Virginia court dismisses nexus standard challenge


Joel Waterfield
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Michael Cronin
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Guinevere Seaward Shore
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Sonia Shaikh
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Jamie C. Yesnowitz
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Chuck Jones
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Lori Stolly
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Patrick Skeehan
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A Virginia Circuit Court judge recently dismissed a case brought by a Virginia taxpayer challenging the applicability of Massachusetts’ 2017 remote seller nexus standards for sales and use tax purposes. Specifically, the judge found a lack of jurisdiction based on the absence of sufficient contact.1

Background On April 3, 2017, the Massachusetts Department of Revenue issued a directive advising taxpayers that it had adopted an administrative bright-line rule that would require out-of-state Internet vendors to collect sales or use tax if they met certain sales and transaction thresholds.2 Under the rule, which was to become effective July 1, 2017, an Internet vendor with a principal place of business located outside Massachusetts was required to register, collect and remit sales or use tax on its Massachusetts sales if during the preceding year it had over $500,000 in Massachusetts sales and made sales for delivery into Massachusetts in at least 100 transactions. On June 2, 2017, the Department’s Commissioner of Revenue sent an informational letter to the taxpayer advising the company of the new directive.

Following concerns regarding whether the Department could issue remote seller nexus policies through a directive, on June 28, 2017, the Department issued a second directive immediately revoking its prior guidance and announcing its intent to formally propose similar administrative regulations on Internet vendor sales and use tax nexus issues.3 Effective Sept. 22, 2017, the Department adopted a regulation that requires out-of-state Internet vendors to collect sales or use tax if they meet certain sales and transaction thresholds.4 In addition to establishing a bright-line nexus standard, the regulation explained how the Massachusetts general sales and use tax jurisdictional standard5 applied to Internet vendors, and how the regulation complied with the Due Process and Commerce Clauses of the U.S. Constitution as well as the Internet Tax Freedom Act (ITFA).6 Further, it reasoned that remote sellers meeting the adopted thresholds invariably had sufficient contacts with the state to facilitate sales which constituted a physical presence in Massachusetts, including the use of ancillary data (i.e., “cookies”), which are distributed and stored on computers of in-state customers. The regulatory language was similar to the original wording included in revoked Directive 17-1. Subsequently, the Commissioner sent a second letter to the taxpayer informing it of the newly adopted regulation. On Oct. 20, 2017, the Commissioner sent a third letter to the taxpayer advising the company to review its sales to Massachusetts customers in order to determine whether it might have a duty to collect and remit Massachusetts sales and use tax. Notably, the letter did not directly assert that the taxpayer had nexus. To be consistent with the argument that the taxpayer lacked any connection to Massachusetts, the taxpayer responded to the Department’s letters by commencing litigation in Virginia, the state of its commercial domicile.

Decision The taxpayer requested a declaratory judgment that the Massachusetts law imposing sales and use tax collections on remote sellers is invalid under the federal Commerce Clause and violates the ITFA. Further, it alleged that Virginia has jurisdiction to adjudicate the issue under the terms of its state law.7 Specifically, the statute purportedly allowing jurisdiction provides that “[c]ircuit courts shall have original jurisdiction over civil actions seeking declaratory judgment where: (i) the party seeking declaratory relief is a business that is organized under the laws of the Commonwealth …and (ii) the responding party is a government official of another state…who asserts that the business in question is or was in the past obliged to collect sales or use taxes … based upon conduct of the business occurring wholly or partially within the Commonwealth.” Further, any government official meeting these requirements is subject to the personal jurisdiction of Virginia circuit courts to the extent permitted by the U.S. Constitution.

To evaluate whether it had jurisdiction, the Court turned to the limits imposed by the federal Due Process Clause, finding they required an examination of the quality and nature of the Commissioner’s activity in Virginia. Both parties agreed that the Commissioner’s contacts in Virginia with the taxpayer were limited to the three letters described above. Despite the taxpayer’s argument that the letters were not mere notices, but constituted registration and filing demands, the Court found them insufficient to confer jurisdiction over the Commissioner’s objection and granted his request to dismiss the case.

Commentary It is not surprising that the Virginia Circuit Court found a lack of jurisdiction in this case. Historically, state courts have largely refrained from evaluating the constitutionality of laws and regulations adopted by other jurisdictions. The brief decision provides little insight into the Court’s specific reasoning. The taxpayer is left with several options: appeal the decision, comply with the Department’s request, or begin new legal proceedings in Massachusetts, It is possible and perhaps likely, given the statutory change described below, that they could reach an agreement with the Department to register and begin collecting tax prospectively, if they haven’t already done so.

Interestingly, the Massachusetts economic nexus regulation at issue in the decision has recently been rendered moot, at least with respect to future periods.8 Earlier this year, Massachusetts legislatively adopted new nexus standards for remote sellers, following the lead of many other jurisdictions that have taken similar action in the wake of the U.S. Supreme Court’s Wayfair decision. In particular, the Massachusetts law, which became effective Oct. 1, generally requires remote sellers and marketplace facilitators to collect and remit tax if they have Massachusetts sales in the prior or current year of more than $100,000.9 Corresponding emergency regulations have been adopted, with a hearing to consider permanent adoption scheduled to take place in November.10 However, questions remain as to the applicability of the 2017 regulations. The Wayfair decision clarified that physical presence is not necessary to assert nexus, and implicitly endorsed the $100,000 threshold initially adopted by South Dakota. However, it did not evaluate the constitutionality of cookie nexus or any other nexus thresholds. Thus, both states and taxpayers continue to face some degree of uncertainty with respect to these provisions.

Remote sellers with Massachusetts customers should evaluate their current nexus status in light of these new rules. The Department provides pertinent practical guidance to remote sellers for both periods prior to and following the enactment of the law to help them evaluate and fulfill potential collection and reporting obligations.11

1 Crutchfield vs. Commonwealth of Mass., Case No. CL17001145-00, Commonwealth of Virginia 16th Judicial Court (Oct. 9, 2019).
2 Directive 17-1, Massachusetts Department of Revenue, April 3, 2017. According to the Department’s Web site, a “Directive states the official policy of the Department, has the status of precedent unless revoked or modified, and may be relied upon by taxpayers in situations where the facts, circumstances and issues presented are substantially similar to those in the Directive.” Note that the Directive terms this bright-line nexus standard as a “rule,” but it is not an official administrative rule or regulation.
3 Directive 17-2, Massachusetts Department of Revenue, June 28, 2017.
4 MASS. REGS. CODE tit. 830, § 64H.1.7, effective Sept. 22, 2017.
5 The sales and use tax nexus standards are provided by MASS. GEN. LAWS ch. 64H and 64I.
6 MASS. REGS. CODE tit. 830, § 64H.1.7(1)(a).
7 VA. CODE ANN. §§ 8.01-184.1(A), (C).
8 A proposal to repeal the regulations is currently outstanding, with a planned hearing on Nov. 7, 2019.
9 H. 4000, Laws 2019.
10 MASS. REGS. CODE tit. 830, § 64H.1.9.
11 See Remote Vendors FAQs for Sales and Use Tax periods ending before Oct. 1, 2019 and Remote Seller and Marketplace Facilitator FAQs.

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