On June 21 the United States Supreme Court issued its ruling in the case of South Dakota v. Wayfair. This case, which Accounting Today referred to as “the tax case of the millennium,” held the promise of clarifying, once and for all, the thorny issue of local internet sales tax collection.
The issue at hand: Companies that sell goods over the internet are still subject to the same sales tax collection requirements as physical stores. The challenge, of course, has been the question of actually collecting those taxes, particularly when one considers that (once local sales taxes are taken into account) that there are well over 10,000 individual tax jurisdictions in the United States.
Until this latest ruling, the guiding legal principle in this issue was established by the Supreme Court in their 1992 Quill Corp. v. North Dakota ruling. At that time, the Court ruled that the test for whether internet companies would be required to collect and remit sales taxes would be whether or not the company has a physical presence in that state. The definition of “physical presence” has been controversial for years as Amazon grew its fulfillment network across dozens of states using subsidiaries that did not meet the definition of “physical presence.”
Ultimately the Quill ruling weighed the “minimum contacts” nexus required by the Due Process Clause with the “substantial nexus” required by the Commerce Clause and came down in favor of internet retailers.
It’s critical to note that the Quill ruling never absolved consumers of their responsibility of paying local sales taxes on the purchases they made online. It just absolved internet retailers from the responsibility of collecting those taxes. In practice, this essentially created a huge tax loophole for consumers when it came to purchases online. Consumers were still legally responsible for paying any sales taxes due in their local municipalities or states, but you likely could fit on the head of a pin the number of shoppers that voluntarily paid these taxes due.
With South Dakota v. Wayfair, the Supreme Court has effectively closed that loophole. The case, which garnered the support of 40 other states, pitted South Dakota’s argument that states were losing out on billions of dollars of uncollected sales tax revenues against Wayfair’s argument that a mandatory bill would be devastating to online businesses.
Of course, when the Quill ruling was issued online sales accounted for less than $400 million annually. By next year retail eCommerce in the United States will leap well past $500 billion. In their 5-4 ruling, the Supreme Court overturned Quill, stating the obvious—that eCommerce had radically changed the way that American consumers spend their money with Justice Kennedy weighing in, “our states are losing massive sales tax revenues that we need for education, health care, and infrastructure.”
The ruling was immediately greeted with a supportive tweet from President Trump; “Court win on internet sales tax – about time! Big victory for fairness and for our country. Great victory for consumers and retailers.” While Donald Trump has been a vocal supporter of such a measure, this actually is an about face of some sorts for the Republican Party on the issue. Thanks largely to pressure from lobbyist groups like Americans for Tax Reform and others, Congress has previously opposed legislative efforts in the past to deal with the issue of internet sales tax collection. Most notably, the Main Street Fairness Act and later Marketplace Fairness Act (first proposed in 2011), which were championed by bricks-and-mortar retailers and trade groups such as the National Retail Federation and International Council of Shopping Centers, were defeated multiple times. Many legislators feared being viewed as voting for a “new” tax on constituents, while proposed legislation only made consistent across all states the obligation to pay an existing tax. While retail groups advocated that the legislation simply closed a tax loophole that was created an unfair trade advantage for internet retailers, anti-tax advocacy groups argued that any movement on the matter constituted a new tax on Americans.
Another major sticking point for the Marketplace Fair Act was limiting who would be exempt from tax collection, known as the Small Business Exemption. Opponents argued calculation and collection in the over 10,000 jurisdictions is too heavy a burden to put on small businesses. The evolution of tax management software has simplified this process significantly. Nonetheless, Congress now faces the issue of agreeing below what level of annual revenue small businesses are exempt. Is it $100k? $1 million? What’s fair for both the Mom-and-Pops and the market leaders?
The reality, whether or not you view the new ruling as a new tax on consumers or not, is that the issue of internet sales taxation has been a major challenge for bricks-and-mortar retailers over the past few decades.
There are three things to get a consumer into a store or a shopping center; value, convenience or experience. The original value proposition of eCommerce was value. Because internet retailers didn’t have to pay retail rents or deal with the expensive infrastructure of operating hundreds or thousands of retail locations, the model already had some built in pricing advantages. Industrial warehouse rents are vastly cheaper than retail rents, particularly those in place in the nation’s premium malls and high street retail districts so most pure play internet retailers already had significantly lower expense structures that helped to create pricing advantages.
The issue of sales tax collection only added to those advantages, particularly when it came to big ticket sale items. For example, a flat screen television that might retail for $1,000 in California would cost the consumer anywhere from $1,065 to $1,100 once sales taxes were factored in. That same consumer might be able to find the same television online for just $900. And, if the internet retailer didn’t have a presence (warehouse) in California—that shopper could save as much as $200 on the final retail price they would have paid.
As a result, the issue of local sales tax advantages drove the real estate strategies of virtually every major eCommerce player… originally. Meanwhile, advantages in pricing helped to fuel the rise of “showrooming.” This is the practice of consumers inspecting merchandise in physical stores and then purchasing those goods online. This practice proved particularly devastating to retailers when it came to big ticket items and is often cited as one of the contributing factors to the demise of dozens of retailers like Circuit City.
Within that historical context, it is easy to understand why so many sources in the media are referring to the latest Supreme Court ruling as being a major game changer with an immensely positive impact for bricks-and-mortar retail. Unfortunately, these analyses to some degree are backwards looking. Had it been addressed a few years back, the internet sales tax issue could have had the potential to be a major game changer for physical retailers and could have made a dramatic impact on the rise of eCommerce—a force that would have shaped its evolution. And that said, this ruling will have some impact; physical retailers will see a slight, perhaps even minuscule, benefit mostly on the sale of high ticket items. Likewise, the ruling will have a substantial impact on the real estate strategies of some pure play eCommerce retailers. But the timing of this ruling has come far too late to be a game changer and that is because the game itself has already changed.
For truly national omni-channel retailers such as Walmart, Target, Macy’s and Best Buy, the ruling is nearly a non-event: They are already collecting sales tax. With a physical presence in almost all states, the ruling changes nothing for them. Retailers with operations in a limited number of states, such as the defendants in the South Dakota case including Newegg, Overstock and Wayfair, will now have to turn on collection in all states with a sales tax.
This decision also still leaves open the contentious issue of third-party sellers’ obligations to collect tax. The Amazon marketplace, for instance, facilitates tens of billions of dollars in sales for its seller community on which it does not collect sales tax. Amazon and other large marketplaces contend that obligation is the sellers’ and not theirs. Still another add to Congress’ homework list to address.
While the original value proposition of eCommerce to the American consumer was value, it is now convenience. The catalyst behind this change was Amazon, which starting in 2010 began aggressively opening vast eCommerce fulfillment centers outside of virtually every major metro in the U.S. Jeff Bezos and crew has developed over 110 million square feet of distribution space since 2010, with Amazon continuing to add more infrastructure to accelerate the delivery of goods to the consumer even further.
The result is that roughly 90% of Americans now have access to same day or next day delivery via Amazon. This is why as overall eCommerce growth has averaged in the 15% annually since 2010, Amazon’s growth has continually outpaced those numbers—at times doubling or more, that rate of growth. Keep in mind, overall retail growth during this period has averaged roughly 3% per year, and roughly one third of that has been driven by eCommerce.
Amazon’s real estate strategy was about making the value offering of eCommerce convenience and speed. Amazon was among the first eCommerce players to voluntarily pay local taxes and to actually lend support to the Main Street Fairness Act and later Marketplace Fairness Act when they were before Congress. Today it collects in every state with a sales tax. And the reality is– the marketplace has followed. Most newCommerce players (retailers with both a physical and online presence) began opening fulfillment hubs closer to population centers years ago. This is not to say that tax advantages aren’t part of the eCommerce fulfillment center real estate equation, but that where this used to be the top priority for online players looking to beef up infrastructure, it now takes a backseat to considerations regarding speed of delivery, infrastructure and proximity to transportation hubs.
We spoke to the real estate manager for a large national apparel company about his thoughts on the ruling and found his answer to be spot on; “it’s too late to have a huge benefit for us, though we hope it does us some good. At the end of the day it reminds me of when I was a boy and wanted a Stretch Armstrong doll for my eighth birthday. I didn’t get it but for some reason my grandmother sent me one for my 15th birthday. It was appreciated, but I didn’t have the heart to tell her that it came long after it would have done me any good. That’s what this feels like.”
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