United States: South Dakota: The Next Frontier Of Sales Tax Nexus

This morning, a declaratory action was filed challenging the constitutionality of South Dakota's sales and use tax economic nexus legislation, which is scheduled to take effect Sunday, May 1, 2016. In American Catalog Mailers Association and NetChoice v. Gerlach, the plaintiffs are asking the South Dakota state courts to declare the legislation unconstitutional, as it violates the physical presence rule from Quill Corp. v. North Dakota1. This client alert details South Dakota's legislation, analyzes the complaint filed by American Catalog Mailers Association and NetChoice, and highlights the challenges other taxpayers face in South Dakota and other jurisdictions.

S.B. 106

On March 22, South Dakota passed S.B. 106 and adopted an economic nexus standard to determine whether out-of-state retailers are required to collect and remit sales tax for sales made to South Dakota purchasers. Specifically, the law requires that an out-of-state seller must collect sales tax on its sales to South Dakota purchasers if one of two conditions is satisfied:

  1. The seller's gross revenue from the sale of tangible personal property, any product transferred electronically, or services delivered into South Dakota exceeds $100,000; or
  2. The seller sold tangible personal property, any product transferred electronically, or services for delivery into South Dakota in 200 or more separate transactions.2

This standard radically deviates from the physical presence standard reaffirmed by the U.S. Supreme Court in Quill Corp. v. North Dakota.3 In Quill, the U.S. Supreme Court held that sales and use tax collection obligations could only be imposed on entities physically present in the state. S.B. 106 reaches out-of-state sellers with $100,000 of sales to South Dakota purchasers or 200 or more separate transactions to South Dakota purchasers, regardless of whether the seller is physically present in South Dakota.

The legislation provides unique procedural rules in an effort to expedite review by the South Dakota Supreme Court. First, the legislation provides that enforcement will be "stayed by the courts until the constitutionality of [S.B. 106] 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."4 This section restricts the ability of the South Dakota Department of Revenue to assess remote sellers that meet either threshold established in S.B. 106. Furthermore, if the legislation is upheld, remote sellers will not face retroactive liability for their sales prior to S.B. 106's affirmance by the U.S. Supreme Court. The legislation provides that "[i]f an injunction provided by this Act is lifted or dissolved, in general or with respect to a specific taxpayer, the state shall assess and apply the obligation established in section 1 of this Act from that date forward with respect to any taxpayer covered by the injunction."5

In addition to staying enforcement of the legislation until a final determination of its constitutionality, the legislation requires the South Dakota Department of Revenue to seek a declaratory action in circuit court against a taxpayer that allegedly meets either or both of S.B. 106's economic nexus thresholds. When such an action is filed, S.B. 106 urges circuit courts to act "as expeditiously as possible," and the action must "proceed with priority over any other action presenting the same question in any other venue."6 Moreover, the circuit court is not only encouraged to resolve the case as expeditiously as possible, but is also required to adopt expedited discovery procedures provided for in SDCL 15-6-73. The legislation is set to take effect May 1, 2016.

Complaint Filed by American Catalog Mailers Association and NetChoice

In its complaint filed this morning, American Catalog Mailers and NetChoice (collectively, "Plaintiffs") argue that S.B. 106 violates the Commerce Clause of the U.S. Constitution.7 Because S.B. 106 adopts an economic nexus standard instead of the physical presence standard announced in Quill, the legislation usurps settled U.S. Supreme Court precedent. The Complaint alleges that "Because SB 106 violates the Quill physical presence requirement, usurps the role of Congress in regulating interstate commerce, and unlawfully expands the State's taxing authority over companies, individuals, and organizations located throughout the United States, and potentially the world, based solely on their having customers in South Dakota, the law is plainly unconstitutional."8 Plaintiffs are trade associations incorporated in Washington, D.C., comprising sellers not physically present in South Dakota.9 They allege that because the legislative findings of S.B. 106 "expressly acknowledge that 'existing constitutional doctrine calls this law into question' and that established constitutional doctrine under Quill would have to be 'changed to permit the collection obligations of this Act,'" S.B. 106 is clearly unconstitutional under current U.S. Supreme Court precedent.10

What's Next?

The Plaintiffs did not wait to receive a declaratory action by the South Dakota Department of Revenue, choosing instead to seek a declaratory action against S.B. 106's enforcement. Accordingly, Department's enforcement of S.B. 106 is not stayed by the Plaintiff's Complaint. It is unclear whether the Department will file its own declaratory action against a remote seller after the May 1 effective date of S.B. 106. Nevertheless, remote sellers can take solace in the fact that until a remote seller receives a declaratory action by the Department, it does not need to affirmatively change its procedures to begin collecting sales tax on its sales to South Dakota purchasers.

Although no taxpayer is accruing tax liability for sales to South Dakota purchasers as a result of the new nexus standard in S.B. 106, taxpayers should review their collection procedures to prepare for the eventuality that S.B. 106 is upheld. If the constitutionality of the legislation is affirmed, the Department will require out-of-state sellers that meet the economic nexus thresholds in S.B. 106 to collect and remit sales tax for sales to South Dakota purchasers. In addition to reviewing their collection procedures, taxpayers should examine their reserves—and not just for South Dakota. The outcome of South Dakota's legislation will produce ripples felt nationwide.

Economic Nexus Positions Beyond South Dakota

South Dakota is not the only state targeting remote sellers. Earlier this year, a regulation adopted by the Alabama Department of Revenue in late 2015 that applies economic nexus to out-of-state retailers with substantial sales in the state went into effect.11 Specifically, remote sellers who lack physical presence in the state must collect and remit sales tax if they make retail sales of tangible personal property into the state exceeding $250,000 and conduct one of a host of other "doing business in the State" activities specified in the Regulation, such as solicitation of sales through agents in the state or contracting with a broadcaster, or—notably—distributing catalogs and accepting orders from purchasers located in the state. Some out-of-state retailers have already received—and appealed—tax assessments from the Alabama Department of Revenue, and we expect that additional remote sellers will receive tax assessments until the constitutionality of the regulation is decided by the Alabama Supreme Court and, perhaps eventually, the U.S. Supreme Court.

In addition to Alabama, other states have either considered legislation or revenue regulations that would create an economic nexus for remote sellers. Iowa, Utah, and New York have each either considered or expanded their doing-business regulations in the past year, with the goal of expanding the scope of the regulations to include remote sellers with sales into these states that exceed certain thresholds. Even in states with no pending economic nexus legislation or regulation, the taxing authorities have been taking the position that the activities of a remote seller established nexus with the state for sales and use tax purposes. For example, the Chief Administrative Law Judge of the West Virginia Office of Tax Appeals recently ruled that independent contractors who performed property maintenance and landscaping services within the state on behalf of a company with no physical presence in West Virginia created substantial nexus for the out-of-state company.12

The takeaway from today's judicial challenge in South Dakota and the flurry of activity in other states that are trying to expand their tax jurisdiction over remote sellers is that retailers now need re-evaluate their sales and activities in all states, including states in which the traditional markers of physical presence under Quill are lacking.

If you have questions about whether your company should be collecting sales and use tax, please contact one of the authors of this Alert or the Reed Smith attorney with whom you usually work.

Footnotes

1. Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

2. S.B. 106, § 9, 2016 Leg., 91st Sess. (S.D. 2016).

3. Quill, 504 U.S. 298.

4. Id. at § 8(10).

5. Id. at § 6.

6. Id. at § 2.

7. Complaint, American Catalog Mailers Association and NetChoice v. Gerlach, 32CIV16-__ (6th Circuit, S.D.) (April 29, 2016) (hereinafter, the "Complaint").

8. Id.

9. Complaint at ¶¶ 2-3.

10. Id. at ¶ 16.

11. Ala. Reg. 810-6-2-.90.03, effective January 1, 2016.

12. Redacted Decision – DK#'s 12-432 U, 12-433 CU, 12-434 C, 12-435 NFN, West Virginia Office of Tax Appeals, Jan. 30, 2015 (released Jan. 27, 2016).

This article is presented for informational purposes only and is not intended to constitute legal advice.

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