Physical Nexus & The Online Sales Tax Debate

The U.S. Supreme Court has agreed to decide the fate of online sellers and their obligation to collect state and local sales/use tax from their customers in states where the online sellers have no physical presence.[1]  To do so, the Court will need to overturn its 26 and 50-year old precedents.  Nexus can be categorized as physical nexus, affiliate nexus, “click through” nexus (which is a form of affiliate nexus) and economic nexus.  We will begin with physical nexus, and subsequent posts will address the other nexus types.

Mail order selling had been around since the mid-1800s, but underwent substantial growth in the 1960s with increasingly sophisticated customer targeting efforts. Mail order sellers were able to sell to consumers without charging or collecting state sales and use taxes because they had no physical presence except in their home state.  Mail order sellers were protected by two Constitutional limitations to a state’s power to tax: (1) the Commerce Clause, which prohibits states from “burdening” interstate commerce; and (2) the Due Process Clause, which had been interpreted by the U.S. Supreme Court, in the context of state taxation to require “some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax."[2]

The states saw an erosion in their tax base and began to assert nexus on mail order companies, even though they lacked a physical presence.  Illinois was the first state to reach the U.S. Supreme Court with the Bellas Hess[3] case in which National Bellas Hess, a Missouri-based mail order retailer with no property or employees in Illinois, was sued by Illinois for its failure to collect sales tax.   The Court ruled in favor of National Bellas Hess under both the Commerce and Due Process Clauses and held that Illinois could not impose a sales/use tax collection obligation on National Bellas Hess since it did not have a physical presence in Illinois.

Beginning in the 1980s, states began enacting so-called “expanded nexus” statutes that sought to challenge the National Bellas Hess precedent.  As a result, litigation ensued with mail order retailers relying on National Bellas Hess to defend against various states imposing sales/use tax collection requirements.

In 1991, the North Dakota Supreme Court ruled in favor of the state against Quill Corporation, a large mail order seller of office supplies and equipment.  The North Dakota Supreme Court reasoned, in part, that “’mail order’ has grown from a relatively inconsequential market niche into a goliath…[using] the burgeoning technological advances…[which] have created revolutionary communications abilities and marketing methods.”  The Court went on to note “the irony in Quill's reliance upon the Due Process Clause and the Commerce Clause in seeking to maintain a tax-free mail order haven and thereby retain[ing] an economic advantage over its local competitors.” [4]  The case was appealed to the U.S. Supreme Court by Quill, as it attempted to challenge the North Dakota court’s decision that physical presence was not a requirement for a taxpayer to have nexus with a state under both the Commerce and Due Process Clauses.[5]  

In its Quill ruling, the U.S. Supreme Court held that Quill’s “purposefully directed” economic activity at the North Dakota market was sufficient to constitute “minimum contacts” nexus under the Due Process Clause.  However, because the Commerce Clause is concerned with prohibiting state interference or burdens on the national economy, as opposed to the Due Process Clause concerns with notice and fairness, the Court re-affirmed the National Bellas Hess physical presence requirement for “substantial nexus” under the Commerce Clause.  The Court reasoned that the concept of stare decicis also supported the continuing reliance on the National Bellas Hess “physical presence” standard.[6]  

Thus, online sellers find themselves in a similar situation today as mail order sellers did over the last 50 years.  Wayfair is merely the 21st century version of Quill.  If we do not want to wait another 50 years, Congress, not the Courts, must act.  As stated in Quill, “the underlying issue is not only one that Congress may be better qualified to resolve, but also one that Congress has the ultimate power to resolve.”[7]   Without clear legislation by Congress, the states will continue to enact “enhanced nexus” legislation and online sellers and their technological successors will continue to face financial and operational uncertainty.  Thus, Congress is the ultimate arbiter of this ongoing dispute.   Hopefully, the Wayfair case, regardless of its outcome, will be sufficient impetus to get Congress to act.

[1] On 1/12/2018, the Supreme Court granted South Dakota’s petition for a Writ of Certiorari in its case against Wayfair, Inc., Inc. and Newegg Inc. (South Dakota v. Wayfair, Inc., Inc. and Newegg Inc. Supreme Court of South Dakota, September 13, 2017.
[2] Miller Bros. v. Maryland 347 U.S. 340 (1954).
[3] Bellas Hess, 386 U.S. at 763 (Fortas, J., dissenting).
[4] State v. Quill Corp., 470 N.W. 2d 203, 208 (N.D. 1991).
[5] Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
[6] Latin meaning “to stand on the decisions.” It expresses the common law doctrine that court decisions should be guided by precedent.
[7] Ibid 5; Footnote 10 referenced therein states, in part that “…An overruling of Bellas Hess might raise thorny questions concerning the retroactive application of those taxes [use tax] and might trigger substantial unanticipated liability for mail order houses. The precise allocation of such burdens is better resolved by Congress rather than this Court.”

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