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Contractor Petitions U.S. Supreme Court Over South Dakota Use Tax Apportionment

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In May, Ellingson Drainage, Inc. filed a petition with the U.S. Supreme Court to appeal the South Dakota Supreme Court’s decision to uphold a use tax assessment related to equipment purchased out of state. We previously wrote on this case in early 2023 before it reached the final stages of appeal through the South Dakota court system. The current petition to The U.S. Supreme Court raises important questions about the constitutionality of use tax regulations for property purchased out of state but periodically used in the taxing jurisdiction to perform services.

As interstate commerce continues to grow, especially through internet platforms, federal scrutiny over state sales and use tax laws will be an important topic. Certain industries, such as real property contractors and digital companies, will have a keen interest in how these taxes develop through court review and other regulatory efforts. If your business or client is facing a challenge from an unfair sales and use tax assessment, consult with our sales tax professionals about assistance in an audit or administrative appeal.

Background on Ellingson Drainage, Inc. v. South Dakota Department of Revenue

The Taxpayer, Ellingson Drainage, Inc,. is a Minnesota company that installs drain tiles on farm and government property. The Taxpayer completed 30 jobs in South Dakota between 2017 and 2020 that involved eleven pieces of equipment ranging in usage for as little as one day in the state. An audit led to the South Dakota Department of Revenue assessing $60,655.44 based on the fair market value of the equipment in addition to $14,862.88 in interest. South Dakota Code Section 10-46-3 assesses use tax on the fair market value of property regardless of how long the Taxpayer used the property in the state. However, ARSD 64:09:01:20 applies a 10 percent reduction in the fair market value each year following the date of purchase to account for asset depreciation.

The Taxpayer appealed the assessment on the basis that South Dakota’s use tax, as applied under Section 10-46-3 and ARSD 64:09:01:20, is unconstitutional because it is unfairly disproportionate to the equipment’s usage in the state. After a series of appeals, The Supreme Court of South Dakota upheld the use tax as constitutional and affirmed the assessment against the Taxpayer, which led to the Taxpayer’s appeal to the U.S. Supreme Court.

The Center of Ellingson Drainage, Inc.’s Petition to the U.S. Supreme Court

The Taxpayer asserts that South Dakota’s use tax is unconstitutional as a violation of the Interstate Commerce Clause. Courts apply a four-pronged test established under Complete Auto Transit, Inc. v. Brady, which maintains a tax does not violate the Interstate Commerce Clause if it meets the following conditions:

  1. The tax is sufficiently connected to the state.
  2. The tax is fairly related to benefits provided to the taxpayer.
  3. The tax does not discriminate against interstate commerce.
  4. The tax is fairly apportioned.

The Taxpayer’s petition centers around application of the fourth prong–whether South Dakota’s use tax is fairly apportioned. In the past, courts have used a test known as the External Consistency Doctrine to determine if a tax meets the fair apportionment requirement. The test identifies the economic justification for a state’s claim to the value taxed to decide if the tax is fairly attributable to the economic activity.

The Taxpayer makes three arguments in its petition. First, it explains that the use tax should have its basis in the time period it is used in the state rather than its fair market value. Second, the petition asserts that a use tax based on value is not externally consistent simply because it operates as an equivalent to sales tax. Third, the Taxpayer argues that South Dakota’s credit for sales and use tax paid in another state is not an adequate substitute for its failure to apportion the tax fairly in the first place.

What Ellingson Drainage, Inc. v. South Dakota Department of Revenue Could Mean for State Use Tax Challenges

If The Supreme Court grants review of this case, we could see greater clarity around the authority of states to impose sales and use tax on both out-of-state purchases and more limited uses of property. This clarity could develop in two ways. In the event The Supreme Court affirms the prior ruling, it may provide more details on the reasoning behind the standards for determining the constitutionality of use taxes under the Commerce Clause. A future opinion in favor of Ellingson, however, could signal that states have a higher burden for determining how to calculate use tax on items used across multiple states. In turn, this could open the door for future challenges to other use tax methodologies across the country.

Get Help with a Use Tax Audit or Appeal Today

Use tax is an often overlooked issue for multi-state businesses that provide sales tax-exempt services but do so using taxable property. If you or your clients are facing challenges with a state revenue or tax department over application of use tax on a business’s equipment and other property, consider meeting with our sales tax professionals. We provide a host of services to help businesses and individuals in these situations including audit defense and assessment appeals.

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