On September 22, 2017, the Massachusetts Department of Revenue (the “Department”) officially promulgated a remote vendor sales tax nexus regulation, 830 CMRH.1.7: Vendors Making Internet Sales (the “Regulation”). The Regulation sets forth the following bright-line nexus threshold:
An Internet vendor with a principal place of business located outside the state that is not otherwise subject to tax is required to register, collect and remit Massachusetts sales or use tax with respect to its Massachusetts sales […] if during the preceding 12 months […] it had in excess of […]” (1) “$500,000 in Massachusetts sales from transactions completed over the Internet […]”; and (2) “made sales resulting in a delivery into Massachusetts in 100 or more transactions.
The Regulation is effective immediately, with the first reportable period beginning October 1, 2017 and lasting through December 31, 2017. Out-of-state internet vendors must therefore review their records from October 1, 2016 through September 30, 2017 to determine whether Massachusetts sales and deliveries exceed the new bright-line nexus standard. If nexus exists, out-of-state vendors must register with the Department and begin collecting and remitting Massachusetts sales/use tax (generally) on a monthly basis.
Massachusetts Department of Revenue Directive 17-1 Declared Invalid
The Regulation’s bright line nexus threshold is substantially similar to the Department’s Directive 17-1 (the “Directive”) that was issued on April 3, 2017. After the Directive was issued, two trade associations, American Catalog Mailers Association and NetChoice, filed a Verified Complaint for Declaratory Judgment with the Superior Court of Suffolk County challenging the Directive for violating Massachusetts’s Administrative Procedure Act (“APA”), along with the commerce clause, due process clause, and the Internet Tax Freedom Act. See Massachusetts Draws a Bright Line in the Silicon, May 16, 2017, updated June 19, 2017, for our prior coverage.
On June 28, 2017, shortly after the trade associations filed their complaint, the superior court issued a declaratory judgment memorandum declaring the Directive “invalid.” Specifically, the superior court stated that the Directive “was used to announce an abrupt change in policy”, and thus, under Massachusetts’s APA, “[a]ffected persons and businesses should have the opportunity for notice, input, and perhaps debate before [the Directive] is effective […].” On the same date the superior court issued its ruling, the Department revoked the Directive, and stated it will instead issue a proposed regulation that “will be based upon legal rational similar to that stated in Directive 17-1.”
Remote Vendor Nexus Regulation Corrects Procedural Deficiencies; Constitutional Challenges Await
After the Directive was declared invalid, the Department promulgated the new Regulation, as promised, and in accordance with Massachusetts’s APA by holding a public hearing on the proposed regulation on August 24, 2017 and providing a public comment period that ended on August 30, 2017.
With the Regulation now promulgated, the focus moving forward will shift to taxpayers’ potential constitutional challenges. The substantive content of the Regulation largely mirrors the substance of the Directive, as discussed above. However, two notable developments include that the Regulation (1) broadens the type of activity that vendors may engage in to facilitate/enhance their Massachusetts sales, and thus create an in-state physical presence; and (2) directly addresses the Internet Tax Freedom Act (“ITFA”) and attempts to explain how the Regulation is not inconsistent with this federal law.
With respect to the first development, the Regulation states that large internet vendors may create “physical presence” in Massachusetts through either “property interests in” or “the use of” in-state software (e.g., “apps”) downloaded by in-state customers and ancillary data files (e.g., “cookies”) used to track customer behavior. The Directive, by contrast, more narrowly stated that nexus is created only though a vendors’ “ownership and use” of such software within Massachusetts. The purpose behind broadening the language likely appears to address situations where software may be owned by another party, e.g., software downloaded by in-state customer, but still used by the vendor to facilitate/enhance in-state sales. Notwithstanding this clarification, it remains unclear whether a vendor who “owns” or “uses” software/cookies on a Massachusetts customer’s in-state computer meets the physical presence standard required by the U.S. Supreme Court in Quill Corp. v. North Dakota. See Is the Kill-Quill Movement Gaining Momentum?, April 4, 2017, for our prior coverage.
With respect to the second development, the Regulation directly addresses the ITFA and states that it “is non-discriminatory because it asserts jurisdiction over all vendors (Internet or non-Internet) who have the [physical presence] contacts identified in the [Regulation] and applies the same jurisdictional standards to all vendors (Internet or non-Internet) that are otherwise subject to tax.” It is interesting to consider this statement in light of the central purpose of the ITFA–to prevent states from imposing discriminatory taxes on electronic commerce. Under the Regulation, remote internet vendors are expressly required to collect and remit Massachusetts sales tax from in-state sales. In contrast, for similar transactions involving remote mail-order vendors, the Quill standard still applies, and thus, a Massachusetts use tax is imposed on in-state customers, while the remote mail-order vendors may have no direct Massachusetts sales tax collection responsibilities. Therefore, it appears the Regulation arguably does not apply “the same jurisdictional standards to all vendors (Internet or non-Internet).”
E-Commerce Retailer Files Suit In Virginia State Court to Enjoin Enforcement of the Regulation
Given the concerns highlighted above, the Regulation’s validity will likely be challenged by out-of-state taxpayers. In this regard, on October 25, 2017, Crutchfield Corp, an electronics retailer, filed a complaint in a Virginia state court challenging the validity of the Regulation. Crutchfield is a Virginia retailer headquartered in Albemarle, Virginia and sells electronics, automotive, and other products via catalog and the Internet to customers across the U.S. According to the complaint, during the period October 1, 2016 to September 30, 2017, “Crutchfield had in excess of $500,000 in Massachusetts sales from transactions completed over the Internet and made sales resulting in a delivery into Massachusetts in 100 or more transactions.” However, during this time “Crutchfield did not […] have a physical presence in [Massachusetts].”
Under these facts, Crutchfield has argued the Regulation is invalid because (1) “it violates the United States Constitution by exceeding the limitations on state authority to regulate interstate commerce under the dormant Commerce Clause, as interpreted by the Supreme Court in Quill v. North Dakota […]”; (2) “it constitutes an undue burden on interstate commerce […]”; and (3) it is preempted by the ITFA by imposing tax collection obligations on internet vendors “that are not imposed on other vendors who […] make sales of similar goods and services through other means, e.g, by catalog, mail order, television infomercial, or toll-free telephone number.” As part of its IFTA argument, Crutchfield also stated the Regulation “discriminates against electronic commerce […] by relying on ‘electronic contacts’ associated with Internet sales as the basis for establishing substantial nexus” when the “ITFA was drafted with the intent of prohibiting states […] from using Internet-based contacts as a factor in determining whether an out-of-state business has substantial nexus with the taxing jurisdiction.”
We will continue to monitor Crutchfield Corp. v. Harding et al. and all other developments as controversy surrounding the Regulation will gain traction in the coming weeks and months ahead.: