(This is a republication of Law360’s October 29 installment of Reed Smith’s California Tax Takes monthly column.)
Stakeholders meeting
On October 24, 2018, in response to the U.S. Supreme Court decision in South Dakota v. Wayfair, Inc.,1 the California Department of Tax and Fee Administration (CDTFA) held a Wayfair Stakeholders Meeting to solicit comments from the public with respect to its plan to issue a notice containing new tax collection rules for retailers. This notice would impose use tax collection thresholds for remote vendors similar to the $100,000 in sales or 200 transaction thresholds adopted under South Dakota’s law by the end of the year. The exact compliance deadline was not announced, however, it is expected to be in early 2019.
Representatives from the CDTFA (including CDTFA Director, Nick Maduros, and CDTFA’s Legal Division lawyers) did not commit to specific nexus thresholds during the meeting. But when asked about the enforceability of Wayfair via a notice, the CDTFA representatives stated that CDTFA’s lawyers currently believe that between the California ‘Long-Arm’ provision (discussed below) and the Wayfair decision, CDTFA has the authority to enforce the same nexus thresholds in South Dakota without passing any additional legislation or regulation.
Current California law
California Revenue and Taxation Code Section 6203(a) currently provides that “every retailer engaged in business in this state” making non-exempt sales of tangible personal property for storage, use or other consumption in California shall collect California sales and use tax from the purchaser at the time of the sale.
Section 6203(c) (the ‘Long-Arm’ Provision) defines “retailer engaged in business in this state” to mean “any retailer that has substantial nexus with this state for purposes of the commerce clause of the United States Constitution and any retailer upon whom federal law permits this state to impose a use tax collection duty.”
Prior inadvertent posting of Wayfair tax collection rules and proposed legislation
This is not the first time since the Wayfair decision that CDTFA has expressed its intent to adopt nexus thresholds similar to the ones adopted under South Dakota’s law.
Shortly after the Wayfair decision, the CDTFA inadvertently posted on its website a draft notice containing new tax collection rules for retailers, indicating that California may adopt use tax collection thresholds for remote vendors similar to the thresholds adopted under South Dakota’s law effective August 1, 2018. The draft notice stated that certain retailers would be required to register with the CDTFA and to collect California use tax, if they met one of the following thresholds during the preceding or current calendar year:
- The cumulative sales price of the retailer’s sales of tangible personal property for delivery in California exceeds $100,000, or
- The retailer sold tangible personal property for delivery in California in 200 or more separate transactions.
The CDTFA has since removed the draft notice from its website, and a CDTFA representative has said that the document was an unofficial, internal-only document that was inadvertently placed on the CDTFA website. The CDTFA’s representative added that the draft was written prior to the Wayfair decision and was not intended for publication.
Subsequent to this inadvertent posting, a draft bill from the Department of Finance was introduced with a $500,000 nexus threshold for use tax collection. But lawmakers adjourned for the year without considering this legislation.
In response to the Legislature’s inaction, the CDTFA affirmatively announced its intent to apply new tax collection rules for retailers based on sales thresholds for remote vendors similar to the thresholds adopted under South Dakota’s law.
Questions and potential legal challenges
1. Will California’s apply Wayfair retroactively?
The answer appears to be no. During the Stakeholder Meeting, a CDTFA representative stated that Wayfair will not be applied retroactively. But once California adopts a compliance date, retailers’ requirement to use tax will likely be determined based on whether the retailer exceeded the nexus thresholds in the prior year or preceding 12-months.
2. Can California simply issue a notice to adopt new nexus thresholds?
If the CDTFA simply issues another notice by the end of the year adopting nexus thresholds similar to South Dakota’s, the enforceability of such notice may come into question. Potential legal challenges to such notice may include the following:
(a) The notice may constitute an improper adoption of a regulation due to non-compliance with the procedural requirements of the California Administrative Procedure Act (APA).
The APA establishes rule-making procedures and standards for state agencies in California. The requirements set forth in the APA are designed to provide the public with a meaningful opportunity to participate in the adoption of state regulations and to ensure that regulations are clear, necessary, and legally valid. State agencies that wish to adopt, amend, or repeal a regulation must comply with certain procedural filing, publishing, notice, and hearing requirements to allow the public an opportunity to participate.2
Just this year, the California Superior Court granted summary judgment and an injunction in favor of the plaintiff on a matter involving California’s attempt to circumvent the regulatory process outlined in the APA.3 The Thrivent case underscores the willingness of California courts to strike down broad rules of general applicability that do not go through the formal regulatory process.
(b) The new collection rules, under certain circumstances, may constitute a tax increase, which requires a two-thirds supermajority approval under California Proposition 26.
California’s Proposition 26 provides that the passage of any law that leads to an increase in tax for any taxpayer in California requires a two-thirds supermajority vote in the Legislature. While a notice posted by the CDTFA only imposes a use tax collection obligation on out-of-state sellers (i.e., the use tax obligation would shift from the consumer to the out-of-state seller under the notice), there may be indirect tax increases as a result of the new obligation. For example, under the first inadvertent notice, an out-of-state seller would have been obligated to collect use tax at the highest combined rate (state, local, and district) from its consumers for the sake of ease of compliance. Arguably this obligation may increase the use tax due on the out-of-state seller’s sales to California consumers compared to a scenario in which the consumers continued to self-assess the use tax based on the applicable local rates. While uncertain, this type of an increase in the effective use tax rate imposed on sales by out-of-state sellers may require the CDTFA to obtain approval for the rule by a supermajority in the Legislature.
Conclusion
An attempt by the CDTFA to use tax collection requirements by administrative notice will likely be subject to challenge based on multiple grounds.
Office of Tax Appeals update
The Office of Tax Appeal’s (OTA’s) is currently operating under a set of Emergency Regulations adopted on December 26, 2017. Those Emergency Regulations expire in December 2018. In October, the OTA submitted its proposed regulations to the Office of Administrative Law (the “OAL”) for review. The OTA e-mailed the Rulemaking File, which includes the complete regulatory package under review, including comments received during the formal comment period, to interested parties on October 17, 2018. After an agency submits a regulation to the OAL, the OAL has 30 working days to either approve or disprove the submitted regulation. Thus, the OAL must make a decision on the OTA’s proposed regulations by November 26, 2018.
The OTA has held hearings in Sacramento, Fresno, and Los Angeles since the beginning of the year. The OTA held hearings in Los Angeles on October 22 and 23 and hearings in Sacramento on October 30.
- 138 S. Ct. 2080 (2018).
- See Cal. Gov. Code 11340 et seq.
- See e.g., Thrivent Financial For Lutherans vs. Betty Yee, Case Number: CGC-15-548384 (Cal. Super. Ct. July 18, 2018) (California Superior Court granted summary judgment and an injunction in favor of a life insurer contesting California’s unclaimed property handbook requirements as “regulations” not promulgated consistently with the APA).
Client Alert 2018-218
