Internet retailers will soon be required to pay state sales tax across the entire United States following a 5-4 decision by the Supreme Court.
The decision [PDF] will have a huge impact on American ecommerce, with large companies required to calculate, charge and hand over billions of dollars through dozens of different taxes.
On the flipside, US states will benefit to the tune of somewhere between $8bn and $33bn annually in increased revenues.
The decision itself overturns a Supreme Court decision made back in 1992, before the internet was in widespread use. Quill Corporation v North Dakota decided that a company could not be charged state sales tax in a state that it did not have a physical presence.
The current case – South Dakota v Wayfair – is the third challenge to that decision that has been heard by the court and it is notable that even the four dissenting judges agreed that the original case had been wrongly decided.
The original decision had the unintended but incredibly beneficial impact of boosting e-commerce in the early days of the internet. But times have changed, the majority decided.
"The Internet revolution has made Quill’s original error all the more egregious and harmful," said the majority decision. "The Quill Court did not have before it the present realities of the interstate marketplace, where the Internet’s prevalence and power have changed the dynamics of the national economy."
The current situation where billion-dollar companies don't pay state tax is actually damaging to the overall economy and states, the court's majority opinion argued.
The Quill decision "creates rather than resolves market distortions," the court decided. "In effect, it is a judicially created tax shelter for businesses that limit their physical presence in a State but sell their goods and services to the State’s consumers, something that has become easier and more prevalent as technology has advanced."
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The law also creates the perverse incentive of rewarding companies for not opening warehouses or setting up offices in other states, it noted. "The expansion of e-commerce has also increased the revenue shortfall faced by States seeking to collect their sales and use taxes."
It was inevitable that the law would eventually be overturned and in many respects the law that led to this Supreme Court decision was specifically designed to bring about that change.
Following an earlier indication by the court in 2015 that it would reconsider the Quill decision, the South Dakota legislature decided to charge companies that deliver more than $100,000 worth of goods or services or have more than 200 separate transactions within the state its 4.5 per cent sales tax. It also noted that the law would not be applied retroactively i.e. companies would not be forced to pay millions in back taxes.
Those parameters were designed to avoid the most frequently cited concern over e-commerce state sales taxes: that they will fall disproportionately on small businesses.
The state then sued several online retailers for failing to pay the tax – Wayfair, Overstock.com and Newegg. And they fought the case all the way up to the Supreme Court.
Pressure has been building both in state legislatures and in Washington DC for over a decade to overturn the original decision and several years ago, the US' biggest online retailer Amazon decided to stop fighting it and agreed to voluntarily collect sales taxes. It was only a matter of time before the online world was forced to live with the same tax system as physical stores.
Leave it to the Hill
However, the four dissenting judges argued, it should have been Congress and not the Supreme Court that decided to flip the tables for the simple reason that the impact will be so significant.
"E-commerce has grown into a significant and vibrant part of our national economy against the backdrop of established rules, including the physical-presence rule," the dissenting opinion read. "Any alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress."
The majority rejected that argument saying effectively that the Supreme Court created the problem and so it should resolve it.
The issue of no e-commerce states sales tax is particularly bad in states that do not have income tax and are not situated in economic hotspots or with great transportation options - like South Dakota. The decision noted that South Dakota is reliant on sales taxes for 60 per cent of its general fund and uses those taxes to fund essential services.
That said, with the Supreme Court decision opening the floodgates to an online sales tax, businesses are worried – and with good reason.
For one, there is no certainty that other states will follow South Dakota's example and only apply the tax to large businesses, or that they will not include retroactive taxes: lawmakers will be very tempted to try to reap a financial windfall from the change in the law.
But more pragmatically, the change in the law means that companies operating online and selling across the US will now have to deal with the vagaries of 50 different tax regimes. And, as the dissenting opinion pointed out, they can be a bit of a mess.
"Over 10,000 jurisdictions levy sales taxes," it noted, "each with 'different tax rates, different rules governing tax-exempt goods and services, different product category definitions, and different standards for determining whether an out-of-state seller has a substantial presence' in the jurisdiction."
It gives the example of New Jersey that puts a sales tax on yarn purchased for art projects but not on yarn earmarked for sweaters.
Reiterating the concerns of business groups, the dissenting opinion also argued that "the burden will fall disproportionately on small businesses."
But, then any change always brings with it a host of other problems. The reality is that it was only a matter of time before what was increasingly looking like an online tax loophole was finally closed.
It seems that legal systems across the world are finally catching up to the internet and imposing traditional approaches. Europe is enforcing privacy protections over online data, and requiring online platforms to stop posting other people's copyrighted videos. And the US is reintroducing sales taxes and forcing the cable TV model onto broadband access.
You may not like all the changes but they are a reflection of the fact that there is no online and offline world any more. The internet is no longer a special exception; it is embedded into our every day lives. And the law is increasingly reflecting that. ®