Ecommerce taxation: Brick-and-mortar stores vs. Online stores

Taxation of ecommerce transactions has always been a controversial issue in most of the jurisdictions

Published: 01, Aug 2018

Rajdeep Banerjee is an advocate and legal consultant. He has additional PG Diplomas in Alternate Dispute Resolution, Media Laws, Cyber Laws, Intellectual Property Laws and Human Rights Law from NALSAR, Hyderabad and NLSIU, Bengaluru. He has been practicing law for the last ten years. He is also a visiting faculty at various premier institutions and has taught Corporate Taxation, Business Laws, Labour Laws, Intellectual Property Laws, Cyber Laws, Business Process Outsourcing, Drafting and Conveyancing, Constitutional Law, Sports Law, Public International Law and Human Rights to MBA and Law students. He delivers guest lectures on diverse topics to working professionals and students. He has been a resource person and has also presented research papers at various International and National Seminars and Conferences. He knows various languages including German, French, Spanish and Japanese. Joyeeta Banerjee is a legal consultant and practicing advocate for the last ten years. She is also a qualified Mechanical Engineer. She is also a visiting faculty at various premier institutions teaching Business and Economic Laws, Corporate Laws, Taxation Laws, Legal and Regulatory aspects of Banking, Intellectual Property Laws, Drafting and Conveyancing, Criminal law and Cyber Laws to MBA and Law students. She has delivered various guest lectures to working professionals and students. She has been resource person and has also presented research papers at various International and National Seminars and Conferences. She has PG Diplomas in Cyber Laws, Intellectual Property Laws, Media Laws, Alternate Dispute Resolution and Human Rights Law from NALSAR, Hyderabad and NLSIU, Bengaluru. She knows seven languages including Japanese, German, French and Spanish.

Image: Shutterstock
Image: Shutterstock

The absence of physical presence in the customer’s state has prompted ecommerce retailers to suggest that there can be no taxation in the customer state. India has now moved to Goods and Services Tax (GST) which has included ecommerce transactions in its ambit. But in US ecommerce players escaped the sales tax of the customer state because of a certain interpretation of the ‘Commerce Clause’ by the US Supreme Court in its earlier judgments. But now the Supreme Court in South Dakota v. Wayfair, Inc. (June 21, 2018) has reversed its position and has put ecommerce players at par with retail stores.

Commerce clause is a vital clause under the US constitution. Though Congress has a primacy, cases as early as decided in 1829 (Willson v. Black Bird Creek Marsh Co., 27 U.S. 2 Pet. 245) had clearly indicated that a state’s regulation in interstate commerce can be sustained in appropriate cases. The Supreme Court has held that the power to regulate commerce is not the sole prerogative of the Congress and there can be a concurrent regulatory power. But there has to be a necessary balance between the two. Also, such state regulations cannot discriminate against interstate commerce and states cannot impose undue burdens on interstate commerce.

In South Dakota v. Wayfair, Inc. (US SC, 2018) South Dakota passed a law to provide for the collection of sales taxes from certain remote sellers. It reasoned that its inability to collect sales tax from remote sellers was seriously eroding the sales tax base and hence causing revenue losses and imminent harm through the loss of critical funding for state and local services. Thus the Act required out-of-state sellers too to collect and remit sales tax as if the seller had a physical presence in the state. The question was whether South Dakota may require remote sellers to collect and remit the tax without some additional connection to the state. Since the lower courts were bound by the Supreme Court precedents the case ultimately reached the Supreme Court.

It is not the first time that this issue has reached the highest court. The US Supreme Court in National Bellas Hess vs. Department of Revenue of Ill., 386 U. S. 753 (1967) was seized of the question whether a mail-order company whose only connection with customers in the state was by common carrier or the US mail lacked the requisite minimum contacts. Answering the question in the negative the Court asked for a physical presence in the form of retail outlets, solicitors, or property within the state. But the dissent had then pointed out that the systematic, continuous solicitation and exploitation of the Illinois consumer market should be considered sufficient ‘nexus’ for taxation purposes.

In one of the landmark judgments on the validity of state taxes, the Supreme Court in Complete Auto Transit, Inc. v. Brady, 430 U. S. 274 (1977) held that a state can tax exclusively interstate commerce so long as the tax does not create any effect forbidden by the Commerce Clause. Detailing the requirement of validity of such a state tax, it required that the impugned tax should apply to an activity with a substantial nexus with the taxing state, should be fairly apportioned, not discriminate against interstate commerce and be fairly related to the services the state provides.

But the opportunity of taxing ecommerce retailers received a jolt in a subsequent Supreme Court case (Quill Corp. v. North Dakota, 504 U. S. 298, 1992) where the question was whether an out-of-state mail-order house that did not have outlets or sales representatives in state to collect and pay a use tax on goods purchased for use within the state could be taxed by the state (North Dakota). Concurring with Bellas, the Supreme Court held that the physical presence rule was necessary to prevent undue burden on interstate commerce and hence the transactions in the case could not be taxed.

Broadly for a state to allow tax ecommerce transactions, both ‘due process’ and ‘commerce clause’ requirements need to be satisfied. By due process requirement the courts have held that some definite link, some minimum contact between state and the person or transaction it seeks to tax has to be present. It is already settled that a business need not have a physical presence in a state to satisfy the demand of due process. The question before the Supreme Court in South Dakota case was regarding the satisfaction of Commerce clause. It has already been settled that the requirement of due process and commerce clause are not the same.

Commenting on the present state of affairs, the Supreme Court observed remote sellers are now avoiding the regulatory burdens of tax collection and hence offering de facto lower prices caused by the widespread failure of consumers to pay the tax on their own. Such a rule is producing an incentive to avoid physical presence in multiple states resulting in less storefronts, distribution points and even employment centres which would otherwise have been present. The Supreme Court reasoned that in the earlier occasions the Court did not have before it the present realities of the interstate marketplace as the percentage of Americans having internet access has increased exponentially. The Supreme Court observed that the Quill judgment had created an inefficient ‘online sales tax loophole’ that gave out-of-state businesses an advantage and hence rejecting Quill held that the sale of goods or services in itself had a sufficient nexus to the state in which the sale was consummated to be treated as a local transaction which could be taxed by that state.

The Supreme Court has now rightly held that ‘physical presence rule’ continues to get removed from economic reality resulting in serious market distortions. Rejecting the arguments of high administrative cost of compliance, the court said that in today’s modern economy with its internet technology, the cost of compliance is not related with the physical premises. The Court has thus formally rejected the ‘physical presence’ requirement.

In India, GST has replaced the indirect taxes. It is a destination-based consumption tax as opposed to erstwhile origin-based tax which has now been subsumed in GST. GST has now provisions with respect to e-commerce operators and vendors selling through such operators. Electronic Commerce has been defined under the GST to mean the supply of goods or services or both, including digital products over digital or electronic network. Electronic Commerce Operator means any person who owns, operates or manages digital or electronic facility or platform for electronic commerce. As per the provisions of GST the e-commerce operator is required to collect Tax Collection at Source (TCS) which is calculated at the rate not exceeding one percent of the net value of taxable supplies made through it, where the consideration with respect to such supplies is to be collected by such operator. Being a new tax, Indian ecommerce retailers and suppliers can expect changes in the present scheme.

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