Bill Would Impose Sales Tax on Web Purchases


South Carolina’s sales tax is unfair in its imposition and isn’t producing enough revenue. At least that appears to be the opinion of many senators. Several who take that view introduced a measure they no doubt believe will help to remedy the problem. Rather than taking the straightforward approach of eliminating the many sales tax exemptions in the current code and using the revenues to cut general tax rates, these lawmakers have decided to go after online retailers, specifically out of state online retailers.

S.170 would require online retailers that make more than $10,000 a year in South Carolina sales, and that enter into an agreement with South Carolina-based web users to refer clients, to collect and remit sales tax. (The bill’s language is more precise: the triggering agreement would be between the state and “a resident of this State under which the resident, for a commission or other consideration, directly or indirectly refers potential customers, whether by a link on an Internet website or otherwise, to the retailer.” This referral process is commonly referred to as “click-through referrals” or “affiliate marketing.”

Leaving aside the wisdom of enacting another tax increase, S.170 faces two possible legal hurdles.

First, S.170 may violate the U.S. Constitution. Some online retailers, particularly retailers physically based outside South Carolina, don’t currently collect South Carolina sales tax. This is because the Supreme Court, citing the commerce clause, ruled in Quill v. North Dakota that a business must have a physical presence in a state before that state can require the business to collect sales and use tax. In technical terms, in order to be sustained against a commerce clause challenge, a tax must be “applied to an activity with a substantial nexus with the taxing state.”

Several states have passed – and South Carolina lawmakers are currently trying to pass – laws that sidestep the physical presence/substantial nexus requirement by claiming a resident individual providing click-through referrals for an out of state retailer constitutes a substantial nexus. These laws have met with mixed results when challenged in court, although the U.S. Supreme Court has yet to issue a decision on it.

In 2013 the New York Court of Appeals (the highest court in New York State) rejected a challenge to New York’s internet sales tax law, upon which S.170 is based. However, later the same year the Illinois Supreme Court struck down a similar law in Illinois. In the Illinois case the court struck down the law because it violated the federal Internet Tax Freedom Act by imposing discriminatory taxes on electronic commerce.

The current divide among state courts makes it uncertain whether or not S.170 (as currently written) would survive a court challenge.

Second, Congressional action may invalidate South Carolina’s proposed law. In Quill v. North Dakota the Supreme Court made it clear that Congress could resolve the internet sales tax issue by passing legislation. A bill currently before Congress, the Online Sales Simplification Act of 2015, attempts to do just that. The federal bill would permit sales tax on online purchases, but would require that taxes imposed on online purchases be “origin based.” This means online sales tax would be imposed at the rate of the state where the selling company has the largest physical presence. For example, if a South Carolinian purchased a product from an online retailer based in Maine, he or she would pay Maine’s 5.5 percent sales tax rate rather than South Carolina’s 6 percent rate.

If the Online Sales Simplification Act of 2015 becomes law, it would invalidate any state laws (like S.170) that impose an internet sales tax based on a buyer’s location.

One doesn’t have to oppose the imposition of new taxes to see the potential problems facing S.170. Even lawmakers who are indifferent to the size of the state’s tax burden should think twice before passing a law that may well be struck down as unconstitutional or invalidated by federal statute.

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