Editor: Mary Van Leuven, J.D., LL.M.
In June 2018, the U.S. Supreme Court released its opinion in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (U.S. 2018), a decision that had far-reaching consequences for businesses selling products or services across states lines. Previously limited by the Court's physical presence rule as set forth in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and earlier cases, Wayfair opened the door for states to impose tax collection requirements on certain remote sellers that avail themselves of the "substantial privilege of carrying on business" in the state. Now, states can require a remote seller to collect tax based on the volume or number of sales delivered to in-state buyers.
While most states rushed to adopt these economic nexus thresholds, either by legislation or regulation, one of the largest states, New York, remained strangely silent for months after the decision. This changed in 2019, when the New York State Department of Taxation and Finance (the Department) released Notice N-19-1, announcing that Wayfair caused existing provisions in New York law to "immediately" become effective. Although the notice provides some guidance to remote sellers doing business in New York, several uncertainties remain, and additional guidance would be helpful.
The Wayfair decision
The rise of online retailing (or e-commerce) and the decline of its brick-and-mortar counterpart are old news by now. Until recently, online retailers shipping goods across state lines could not be required by the delivery state to collect and remit sales tax unless the retailer had a physical presence in the delivery state (i.e., a brick-and-mortar store, employees, or sales representatives). The physical presence rule was first recognized by the U.S. Supreme Court in National Bellas Hess v. Illinois, 386 U.S. 753 (1967), and was expressly affirmed in Quill. The rule was grounded on the constitutional requirement that a state must have a "substantial nexus" with the activity being taxed and was intended to prevent undue burdens on interstate commerce (Quill, 504 U.S. at 313).
As e-commerce grew into a major pillar of the American marketplace, however, so did states' lamentations against the physical presence rule's perceived unfairness and costliness to state tax revenue. In addition, brick-and-mortar retailers, both large and small, complained that the physical presence rule provided an incentive for consumers to buy goods from out-of-state e-commerce retailers to avoid paying sales tax (as most consumers failed to remit use tax for these purchases). Although Congress failed to take action in response to these complaints, at least one U.S. Supreme Court justice took notice and expressed an inclination to reverseQuill.
In a concurring opinion in a dispute involving the Tax Injunction Act, Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2015), Justice Anthony Kennedy stated that, given "changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court's holding in Quill" (Brohl, 135 S. Ct. at 1135). South Dakota, a state heavily dependent on the sales tax for revenue and lacking a state income tax, took up Kennedy's invitation and passed a law that required certain remote sellers to collect and remit the South Dakota sales tax for sales made into the state, directly at odds with Quill's physical presence rule. The law was quickly challenged by several large e-commerce retailers without a physical presence in the state, and the case eventually wound its way up through appeals to the U.S. Supreme Court.
In Wayfair, a 5-4 decision authored by Kennedy, the Court struck down the physical presence rule and overruled Quill and Bellas Hess. In the absence of these cases, the Court stated that the constitutional requirement of substantial nexus between the taxing state and an activity sought to be taxed can be met when the taxpayer "avails itself of the substantial privilege of carrying on business in that jurisdiction." In this case, the Court found nexus to be sufficient based on "both the economic and virtual contacts" between the out-of-state retailers and South Dakota.
The South Dakota law at issue in Wayfair imposed the tax collection obligation on out-of-state retailers with at least $100,000 in sales of goods or services made into the state or at least 200 separate transactions in the state. The Court stated that "this quantity of business could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota." In addition, the Court noted that the retailers at issue were "large, national companies that undoubtedly maintain an extensive virtual presence." Therefore, the Court held that the requirement of substantial nexus was satisfied in this case.
New York's notice
Following the Court's decision in Wayfair, many states, either by legislation or regulation, adopted the same or similar economic nexus thresholds for remote sellers established in the South Dakota law. The states seemed to fall like dominoes in responding to Wayfair, until by the end of 2018, over half of the states with a sales tax had adopted economic nexus thresholds with an effective date of enforcement. One notable exception was New York state, which remained silent on the consequences of Wayfair until January 2019, when the Department released Notice N-19-1, "Notice Regarding Sales Tax Registration Requirement for Businesses With No Physical Presence in New York State." This notice explained that due to the ruling in Wayfair, "existing provisions in the New York State Tax Law that define a sales tax vendor immediately became effective," and remote sellers meeting this definition were required to collect and remit New York state and local sales tax. Although the notice did not cite the existing law that became effective following the Wayfair decision, the existing law is the statutory definition of "vendor" that was enacted in 1989 (N.Y. Tax Law §1101(b)(8)).
Under this definition, a "vendor" required to register for sales and use tax includes a person who regularly or systematically solicits business and makes sales of tangible personal property to persons within New York, if the solicitation satisfies the nexus requirement of the U.S. Constitution (N.Y. Tax Law §1101(b)(8)(i)(E)). Further, a person is presumed to be regularly or systematically soliciting business in the state if, for the immediately preceding four quarterly periods, the cumulative total of the person's gross receipts from sales of property delivered in the state exceeds $300,000 and the person made more than 100 sales of property delivered in the state (N.Y. Tax Law §1101(b)(8)(iv)). The presumption can be rebutted by demonstrating to the Department that a person cannot reasonably be expected to have gross receipts in excess of this threshold for the next succeeding four quarterly periods. The relevant four quarterly periods end on the last day of February, May, August, and November.
The notice concludes by stating that a business that has met the statutory thresholds, but has not yet registered as a vendor, "should do so now." The Department also states that additional information regarding the registration requirement would be forthcoming. In March 2019, the Department published guidance for frequently asked questions about the notice.
Remote sellers doing business in New York, or contemplating doing business there, will likely have two main questions regarding the notice: What is the effective date of enforcement of the economic nexus threshold? Does enforcement of this 1989 rule pass constitutional muster?
The effective date of the notice
While the notice is clear that businesses that meet the state's definition of a "vendor" should register immediately, it is unclear whether the Department intends to enforce this rule prospectively or retroactively. Remote sellers that meet the state's threshold but have not registered with the state may have legitimate concerns about tax liabilities for previous periods. Theoretically, it appears that the Department has three options: (1) enforcing the rule as of the date of the notice; (2) enforcing the rule as of the date of the Wayfair decision, on June 21, 2018; or (3) enforcing the rule all the way back to 1989, the date of enactment of the New York law.
While the Department has given no indication of any intent to do so, retroactive enforcement of the statute back to 1989 is not completely outside the realm of possibility. In Wayfair, the Court did not limit its holding to a purely prospective application. The default rule on the retroactivity of the Court's decisions is that when the Court "applies a rule of federal law to the parties before it, that rule is the controlling interpretation of federal law and must be given full retroactive effect," regardless of whether events predate or post-date the Court's announcement of the rule (see Harper v. Va. Dep't of Taxation, 509 U.S. 86, 97 (1993)). This essentially means that when the Court overruled the physical presence rule from Quill and Bellas Hess, relied on by businesses for decades, it held that physical presence was never the correct constitutional standard. Therefore, unless some other law limits or invalidates the 1989 statute, New York could potentially enforce the statute as of the date of enactment.
Enforcing the rule prior to the date of the Wayfair decision would be susceptible to a challenge by remote sellers that the rule imposes an undue burden on interstate commerce. For decades, both the Department and businesses relied on the Court's physical presence rule. In the notice, the Department seems to acknowledge that the notice would not be enforceable prior to Wayfair by stating that the existing provisions in the law "immediately became effective" not "were effective upon enactment."
A more likely outcome is that the Department will enforce its economic nexus threshold as of the date of the notice or the date of the Wayfair decision. The Department's guidance released in March provides that businesses should review their New York sales from June 1, 2017, through May 31, 2018, to determine if they have met the threshold as of the "effective date" of the law — the date of the Wayfair decision. Despite this guidance, if the Department attempts to enforce the notice as of the date of the Wayfair decision, it could be susceptible to an undue burden or due process challenge by a remote seller because the Department waited nearly seven months from the date of the decision before informing remote sellers of a previous obligation to register and collect tax.
The constitutionality of the notice
Remote sellers might also question whether New York's economic nexus threshold is enforceable in light of the Court's constitutional analysis in Wayfair. Although the Court did not explicitly approve the South Dakota law and stated that the question remained as to whether "some other principle in the Court's Commerce Clause doctrine" might invalidate it, the Court did cite several features of the law that "appear designed to prevent discrimination against or undue burdens upon interstate commerce" (Wayfair, 138 S. Ct. at 2099). These features include a safe harbor for small sellers, a prohibition against retroactive enforcement of the law, and South Dakota's adoption of the Streamlined Sales and Use Tax Agreement (SSUTA). Aside from the retroactivity issue, a comparison of these features to New York's law appears to show some favorable aspects of the law and other areas where the Department could provide more explicit protections for remote sellers.
Most states that adopted economic nexus thresholds mimicked South Dakota's safe harbor for small sellers, establishing a threshold of $100,000 of sales delivered into the state or 200 separate transactions delivered into the state. New York's economic nexus threshold actually provides a larger safe harbor. Notably, New York's threshold requires both a dollar amount prong and a transaction volume prong to be met, as opposed to the standard set by South Dakota's threshold requiring that either prong be met. Further differentiating New York from the South Dakota threshold are the amounts within each prong: New York law sets the dollar amount of sales at a higher $300,000 and the transaction volume at a lower 100 transactions. For practical purposes, New York's threshold means that remote sellers can make a small volume of sales into the state well above $300,000 and still not have nexus. Perhaps more helpful for a small seller, a high volume of sales can be made into the state, but as long as sales do not surpass $300,000, the seller will not be deemed to have nexus. The statute also allows a remote seller to rebut the presumption that it is doing business in the state by proving to the Department that it cannot reasonably be expected to meet the state's economic nexus threshold during the succeeding four quarters.
Finally, although the Court approvingly noted South Dakota's adoption of the SSUTA, it should not be assumed that membership in the SSUTA is required for a state to enforce economic nexus thresholds. New York has not adopted the SSUTA, but neither have a number of other states, including populous states such as California, Florida, Pennsylvania, and Texas. Importantly, New York requires all state and local sales taxes to be administered at the state level, and many practitioners believe that this is the key administrative feature a state must have to avoid a constitutional challenge based on undue burdens to interstate commerce.
More gray areas ahead
New York's economic nexus threshold for remote sellers is not without gray areas. In addition to the issues discussed in this item, another question is: Will the Department apply the state's economic nexus threshold to sales of services in addition to sales of tangible personal property? The law's presumption of doing business in the state explicitly applies only to sales of property, and the threshold is stated in terms of the volume of tangible personal property sold. Additional guidance may be necessary to determine whether the threshold is also considered to apply to remote service providers, such as providers of information services. Another question: Should a remote seller of both property and services only count its sales of property toward the threshold, or should the seller also count its sales of services? Finally, remote sellers should also be aware that in New York, sales of prewritten software and most sales of software as a service (SaaS) or hosted software are considered to be sales of tangible personal property. Additional guidance from the Department may resolve some outstanding questions for remote sellers, or it may set the stage for disputes that must be resolved by the courts.
EditorNotes
Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C.
For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or mvanleuven@kpmg.com..
Contributors are members of or associated with KPMG LLP. These articles represent the views of the author(s) only, and do not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
