On Dec. 7, 2021, the Massachusetts Appellate Tax Board issued a decision granting a sales tax abatement to an out-of-state retailer.1 The Board held that the out-of-state retailer did not have physical presence with the state when its contacts were limited to cookies and apps placed on the devices of Massachusetts customers and the use of third-party content delivery networks prior to the U.S. Supreme Court’s Wayfair decision.2 Accordingly, the Board ruled that the retailer was not required to remit use tax under the Massachusetts Department of Revenue’s “cookie nexus” regulation promulgated prior to Wayfair.
Cookie nexus regulation
Adoption of pre-Wayfair bright line nexus standard
The genesis of this case can be traced back to the Department’s adoption of a regulation clarifying when out-of-state Internet vendors would be required to collect sales or use tax if they met certain sales and transaction thresholds.3 Under the bright-line rule, an Internet vendor with a principal place of business located outside Massachusetts that is not otherwise subject to tax is required to register, collect, and remit Massachusetts sales or use tax for its sales to Massachusetts customers if the following two conditions are satisfied for the prior calendar year:
- The vendor made more than $500,000 in sales to Massachusetts customers over the Internet; and
- The vendor completed 100 or more transactions that were delivered into Massachusetts.4
The Department adopted the regulation with an effective date of September 22, 2017, several months prior to the release of the Wayfair decision. The Department’s regulation stated that the bright-line rule would be applicable to an Internet retailer’s October 1, 2017 to December 31, 2017 period by looking back at sales made from October 1, 2016 to September 30, 2017. Following that period, for calendar years beginning in 2018 and thereafter, the bright-line tests for Internet retailers would be applied by looking at prior calendar year data.5
In addition to establishing a bright-line nexus standard, the Department’s regulation expanded its taxable reach regarding out-of-state Internet vendors. The regulation stated that out-of-state vendors were considered to maintain physical presence (i.e., sufficient minimum contacts) when their contacts with the state included cookies and apps placed on the devices of Massachusetts customers and the use of third-party content delivery networks.6 This particular type of nexus was subsequently dubbed “cookie nexus” and was unique to vendors with contacts in Massachusetts.
Application of constitutional standards and federal law
In its support of expansive nexus provisions, the regulation went to great lengths explaining that vendors making taxable sales in Massachusetts or selling taxable tangible personal property or services for use in the state must collect sales or use tax when they are “engaged in business in the commonwealth” under Massachusetts law and meet the requirements of the U.S. Constitution. As the sales tax collection requirements generally are enforced to the extent allowed under the constitutional limits, the Department cited the policy’s compliance with the dormant Commerce Clause, the Due Process Clause, and the Internet Tax Freedom Act (ITFA) in support.
Under the dormant Commerce Clause, the Department stated that its regulation enforcing the Massachusetts sales and use tax nexus statute was bounded by the “physical presence” standard under the dormant Commerce Clause specified in Quill.7 However, the Department distinguished Quill, stating that unlike the mail order vendor at issue in Quill, Internet vendors with a large number of Internet sales “invariably” have sufficient contacts that allegedly constitute physical presence with the state. One of these contacts noted by the Department includes property interests in and/or the use of in-state software and ancillary data (such as “apps” or “cookies”)8 which are distributed to or stored on the in-state customers’ computers or other physical communications devices.
With respect to the limitations of the Due Process Clause,9 the Department again distinguished Quill in its regulation. In Quill, the U.S. Supreme Court held that due process requires that an out-of-state vendor must purposefully avail itself of the state’s economic market before the state can collect sales or use tax. Because the degree to which an out-of-state Internet vendor must purposefully avail itself of the state’s market may be uncertain, the Department argued in its regulation that a bright-line standard intended to reflect a level of activity would satisfy due process requirements.
The regulation also addressed its compliance with ITFA.10 As summarized in the regulation, ITFA prohibits discriminatory taxation of e-commerce transactions and prohibits a state from asserting jurisdiction over an Internet vendor based on certain factors. The Department argued in the regulation that its policy is nondiscriminatory because it asserts jurisdiction over all vendors (both Internet and non-Internet) with certain Massachusetts contacts, applies the same jurisdictional standard to all vendors, and does not implicate the prohibited factors in ITFA through its use of the bright-line test.
Cookie nexus application to internet and non-internet vendors
Finally, the scope of the Department’s regulation extends beyond the application of bright-line nexus to Internet vendors, in that a non-Internet vendor may have sales tax nexus based on the ownership or use of computer software or hardware (or other inventory or property) within the state, or if it receives services in the state from a marketplace facilitator or delivery company.11 For non-Internet vendors, a facts and circumstances test is used to determine whether nexus exists.
Retailer challenge to department’s assessment
Once the regulation became effective, the Department quickly began enforcement efforts, particularly with respect to Internet retailers with significant market activities in Massachusetts despite the lack of formal physical presence. One of these retailers, U.S. Auto Parts Network, was notified by a letter from the Department issued on Oct. 20, 2017, that the taxpayer met the nexus criteria under the state’s cookie nexus regulation and was therefore required to collect and remit sales and use tax for October 2017 and thereafter. Following the retailer’s failure to comply by registering, collecting and remitting use tax from its Massachusetts customers, the Commissioner ultimately issued a notice of assessment in March 2018.12 In response, the retailer appropriately filed an abatement application, which was deemed denied after the Commissioner took no action, leading to the controversy at the Board at which both parties filed motions for summary judgment.
Board rejects application of cookie nexus theory
Agreeing with the retailer, the Board held that to the extent the retailer’s contacts were limited to cookies and apps placed on the devices of Massachusetts customers (or used on third-party content delivery networks), such contacts did not constitute physical presence within the meaning of Quill. The Board declined to apply cookie nexus (and thereby expand the parameters of physical presence) upon transactions which took place prior to the Wayfair decision. The Board stated that the Commissioner’s primary argument in support of the assessment was that Wayfair must be applied retroactively to overrule the physical presence requirement set out in Quill. The Board rejected the Commissioner’s argument, stating that retroactive application of Wayfair would allow the Commissioner “to tax a vendor that acted consistently with then-current Commerce Clause jurisprudence.”
The Board determined that upholding cookie nexus on transactions that occurred prior to Wayfair would be both unfair and inconsistent with Wayfair’s essential tenets. The Board noted that the Wayfair Court endorsed South Dakota’s remote seller regime in part because it provided a safeguard against retroactive application of the law, in order to prevent discrimination against interstate commerce and undue burden. Adding that the terms of the regulation contemplate physical presence within the meaning of Quill, the Board concluded that retroactively applying Wayfair would “expand the Regulation beyond the scope of its publicly promulgated terms.”13 The Board pointed to the Court’s reasoning in Wayfair as evidence that it did not view the “physical aspects” of modern technology as satisfying the physical presence requirement under Quill, noting that the Court stated in Wayfair that modern e-commerce did not align with a physical presence test and that it should not maintain a rule that ignored the substantial virtual connections with a state. In addition, the Board noted that since the tax at issue was a transactional tax, allowing retroactive effect would require the retailer to pay the use tax to the Department from its own resources, with no practical way to recover such tax payments from its customers.
Massachusetts has consistently maintained its controversial and aggressive approach toward sales and use tax nexus via regulation, and it is an open question as to whether the Department will relent in light of the Board’s decision. The retailer’s ability to successfully abate the use tax assessed by the Department from cookie nexus in front of the Board reflects the Board’s adherence to applying its precedents and holdings in a consistent manner with the U.S. Supreme Court. In many instances, court case holdings are presumed to be applied retroactively and statutes applied prospectively. However, given the impact of its holding in Wayfair, the U.S. Supreme Court ensured that any such application of its precedents in this situation would not be applied retroactively for the exact reason that the retailer’s use tax assessment was abated: to avoid unfair taxation and related penalties. Unfair taxation is rooted in constitutional notions of due process and will be a cornerstone foundation in the coming years, as Wayfair is applied to a variety of state sales and use tax issues.
1 U.S. Auto Parts Network, Inc. v. Commissioner of Revenue, Mass. App. Tax Bd., Docket No. C339523, Dec. 7, 2021.
2 South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018).
3 MASS. REGS. CODE tit. 830, § 64H.1.7, effective Sep. 22, 2017. The regulation is designed to interpret when a vendor is engaged in business in Massachusetts for the purpose of being subject to a sales or use tax collection duty. MASS. GEN. LAWS Ch. 64H, § 1.
4 MASS. REGS. CODE tit. 830, § 64H.1.7(3)(a).
5 MASS. REGS. CODE tit. 830, § 64H.1.7(3).
6 MASS. REGS. CODE tit. 830, § 64H.1.7(1), (2).
7 Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
8 Cookies are text files generally used by an Internet vendor to enhance its customer sales. Cookies are stored locally on computers and physical communications devices (such as smart phones) of the Internet vendor’s customer when the customer visits the vendor’s Web site for the first time. On subsequent visits, the cookies identify the customer. MASS. REGS. CODE tit. 830, § 64H.1.7(2).
9 MASS. REGS. CODE tit. 830, § 64H.1.7(1)(b)3.
11 MASS. REGS. CODE tit. 830, § 64H.1.7(5), (6).
12 The assessment totaled $60,139.81, which included a double assessment of the tax and penalties.
13 The Department had argued that the U.S. Supreme Court’s rejection of the physical presence rule in Wayfair should have been given full retroactive effect based on the Court’s decision in Harper v. Virginia Department of Taxation, 509 U.S. 86 (1993). In Harper, the Court addressed a situation in which taxpayers were being taxed in an unconstitutional manner (as declared by the Court in a prior case), and required retroactive application to similarly situated taxpayers to prevent unequal treatment.
Jamie C. Yesnowitz
Principal, SALT Services
National Tax Office Leader
Jamie Yesnowitz, principal serving as the State and Local Tax (SALT) leader within Grant Thornton's Washington National Tax Office, is a national technical resource for Grant Thornton's SALT practice. He has 22 years of broad-based SALT consulting experience at the national and practice office levels in large public accounting firms.
Washington DC, Washington DC
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