Tuesday, August 6, 2019
Kansas Revenue Department Takes Aggressive Position Against Remote Sellers
In 2018, the U.S. Supreme Court, in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018), handed South Dakota a narrow 5-4 win in its quest to collect taxes from online sales. The Court held that the Constitution’s Commerce Clause did not bar South Dakota from statutorily requiring remote sellers without a physical presence in the state to collect and remit sales tax on goods and services that are sold to buyers for delivery inside the state of South Dakota. In so doing, the Court distinguished and at least partially overruled 50 years of Court precedent on the issue.
But, did the Court open the floodgates for the states to tax every dollar of sales in a state from an out-of-state seller? That’s a hard case to make because the Court ruled specifically on a South Dakota statute that contained a de minimis sales requirement before state sales tax kicked-in. However, the Kansas Department of Revenue (KDOR) has now taken the position that any amount of sales by a remote seller (a seller without any physical presence in Kansas) to a Kansas buyer triggers the need of the remote seller to register with the state and pay Kansas sales tax.
The Kansas position concerning sales taxation of remote sellers and implications – the focus of today’s blog post.
Online Sales - Historical Precedent
The core constitutional issues concerning a state’s ability to impose sales (and/or use) tax on a seller with no physical presence in the state involve interstate commerce and due process. In 1967, the U.S. Supreme Court determined that the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States” in holding that Illinois could not subject a mail order seller located in Missouri to use tax where the seller had no physical presence in Illinois. National Bellas Hess, Inc. v. Illinois Department of Revenue, 386 U.S. 753 (1967). In holding the law unconstitutional, the Court reasoned that subjecting the seller’s interstate business to local “variations in rates of tax…and record-keeping requirements” would violate the purpose of the Commerce Clause “to ensure a national economy free from…unjustifiable local entanglements.”
Twenty-five years later, the Court reaffirmed the limitations of the Commerce Clause on state regulatory authority in Quill Corporation v. North Dakota, 504, U.S. 298 (1992). In Quill, the Court held that a mail order house with no physical presence in North Dakota was not subject to North Dakota use tax for “property purchased for storage, use, or consumption within the State.” The Court followed closely its holding in National Bellas Hess, Inc. because doing so “encourage[d] settled expectations and …foster[ed] investment by businesses and individuals.” As applied to internet sales, Quill (which predated the internet) does not exempt all internet sales from state sales taxes – just sales by sellers who don’t have a physical presence in a particular state. National retailers have a presence in many states.
More recently, in 2015, the Court examined a Colorado “tattletale” law that required out-of-state sellers with no physical presence in the state “to notify…customers of their use tax liability and to report” sales information back to Colorado. Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2013). The trial court enjoined enforcement of the law on Commerce Clause grounds. On appeal, the Tenth Circuit held that it couldn’t hear the challenge to the law because the Tax Injunction Act (28 U.S.C. §1341) divested it of jurisdiction and the matter belonged in state court and, ultimately, the U.S. Supreme Court. The Tenth Circuit remanded the case for dismissal of the Commerce Clause claims and dissolution of the permanent injunction. The U.S. Supreme Court reversed and remanded the decision of the Tenth Circuit on the jurisdiction issue and, on remand, the Tenth Circuit, invalidated the Colorado law on Commerce Clause grounds. Direct Marketing Association v. Brohl, 814 F.3d 1129 (10th Cir. 2016).
In the U.S. Supreme Court’s reversal and remand of the Tenth Circuit’s decision in Direct Marketing Association, Justice Kennedy wrote a concurring opinion that essentially invited the legal system to find an appropriate case that would allow the Court to reexamine the Quill and National Bellas Hess holdings. Hence, the South Dakota legislation.
South Dakota Legislation and Litigation
S.B. 106 was introduced in the 2016 legislative session of the South Dakota legislature. It requires the collection of sales taxes from certain remote sellers – those with “gross revenue” from sales in South Dakota of over $100,000 per calendar year or with 200 or more “separate transactions” in the state within the same timeframe.
S.B. 106 was signed into law on March 22, 2016, and the state Department of Revenue soon thereafter began issuing notices to sellers that it thought were in violation of the law. Several out-of-state sellers that received notices did not register for sale tax licenses as the law required. Consequently, the state brought a declaratory judgment action against the sellers in circuit court, and sought a judicial declaration that the S.B. 106 requirements were valid and applied to the sellers. The state also sought an order enjoining enforcement of S.B. 106 while the action was pending in court, and an injunction that required the sellers to register for licenses to collect and remit sales tax.
The sellers tried to remove the case to federal court based on federal question jurisdiction, but the federal court rejected that approach and remanded the case to the South Dakota Supreme Court. South Dakota v. Wayfair, Inc., 229 F. Supp. 3d 1026 (D. S.D. 2017). On remand, the South Dakota Supreme Court invalidated S.B. 106 on Commerce Clause grounds based on the U.S. Supreme Court precedent referenced above. State v. Wayfair, Inc., et al., 901 N.W.2d 754 (S.D. 2017). The state of South Dakota filed a petition for certiorari with the U.S. Supreme Court and the Court granted the petition.
U.S. Supreme Court Decision – The Importance of “Substantial Nexus”
Article I, Section 8 of the U.S. Constitution says that, “The Congress shall have the power...to regulate commerce…among the several states…”. That was the key point of the Court’s 1967 Bellas Hess, Inc. decision. As noted above, in that case the Court stated that the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States.” In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), the Court ruled that a state tax would be upheld if it applied to an activity having a substantial nexus with the state; was fairly apportioned; did not discriminate against interstate commerce; and, was fairly related to the services that the state provided. Later, in the Quill case, the Court determined that a physical presence in the taxing jurisdiction was what satisfied the Brady “substantial nexus” requirement.
In Wayfair, the Court determined that a “substantial nexus” could be present without the party subjected to tax having a physical presence in the taxing jurisdiction. But, the key point is that the “substantial nexus” test of Brady remains. Likewise, the other three requirements of Brady remain. A state can only impose sales (or use) tax on a remote seller without a physical presence in the state if the tax is fairly apportioned; does not discriminate against interstate commerce; and is fairly related to services that the state provides. In other words, taxing a business without a physical presence in the state cannot unduly burden interstate commerce. The Wayfair majority determined that the South Dakota law satisfied these tests because of the way it was structured – it had only a limited application due to the requirement of a de minimis a dollar amount of sales or transactions in the state; it was not applied retroactively; South Dakota was a member of the Streamlined Sales and Use Tax Agreement (SSUTA); the sellers at issue were national businesses with a large online presence; and South Dakota provided tax software to ease the administrative burden.
On August 1, 2019, the KDOR issued Notice 19-04 designed to provide “guidance” to remote sellers doing business in Kansas. https://www.ksrevenue.org/taxnotices/notice19-04.pdf In the Notice, the KDOR noted that Kansas law (Kan. Stat. Ann. §79-3702(h)(1)(F)) defines a “retailer doing business in this [Kansas]” as: “any retailer who has any other contact with this state that would allow this state to require the retailer to collect and remit tax under the provisions of the constitution and the law of the United States.” The KDOR also noted that the Kansas requires online (and other remote) sellers with no physical presence in Kansas to collect and remit “the applicable” sales and use tax on sales delivered into Kansas. KDOR indicated that remote sellers are to register and begin collecting and remitting Kansas sales and/or use tax by October 1, 2019.
The Notice, as strictly construed, is correct. The state can require a remote seller to register with the state and collect and remit sales and/or use tax “under the provisions of the constitution and the laws of the United States.” That would mean as the applicable law has been defined by the U.S. Supreme Court, including the Court’s most recent Wayfair decision – which involved a state law that contained a de minimis requirement based on amount of sales or number of transactions. However, the KDOR Notice did not specify any level of de minimis sales before sales tax was triggered. Indeed, the Director of Research and Analysis for KDOR was quoted in the Bloomberg Daily Tax Report (online) on August 1 as stating that KDOR “does not believe it needs a de minimis threshold” based on Kan. Stat. Ann. §79-3702. This is an inaccurate statement that will likely invite a legal challenge to the KDOR’s position. There simply is no protection in the Wayfair decision for KDOR’s position. The “substantial nexus” test still must be satisfied – even with a remote seller. Indeed, during the 2019 session of the Kansas legislature, a major tax bill contained de minimis requirements that mirrored the South Dakota legislation, but the Governor vetoed the bill and the Kansas House failed to override the veto. Presently, no other state has taken the position that the KDOR has taken.
The KDOR’s position amounts to a frontal assault on the Commerce Clause post-Wayfair. Presently, 23 states are “full members” of the SSUTA. For those states, Wayfair at least implies that membership in the SSUTA has the effect of minimizing the impact on interstate commerce. But, that doesn’t mean that SSUTA membership eliminates the “substantial nexus” requirement. Indeed, South Dakota was an SSUTA member and the Court still went through the “substantial nexus” analysis. Thus, it appears that any state legislation must have exceptions for small businesses with low volume transactions and sales revenue. Whether a series LLC (in some states such as Iowa) or subsidiaries of a business could be created, each with sales below the applicable threshold, remains to be seen.
On a related note, could the KDOR (or any other state revenue department) go after a portion of business income of the out-of-state business via income tax? That seems plausible. However, the Interstate Income Act of 1959 (15 U.S.C. §381-384), requires that a business (or individual – the business form does not matter because corporations have long held personhood status under the Constitution (see, Bank of the United States v. Deveaux, 9 U.S. 61 (1809); Burwell v. Hobby Lobby Stores, Inc., 134 S. Ct. 2751 (2014)) have some sort of connection with a state before its income can be taxed (at least with respect to the solicitation of orders for tangible personal property). Is that legislation now unconstitutional too? Or, is there a distinction remaining between taxing receipts as opposed to income? That may be at issue in a future Supreme Court case.
For now, it’s practically a sure bet that, unless the Kansas legislature passes a bill containing de minimis thresholds that can withstand the Governor’s veto, the state will be devoting taxpayer resources to defending a lawsuit that will challenge the state’s (as of now) unsupportable position.