Are More Audits Coming For the Direct-to-Consumer Market?

By: Alex Koral, J.D., Senior Regulatory Counsel with Sovos ShipCompliant

Last fall, the state of Texas began the process of auditing all of their direct-to-consumer (DtC) wine shipping licensees, the biggest such audit in the history of this market.

  While all states reserve the right to audit their licensees, the scope of this mass audit surprised many. More than 1,600 wineries possess permits to ship directly to Texas customers. Many have already received a notice from the Texas Alcoholic Beverage Commission (TABC) requesting to review their records. This time-consuming process began in September 2019, when the first round of notices were sent, and will continue as the TABC reviews all permit holders to ensure they are in compliance with the state’s laws.

  At the heart of this heightened regulatory scrutiny by Texas is the dramatic rise in popularity of the DtC channel in recent years. Many wine drinkers have come to appreciate the DtC wine shipping market for bringing a direct connection to their favorite brands and greater access to wine clubs and highly-allocated labels, creating a $3 billion national market.

  The beverage alcohol industry has long been one of the most regulated enterprises in the country, so it is little surprise that this increased scrutiny has come to the DtC wine shipping channel. States have a vested interest in making sure they collect the full balance of tax money they are due and that their laws are followed to the letter. As Texas’s audits proceed, they could well represent a harbinger of what’s to come for DtC wine shippers, making it important to understand how and why regulators are examining this market.

Even the Audits Are Bigger in Texas

  In May 2005, Texas Governor Rick Perry signed into law Senate Bill 877, a transformative reform of the state’s Alcoholic Beverage Code that smashed open the door for wineries to ship directly to consumers in the state. Since then, wine enthusiasts in Texas have been able to purchase wine directly from out-of-state wineries, provided those wineries obtain the necessary sales tax and Winery Direct Shipper’s permits.

  The state’s timing was no coincidence. Just one week after Gov. Perry signed the new bill into law, the Supreme Court held in Granholm v. Heald that the states’ ability to control their internal alcohol markets under the 21st Amendment did not supersede the general prohibition on discriminating against out-of-state interests under the Commerce Clause.

  Under the decision, states could no longer prohibit direct-to-consumer wine shipping if they allowed in-state shipping. In the years following Granholm, a wave of reforms flowed across the country. But Texas was one of the first to update its wine shipping laws. And today, the state lives up to its outsized reputation by being the second-biggest recipient state for direct-to-consumer wine shipping, according to Sovos ShipCompliant data.

  So what are Texas regulators seeking to achieve with this wave of audits? The goal appears to be ensuring wine shippers are properly licensed, paying excise taxes, reporting shipments, and not exceeding limits on how much they can send to individual Texans. The TABC has asked licensees for the sales data used to produce their Texas Excise Tax returns, including requests for copies of certain invoices

  In addition to order data and invoice copies, the TABC has requested information regarding licensees’ business structures, including copies of their state and federal permits, and lists of corporate officers and directors. Contracts or other agreements that licensees have made with fulfillment houses and similar service providers have also been sought.

  Finally, the TABC is looking into the specific wines that licensees have shipped to Texas consumers. Texas’s DtC statutes prohibit licensees from selling wines that the licensee does not personally produce or bottle. As such, the TABC has requested licensees provide Certificates of Label Approval (COLAs) and production records for wines shipped to Texas consumers.

  These past requests, though, are subject to change at any time and any DtC wine shipper that does receive an audit notice should ensure they comply with the specific requests on their notice.

  This heightened review by the state of Texas comes at a time when many states are working to ensure that direct-to-consumer shippers are complying with local regulations. For example, the Michigan Liquor Control Commission is stepping up in response to reports by the Michigan Beer and Wine Wholesalers Association alleging widespread violation of its DtC shipping laws, and the Mississippi Supreme Court recently heard a case regarding stings conducted by the state Alcohol Control Board to catch illegal DtC shippers.

While Texas is currently the only state to have announced a review of this size, it almost certainly won’t be the last.

As the Market Grows, So Will Regulator Scrutiny

  The Supreme Court’s decision 15 years ago in Granholm v. Heald triggered a wave of wine shipping reforms across the country. Today, 45 states plus the District of Columbia permit DtC shipping, enabling over 90% of Americans to connect directly with their favorite wineries.

  As a result, direct-to-consumer wine shipping has grown from a small, niche market in 2005 into a hugely important channel worth more than $3.2 billion in 2019. According to Sovos ShipCompliant’s annual Direct-to-Consumer Wine Shipping Report, the channel grew by  7.4% percent in value and 4.7% in volume last year as more wineries invested in e-commerce, the average price-per-bottle increased, and Oregon and Washington again outpaced the overall channel in shipment growth, among other trends.

  In many cases, DtC shipping succeeds because it allows smaller wineries access to markets they would struggle to enter if they relied solely on the traditional three-tier system due to their relative size. According to the 2020 Direct-to-Consumer Shipping Report, wineries in the small winery category (5,000 to 49,999 annual case production) again dominated the winery shipping channel in 2019, accounting for 42% of the volume of shipments and 45% of the value of the DtC channel. DTC shipping has emerged as one of the best ways for these smaller producers to reach a national audience.

  This growth also reflects consumer demand across the economy for goods delivered directly to their doorsteps. Apps like Instacart and UberEats have democratized delivery, and consumer expectations for quick and convenient delivery have never been higher. This presents a tremendous opportunity for wine sellers to expand their reach, develop their customer base and increase their sales online.

The marketplace is also likely to get more competitive in the new decade. In 2019, the Supreme Court paved a path for expanded DtC shipping of wine by retailers in its ruling in Tennessee Wine & Spirits Retailers Association v. Thomas. While only 15 states currently allow some DtC wine shipping by out-of-state retailers, many see this decision as an opportunity to challenge old laws to expand this market. Litigation is ongoing in several states that seemingly discriminate against out-of-state retailers in regards to their ability to ship wine DtC – notably Illinois, Michigan, and Missouri. Much in the same way that Granholm prompted a wave of statutory reform, observers expect consumers and advocates to push legislative changes across the country. While it may take a number of years for these changes to take effect, expanded retail shipping is something everyone should be watching closely.

  In the meantime, regulators have a vested interest in making sure all sellers—whether package stores, direct wine shippers or otherwise—are in compliance with the law. That means ensuring they are properly licensed, collecting all applicable taxes, not overselling to individuals and preventing sales to minors. So if other states see the Texas audits bring positive results, they are likely to follow suit to uncover gaps in their own systems.

  Overall, the DtC wine shipping market is still young and regulators are still figuring out how to manage it. As the market grows, we can expect this trend of closer attention being paid to DtC shipping to continue at the state levels, making now the best time for wine producers to firm up their direct-to-consumer compliance processes and overall channel strategy.

Now Is the Time to Ensure Compliance

  The risk of audits like those in Texas underscores the importance of closely adhering to the various laws and reporting requirements imposed by states. That the regulations can vary among states only adds to the complexity, whereas failure to comply may result in fines, loss of home state or federal licenses, and even possible criminal charges.

  Wineries have a number of ways to handle this. Some are able to build in-house teams that can manage compliance, though this can be expensive. Others rely on outside consultants to manage their compliance needs. But of course, automating compliance processes is the easiest way to ensure audit success, limit compliance risk and reduce the overall administrative burden on shippers as state-by-state tax rules, rates and forms change.

  Shipping wine can be complicated, and compliance will never be a task that anyone relishes. However, as the direct-to-consumer channel grows in its importance to the industry, it’s vital that producers shore up their compliance strategy now before the next round of state audit notices goes out.

About the Author:

  Alex Koral, is Senior Regulatory Counsel with Sovos, ShipCompliant. He actively researches beverage alcohol regulations and market developments in order to inform development of Sovos’ ShipCompliant product and help educate the industry on compliance issues. Alex has worked with the company since 2015, after receiving his J.D. from the University of Colorado Law School.

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