20 Jul An AgTech Burden: Out-of-State Sales Tax Collection
In the last few decades, many AgTech businesses have found it increasingly difficult to navigate the multitude of tax laws imposed by states and localities. The process of determining the correct tax base, collecting tax from customers, and remitting that tax to the appropriate authority can be an overwhelming burden for businesses that lack substantial tax management resources. To minimize the burden of tax compliance, it is important that businesses know which states legally require them to collect and remit taxes. As AgTech investment continues to grow, receiving over $2.36 billion across 264 investment deals in 2014, many in the industry are finding it difficult to determine their state tax liability on sensors, machines, and services sold across state lines.
Does the seller have a physical presence in the state?
In Quill v. North Dakota, the U.S. Supreme Court held the physical presence of an out-of-state business is required before a state can require that business to collect and remit sales tax. This physical presence standard created a bright-line rule for “substantial nexus,” which is the constitutional threshold for states to exercise their taxing authority. As a result, the lack of a physical presence in a state is sufficient under subsequent case law to exempt a seller from having to collect taxes on behalf of customers for their out-of-state purchases. The courts generally find a physical presence when the seller has an office, property, or any employees working within the state. Conversely, a seller whose only contacts with the taxing state are by mail or common carrier does not meet the physical presence standard.
Unfortunately, the physical presence standard was adopted by the U.S. Supreme Court before the internet and technology were as ubiquitous as they are today. Accordingly, determining state sales tax liability has become increasingly difficult, for the holding in Quill has been slowly eroded by the states. Today, the U.S. Supreme Court and the states disagree about what constitutes sufficient nexus to exercise their taxing authority over out-of-state purchases.
While Congress is best suited to redefine substantial nexus, the physical presence standard has been stealthily broadened by state legislatures across the country to include an increasing amount of companies who conduct business online. States have been hungry to replace significant revenue lost to burgeoning online sales, leading to a higher frequency of laws with nexus thresholds below the physical presence standard. Some of these state laws have even been upheld in court, even though Quill is still technically good law.
Is the seller subject to a lower nexus threshold?
The U.S. Supreme Court has seemingly emboldened states even further through recent discussion of the Quill decision. Justice Kennedy’s concurring opinion in Direct Marketing Association v. Brohl states that the internet has caused far-reaching structural changes in the economy and, as a result, necessitated a reconsideration of the physical presence standard. The result has been a frenzied effort in the last few years by states to increase the collection of taxes from out-of-state businesses with a virtual or economic presence.
Following Kennedy’s opinion, multiple states have enacted laws or rules that appear to be an effort to directly challenge the Quill ruling. Alabama, the first to act, now requires out-of-state retailers with sales of tangible personal property in excess of $250,000 to collect and remit taxes. Following its lead, South Dakota only requires that retailers generate over $100,000 of gross revenue from sales of products or services delivered into the state or, alternatively, 200 or more separate transactions of products or services. Additionally, states like Wyoming, Vermont, Massachusetts, and Tennessee have passed similar, even nearly identical, legislation.
Pending legislation in 2017
Jim Sensenbrenner, a House representative from Wisconsin, has proposed to restrict the states’ ability to challenge Quill. The House Subcommittee on Regulatory Reform scheduled a hearing in July 2017 to consider Sensenbrenner’s bill, titled the “No Regulation Without Representation Act of 2017.” His bill states, “To the extent otherwise permissible under Federal law, a State may tax or regulate a person’s activity in interstate commerce only when such person is physically present in the State during the period in which the tax or regulation is imposed.”
A competing proposal, the “Remote Transactions Parity Act of 2017,” by House representative Kristi Noem from South Dakota, would allow states to mandate out-of-state sellers to collect sales tax without a physical presence. This legislation was introduced alongside the Marketplace Fairness Act of 2017, a bipartisan Senate proposal, which would also enable state governments to collect sales tax from remote sellers. The Senate proposal contains an exemption for remote sellers with less than $1 million in annual nationwide remote sales. While Congress has yet to codify a solution to the existing uncertainty under Quill, it has come very close in the past to expanding the physical presence standard with the small seller exemption.
Sales tax in the AgTech sector
While AgTech investment in 2016 fell to $3.2 billion, a 30% drop from 2015, there is still significant growth in the sector from 2014. Support from a growing number of accelerators and other early stage resources indicate that the field will likely see greater exposure to tax compliance requirements. Until there is some resolution at the federal level, it seems likely that the requirements for tax collection and remittance will continue to increase unchecked.
“Amazon” laws in the past two years, such as click-through nexus and notification laws that hold online customers accountable for the tax on out-of-state purchases, have created substantial compliance burdens on many of the AgTech businesses that sell products to out-of-state customers. These businesses may now find themselves on the wrong end of a substantial tax obligation—even tax penalties that they did not have two years ago. While there are means available to lessen the burden of sales and use taxes, it is more important now than ever to have knowledgeable advisors who can assist with reducing the company’s overall tax burden while minimizing the risk of penalties.