In overturning the Commonwealth Court, the Pennsylvania Supreme Court recently held that royalty fees for certain intellectual property were not subject to Pennsylvania sales tax. See Downs Racing LP v. Commonwealth of Pennsylvania, Dkt. No. 70 MAP 2017 and 71 MAP 2017 (Pa. Oct. 25, 2018). The royalties at issue were payments between third parties for IP used in the operation of gaming machines (“Gaming IP”). The Commonwealth argued the Gaming IP was canned software, and thus taxable in Pennsylvania. The Commonwealth also argued, in the alternative, that sales tax was due on the full price paid for the gaming machines along with any ancillary items, such as the Gaming IP. In siding with the taxpayer, the court found the Gaming IP was not subject to sales tax because it did not constitute, nor was it ancillary to, tangible personal property.
The physical presence standard is no more. In a 5-4 decision issued this morning, the U.S. Supreme Court reversed its own precedent that, for over fifty years, provided an in-state physical presence by a retailer was a prerequisite for the constitutional imposition of a state sales or use tax collection obligation. See South Dakota v. Wayfair, Inc., No. 17-494 (U.S. Jun. 21, 2018), rev’g Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and National Bellas Hess Inc. v. Illinois, 386 U.S. 753 (1967).
Baker McKenzie attended the U.S. Supreme Court’s oral arguments yesterday in South Dakota v. Wayfair, Docket No. 17-494. At issue in the case is whether the Court should abrogate the physical presence nexus standard that it first articulated in National Bellas Hess v. Dep’t of Revenue, 386 U.S. 753 (1967), and later affirmed in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The Court’s decision could have a profound impact on sales and use tax nexus in the United States by altering the limitations currently imposed on a state’s ability to require out-of-state retailers to collect such tax.
Just over a month ago, the U.S. Supreme Court surprised many in the state tax community when it announced that it granted certiorari in South Dakota v. Wayfair, Inc., Docket No. 17-494; appealed from 901 N.W.2d 754 (S.D. 2017). Granting cert. in Wayfair means that the U.S. Supreme Court may be willing to overturn precedent that, for over fifty years, has provided and continues to provide a bright-line physical presence nexus standard applicable to states’ ability to impose sales and use taxes. See National Bellas Hess Inc. v. Illinois, 386 U.S. 753 (1967), affirmed in part by Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The U.S. retail economy and its transition from brick-and-mortar storefronts to e-commerce retailers have thus been shaped by the expectation that physical presence within a taxing state is required before that state may impose sales or use taxes on a retailer.