Economic vs. Physical Nexus: Should Remote Sellers be Required to Obtain Business Licenses?

More than 2.7 million e-commerce businesses are estimated to be operating in the United States. With quick access to how-to guides and easy-to-follow programs for starting online businesses, and many individuals looking for ways to supplement their income, the number of e-commerce businesses is expected to increase exponentially over the next several years.

This exciting new frontier of e-commerce has presented a multitude of challenges and opportunities, not only for businesses but also for local governments looking to regulate and tax commercial activities. In recent years, questions have been swirling around the legitimacy of applying traditional tax and licensing models to remote sellers, particularly in the wake of the landmark South Dakota v. Wayfair case.

For local governments, it will become critical to have an answer ready on whether remote sellers operating in your jurisdiction are required to obtain a business license.

Here’s what to know about the economic vs. physical nexus debate and what your agency may want to consider.

What Is “Nexus” and Why Is It Important? 

First, it’s important to understand how the word nexus is defined. “Nexus” refers to the connection between a seller and a local jurisdiction that obligates the seller to collect and pay sales tax. There are two primary forms of nexus: physical and economic.

Physical nexus arises when a business has a tangible presence in a state, like a brick-and-mortar store, while economic nexus is related to the revenue earned or the number of transactions in a state.

While it was once fairly straightforward, the sharp rise of e-commerce and social media businesses over the last 15 years has muddied the waters over which nexus an online business falls under. In 2018, the debate finally reached the Supreme Court in a landmark case.

South Dakota v. Wayfair Sets a New Precedent 

In 2018, the Supreme Court ruled on a case that provided more clarity on the physical vs. economic nexus debate. The South Dakota v. Wayfair case established that states could mandate out-of-state sellers to collect and remit sales taxes, even without a physical presence in the state.

This case introduced a renewed debate on whether states could or should impose local business license requirements on remote sellers solely based on economic nexus.

However, the legalization of requiring remote sellers to adhere to local business license mandates based only on economic nexus still poses significant legal and ethical considerations. The Wayfair case primarily focused on sales tax collection, leaving the intricacies of business licensing largely unanswered.

Thus, states and local jurisdictions remain in muddied waters, dealing with the implications of imposing local business licenses on entities operating in a virtual space.

The Pros and Cons of Requiring Business Licenses for Remote Sellers 

A primary benefit of requiring remote sellers to obtain business licenses is that local governments can provide a level playing field for anyone operating in their jurisdiction. It guarantees that remote sellers benefitting from the state’s infrastructure and market contribute directly by obtaining business licenses and adhering to local regulations and standards.

On the flip side, this requirement could quickly become an undue burden on remote sellers. Economic growth could be stifled, as the administrative and financial hurdles of obtaining a license in every jurisdiction where a remote seller has an economic nexus could be overwhelming. This is especially true for smaller businesses that lack the resources and time to get multiple business licenses.

How Can Local Governments Manage the Implications for Remote Sellers? 

There are a few ways that requirements to obtain business licenses based on economic nexus could significantly alter remote sellers’ operational landscape. Obtaining business licenses in multiple jurisdictions can lead to a complex and fragmented compliance landscape, impacting business operations and necessitating additional resources for adherence to varied regulations.

Local governments need to clarify compliance early and have a system in place to help remote sellers remain compliant.

Additionally, the financial implications of securing and maintaining multiple business licenses can be substantial, potentially impacting the profitability of small and medium-sized enterprises. The operational adjustments needed to comply with varied licensing requirements across states can influence business strategies, product offerings, and market presence.

Local governments need to have a streamlined process for remote sellers to secure and renew business licenses if they want to encourage economic growth.

Should Local Governments Revisit Licensing Models? 

In light of the ongoing debates, it becomes imperative for local governments to revisit and rethink licensing models, ensuring they are equitable and adaptable to the evolving legal landscape. Striking a balance between maintaining regulatory standards and fostering economic growth will play a factor in the long run in the economic success of a jurisdiction. Should your agency decide to require business licenses for remote sellers, it is essential to have a solid communication plan in place about the new requirement to support compliance.

Will Your Municipality Be Proactive in the Physical vs. Economic Nexus Debate? 

As e-commerce continues to evolve, states and local governments need to embrace a decision that works for both the jurisdiction and the remote seller. Your agency must find the right balance between safeguarding local interests and fostering an environment that’s conducive to remote sellers.

The discussions around economic vs. physical nexus and the subsequent requirements for remote sellers to obtain business licenses are far from over. The Wayfair case opened Pandora’s box of legal, ethical, and operational questions that are still being navigated. When it comes to requiring remote sellers to obtain a business license, what will your agency decide?