A version of this article was previously published in the September 2018 editions of the Denver Business Journal, Dallas Business Journal, and Austin Business Journal.
For more than fifty years, vendors have controlled their sales tax compliance burden by limiting their activities in market states.
But following the US Supreme Court’s (the Court’s) South Dakota v. Wayfair, Inc. ruling (Wayfair), which overturned the physical presence standard, interstate vendors are subject to tax laws in each state where they sell goods or services. This means vendors need to consider sales tax compliance requirements as soon as they begin making significant sales in another state—which could present significant tax and logistical challenges.
Changes for Technology Sellers
Registering, collecting, and remitting tax in destination states has received significant attention since the Court’s ruling. But for technology sellers, the ruling introduces additional complexities.
Sellers of digital products and services face industry-specific problems, including analyzing and determining each state’s treatment and sourcing of digital products. Here’s a look at the Court’s decision, some of the issues the case left unresolved, and tax and sourcing problems left in Wayfair’s wake.
In 1992, the Court reaffirmed that a seller must be physically present for a state to require vendor collection of the sales tax. On June 21, 2018, the Court replaced this requirement by approving a standard stipulating that vendors making over $100,000 dollars annually, or completing over 200 transactions in a given state, must collect sales taxes in that state.
While states are rushing to implement the standard, the ruling includes language suggesting limitations on their power to require collection.
Wayfair suggests the South Dakota statute at issue included elements that made state collection constitutional. For example, South Dakota’s membership in the Streamlined Sales and Use Tax Agreement (SSUTA), requires it do the following:
- Simplify its sales tax regime to allow easy registration
- Use uniform definitions and single-point remittance in a state
- Implement certain vendor protections
Wayfair also suggests that retroactively applying a state’s statute could violate the US Constitution.
The Court’s opinion leaves several important questions unanswered:
- How is the opinion applied in states that haven’t simplified their sales tax structures?
- What constitutes retroactive application?
- If a vendor exceeds a threshold, may the state assert tax liability for sales made before reaching the threshold?
The opinion also creates issues related to elimination of the physical presence test.
For example, Alabama allows vendors that aren’t required to collect tax to voluntarily collect and remit tax under a simplified regime. Under the new ruling, these vendors may not qualify as voluntary collectors because Wayfair suggests the state may require them to collect tax if they have a significant economic presence. This creates uncertainty as to whether these vendors can continue using the simplified system.
Digital Product Issues
Many vendors don’t have physical presence outside their home state, which previously allowed them to ignore many issues relating to digital products and services. Following Wayfair, virtually all digital products and services vendors are exposed to issues in states where they make significant sales.
Taxing digital products and services has been complicated for some time. For example, it’s unclear if digital products are deemed to be tangible personal property taxable (TPP) under a given state’s sales tax system.
While SSUTA-member states are required to clarify sales taxability of digital products, some tax agencies in states that haven’t legislatively addressed taxability of digital goods have asserted that digital goods and software are TPP. This means states can tax the products despite lack of legislative direction.
Taxing digital services is a more nuanced issue. While some states tax digital services explicitly, others regard them as rental of the underlying software or hardware.
Consider Massachusetts: In one regulatory example, the state indicates that remote access of “software to prepare [a] personal income tax return” is the “use of the software,” making the transaction “subject to sales or use tax.” This means using a software as a service (SaaS) platform of tax preparation software equates to leasing the underlying software, which is TPP and subject to sales taxation.
This classification problem brings up some related issues:
- Under these circumstances, the state must clarify whether the taxable location is that of the user or the server. If the server is out of state and the user is in-state, a state may assert either location, but it can’t assert both. States have been hesitant to address this issue.
- The Massachusetts tax preparation software example implies, but doesn’t state, that using the software is taxable at the point of use. Elsewhere in the regulation, Massachusetts asserts hardware is taxable at its location. This creates an unjustified and indefensible difference in treatment between hardware and software.
These questions—and many more—await the vendor navigating the Wayfair ruling’s choppy waters.