How the SCOTUS Sales Tax Decision May Impact the Financial Services Industry
By Robert Zonenshein
The Supreme Court of the United States (“SCOTUS”) has issued a landmark ruling, South Dakota v. Wayfair, Inc., Dkt. No. 17-494 (U.S. S. Ct. June 21, 2018), that paves the way for states to require out-of-state businesses to collect and remit sales/use tax, regardless of whether the business has a physical presence in the State. In two prior decisions, once in 1967 and again in 1992, SCOTUS ruled there must be some bright-line physical presence in the state in order for the state to impose sales/use tax collection requirements (see National Bellas Hess, Inc. v. Illinois Dept. of Rev., 386 U.S. 753 (1967); Quill Corp. v. North Dakota, 504 U.S. 298 (1992)). In Wayfair, SCOTUS ruled that the physical presence test was an unsound and incorrect interpretation of the Commerce Clause and that physical presence is not perquisite for states’ ability to impose sales/use tax collection obligations.
At a basic level, individuals and businesses should expect to see an increase in sales/use tax paid on purchases, as well as their obligation to collect and remit sales tax as a retailer -- regardless of where the retailer is physically (or digitally) located. For more on the sales tax implications, see EisnerAmper’s SCOTUS Rules on Landmark Wayfair E-Commerce Taxation Case. However, the decision has the potential to have far-reaching implications beyond sales tax responsibilities.
The decision involved a South Dakota statute enacted specifically to test the physical presence requirement. South Dakota was encouraged by a prior comment from Justice Kennedy (who authored the majority opinion in Wayfair) inviting such a challenge (see Direct Marketing Assn. v. Brohl, 135 S.Ct. 1124 (2015)). The law enacted an “economic nexus” threshold for sales tax collection purposes for entities with annual sales of $100,000 or more or engaging in 200 or more separate transactions in South Dakota (regardless of the dollar amount of each transaction) (note that South Dakota’s sales tax applies to most services).
Potential Income Tax Implications
Over the years, there has significant debate regarding whether the physical presence standard extended beyond sales/use tax collection responsibilities, which was the issue presented in the former Supreme Court decisions (National Bellas Hess, supra; Quill, supra).
States have become increasingly aggressive in asserting that out-of-state companies have income or other tax obligations based solely on economic or financial connections with a state. Several states have enacted so called “factor-presence” nexus standards, where the mere receipt of income from state sources is sufficient to trigger an income tax liability (e.g., $500,000 sales in California indexed for inflation, $500,000 sales in Connecticut, $1 million receipts in New York State for corporations only). In addition, several states have imposed gross-receipts-type taxes based on sales thresholds (e.g., the Washington Business & Occupations tax threshold of $250,000 or the Ohio Commercial Activity Tax minimum of $150,000). Other states have adopted “economic nexus” standards that impose income tax based solely on economic activities in the state (e.g., New Jersey for corporate entities). Further, several states have bright-line rules for financial organizations, such as West Virginia’s rule that soliciting business with 20 or more persons in the state or having $100,000 of West Virginia gross receipts triggered income tax nexus. SCOTUS has previously denied certiorari in cases involving the New Jersey and West Virginia provisions (see Lanco, Inc. v. Director, Division of Taxation, Dkt. # 06-1236; FIA Card Services, f/k/a MBNA America Bank v. Tax Commissioner of the State of West Virginia, Dkt. No. 06-1228). According to a recent survey by the Bureau of National Affairs, Inc. at least 15 states definitively stated that making “personal loans to 20 or more residents” in the state created nexus for income tax purposes.
Considerations for the Financial Service Industry
For retailers, the ultimate cost of the Wayfair decision is likely to be the increased costs of complying with sales/use tax laws in all of the relevant jurisdictions. The additional taxes paid in to the states is ultimately borne by the customer. However, if states are encouraged to enact nexus standards based solely on economic activities in the state, any additional tax and compliance costs would be a direct additional cost to the business (or to the owners of the business). Consider a financial service partnership based in New York City, with all of its physical activities (offices, employees, etc.) in New York City. Under New York’s apportionment rules for partnerships, 100% of the entity’s income is likely to be sourced and taxed by New York (unless an exemption is applicable). If the entity meets the factor-presence nexus standard (e.g., more than $500,000 in receipts from customers in another state), the entity would also have to file returns and pay tax to the other state. In addition, states that apply economic nexus concepts (without a fixed dollar threshold) may also require returns to filed and tax to be paid in that state based on some economic activity in the state. The result for financial service businesses could be multiple taxation on the same streams of revenue in multiple states.
Although the immediate impact of the Wayfair decision will be focused on sales/use tax compliance and related obligations, financial service companies should be aware of the real possibility that states will be encouraged to enact or enforce economic nexus concepts for income tax purposes.
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