Sales tax must be uniform for businesses inside and outside the state.
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In a strongly worded ruling, the South Carolina Supreme Court has ruled that an existing sales tax law “unconstitutionally discriminates against interstate commerce, thereby violating the dormant Commerce Clause.” The exemption favors in-state sellers over out-of-state ones – a distinction that is not permissible.
Facts
Under South Carolina law, the sale of durable medical equipment (DME) paid for directly with Medicaid or Medicare funds is exempt from sales tax, but only if the seller’s principal place of business is in South Carolina (DME exemption).
Orthofix, Inc. and KCI USA, Inc. are two companies that do not qualify for the DME exemption because both have their principal offices out of state. Specifically, both companies are Delaware corporations with headquarters in Texas. Both companies also hold a South Carolina retail license and sell DME and related products in South Carolina.
Under South Carolina law, a 6% sales tax is typically imposed on the gross proceeds of most sales in the state, but 83 categories of sales are exempt from the tax. One of these provisions exempts DME when it is sold by a vendor with a South Carolina retail sales license whose principal place of business is in the Palmetto State.
Orthofix and KCI first paid the relevant sales tax to the state. The companies then requested a refund of the sales tax paid between October 1, 2014 and September 30, 2017 (KCI) and between March 1, 2017 and March 31, 2020 (Orthofix).
Dormant trading clause
The South Carolina Department of Revenue (DOR) denied the refund requests on the grounds that the companies’ principal places of business were not located in South Carolina.
The companies appealed (separately), arguing that the DME exemption violated the dormant Commerce Clause of the U.S. Constitution.
If you think you’ve heard this term recently, you’re not wrong—it’s the same clause cited in a Philadelphia payroll tax case that the U.S. Supreme Court justices may consider (the U.S. Supreme Court justices have invited the U.S. Solicitor General to weigh in on the matter). The dormant commerce clause was first introduced in principle in the 19th century, and has come to mean that states cannot discriminate against or unduly burden interstate commerce, even in the absence of specific federal laws relating to commerce.
After another defeat at the administrative level, the companies filed suit in district court challenging the constitutionality of the DME exemption.
After separate hearings, the court granted summary judgment to each company, finding that the DME exemption discriminated against interstate commerce. In addition, the court held that the “principal place of business in South Carolina” requirement could be severed from the rest of the DME exemption, thereby expanding the application of the exemption to all DME sellers, resulting in refunds for the companies.
It’s worth noting that the district court in this case was a state court — the term is also used in the federal context, which can be confusing. South Carolina’s trial courts are called district courts and are located in every county in the state. A district court ruling can be appealed to the South Carolina Court of Appeals or directly to the South Carolina Supreme Court. The latter is what happened here — the appellate court heard the appeal and the South Carolina Supreme Court consolidated the cases for appeal.
Supreme Court
In the South Carolina Supreme Court, the companies again applied the dormant commerce clause to challenge the DME exemption. The court agreed that the DME exemption “unconstitutionally discriminates against interstate commerce, thereby violating the dormant commerce clause” and found the refunds appropriate.
The court referred to previous cases, including Armco Inc. v. Hardestyand states: “(A) The State shall not tax a transaction or occurrence more heavily when it crosses State lines than if it occurred wholly within the State.”
As part of its analysis, the court looked to see whether the law had either a discriminatory effect or a discriminatory purpose. It only had to find one of these, but in this case, the court concluded that the DME exemption had both.
The first part is simple: A DME seller with a principal place of business outside the state must remit sales tax, while a similar DME seller with a principal place of business in the state does not have to remit tax.
On the second part, the DOR argued that the DME exemption was constitutional because it had no discriminatory purpose. The disparate treatment, it said, was merely intended to “promote economic development” in South Carolina. However, the court found that the DOR failed to demonstrate that the DME exemption “serves a legitimate local purpose that cannot be adequately satisfied by reasonable, non-discriminatory alternatives.”
The Supreme Court could have kept the DME exemption and simply removed the challenged language. However, it found that there was insufficient evidence that the legislature would have passed the DME exemption even without the unconstitutional language. As a result, the Supreme Court declined to amend the DME exemption and instead invalidated the entire exemption.
There was one bright spot for the state, however: The Supreme Court held that the legislature could reinstate the DME exemption in the future as long as there was no unconstitutional restriction on a seller’s principal place of business.
The cases are Orthofix, Inc. v. South Carolina Department of Revenue (Appeal No. 2023-000317) and KCI USA, Inc. v. South Carolina Department of Revenue (Appeal No. 2023-000318).
