Supreme Court abolishes physical presence requirement for sales tax collection.

• Author: Stanton, Catherine

On June 21, 2018, the U.S. Supreme Court overturned decades of established law that required vendors to have a physical presence in a state before that state could require them to collect and remit sales tax on purchases by customers within the jurisdiction. The Court overturned its 1992 decision, Quill Corp. v. North Dakota, (1) with its recent decision in South Dakota v. Wayfair, Inc., noting that "the physical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause." (2) While it will take some time to completely understand the full effects of this decision, it is safe to say that this is the most important development in the sales tax world in at least 25 years.

Decades of precedent

Before it issued its Wayfair decision, the Court had established the physical presence standard in several landmark state tax cases. In 1967, the Court decided National Bellas Hess v. Department of Revenue of Ill., (3) in which it held that both the Due Process Clause and the Commerce Clause prevented the state of Illinois from requiring a mail-order seller of tangible personal property to collect and remit sales tax on purchases made by customers in Illinois when the seller did not have a physical presence in the state. The Court noted it "has never held that a State may impose the duty of use tax collection and payment upon a seller whose only connection with customers in the State is by common carrier or the United States mail." (4)

The Court again encountered the topic of state taxation in 1977, when it issued a decision in Complete Auto Transit, Inc. v. Brady. (5) In this case, the Court had to decide whether Mississippi's privilege tax could be imposed on a Michigan company that transported cars for General Motors to car dealerships in Mississippi via motor carrier. The Court ruled in favor of the state, holding that the imposition of the privilege tax did not violate the Commerce Clause, and noted that "the Court has rejected the proposition that interstate commerce is immune from state taxation." (6) The Court enunciated four criteria that a tax must meet to survive a Commerce Clause challenge:

[T]he tax is applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the state. (7)

In 1992, the Court's holding in Bellas Hess was challenged in Quill Corp. v. North Dakota. Quill Corp., incorporated in Delaware with offices and warehouses in California, Georgia, and Illinois, sold office equipment and supplies through catalogs, flyers, advertisements in national periodicals, and telephone calls. The company fulfilled orders using common carriers. In 1987, the North Dakota Office of State Tax Commissioner sent a notice to Quill Corp. informing the company that purchases made by North Dakota residents through Quill's catalog were subject to tax and that Quill had an obligation to collect and remit tax on behalf of its customers. Quill challenged the notice, and the case ultimately went to the Supreme Court.

In its decision, the Court carefully analyzed the Commerce Clause and found that the "substantial nexus" requirement enunciated in Complete Auto necessitates a physical presence to be satisfied. Somewhat ironically, considering the recent Wayfair decision, the Court noted that "the continuing value of a bright line rule in this area and the doctrine and principles of stare decisis indicate that the Bellas Hess rule remains good law." (8) The Court also found that different standards exist for the Due Process and Commerce Clause requirements. Specifically, a physical presence standard was not required under the Due Process Clause, but it was under the Commerce Clause. (9)

Evolution of and challenges to Quill

While the Court may have affirmed the physical presence "bright line rule" in Quill, the Court also made it known that 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." (10) However, Congress never enacted legislation governing the imposition of state sales and use taxes. As such, Quill was the law of the land until June 21, 2018.

That is not to say that the physical presence requirement has not been tested or its boundaries stretched in the intervening years. The rapid expansion of the digital economy, coupled with the limitation on the power of states to impose sales tax under...