Economic Nexus Laws’ Unexpected Impacts On Restricted Substance Retailers

eCommerce sales tax laws are having unintended consequences in the tobacco industry. State governments began rolling out economic nexus laws after 2018’s South Dakota vs. Wayfair ruling. These laws were meant to make online sellers face sales tax requirements similar to those for retailers with on-the-ground locations, putting both types of businesses on equal footing. The Wayfair ruling enabled states and cities to apply sales taxes to businesses based on the latter’s economic activities within their jurisdictions, whether or not businesses have physical presences there.

It appears that economic nexus laws are falling short of leveling the playing field in at least one niche industry, however. Pierre Rogers, founder of luxury cigar marketplace PuroTrader, believes the laws are exacerbating a situation in which large tobacco eCommerce sellers dominate smaller ones.

How economic nexus policies play out with restricted substances

Virginia-based PuroTrader connects approximately 10,000 active luxury cigar sellers — a group primarily made up of retailers, with a smaller share of individual sellers — with collectors interested in making purchases. The platform facilitates nearly 150 transactions per week with the average checkout value totaling $570. Sales tax becomes a significant factor when applied to such expensive transactions, especially when considering the high rate set for restricted items.

The U.S. in 2017 had a 52.75 percent tax on each imported premium cigar, limited to a maximum of about $0.40 each. Local jurisdictions impose their own taxes on domestic cigar sales, with tax levels currently ranging from 0 percent in Pennsylvania and Florida to 95 percent in Minnesota and Washington state. Sales taxes are “pretty devastating” in this industry, Rogers admitted.

Companies in states with low to no tobacco taxes — such as Florida, North and South Carolina, Texas and Virginia — have enjoyed the financial advantages of these lower costs of doing business, which have given them resources for better boosting their online presences. Retailers in high-tax states have largely not been able to build themselves up or expand online beyond their local markets to the same extent, Rogers said.

Economic nexus laws were expected to support fair business competition between tobacco eCommerce sellers in high- and low-tax states by ensuring that all companies met the same sales tax burdens in each jurisdiction. Rogers anticipated that this goal would not be achieved, however, and that large businesses would maintain their leads in the eCommerce space, even with such tax laws. Strict advertising regulations on restricted substance sellers have meant that tobacco companies that try to sell online often struggle to get attention, resulting in large retailers with existing reputations dominating the digital market. Economic nexus laws will not resolve that issue and will instead place more burden on small retailers that must now also cope with paying higher taxes when selling into high-tax states.

“There are five or six large eCommerce players within the tobacco space. They will continue to dominate, and the hurdle to enter into the marketplace will be too high for everybody else,” Rogers said.

Tobacco distributors, manufacturers and retailers have been banned from television and radio advertising since 1971, from billboards and outdoor advertising since 1997 and from most event sponsorships since 2010. These companies are also not allowed to advertise on digital platforms, such as social media or search engines, Rogers said. Small tobacco retailers can therefore struggle to build visibility among consumers when entering new markets. eCommerce marketplaces tend not to list restricted substances, meaning that tobacco product purveyors do not have the option of joining well-established platforms like Amazon to gain visibility.

“The idea that [the] Wayfair [ruling] will level everybody’s competitive advantage makes sense from a 50,000-foot view,” he said. “However, due to other laws … it’s enormously difficult to be competitive in that landscape [because tobacco retailers] are considered restricted brands. So, from an advertising perspective, your ability to sell out into the market is very difficult, if not impossible. … How do you get people to your website [if] you can’t do any marketing at all?”

Tax support as competitive advantage

PuroTrader launched in 2013 with a business model that was deliberately designed to prevent tax collection and remittance responsibilities from falling on the marketplace. The platform facilitates price negotiations and secures transactions, but it does not handle the payments in a way that would create tax obligations, Rogers said. The laws then required PuroTrader to collect taxes only on sales facilitated between Virginian buyers and sellers, as a Virginia-based company. The company therefore prevented Virginian buyers from seeing product listings from sellers within the state.

The platform is now developing capabilities to help it assess and inform sellers on how much they owe based on where their buyers are located.

“[Sellers] won’t stick around if you don’t make that regulatory burden easier for them,” Rogers said.

Providing such features is no easy task, largely because of the number of different state and municipal sales tax laws PuroTrader must navigate. Rogers anticipated that handling economic nexus laws will drive up his legal bills at least 50 percent this year — costs that will be passed on to his customers.

“Not only is [the seller] going to feel higher taxation, but now it’ll be more expensive just to do business because it costs me and many retailers more money to understand the tax collection issues,” he said.

States are deploying economic nexus policies to safeguard their revenue streams and avoid giving undue advantages to out-of-state sellers over local businesses. The lack of a cohesive national digital sales tax policy is causing confusion for marketplaces and retailers that are striving to stay compliant, however. These laws are also not leveling playing fields, despite governments’ best intentions. The digital sales tax landscape is still inchoate, and it is having unintended impacts on some industries as it develops.