Supreme Court overturns Quill’s physical presence requirement

Whether it is because of the convenience, low prices, or wide selection we’ve been seeing more and more of online shopping in recent years. Online purchases can have another characteristic: online purchase can be sales tax free. This may now change after the Supreme Court ruled in South Dakota vs. Wayfair, Inc. on June 21, 2018.

Under previous rulings (*1), states may not require businesses to collect sales tax unless they have a physical presence to the state. Instead, in-state consumers are responsible for paying use tax at the same rate; but compliance with the use tax is low. This could provide more savings for customers and hence better operating environment for sellers, but this also means loss of revenue for states.

South Dakota, like many states, taxes only the businesses with physical presence in the state and it is estimated that the state loses between $48 and $58 million sales tax revenue annually. Concerned about the erosion of its sales tax base and corresponding loss of critical funding for the state and local services, South Dakota enacted a law requiring certain out-of-state sellers to collect and remit sales tax. The act only applies to sellers that, on an annual basis, i) deliver more than $100,000 of goods or services into the state or ii) engage in 200 or more separate transactions for the delivery of goods or services into the state.

South Dakota’s Legislature knew that its new act would be considered unconstitutional unless previous rulings were overturned. South Dakota filed a declaratory judgment action in state court against Wayfair Inc., Overstock.com, and Newegg Inc., all of which are large internet merchants that have no physical presence in South Dakota and do not collect sales tax. The law was first declared unconstitutional by South Dakota courts, then the Supreme Court granted certiorari.

In deciding to overrule the prior ruling, the U.S. Supreme Court stated that Quill banning sales tax collection when businesses lack “physical presence” in a state was an incorrect interpretation of the Commerce Clause. First, the Court criticized that the physical presence rule is not a necessary interpretation of the “closely related” nexus requirement. Second, the Court found that the prior ruling creates, rather than resolves, market distortions, calling it a “judicially created tax shelter for businesses that decide to limit their physical presence”. Third, the Court found that Quill imposes “arbitrary, formalistic” distinctions that run counter to the Court’s modern precedents under the Commerce Clause. The Court also provides an example: a business that has a warehouse, even though the warehouse has nothing to do with the sales, would be required to collect sales tax, while an online retailer with pervasive internet sales cannot be subject to the same tax for the sales of the same items. The Court states “this distinction simply makes no sense”.

In dissenting opinion, Chief Justice John Roberts, with whom Justices Breyer, Sotomayor, and Kagan joined, wrote that, although he agreed that previous ruling was wrongly decided, and that the internet commerce has improved the economy greatly, 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. Which may have put some pressure on congress to move ahead with legislation on this issue to provide a national standard for e-commerce. Also, it is expected that other states will now change their laws to take advantage of the decision.

Companies with remote sales should closely monitor current and potential state and federal legislation and related sales tax exposures. Before Wayfair, even though some states require sales tax responsibilities to remote sellers without physical presence in the jurisdictions, some companies chose not to comply with the regulations since they have favorable previous rulings. This position needs to be re-analyzed as the previous rulings were overturned. Companies should consult with sales tax experts.

Please refer to the Supreme Court Opinion: https://www.supremecourt.gov/opinions/17pdf/17-494_j4el.pdf

*1: National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967), and Quill Corp. v. North Dakota, 504 U.S. 298 (1992)

IRS Notice 2018-122: 주정부세 및 지방세 납부 공제

세법개정에 따라 과세년도 2018년부터 2025년까지 개인이 지불한 주정부세 및 지방세에 대한 공제가 연 $10,000로 제한된다 (부부개별신고의 경우 $5,000).

이러한 제한에 대응하여, 일부 주정부에서는 납세자들이 납세의 형태로 지불하는것이 아닌, 주 정부 또는 지방 정부가 관리하는 펀드 및  주 정부가 지정한 다른 양수인에게  지불하는 방법을 허용하는 입법안을 고려하고 있거나 이미 채택하였다. 이러한 입법안들이 바라는 효과는, 납세자들이 주정부세 및 지방세 납부 의무를 다하는 동시에, 연방 소득세 계산 시 이와 같은 송금액을 공제대상인 자선 기부금으로 처리 할 수 있게 되는 것이다.

IRS가 Notice 2018-122를 통해 밝힌 바에 따르면, IRS는 추후에 이와 같은 주 정부 또는 지방 정부가 관리하는 펀드에 송금되는 금액에 대한 연방 소득세에 대한 규정을 발표할 계획이다. 이 규정을 통해 IRS는 실질 과세의 원칙 (Substance over Form)을 통해 이러한 송금액이 연방세법에서 규정하는 자선기부금인지가 결정될 것임을 밝힐 것이다. 이에 따라, 납세자들이 실질적인 납세금액을 공제받을 수 있는 자선 기부금으로 임의로 재특정 지을 수 없도록 제한될 것이다.

자세한 설명은 아래의 링크를 참고하시기 바랍니다.
https://www.irs.gov/pub/irs-drop/n-18-54.pdf

IRS Notice 2018-122:  Federal Deduction for State and Local Tax Payments

The new federal tax law limits an individual’s deduction for the amount of state and local taxes paid during the year to $10,000 ($5,000 in the case of married filing a separate return).  This limitation applies to tax years 2018 through 2025.

In response to this new limitation, some state legislatures are considering or have adopted legislative proposals that would allow taxpayers to make transfers to funds controlled by state or local governments, or other transferees specified by the state, in exchange for credits against the state or local taxes that the taxpayer is required to pay.  The aim of these proposal is to allow taxpayers to characterize such transfers as fully deductible charitable contributions for federal income tax purposes, while using the same transfers to satisfy state or local tax liabilities.

IRS stated in the Notice 2018-122 that it intends to issue regulations addressing the federal income tax treatment of transfers to funds controlled by state and local governments that the transfer can treat in whole or in part as satisfying state and local tax obligations.  The regulations will make clear that the substance-over-form would dictate the proper characteristic of such payment for federal income tax purposes, thereby limiting taxpayers’ ability to recharacterize tax payments subject to deduction limitation to fully deductible charitable contributions.

Please refer to the link below for further detail:
https://www.irs.gov/pub/irs-drop/n-18-54.pdf

Withholding on Partnership Interest Sale or Exchange By a Foreign Person

Newly enacted Internal Revenue Code sections 864(c)(8) and 1446(f) impose a 10% withholding tax on amount realized by foreigners from a sale or exchange of interest in a partnership with an effectively connected income of U.S. trade or business effective for a transaction entered into after November 27, 2017.

Section 1446(f) provides that a purchaser of a partnership interest is generally required to withhold 10% of the amount realized on the disposition if any portion of the foreign seller’s gain is effectively connected income of U.S. trade or business, as defined under section 864(c)(8).  Withholding is exempted if:

• The purchaser receives a non-foreign affidavit from the seller;
• The purchaser receives an affidavit that no gain is attributable to a U.S. trade or business;
• The IRS provides for reduced withholding through issuance of a withholding certificate; or
• The partnership is publicly traded.

If the purchaser does not withhold when required, the partnership is required to withhold from distributions to the purchaser an amount equal to the under-withholding plus interest, thereby putting an ultimate responsibility to the partnership.

How the changes to sections 864 and 1446 will affect foreign sellers of residents of countries with income tax treaty with U.S. is unclear.  Generally, U.S. tax treaties exclude gain on sale of partnership interest by a foreign person from U.S. taxation if that person has does not have a permanent establishment in the U.S.  However, in general, newly enacted domestic tax laws override older tax treaty provisions.  Hence, it is unclear whether a non-U.S. person can successfully claim exemption from the new withholding requirement under section 1446(f).

Below is a link to an article covering interplay of newly enacted section 1446(f) with income tax treaties.
- http://www.klgates.com/disposition-of-a-partnership-interest-now-subject-to-tax-withholding-01-18-2018/

Below are the links to the inquiries made by American Bar Association and NY State Bar Association for clarification on interplay between the 1446(f) withholding requirement and existing income tax treaties.
- https://www.americanbar.org/content/dam/aba/administrative/taxation/policy/031918comments.authcheckdam.pdf
- https://www.nysba.org/Sections/Tax/Tax_Section_Reports/Tax_Section_Reports_2018/1387_Letter.html