South Dakota v. Wayfair

Case Year: 2018

Case Ruling: 5-4

Opinion Justice: Kennedy

FACTS

In this case the Court reconsidered two previous rulings regarding the constitutional authority of a state to require out-of-state retailers that have no physical presence in the state to collect and remit sales taxes from in-state transactions. In National Bellas Hess v. Department of Revenue of Illinois (1967), the Court ruled that the due process and commerce clauses prohibit states from imposing such obligations on out-of-state businesses. That case involved a Missouri mail order company that had no property or employees in Illinois, but sold goods to that state’s residents. Twenty-five years later in Quill Corp v. North Dakota (1992) the justices abandoned their due process objections, but reaffirmed the commerce clause barrier against such state taxation policies. The Court emphasized, however, that Congress under the authority of the commerce clause could free states from this restriction. But Congress has not done so.

With the explosive growth of internet sales, cash-starved states have been eager to exploit e-commerce as a revenue source. In-state retailers with brick and mortar outlets supported this effort as a method of eliminating the market advantage enjoyed by their internet competitors who are not obliged to collect sales taxes.

In 2016, South Dakota passed a law requiring out-of-state retailers to collect and remit sales taxes as if the seller had a physical presence in the state. The law applied only to sellers that annually delivered more than $100,000 of goods and services into South Dakota or engaged in 200 or more yearly sales transactions with state residents.

Wayfair, Overstock, and Newegg, large internet retailers, sell and ship goods across the United States, including to residents of South Dakota. None of these companies had a physical presence in the state, and none of them collected sales taxes on South Dakota transactions. South Dakota took legal action against the companies to force compliance with the law; the companies responded by arguing that the law violated the commerce clause. State courts, on the basis of Quill, ruled in favor of the companies, and South Dakota requested Supreme Court review.

 

OPINION

 

Justice Kennedy Delivered the opinion of the Court

Modern precedents rest upon two primary principles that mark the boundaries of a State's authority to regulate interstate commerce. First, state regulations may not discriminate against interstate commerce; and second, States may not impose undue burdens on interstate commerce. State laws that discriminate against interstate commerce face “a virtually per se rule of invalidity.” Granholm v. Heald  (2005). State laws that “regulat[e] even-handedly to effectuate a legitimate local public interest … will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits.” Pike v. Bruce Church, Inc. (1970). Although subject to exceptions and variations, these two principles guide the courts in adjudicating cases challenging state laws under the Commerce Clause.

These principles also animate the Court’s Commerce Clause precedents addressing the validity of state taxes. The Court explained the now-accepted framework for state taxation in Complete Auto Transit, Inc. v. Brady (1977). The Court held that a State “may tax exclusively interstate commerce so long as the tax does not create any effect forbidden by the Commerce Clause.” After all, “interstate commerce may be required to pay its fair share of state taxes.” D. H. Holmes Co. v. McNamara (1988). The Court will sustain a tax so long as it (1) applies to an activity with a substantial nexus with the taxing State, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the State provides. Complete Auto.

Before Complete Auto, the Court had addressed a challenge to an Illinois tax that required out-of-state retailers to collect and remit taxes on sales made to consumers who purchased goods for use within Illinois. [National Bellas Hess v. Department of Revenue of Illinois (1967)]. The Court held that a mail-order company “whose only connection with customers in the State is by common carrier or the United States mail” lacked the requisite minimum contacts with the State required by both the Due Process Clause and the Commerce Clause. Unless the retailer maintained a physical presence such as “retail outlets, solicitors, or property within a State,” the State lacked the power to require that retailer to collect a local use tax. The dissent disagreed: “There should be no doubt that this large-scale, systematic, continuous solicitation and exploitation of the Illinois consumer market is a sufficient ‘nexus’ to require Bellas Hess to collect from Illinois customers and to remit the use tax.”

In 1992, the Court reexamined the physical presence rule in Quill [Corp. v. North Dakota]. That case presented a challenge to North Dakota’s “attempt to require an out-of-state mail-order house that has neither outlets nor sales representatives in the State to collect and pay a use tax on goods purchased for use within the State. Despite the fact that Bellas Hess linked due process and the Commerce Clause together, the Court in Quill overruled the due process holding, but not the Commerce Clause holding; and it thus reaffirmed the physical presence rule.

… [T] he Quill majority concluded that the physical presence rule was necessary to prevent undue burdens on interstate commerce. It grounded the physical presence rule in Complete Auto’s requirement that a tax have a “ ‘substantial nexus’ ” with the activity being taxed …

The physical presence rule has “been the target of criticism over many years from many quarters.” Quill, it has been said, was “premised on assumptions that are unfounded” and “riddled with internal inconsistencies.” Quill created an inefficient “online sales tax loophole” that gives out-of-state businesses an advantage. And “while nexus rules are clearly necessary,” the Court “should focus on rules that are appropriate to the twenty-first century, not the nineteenth.” Each year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the States. These critiques underscore that the physical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.

Quill is flawed on its own terms. First, the physical presence rule is not a necessary interpretation of the requirement that a state tax must be “applied to an activity with a substantial nexus with the taxing State.” Complete Auto. Second, Quill creates rather than resolves market distortions. And third, Quill imposes the sort of arbitrary, formalistic distinction that the Court’s modern Commerce Clause precedents disavow.

All agree that South Dakota has the authority to tax these transactions …

The central dispute is whether South Dakota may require remote sellers to collect and remit the tax without some additional connection to the State … There just must be “a substantial nexus with the taxing State.” Complete Auto…

The Quill majority expressed concern that without the physical presence rule “a state tax might unduly burden interstate commerce” by subjecting retailers to tax-collection obligations in thousands of different taxing jurisdictions. But the administrative costs of compliance, especially in the modern economy with its Internet technology, are largely unrelated to whether a company happens to have a physical presence in a State. For example, a business with one salesperson in each State must collect sales taxes in every jurisdiction in which goods are delivered; but a business with 500 salespersons in one central location and a website accessible in every State need not collect sales taxes on otherwise identical nationwide sales. In other words, under Quill, a small company with diverse physical presence might be equally or more burdened by compliance costs than a large remote seller. The physical presence rule is a poor proxy for the compliance costs faced by companies that do business in multiple States …

The Court has consistently explained that the Commerce Clause was designed to prevent States from engaging in economic discrimination so they would not divide into isolated, separable units. But it is “not the purpose of the [C]ommerce [C]lause to relieve those engaged in interstate commerce from their just share of state tax burden.” Complete Auto. And it is certainly not the purpose of the Commerce Clause to permit the Judiciary to create market distortions …

Quill puts both local businesses and many interstate businesses with physical presence at a competitive disadvantage relative to remote sellers. Remote sellers can avoid the regulatory burdens of tax collection and can offer de facto lower prices caused by the widespread failure of consumers to pay the tax on their own. This “guarantees a competitive benefit to certain firms simply because of the organizational form they choose” while the rest of the Court's jurisprudence “is all about preventing discrimination between firms.” In effect, Quill has come to serve as a judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a State’s consumers—something that has become easier and more prevalent as technology has advanced.

Worse still, the rule produces an incentive to avoid physical presence in multiple States. Distortions caused by the desire of businesses to avoid tax collection mean that the market may currently lack storefronts, distribution points, and employment centers that otherwise would be efficient or desirable. The Commerce Clause must not prefer interstate commerce only to the point where a merchant physically crosses state borders. Rejecting the physical presence rule is necessary to ensure that artificial competitive advantages are not created by this Court's precedents. This Court should not prevent States from collecting lawful taxes through a physical presence rule that can be satisfied only if there is an employee or a building in the State.

… Quill … treats economically identical actors differently, and for arbitrary reasons.

Consider, for example, two businesses that sell furniture online. The first stocks a few items of inventory in a small warehouse in North Sioux City, South Dakota. The second uses a major warehouse just across the border in South Sioux City, Nebraska, and maintains a sophisticated website with a virtual showroom accessible in every State, including South Dakota. By reason of its physical presence, the first business must collect and remit a tax on all of its sales to customers from South Dakota, even those sales that have nothing to do with the warehouse. But, under Quill, the second, hypothetical seller cannot be subject to the same tax for the sales of the same items made through a pervasive Internet presence. This distinction simply makes no sense. So long as a state law avoids “any effect forbidden by the Commerce Clause,” Complete Auto, courts should not rely on anachronistic formalisms to invalidate it. The basic principles of the Court’s Commerce Clause jurisprudence are grounded in functional, marketplace dynamics; and States can and should consider those realities in enacting and enforcing their tax laws …

The “dramatic technological and social changes” of our “increasingly interconnected economy” mean that buyers are “closer to most major retailers” than ever before—“regardless of how close or far the nearest storefront.” Between targeted advertising and instant access to most consumers via any internet-enabled device, “a business may be present in a State in a meaningful way without” that presence “being physical in the traditional sense of the term.” A virtual showroom can show far more inventory, in far more detail, and with greater opportunities for consumer and seller interaction than might be possible for local stores. Yet the continuous and pervasive virtual presence of retailers today is, under Quill, simply irrelevant. This Court should not maintain a rule that ignores these substantial virtual connections to the State.

The physical presence rule as defined and enforced in Bellas Hess and Quill is not just a technical legal problem—it is an extraordinary imposition by the Judiciary on States’ authority to collect taxes and perform critical public functions. Forty-one States, two Territories, and the District of Columbia now ask this Court to reject the test formulated in Quill. Quill’s physical presence rule intrudes on States’ reasonable choices in enacting their tax systems. And that it allows remote sellers to escape an obligation to remit a lawful state tax is unfair and unjust. It is unfair and unjust to those competitors, both local and out of State, who must remit the tax; to the consumers who pay the tax; and to the States that seek fair enforcement of the sales tax, a tax many States for many years have considered an indispensable source for raising revenue …

In the name of federalism and free markets, Quill does harm to both. The physical presence rule it defines has limited States' ability to seek long-term prosperity and has prevented market participants from competing on an even playing field.

“Although we approach the reconsideration of our decisions with the utmost caution, stare decisis is not an inexorable command.” Pearson v. Callahan (2009). Here, stare decisis can no longer support the Court’s prohibition of a valid exercise of the States’ sovereign power.

If it becomes apparent that the Court’s Commerce Clause decisions prohibit the States from exercising their lawful sovereign powers in our federal system, the Court should be vigilant in correcting the error. While it can be conceded that Congress has the authority to change the physical presence rule, Congress cannot change the constitutional default rule. It is inconsistent with the Court’s proper role to ask Congress to address a false constitutional premise of this Court’s own creation. Courts have acted as the front line of review in this limited sphere; and hence it is important that their principles be accurate and logical, whether or not Congress can or will act in response. It is currently the Court, and not Congress, that is limiting the lawful prerogatives of the States.

Further, the real world implementation of Commerce Clause doctrines now makes it manifest that the physical presence rule as defined by Quill must give way to the “far-reaching systemic and structural changes in the economy” and “many other societal dimensions” caused by the Cyber Age. Though Quill was wrong on its own terms when it was decided in 1992, since then the Internet revolution has made its earlier error all the more egregious and harmful …

The Internet’s prevalence and power have changed the dynamics of the national economy. In 1992, mail-order sales in the United States totaled $180 billion. Last year, e-commerce retail sales alone were estimated at $453.5 billion. Since the Department of Commerce first began tracking e-commerce sales, those sales have increased tenfold from 0.8 percent to 8.9 percent of total retail sales in the United States. And it is likely that this percentage will increase. Last year, e-commerce grew at four times the rate of traditional retail, and it shows no sign of any slower pace.

This expansion has also increased the revenue shortfall faced by States seeking to collect their sales and use taxes. In 1992, it was estimated that the States were losing between $694 million and $3 billion per year in sales tax revenues as a result of the physical presence rule. Now estimates range from $8 to $33 billion …

Respondents argue that “the physical presence rule has permitted start-ups and small businesses to use the Internet as a means to grow their companies and access a national market, without exposing them to the daunting complexity and business-development obstacles of nationwide sales tax collection.” … These burdens may pose legitimate concerns in some instances, particularly for small businesses that make a small volume of sales to customers in many States. State taxes differ, not only in the rate imposed but also in the categories of goods that are taxed and, sometimes, the relevant date of purchase. Eventually, software that is available at a reasonable cost may make it easier for small businesses to cope with these problems. Indeed, as the physical presence rule no longer controls, those systems may well become available in a short period of time, either from private providers or from state taxing agencies themselves. And in all events, Congress may legislate to address these problems if it deems it necessary and fit to do so.

In this case, however, South Dakota affords small merchants a reasonable degree of protection. The law at issue requires a merchant to collect the tax only if it does a considerable amount of business in the State …

For these reasons, the Court concludes that the physical presence rule of Quill is unsound and incorrect. The Court’s decisions in Quill Corp. v. North Dakota (1992), and National Bellas Hess, Inc. v. Department of Revenue of Ill. (1967), should be, and now are, overruled …

In the absence of Quill and Bellas Hess, the first prong of the Complete Auto test simply asks whether the tax applies to an activity with a substantial nexus with the taxing State. “[S]uch a nexus is established when the taxpayer [or collector] ‘avails itself of the substantial privilege of carrying on business’ in that jurisdiction.” Polar Tankers, Inc. v. City of Valdez (2009).

Here, the nexus is clearly sufficient based on both the economic and virtual contacts respondents have with the State. The Act applies only to sellers that deliver more than $100,000 of goods or services into South Dakota or engage in 200 or more separate transactions for the delivery of goods and services into the State on an annual basis. This quantity of business could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota. And respondents are large, national companies that undoubtedly maintain an extensive virtual presence. Thus, the substantial nexus requirement of Complete Auto is satisfied in this case …

The judgment of the Supreme Court of South Dakota is vacated, and the case is remanded for further proceedings not inconsistent with this opinion.

It is so ordered.

Justice Thomas, concurring

[A] quarter century of experience has convinced me that Bellas Hess and Quill “can no longer be rationally justified.” The same is true for this Court’s entire negative Commerce Clause jurisprudence. Although I adhered to that jurisprudence in Quill, it is never too late to “surrende[r] former views to a better considered position.” I therefore join the Court's opinion.

Justice Gorsuch, concurring

Our dormant commerce cases usually prevent States from discriminating between in-state and out-of-state firms. National Bellas Hess, Inc. v. Department of Revenue of Ill. (1967), and Quill Corp. v. North Dakota (1992) do just the opposite. For years they have enforced a judicially created tax break for out-of-state Internet and mail-order firms at the expense of in-state brick-and-mortar rivals. As Justice White recognized 26 years ago, judges have no authority to construct a discriminatory “tax shelter” like this. Quill (opinion concurring in part and dissenting in part). The Court is right to correct the mistake and I am pleased to join its opinion.

Chief Justice Roberts, with whom Justice Breyer, Justice Sotomayor, and Justice Kagan join, dissenting

In National Bellas Hess, Inc. v. Department of Revenue of Ill. (1967), this Court held that, under the dormant Commerce Clause, a State could not require retailers without a physical presence in that State to collect taxes on the sale of goods to its residents. A quarter century later, in Quill Corp. v. North Dakota (1992), this Court was invited to overrule Bellas Hess but declined to do so. Another quarter century has passed, and another State now asks us to abandon the physical-presence rule. I would decline that invitation as well.

I agree that Bellas Hess was wrongly decided, for many of the reasons given by the Court. The Court argues in favor of overturning that decision because the “Internet’s prevalence and power have changed the dynamics of the national economy.” But that is the very reason I oppose discarding the physical-presence rule. 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. 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 Court should not act on this important question of current economic policy, solely to expiate a mistake it made over 50 years ago …

In Quill, this Court emphasized that the decision to hew to the physical-presence rule on stare decisis grounds was “made easier by the fact 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.” Even assuming we had gone astray in Bellas Hess, the “very fact” of Congress’s superior authority in this realm “g[a]ve us pause and counsel[ed] withholding our hand.” We postulated that “the better part of both wisdom and valor [may be] to respect the judgment of the other branches of the Government.” The Court thus left it to Congress “to decide whether, when, and to what extent the States may burden interstate mail-order concerns with a duty to collect use taxes.”

This is neither the first, nor the second, but the third time this Court has been asked whether a State may obligate sellers with no physical presence within its borders to collect tax on sales to residents. Whatever salience the adage “third time’s a charm” has in daily life, it is a poor guide to Supreme Court decision making. If stare decisis applied with special force in Quill, it should be an even greater impediment to overruling precedent now, particularly since this Court in Quill “tossed [the ball] into Congress's court, for acceptance or not as that branch elects.” …

A good reason to leave these matters to Congress is that legislators may more directly consider the competing interests at stake. Unlike this Court, Congress has the flexibility to address these questions in a wide variety of ways. As we have said in other dormant Commerce Clause cases, Congress “has the capacity to investigate and analyze facts beyond anything the Judiciary could match.” …

An erroneous decision from this Court may well have been an unintended factor contributing to the growth of e-commerce. The Court is of course correct that the Nation's economy has changed dramatically since the time that Bellas Hess and Quill roamed the earth. I fear the Court today is compounding its past error by trying to fix it in a totally different era. The Constitution gives Congress the power “[t]o regulate Commerce … among the several States.” I would let Congress decide whether to depart from the physical-presence rule that has governed this area for half a century.

I respectfully dissent.