On April 3, 2017 the Massachusetts Department of Revenue Issued Directive 17-1, appropriately titled “Requirement that Out-of-State Internet Vendors with Significant Massachusetts Sales Must Collect Sales or Use Tax.” This is significant not only because it represents yet one more state adopting an “economic nexus” standard for purposes of attributing sales tax nexus to out-of-state retailers, but because the Massachusetts Department of Revenue (DOR) established its economic nexus rule through administrative policy, not through enacted legislation or the formal regulation adoption process. Also significant is that the policy is clearly directed at “Internet vendors” – which could be viewed as a discriminatory.
Massachusetts Economic Nexus Thresholds:
The DOR states its purpose for adopting an administrative bright line rule is for clarity and administrative simplicity, rather than applying the state’s sales and use tax collection requirements on a case-by-case basis. The main issue addressed by the Directive is under what circumstances an Internet vendor with a principal place of business located outside the state (out-of-state Internet vendor) is required to register, collect and remit Massachusetts sales or use tax. Under the DOR's administrative bright-line rule, an out-of-state Internet vendor with Massachusetts sales and transactions that meet the following thresholds is required to comply.
- An out-of-state Internet vendor whose Massachusetts sales during the 12 month period from July 1, 2016 through June 30, 2017 exceeded $500,000 and had 100 or more Massachusetts transactions, must register, collect and remit Massachusetts sales or use tax for the six month period from July 1, 2017 through December 31, 2017. In effective, the new policy has an effective date of July 1, 2017 for any out-of-state Internet vendor who meets these thresholds for the fiscal year ending June 30, 2017.
- Beginning with the 2018 calendar year, an out-of-state Internet vendor whose preceding calendar year Massachusetts sales exceeded $500,000 and had 100 or more Massachusetts transactions, must likewise register, collect and remit Massachusetts sales and use tax.
The Department Justifies its Economic Nexus Policy:
The Directive then continues with a very detailed discussion justifying its new economic nexus policy – and that’s were things get interesting!
The Massachusetts sales tax law subjects a vendor that is engaged in making taxable sales in the Commonwealth or that sells taxable products for use in the Commonwealth to a sales or use tax collection duty when it is “engaged in business in the Commonwealth” as defined in chapter 64H, § 1 and the vendor meets the constitutional requirements as discussed in Quill Corp. v. North Dakota. The Directive notes that a vendor is “engaged in business in the commonwealth” when it has “a business location in the commonwealth” or when it “regularly or systematically solicit[s] orders for the sale of services to be performed within the commonwealth or for the sale of tangible personal property for delivery to destinations in the commonwealth” or “otherwise exploit[s] the retail sales market in the commonwealth through any means whatsoever, including, but not limited to, salesmen, solicitors or representatives in the commonwealth … [and] computer networks or … any other communications medium.” The Directive adds that a vendor is “engaged in business in the commonwealth” when it is “regularly engaged in the delivery of property or the performance of services in the commonwealth” and adds that an Internet vendor with significant Massachusetts sales meets the “engaged in business” definition because, it is exploiting the state’s retail sales market through “computer networks” and “other communications medium.”
In addressing whether the DOR’s economic nexus policy meets Quill’s constitutional requirements, the Directive emphasizes that the Supreme Court of the United States (SCOTUS) in Quill was merely re-affirming National Belles Hess, a SCOTUS case that was decided in 1967, twenty five years prior to Quill (this is true, by the way) and in both Bellas Hess and Quill, the focus was on mail order vendors whose in-state contact was primarily by U.S. mail or common carrier. In its support that its policy meets the Due Process requirement, the Directive points to language right out of Quill that says a state’s sales or use tax jurisdictional standard is met when such a vendor “purposefully avails itself of the benefits of an economic market in the forum State.” The Directive adds that an Internet vendor with significant Massachusetts sales similarly “purposefully avails itself of the benefits of the state’s economic market” by, engaging in “continuous and widespread solicitation of business” in Massachusetts. In addressing the Commerce Clause requirement, the Directive points out that the underlying logic in Quill was primarily that mail order vendors had reasonably relied upon the Court’s prior decision in Bellas Hess, and that the doctrine of stare decision (or to “standby by what has been decided”) applies with greater force when a taxpayer has reasonably relied upon a prior Supreme Court precedent and adds that because Quill specifically intended to reaffirm Bellas Hess in the context of a fact pattern pertaining to a mail order vendor, the case made clear that a vendor that limits its in-state contacts to those of mail or common carrier does not have an in-state physical presence.
Typical Internet/Ecommerce Vendor Activity CAN Create In-State Presence:
The Directive then turns its focus on both highlighting how the business and activities of Internet vendors are factually distinguishable from the business and activities of mail order vendors since the practical reality is that modern day Internet vendors do not limit their contacts with the state to mail and common carrier. Also, modern-day Internet vendors with a large volume of in-state sales (large internet vendors) are likely to have one or more contacts, such as those described below, with the state that constitute an in-state physical presence.
- Mobile and Web Apps On this point, the Directive notes that large Internet vendors almost invariably own software that is downloaded, such as in the case of mobile or browser/web apps, onto the computers and devices of customers and that such software can facilitate or enhance the Internet vendor's in-state sales such as by implementing web-based shopping carts, allowing customers to compare products and read product reviews, and track their customers’ preferences and locations. Since these software mobile and browser/web apps are owned by the out-of-state internet vendor, constitute tangible personal property according to the Massachusetts sales tax law, and may exist on the computers or other devices of the vast majority of the vendor’s in-state customers, the apps constitute an in-state physical presence.
- “Cookies” The Directive also notes that large Internet vendors also enhance their customer sales through the complementary use of “cookies” which are stored on their customers’ computers and devices when customers visit the vendor’s online site. Although cookies are not software, they also serve to facilitate an Internet vendor’s in-state sales by customizing the customer’s shopping experience, facilitating the customer’s account login process, and allowing customers to store items in their shopping cart. For the Internet vendor, having "cookies" resident on its customers' computers and devices allows the vendor to track its customers behavior over time and deliver targeted advertising. Here again, the Directive notes that the ownership and use of in-state cookies results in an in-state business activity by the Internet vendor.
- CDNs: The Directive notes that Internet vendors are also likely to use content distribution networks or “CDNs” which accelerate the delivery of an internet vendor’s web pages to its customers, and, which in turn ensure that the vendors’ customers are less likely to exit the vendor’s site without making a purchase (it its footnotes, the Directive includes references to studies supporting the benefit to online vendors of increasing the page load time). The Directive notes that use of CDNs increase the likelihood that customers will return for future business and help “establish and maintain” a market in the state. Therefore, the use of a CDN with in-state servers also constitutes an in-state presence.
- Online Marketplaces and Delivery Providers: Finally, the Directive turns its focus on the services provided by online marketplaces and delivery providers. Regarding the online marketplaces, the Directive notes that an online marketplace may offer a comprehensive menu of enhanced services beyond just allowing a third-party seller to post their goods for sale. An online marketplace may process orders and payments, provide fulfillment services, handle product return processing, and/or provide its sellers access to the online marketplace’s customer service team, sales reports or other analytics. Because these enhanced services help to establish and maintain the Internet vendor’s market, use of an online marketplace creates an in-state presence for the Internet vendor. The Directive also distinguishes the enhanced services of delivery providers used by Internet vendors today as compared to the services of the common carriers used in the days of Quill. In the same way that online marketplaces may provide enhanced services, today’s delivery providers may offer logistics, order fulfillment, storage, return processing and order management. Here again, these enhanced services provided by some delivery service providers help to enhance an internet vendor’s in-state sales and constitute an in-state presence.
Well, there you have it – the Massachusetts DOR’s new administrative bright light economic nexus policy. Perhaps the most interesting aspect of the Directive is the argument that Quill isn’t relevant in the context of how modern day eCommerce functions and that Internet vendors, through the use of mobile and browser/web apps, "cookies," CDNs and the enhanced services of online marketplaces and delivery services providers, are in effect, establishing a physical presence in the state. Citing Justice Kennedy's opinion in Direct Marketing Assn.(135 S.Ct. at 1135) the Directive emphasizes that since today's purchasers have almost instant access to most retailers via cell phones and other devices, a "business may be present in a State in a meaningful way without that presence being physical in the traditional sense of the term."
So what does this all mean for non-Massachusetts internet retailers? It seems fairly clear that the DOR’s policy is intended to focus on large internet retailers since to be subject to the new economic nexus standard, the retailer must have both at least $500,000 in Massachusetts sales as well as at least 100 transactions in Massachusetts in the prior 12 month period (contrast this to the economic nexus thresholds in Alabama and South Dakota – see my prior post on this topic). However, the DOR has clearly identified several types of activities routinely engaged in by Internet vendors that constitute a physical presence in the state. For this reason, ANY out-of-state Internet retailer – regardless of their Massachusetts sales and transactions – may also be required to register, collect and remit Massachusetts sales or use tax if it allows customers to download its apps, installs “cookies” on its customers computers and devices, contracts with a CDN with servers in Massachusetts or uses the enhanced services provided by some online marketplaces and delivery providers.
Finally, there is a good possibility that the DOR may have already identified certain out-of-state internet retailers the DOR has reason to believe meet the economic nexus thresholds and may already be intending to notify these retailers of their requirement to register prior to July 1st (similar to what South Dakota and Alabama did when they adopted an economic nexus standard) - which could ultimately lead to another legal challenge should this happen. Because the Directive targets "Internet vendors" specifically, this policy could also be challenged as being discriminatory under the Internet Tax Freedom Act. This is by far, not a short Directive. Incidentally, the economic nexus thresholds are discussed in the first half page of the Directive – the majority of the Directive reads more like a legal brief (in this author’s mind) complete with numerous footnotes (36 footnotes to be exact) citing court decisions and other supporting data. Could it be possible that the Massachusetts DOR is readying itself for a legal challenge?
The trend in adopting economic nexus for sales tax is most certainly likely to continue - with the newest states to join the "defy Quill" group in 2017 being indiana, North Dakota and Wyoming. For more about economic nexus and states efforts to require out -of-state lnternet retailers to collect tax on sales to their state's consumer, see my latest posts in the "eCommerce/Internet Tax" blog section: Economic Nexus: The “New Normal” or the Demise of Quill? and Amazon and Other "Nexus Expanding" Laws - By State Summary.
Questions / Comments? If you're an internet retailer concerned about how this new Massachusetts policy might affect you, feel free to post a comment below or contact me through my profile services page here at SalesTaxSupport.
Other recent “Massachusetts (MA)” posts by Sylvia F. Dion, CPA:
- Massachusetts' Economic Nexus Reg to be Enforced Retroactively
- Amazon Exposes FBA Sellers in Massachusetts: 5 Key Considerations
- Massachusetts Expands Sales Tax Nexus Policy for Internet Vendors
- The Massachusetts DOR Website - A Great (Sales) Tax Resource
- MassTaxConnect - 5 Things Massachusetts Sales Tax Filers Should Know