California to follow South Dakota nexus threshold of the Wayfair decision!

California Revenue & Taxation Section 6203(c) put the state in an unusual position after the June 2018 Supreme Court decision in South Dakota v. Wayfair, Inc. The California Department of Tax and Fee Administration (CDTFA) had to decide what the decision meant and administer that finding. Meanwhile, the state legislature had to determine its role and the timing of any action.

R&T Section 6203(c) provides: “Retailer engaged in business in this state” as used in this section and Section 6202 means any retailer that has substantial nexus with this state for purposes of the commerce clause of the United States Constitution and any retailer upon whom federal law permits this state to impose a use tax collection duty." This certainly meant something different on June 21, 2018 than it did prior to that date. With the Court finding that Quill and its physical presence standard for commerce clause nexus was "unsound and incorrect", what is the new standard?

The Court found the 2016 South Dakota law (SB 106) which was before it acceptable as a nexus standard due to these three features:

1. Threshold - Collection obligations only exist if a seller had over $100,000 of sales into the state in the prior or current calendar year, or 200 or more transactions.
2. No retroactive application.
3. South Dakota adopted the Streamlined Sales and Use Tax Agreement (SSUTA) which provides some simplification and requires the state to offer free software to remote sellers and audit protection if they use it.

Well, how do those factors apply in California which is a much larger state than South Dakota and has not adopted the SSUTA and does not provide free software?

South Dakota has just under 1 million people which California has over 39 million. So, with far more buyer in California as well as far more business buyers, considering the worldwide market, the South Dakota threshold would cause hundreds of thousands of small businesses to become collectors of California sales tax In Etsy's amicus brief filed in the Wayfair case, it noted that in 2017, its 1.9 million sellers generated $3.25 billion of gross sales (page 8). That means average sales for an Etsy business of $1,710, well below the $100,000 threshold. But, it would be very easy for many of these businesses to have 200 or more transactions in California in a year. Think of all of the sellers using Fulfillment by Amazon (FBA), eBay, Etsy, crowdfunding sites, and others to sell low value items. With over 39 million possible buyers in California, the CDTFA should be seeing an incredible increase in registered sellers.

Can a state that does not follow the SSUTA or provide free software to remote vendors meet the Court's new nexus standard? We don't know.

Well, on December 11, the CDTFA announced that it would follow the South Dakota thresholds starting April 1, 2019 (NR-18-59). This allows some lead time for the thousands of remote vendors who crossed one of the thresholds in 2018 (the calendar year prior to 4/1/19). It also gives some time for all remote vendors to start tracking sales into California. However, the new procedure does not provide any lead time once you cross the threshold. For example, let's say a vendor selling $10 socks online makes its 200th transaction to a California customer on July 1, 2019, based on 2019 sales. It needs to register and start collecting immediately(similar in most other states as well). There is no lead time once the threshold is crossed to allow for updating or obtaining software and being prepared for the new compliance obligations. For more, see CDTFA Special Notice L-565 (Dec. 2018). Note: The CDTFA held a stakeholder meeting to explain its role per R&T 6203(c) and obtain income (see information and links here).

Another change announced December 11 affects both remote and in-state sellers. Many cities, counties and special districts in California have various sales taxes such as to help fund transportation. These are known as district taxes. Prior to Wayfair, an in-state vendor only had to collect them on sales delivered to districts where they had a physical presence. Now, they must be collected in districts where they meet the over $100,000 sales or 200 or more transactions threshold. See CDTFA Special Notice L-591 (Dec. 2018). So, even in-state sellers already collecting California sales tax must implement new recordkeeping requirements. The CDTFA notes that sellers might just want to "courtesy collect" the district tax for all California sales. That likely is easier than having to track sales into all counties unless the seller knows it won't meet the threshold anywhere so only has to collect where it has a physical presence.

The CDTFA provides a good deal of information on collection obligations at http://cdtfa.ca.gov/industry/wayfair.htm.

On December 10, the chairs of the state's tax committees announced that they would continue to look at whether changes are needed, noting that the decision might not work in a state with almost 40 million residents.

Certainly one area that lawmakers have to address is additional funding for the CDTFA to deal with the hundreds of thousands of new sales tax collectors that should be registering and perhaps seeking assistance of the CDTFA. These vendors are located throughout the world. Also, the CDTFA needs to get and regularly update data on the number of vendors outside of California that meet the threshold. If the number of registrants doesn't match this data, to be fair to instate tax collectors, the CDTFA needs to go out and find these vendors even though they are located throughout the world.

With such a low threshold of 200 or more transactions, the enforcement effort will be a poor use of resources. There needs to be a balance of what is realistic for the CDTFA to enforce among sellers versus continuing to collect use tax from California buyers.

Also, the risk of litigation in California or another state by small vendors challenging the 200 or more transactions threshold seems great. That threshold seems to impede interstate commerce, particularly where the transaction value is low. After all, someone selling $1 items would have to start collecting even though sales into one of several states now using the South Dakota standards is only $200!

We'll see what happens. The April 1, 2019 start date gives lawmakers time to act, such as by removing the transaction threshold and just using the $100,000 gross receipts threshold. They should also see about offering free software to remote vendors as that should help the CDTFA as well. And more funds should be allocated to the CDTFA to help with their expanded tax administration duties. The lawmakers' press release also includes a statement from former BOE member and now State Treasurer-elect Fiona Ma that suggests California should follow the lead of a few others states and have marketplace facilitators, such as Amazon collect.

We'll see.

Originally posed on SalesTaxSupport on 12/17/18.

California, the CDTFA and the Wayfair Decision

On October 24, 2018, the California Department of Tax and Fee Administration (CDTFA) held an information session on the Wayfair decision's application in California. California's statute says we interpret the commerce clause as is done at the federal level. So that interpretation changed with the US Supreme Court's decision on June 21, 2018 when they found that the longstanding physical presence nexus rule of Quill (1992) is incorrect and unsound.

I attended the hearing.  It was short and the CDTFA provided some helpful information about the application of Wayfair to district taxes in California, and more. They also took questions and comments. I offered a few. The CDTFA was also taking written comments.  Following is what I suggested to the CDTFA in my written comments. My key concern is that if California follows the South Dakota standard, hundreds of thousands (possibly even over 1 million, and all over the world) of remote vendors are going to meet the 200 or more transactions per year due to the 39 million possible customers in California (SD has a population under 1 million in contrast). Thus, the transaction threshold should be skipped and we aim for a sales and use tax system that balances realistic enforcement activity by the CDTFA and the continued need to have California buyers self-assess and pay use tax (which will apply in fewer transactions due to larger vendors meeting the $100K per calendar year threshold).

What do you think (please read on)?

“Retailer engaged in business in this state” as meaning “any retailer that has substantial nexus with this state for purposes of the commerce clause of the United States Constitution” (R&T §6203(c)) must now be interpreted in light of the U.S. Supreme Court’s new commerce clause interpretation as spelled out in South Dakota v. Wayfair, 138 S.Ct. 2080 (6/21/18). This is not an easy task, but a necessary one as the statute needs to be followed.

Key elements of the Wayfair decision:

• The “physical presence rule of Quill [Corp. v. North Dakota, 502 U.S. 808 (1992)] is unsound and incorrect.”
• The physical presence standard should not be the standard for the “substantial nexus,” first part of the four-part test of Complete Auto Transit (430 U.S. 274, 279 (1977)).
• Physical presence is an “arbitrary, formalistic” measure.
• South Dakota’s sales tax collection requirement protects interstate commerce by ensuring “sufficient nexus” based on both “economic and virtual contacts” sellers have with the state. Three features of South Dakota law (S. 106 (2016)) support this:

a.     Safe harbor for limited business activity: South Dakota law only requires remote sellers who annually have over $100,000 of sales of goods or services into the state or 200 or more transactions.

b.     No retroactive application: There is no obligation to remit sales tax for years preceding the effective date of the state’s remote sales law.

c.      A system to reduce administrative and compliance costs: South Dakota follows the Streamlined Sales and Use Tax Agreement (“SSUTA”). The SSUTA requires uniform definitions, state level tax administration, and the provision of compliance software to sellers with audit protection to those who use it.

d. The Court did not find that all remote sellers can be subject to a state’s taxes.

The first two of the three features of South Dakota law are relatively easy to implement. However, the third feature is not so simple and it is not clear how important each feature of the SSUTA is. For example, is it the availability of free, audit protected software to remote sellers? Or are other compliance features possible substitutes?

Another factor to consider is that California with a population of 39.5 million, relative to South Dakota’s population of 870,000, presents an entirely different administrative challenge for the CDTFA. That is, far more remote vendors will meet the 200 or more transactions in a year in California than in South Dakota. These sellers are not only located in the U.S. but outside of California, but also outside of the United States. For example, Amazon’s Fulfillment by Amazon (FBA) program, Shopify and eBay serve sellers from outside of the U.S. It would be very easy for a vendor selling socks, books, holiday decorations, or other tangible items to have 200 customers in a year in California. In addition, other sales sites including crowdfunding sites where emerging businesses provide tangible goods to funders, can easily become “retailers engaged in business” in California under the limited business activity thresholds of South Dakota law that were reviewed by the Court.

The significant number of vendors that would be subject to sales tax collection in California under the South Dakota thresholds raises at least two challenges:

1)     Possible litigation under the commerce clause that the burden of compliance with California and other state tax laws is an undue burden on interstate commerce. While the Court did uphold the South Dakota law, the retailers involved in the litigation all had annual revenues exceeding $1 billion. The Court did not consider that the 200-transaction threshold could apply to vendors with far less than $100,000 annual sales in a state. In its amicus brief, Etsy states that in 2017, 1.9 million businesses using its site generated $3.25 billion of gross sales. This averages $1,711 per seller. Many of these sellers though, could easily have 200 or more transactions in states with large populations such as California. This litigation possibility is not unique to California but could arise in any state.

Application of the 200-transaction threshold without the SSUTA features or SSUTA-type features might also lead to litigation on the basis that the state’s broadened nexus reach violates the commerce clause and is not in line with the Supreme Court’s new nexus interpretation.

2)     Can the CDTFA effectively administer sales tax administration for hundreds of thousands of remote vendors that would meet the 200-or-more-transaction threshold and treat such “retailers engaged in business in this state” similar to retailers physically present in the state? Also, is this significant task an appropriate use of resources considering the ability to continue to collect use tax from in-state buyers who are not charged sales tax by a seller? The Wayfair decision does not eliminate the need to continue to enforce use tax laws against in-state buyers as not all sellers will meet sales tax collection requirements under the South Dakota thresholds.

New sales tax collection obligations for vendors requires vendors to make possibly significant changes to be ready to calculate, collect and remit the sales tax. Software is likely needed that needs to be integrated into existing recordkeeping and sales software. Vendors may need to seek assistance from tax advisers which requires time in finding an adviser and ensuring everything is properly in place so that collection and remittance can be performed correctly and efficiently. Thus, when the CDTFA announces a date for when its interpretation of Revenue and Taxation §6203(c) in light of the Wayfair decision is effective, there should be sufficient lead time (likely 90 days minimum) before any vendor is required to start collecting and remitting. Vendors need time to review sales of the past calendar year and current calendar year to see if they even meet the specified thresholds.

Similarly, going forward once a vendor crosses the collection thresholds, they should be given 60 to 90 days before they must start collecting, for the reasons noted earlier.

Also, changes in the responsibility of in-state vendors to start collecting district taxes in districts where the vendor meets the CDTFA threshold requires lead time to review past records and get a recordkeeping system in place to track where and when a vendor has new district tax obligations.

Finally, consumers may think that the Wayfair decision and the announcement of how the CDTFA will modify the interpretation of R&T §6203(c) in light of that decision, means that use tax is no longer required. Thus, it will be important to clarify this for both individual and business buyers so they know they still have use tax reporting and payment obligations when they are not charged sales tax on taxable items.

Additional Information:

• National Conference of State Legislators (NCSL).“Principles of State Implementation after South Dakota v. Wayfair” (6/29/18).
• Nellen, “A Wayfair Whirlwind of Stakeholder Considerations – Part 1,” State Tax Notes, 10/15/18; and Part 2, forthcoming.
• “Is There a Fair Way Forward after Wayfair?  Assessing the Effect in California of the United States Supreme Court’s Recent Decision,” Joint Informational Hearing of the Assembly Committee on Revenue and Taxation and Senate Committee Governance and Finance, 10/15/18; outline of Nellen testimony.
• Nellen, 21^st Century Taxation blog, “State Reactions to Wayfair Decision”.