Why Today’s SCOTUS Decision May Impact Franchisor Royalties
by Taylor M. Vernon
Today, in South Dakota vs. WayFair, Inc., et al., the United States Supreme Court (“Court”) overturned long-standing precedents that required an out-of-state Seller to have a physical presence in a state to collect sales tax from consumers in that state.
The South Dakota law (Senate Bill 106 enacted in 2016) being challenged by giant online retailers, Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc. – none of which had a physical presence in South Dakota – requires out-of-state retailers to collect and remit sales tax “as if they had a physical presence in the state.”
The Court found that the South Dakota law did provide due process, commerce clause and small business safeguards because it:
- Applies only to sellers that, on an annual basis, deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions for the delivery of goods or services into the State,
- Forecloses the retroactive application of this requirement, and
- Provides means for the law to be appropriately stayed until its constitutionality has been clearly established.
The Court acknowledged the new economic realities of e-commerce, that when combined with a judicially created “physical presence” rule, provided a tax shelter and an incentive to do business out-of-state, giving an unfair advantage to e-commerce over in-state retailers. The Court’s decision largely focused on the substantial nexus requirement between the out-of-state seller and the states in which they made on-line sales and found that the physical presence requirement was arbitrary in today’s digital economy.
SCOTUS’s Impact on Franchisors
While the largest economic hit will be to e-commerce giants, such as the ones that challenged the law, this case also has potentially huge implications for franchisors and franchise systems.
Franchisors may need to rethink their e-commerce platforms with regard to the granting or withholding of rights to franchisees to sell goods out of state. More importantly, this case could permit states to tax franchisors on royalties paid by their out-of-state franchisees for the use of marks and intellectual property, which could be a significant financial burden for the primary revenue stream of a franchise system.
Franchisors should begin consulting their franchise and tax attorneys on the potential implications of this decision, as well as any needed modifications to their business model and franchise agreements to account for this change in the law.
Taylor M. Vernon is an attorney in our Franchise and Distribution Practice Group.
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