the state constitutional and enforceable.
In rendering its decision, the Court examined the history of Commerce Clause jurisprudence, as well as the stated justifications in both National Bellas Hess and Quill for exempting remote sellers from the obligation to collect state and local taxes. In a 5 to 4 majority, the Court found that the physical presence requirement was an artificial and arbitrary rule that impermissibly encroached on state sovereignty and actually resulted in discrimination against intrastate commerce by providing an incentive to remote sellers engaged in interstate commerce—the incentive being no requirement to collect tax from purchasers. The Court also noted that the physical presence standard did not reflect the reality of the Internet age, in which the largest retailers in the U.S. are engaged in e-commerce rather than selling through traditional, “brick-and-mortar” premises. Finally, the Court observed that it should not keep “passing the buck” to Congress to resolve the disparate treatment between in-state and remote sellers—and that it was the Court’s responsibility to correct its own “mistake.”
The Court remanded the case to the Supreme Court of South Dakota for further proceedings consistent with its decision. At the present time, this means that:
- Quill and National Bellas Hess have been overruled (those cases had previously determined that companies involved in e-commerce or mail-order selling were not required to collect sales or use tax where they did not have some type of physical presence in a state);
- South Dakota’s law is constitutional; and
- States and local jurisdictions in the United States are now empowered to impose sales and use tax collection obligations on remote sellers, subject to the four-prong test outlined in Complete Auto Transit, Inc. v. Brady [430 U.S. 274 (1977)].
The Complete Auto Transit decision established a four-prong test to be used in determining the constitutionality of a state tax, under which the following are required:
- substantial nexus or a sufficient connection between the taxpayer and the jurisdiction to warrant the imposition of tax;
- non-discrimination, such that intrastate and interstate taxes do not favour one over the other;
- fair apportionment, resulting in only the activity transpiring within a jurisdiction being taxed; and
- the existence of a fair relationship between the tax and services provided by the jurisdiction.
In essence, the Court appears to have replaced the physical presence requirement with an economic substance test in determining whether a taxpayer has nexus within a taxation authority’s jurisdiction.
South Dakota’s law, which passes this new test, requires remote sellers with sales of at least $100,000 worth of goods or services annually to consumers in South Dakota, or with 200 or more separate transactions involving goods or services for delivery to that state, to collect its sales tax. Note that the law is not retroactive. It expressly takes effect only if it is ultimately upheld by the courts, which now appears to be imminent.
Implications for Canadian Business
The Court’s ruling appears to have paved the way for other U.S. jurisdictions to impose sales and use tax compliance requirements on taxpayers located outside of those jurisdictions. As a result, Canadian companies that sell to U.S. consumers, such as online retailers, could soon face a wave of requirements to register for and collect U.S. state sales and use taxes, as well as similar taxes imposed by local authorities within each state. It remains to be seen how many jurisdictions will enact legislation to create these obligations, which could also include significant reporting requirements, as well as how aggressive each jurisdiction will be in pursuing remote sellers. Overly ambitious legislation could face further legal challenges.
However, given the amount of tax revenue at stake, the global trend towards extending taxation authority beyond jurisdictional boundaries, and the fact that several states have either already introduced or are currently contemplating similar legislation, it seems likely that the sales and use tax compliance burden will increase dramatically for many Canadian organizations with business activities in the U.S. At the present time, it is unclear how each jurisdiction intends to successfully enforce any new compliance requirements.
It is recommended that all organizations undertake a review of their U.S. business activities to assess the potential impact of any new requirements on their commodity tax compliance processes. With rules that will vary by state, and local jurisdictions numbering in the thousands, compliance will undoubtedly become more complex, possibly necessitating adjustments to an organization’s procedures, technology use, staffing levels and outsourcing requirements. For example, sales to customers in a state with newly enacted legislation targeting out-of-state sellers will likely compel a Canadian supplier to review that jurisdiction’s threshold or test for nexus, as well as the specific registration, security, tax collection, remittance, and reporting requirements for that particular state. In addition, the tax status of all transactions conducted in the state would need to be determined, taking into consideration the potential application of any exemptions that might be available to purchasers. Further down the road, Canadian suppliers could also face the possibility of audit activity by taxation authorities from states in which they do business.
Similar QST Rules on the Way
Enacting a law to address lost sales tax revenue due to out-of-jurisdiction vendors is not merely a U.S. phenomenon. As announced in its 2018 provincial budget, the Government of Québec intends to pass similar legislation later this year. The proposed rules will require certain non-resident suppliers of intangible personal property, tangible personal property, and services to register for and collect Québec Sales Tax under a new specified registration system, starting in 2019. For more information on this impending change, please see Ryan’s analysis at 2018 Québec Budget.
For full coverage of this significant development in U.S. state sales and use tax, please see ryan.com/canada/wayfair.
If you have any questions about how this development might impact your organization, please do not hesitate to call the Ryan TaxDirectTM line at 1.800.667.1600.