The Supreme Court of the United States (SCOTUS) denied certiorari regarding South Dakota’s imposition of use tax on equipment used in-state by an out-of-state construction company. Minnesota construction company, Ellingson Drainage, Inc. (Ellingson), challenged South Dakota’s imposition of the tax on the unapportioned fair market value of the equipment, regardless of how long the equipment is physically located in the state.
“With the rise in the use of intangible property in interstate commerce, such as licensing of software, taxpayers and the states need guidance on how the use tax should be applied. ”
PERTINENT facts
From 2017-2019, Ellingson, a company specializing in installing drain tile for farming and government applications, completed approximately 30 jobs in South Dakota, requiring the use of 11 pieces of equipment in the state. In 2020, Ellingson was audited by the South Dakota Department of Revenue (Department) and assessed approximately $60k of use tax due on the fair market value of the equipment, as well as approximately $15k of related interest. Included in the assessment was equipment that was physically in South Dakota for less than a day but nonetheless included at its fair market value, without regard to a fair apportionment based on its time in the state.
Ellingson appealed the assessment arguing that not apportioning a use tax violates the dormant Commerce Clause as established by SCOTUS’ decisions as it creates an undue burden on interstate commerce and is not fairly apportioned. “The Commerce Clause requires a tax to have substantial nexus between the activity and the taxing state, to be fairly apportioned, to not discriminate against interstate commerce, and to be fairly related to the services the state provides. Having exhausted all of its appeals with South Dakota, including the South Dakota Supreme Court, Ellingson petitioned SCOTUS with a writ of certiorari.
writ of certiorari
In a persuasive effort to have SCOTUS grant its petition, Ellingson posed a question it claims the Court has never addressed before: “Must a use tax be fairly apportioned when the tax is imposed on movable property that is temporarily in a state?” This, Ellingson stated in its petition, is a “case of first impression; no decision of this Court has examined the constitutionality of unapportioned use tax on movable assets.”
Emphasizing the necessity of a review, Ellingson asserted that taxpayers and the various states urgently need guidance regarding apportioning use tax on intangible property. To illustrate, Ellingson used the example of software licenses, which can be used by remote workers anywhere in the country. As suggested by Ellingson, when property is used in multiple states, taxpayers and states need to know whether use tax should be apportioned.
fairly apportioned
Of the requirements for a valid tax under the Commerce Clause, Ellingson challenged only one in its appeal to SCOTUS - the fairly apportioned requirement. In previous decisions, the Court held that in order for a tax to be fairly apportioned, it must be “externally consistent,” meaning it must not reach beyond the portion of value that can be fairly attributed to the economic activity that occurred in the taxing state.
Ellingson argued that South Dakota’s method of taxing the entire fair market value of property that is only temporarily in the state does not “reasonably reflect” Ellingson’s in-state economic activity. As a result, Ellingson stated it bore “more than a fair share” of the costs related to protections and benefits of doing business in South Dakota.
Ellingson raised four points where it believed the South Dakota Supreme Court erred in its decision. First, it did not apportion the use tax based on the number of days that Ellingson’s equipment was in South Dakota. Second, the state Supreme Court incorrectly applied the external consistency test by requiring that a tax be fairly related to the benefits provided by the taxpayer, instead of requiring that the tax “reasonably reflects” the in-state component of the activity being taxed. Finally, the lower Court wrongly stated that having equipment in the state for as little as one day was enough to impose use tax because Ellingson enjoyed the same benefits as any other business in the state.
in conclusion
SCOTUS’ certiorari denial notwithstanding, the issue of use tax apportionment remains relevant. Undeniably, Ellingson was correct in suggesting that both taxpayers and states need additional guidance with use tax apportionment.
While a tax position may seem reasonable and logical to you, a Department of Revenue auditor, hearing officer, appellate briefer, or judge may not be similarly aligned with your understanding. Reach out to us today for assistance in determining your use tax obligations, before the imposition of significant penalties or a lengthy litigation battle ensues.