On April 3, 2017, the Massachusetts Department of Revenue (the “Department”) issued Directive 17-1 (the “Directive”), setting forth the Department’s bright-line nexus threshold for internet vendors, effective July 1, 2017. Specifically, the Directive provides that an internet vendor with a principal place of business located outside of Massachusetts is required to register, collect and remit Massachusetts sales or use tax with respect to its Massachusetts sales if it: (1) had Massachusetts sales in excess of $500,000 during the preceding calendar year; and (2) made 100 or more sales for delivery into Massachusetts during the preceding calendar year.  For the short period between July 1, 2017 and December 31, 2017, the Department will review whether these sales thresholds were met between July 1, 2016 and June 30, 2017. 

Unlike states like Alabama and South Dakota that are directly challenging the validity of the physical presence nexus standard of Quill Corp. v. North Dakota, 504 U.S. 298 (1992), Massachusetts, through its Directive, attempts to redefine physical presence for the digital age.  (See prior coverage Is the Kill-Quill Movement Gaining Momentum?)  The Directive contends that large internet vendors have a physical presence in Massachusetts through (1) in-state software, such as apps downloaded by in-state customers, virtual shopping carts used by in-state customers, and cookies (i.e., text data files) used to track customer behavior; (2) the use of in-state content distribution networks (“CDNs”) to speed up the delivery of web pages to customers; or (3) other representative contacts such as selling through an in-state online marketplace or using delivery services other than common carriers.  In short, the Department seeks to factually distinguish internet vendors from the mail order vendor at issue in Quill and claims that internet vendors have a physical presence in Massachusetts through one or more of these three factors.

The Directive’s position that in-state software and cookies constitute an in-state physical presence for large internet vendors is suspect (and it should be noted that the Directive does not define the term “internet vendor”, nor does it explain whether and to what extent an internet vendor would be considered a “large” internet vendor). While the sale of software transmitted on physical media such as a disk or tape has historically been considered the sale of tangible property for sales tax purposes, the sale of software delivered electronically has generally not been considered to be the sale of tangible property, notwithstanding the fact that some states have elected to impose sales tax on electronically delivered software (including Massachusetts, which deems the sale of electronically delivered software to be a transfer of tangible personal property).  Thus, the premise that electronically delivered software is in-state tangible property owned by the internet vendor is dubious.  Further, the Directive glosses over the fact that the in-state customers, not the internet vendors, are the owners of the computers or devices that downloaded the software, apps, or cookies free of charge.  Interestingly, Massachusetts is not the first state to suggest that cookies constitute an in-state physical presence.  The Ohio Department of Taxation raised “cookie nexus” in Crutchfield Corp. v. Testa, Slip Opinion No. 2016-Ohio-7760 (2016). (See prior coverage Ohio Supreme Court: Physical Presence Not Required for Commercial Activity Tax).

Another potential issue with the Directive is that its position may be in violation of the Internet Tax Freedom Act (“Act”), which prevents states from imposing discriminatory taxes on electronic commerce. Under the Act, a “discriminatory tax” is defined, in relevant part, as:

(A) any tax imposed by a State or political subdivision thereof on electronic commerce that- . . . (iii) imposes an obligation to collect or pay the tax on a different person or entity than in the case of transactions involving similar property, goods, services, or information accomplished through other means; . . . or

(B) any tax imposed by a State or political subdivision thereof, if-

(i) the sole ability to access a site on a remote seller’s out-of-State computer server is considered a factor in determining a remote seller’s tax collection obligation. Pub. L. No. 105-277, § 1105(2) (codified at 47 U.S.C. § 151 note).

Whether the Directive causes the Massachusetts sales tax to be categorized as a discriminatory tax under the Act remains to be seen, but a challenge on these grounds should be reasonably anticipated. Presumably, a challenger would contend that, under the Act’s definition in (A), the Directive results in a discriminatory tax because it would cause internet vendors to collect sales tax; in contrast, in similar transactions by remote mail-order vendors, the use tax is imposed on in-state customers.  Depending on the facts, a challenger could further contend that the Directive results in a discriminatory tax under the Act’s definition in (B), through the Directive’s position that nexus is created through the in-state customer’s ability to access the internet vendor’s server.

The Massachusetts bright-line nexus standard for internet vendors goes into effect on July 1, 2017. It will be interesting to see whether that bright-line will withstand the inevitable challenges to its fundamental premise, i.e., that software, apps, or cookies housed on the devices of in-state customers constitute an in-state physical presence, or on Internet Tax Freedom Act grounds.


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