Massachusetts Court Takes A Bite Out of Cookie Nexus

The Massachusetts Supreme Judicial Court held that an online retailer was not required to collect and remit the state’s sales and use tax prior to the United States Supreme Court’s 2018 decision in South Dakota v. Wayfair because its use of apps, cookies, and content delivery networks (CDNs) did not create “physical presence” nexus, as required prior to the Wayfair decision, and the Wayfair “economic nexus” standard could not apply retroactively.  U.S. Auto Parts Network, Inc. v. Commissioner of Revenue, SJC-13283, Slip. Op. (Mass. Dec. 22, 2022).

Before the United States Supreme Court’s Wayfair decision (establishing the so-called “economic nexus” standard), states were only permitted to impose sales and use tax on out-of-state retailers that had sufficient “physical presence” with the state, the standard established by the U.S. Supreme Court’s 1992 decision in Quill Corp. v. North Dakota.  Effective October 1, 2017 (before the Wayfair decision), the Massachusetts Department of Revenue promulgated a regulation, colloquially known as the “cookie nexus” regulation, which required out-of-state retailers to collect sales and use tax if they used apps, cookies, or CDNs in connection the sale of goods and services in the state (if the out-of-state retailers had over $500,000 in Massachusetts sales and 100 or more sales delivered into Massachusetts).

In this case, the plaintiff, U.S. Auto Parts Network, Inc., was an out-of-state retailer that sold auto parts over the Internet and shipped them to Massachusetts customers, but had no offices, facilities, inventory, or equipment in the state and had no employees or representatives in the state.  The Massachusetts Department of Revenue relied on its “cookie nexus” regulation to assert that U.S. Auto Parts was liable for sales and use tax beginning October 1, 2017, the effective date of the regulation.  The Department alleged that U.S. Auto Parts fell had nexus under the regulation language because: 1) it placed cookies on in-state customers’ computers; 2) it used CDNs operated by third parties to deliver its website to customers and some of the transactions facilitated through its website could be traced to a third party CDN provider’s Massachusetts servers; and 3) in-state customers could download U.S. Auto Parts’ app to their mobile devices.

U.S. Auto Parts challenged the Department’s position by arguing, inter alia, that these activities did not constitute “physical presence” as required by the Quill standard, and that the Wayfair economic nexus standard could not apply retroactively.  In 2021, the Massachusetts Appellate Tax Board ruled in favor of U.S. Auto Parts, and the Department appealed.  On December 22, 2022, the Massachusetts Supreme Judicial Court affirmed the Appellate Tax Board’s decision.  The court reasoned that the use of cookies, CDNs, and apps is not sufficient “physical presence” to create substantial nexus with the state under Quill (as required to satisfy the dormant Commerce Clause).  The Massachusetts court analogized the use of cookies, CDNs, and apps to minimal amounts of in-state technology to similar activities that did not create nexus in Quill (e.g., where an out-of-state retailer licensed computer software and had “a few floppy diskettes” in the state).  The court also concluded that the Wayfair “economic nexus” standard could not apply retroactively because Massachusetts’ “cookie nexus” regulation expressly incorporated the Quill physical presence standard.  The court also noted that a coalition of states, including Massachusetts, had filed an amicus brief in the Wayfair case assuring the United States Supreme Court that they would not apply an economic nexus standard retroactively, which directly contradicted the Department’s attempt to apply it retroactively in this case.

While the Massachusetts court’s decision concerned sales tax nexus, the court’s reasoning is also relevant in the corporate income tax context.  Under the court’s reasoning, the placement of cookies, use of CDNs, or availability of mobile apps (without more) presumably does not does not create corporate income tax nexus.  The court’s reasoning at least calls into question the Multistate Tax Commission’s recent statement (published in August 2021) on whether various internet activities exceed the protection provided by federal Public Law 86-272 (which prohibits states from imposing corporate income tax on out-of-state retailers that merely solicit orders of tangible personal property within the state and fill the orders from outside the state).  The MTC’s list of activities that allegedly exceed P.L. 86-272 protection includes the placement of cookies on in-state customers’ computers.

While we question the MTC’s narrow reading of P.L. 86-272 in the first instance, the Massachusetts court’s decision here is instructive because if “cookies” do not create nexus in the first instance, cookies presumably cannot exceed the protections of P.L. 86-272.  Additionally, notwithstanding that this case involves tax periods before Wayfair, it still seems clear that the axiom that the “law cares not for trifles” (as set forth by the U.S. Supreme Court in Wrigley) should continue to apply as “cookies” and similar online activities do not seem to rise to the level of substantial nexus or clear “purposeful availment” under Due Process standards.

Contact the Authors: Maria Eberle and Dmitrii Gabrielov