The Effect of Tax Laws on Commercial Real Estate

Recently the Supreme Court decided the case South Dakota v. Wayfair, Inc., in which they addressed whether remote sellers of goods and services can be required to collect and remit sales taxes imposed by the consumer’s State.[1] According to S. 106, 2016 Leg. Assembly, 91st Sess. (S. D. 2016) [hereinafter “the Act”], remote sellers are required to collect and remit sales tax to the State in which the goods are sold.[2] Plaintiff, the State of South Dakota, filed of an injunction requiring respondents to register for licenses to collect and remit sales tax.[3] Respondents Wayfair, Overstock.com, Inc., and Newegg, online merchants selling goods such as furniture and electronics, moved for summary arguing that the Act is unconstitutional.[4] The Supreme Court granted certiorari to determine how to interpret precedent cases “in light of current economic realities.”[5]

In order to decide this issue, the court had to interpret and analyze the Commerce Clause and review the scope determined by two precedent cases, National Bellas Hess, Inc. v. Department of Revenue of Illinois and Quill Corporation v. North Dakota, which were decided in 1967 and 1992, respectively.[6] These cases determined that an out-of-state seller’s ability to collect and remit the tax depended on whether the seller had a physical presence in the State.[7] If the seller only permitted people to order from a catalog, it did not have a physical presence.

According to two key primary principles, state regulations cannot disfavor interstate commerce, and States cannot impose undue burdens on such commerce.[8] These principles, in combination with the

Commerce Clause, aid courts in determining outcomes in cases challenging state laws.[9] The Court laid out the guidelines for state taxation in Complete Auto Transit, Inc. v. Brady, where it held that a State can exclusively tax interstate commerce as long as the tax doesn’t create effects prohibited by the Commerce Clause. The Court determined that it would allow a tax as long as it applies to an activity with a significant connection to the taxing State, is fairly divided, doesn’t “discriminate against interstate commerce,” and is sufficiently connected to the services provided by the State.[10]

The concern about a significant connection arises from the established due process requirement that requires a business to have minimum contacts with the state in which they are selling goods or services.[11] Additionally, in Miller Brothers Co. v. Maryland, the Court held that there must be a connection between a state and the property or transaction it wishes to tax.[12]

The Court found that the physical presence rule is a flawed interpretation of the Commerce Clause in the ever-growing digital age as it gives online out-of-state businesses a significant advantage over companies with a physical presence in the state.[13] In addition, it creates market distortions.[14]

The issue of competition from online vendors has been an important one for South Dakota and the States more generally due to the fact that the States have lost revenue in the amount of $8 and $33 billion each year as a result of the rulings in Bellas Hess and Quill.[15] As a result, South Dakota residents had to “foot the bill” and pay the use tax on their purchases from other states.[16] These taxes constitute an important income source for South Dakota in funding state and local services, such as police and fire departments, as it has no state income tax.[17] Some states, such as Colorado, have imposed notice requirements on remote vendors just below collecting taxes. As a result, in the

future courts may encounter arguments regarding the meaning of physical presence.[18] Courts may also face the issue presented by small businesses seeking relief from tax collection.[19]

Ultimately the Court overruled Quill and Bellas Hess, finding that the physical presence rule was untenable.[20] Subsequently, the Court analyzed the tax under the Complete Auto test and found that the connection between the activity and the taxing State was sufficient, as respondents had significant economic and virtual contacts with the State. However, it remains to be seen whether another Commerce Clause principle could nullify the Act.[21]

In his dissent, Chief Justice Roberts argued that Bellas Hess was incorrectly decided and that deference should be given to Congress (rather than the Courts) to determine interstate commerce issues, citing the importance of stare decisis.[22] Further, Roberts argues that the harm caused by the physical presence rule, if there is any being done, is decreasing over time.[23]

Additionally, Roberts asserts that the Court’s decision will disproportionately and arbitrarily impose unjustified costs on various goods, which will burden small businesses. He opines that imposing taxes on each sale will harm the market by increasing costs for businesses and thereby decrease the variety of goods available.[24] Roberts argues that Congress is most suited to determine competing interests of businesses and analyze the Commerce Clause and might be able to avoid such a drastic policy change and determine any retroactive effect the change might have.[25]

This ruling is vital for commercial real estate and states as stiff competition from online retailers has injured sales.[26] It will have far-reaching implications for large online venders such as Amazon, which does not currently collect state sales taxes on products of third-party sellers (in all states except Washington and Pennsylvania). Following the publication of the decision, Amazon shares tanked. Stocks of other large online marketplaces are expected to show similar decline.[27]

As a result of the decision, South Dakota can require online out-of-state vendors that conduct sales numbering over 200 transactions or generating revenues of over $100,000 to collect taxes on items purchased by South Dakota residents. It is anticipated that other states will change their laws regarding the physical presence requirement to align similarly with South Dakota’s new requirement. It is estimated that the decision could create as much as $13 billion in tax revenue.[28] As the online market grows and improves and more stores face bankruptcy, it will be important to keep an eye out for additional legal issues and tax policies that are likely to arise in the online marketplace arena.

[1] South Dakota v. Wayfair, 138 S. Ct. 2080, 2093 (2018).

[2] Id. at 2088.

[3] Id. at 2089; see U.S. Const., Art. I, §8, cl. 3.

[4] State v. Wayfair Inc., 901 N.W.2d 754, 759-60 (S.D. 2017).

[5] South Dakota, 138 S. Ct. at 2089.

[6] Id. at 2087-88. National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967); Quill Corp. v. North Dakota, 504 U.S. 298(199).

[7] South Dakota, 138 S. Ct. at 2089.

[8] Id. at 2084.

[9] Id.

[10] Id. at 2085.

[11] Id. at 2093.  See Int’l Shoe Co. v. Washington, 326 U.S. 310, 316 (1945); Burger King v. Rudzewicz,  

   471 U.S. 462, 476 (1985).

[12] Miller Brothers Co. v. Maryland, 347 U.S. 340, 344-45 (1954); South Dakota, 138 S. Ct. at 2093.

[13] South Dakota, 138 S. Ct. at 2092.

[14] Id.

[15] Id. at 2088.

[16] Id.

[17] Id. at 2097.

[18] Id. at 2098.

[19] Id. at 2099.

[20] Id.

[21] Id.

[22] Id. at 2101.

[23] Id. at 2103.

[24] Id. at 2104.

[25] Id.

[26] Erin Stackley, Supreme Court Ruling in Wayfair Case a Win for Real Estate and States, RISMEDIA (August 12, 2018), http://rismedia.com/2018/08/12/supreme-court-ruling-wayfair-case-win-real-estate-sales/#close.

[27] Erin Stackley, Supreme Court Ruling in Wayfair Case a Win for Real Estate and States, RISMEDIA (August 12, 2018), http://rismedia.com/2018/08/12/supreme-court-ruling-wayfair-case-win-real-estate-sales/#close.

[28] Jeff Mengoli, The Impact of the Supreme Court’s Ruling in South Dakota v. Wayfair, BigCommerce, https://www.bigcommerce.com/blog/south-dakota-v-wayfair/.