Jamie C. Yesnowitz
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The Multistate Tax Commission (MTC) is continuing to move forward in its efforts to update guidance interpreting longstanding federal legislation that limits states’ ability to impose income taxes. On Nov. 20, 2020, the Executive Committee of the MTC accepted the hearing officer’s report on the project to update the Statement of Information for Public Law 86-272 to address the modern economy and Internet transactions.1
The project began in November 2018 when the MTC’s Uniformity Committee agreed to form a work group to update the statement, which was last revised in 2001. The next step in the process is to survey the revised statement to the 16 Compact Members2
and eight Sovereignty Members.3
In 1959, the federal government enacted P.L. 86-272 to limit a state’s ability to impose a net income tax on transactions occurring in interstate commerce.4
Under this federal law, a state cannot tax the income from sales of tangible personal property if the taxpayer’s only business activities in the state are the solicitation of orders that are approved and shipped from outside the taxing state. The specific meaning of terms such as “solicitation,” “delivery,” and “tangible personal property” that are contained within P.L. 86-272 have been open to interpretation since enactment. In addition, the U.S. economy has dramatically changed since P.L. 86-272 was enacted more than 60 years ago, but the law has never been amended to reflect changes in the typical business model.
In an effort to provide a level of clarity to states in applying P.L. 86-272, the MTC’s Uniformity Committee issued its Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272
in 1986. The guidance has been adopted by several states over time and incorporated in their regulations. Prior to the MTC’s current effort to make substantial revisions to the statement, the MTC updated the statement three times between 1986 and 2001, incorporating the U.S. Supreme Court’s important Wisconsin Department of Revenue v. William Wrigley, Jr., Co.5
decision in the process.6
Proposed revisions to statement
In November 2018, shortly after the U.S. Supreme Court decided South Dakota v. Wayfair, Inc.
the MTC decided that the emphasis on taxpayer protection under P.L. 86-272, along with the growing popularity of contemporary and more technology-dependent business models, required substantial revisions to the statement. The MTC formed a work group that released a proposed revised statement in February 2020.8
On April 22, 2020, the MTC’s Uniformity Committee approved its work group’s proposed revisions to the statement. The most significant proposed revision relates to the development of a third subsection to determine what may constitute a protected or unprotected activity, specifically addressing activities conducted using the Internet.9
The MTC introduces this new proposed subsection by stating that “[a]s a general rule, when a business interacts with a customer via the business’s website or app, the business engages in an activity within the customer’s state.” Alternatively, if the website merely presents static text or photos, there is no engagement or facilitation within the customer’s state. The proposed revised statement details 11 different activities conducted by Internet businesses and explains whether such activities are protected or unprotected for purposes of P.L. 86-272. For example, activities such as post-sale assistance to an in-state customer utilizing an electronic chat or email icon are not protected because they are not ancillary to in-state solicitation. This is stated in contrast to post-sale assistance in the form of posting an online list of static frequently asked questions (FAQs) with answers, which the MTC deems not to be an activity within the customer’s state. The proposed revised statement provides additional activities not immune under P.L. 86-272, such as solicitation and receipt of online applications for branded credit cards, employment invitations, extended warranty offerings, placement of certain Internet cookies, remote repair, audio and video streaming, and even the use of marketplace facilitators.
The proposed revised statement utilizes the U.S. Supreme Court’s analysis in Wayfair10
when considering whether a seller’s business activities are performed in the state, explaining “that an Internet seller ‘may be present in a State in a meaningful way without that presence being physical in the traditional sense of the term.’” Interestingly, the proposed revised statement adopts the Wayfair
analysis that virtual contacts are “relevant to the question of whether a seller is engaged in business activities in states where its customers are located” for purposes of P.L. 86-272, even though the Court did not address P.L. 86-272 in its decision.
Hearing officer’s report
The MTC held a public hearing to consider the proposed revisions to the statement on August 5, 2020. The hearing officer, Robert J. Desiderio, released his report in support of the proposed revisions to the MTC’s Executive Committee on Oct. 30, 2020.11
As explained in the report, the work group raised two primary issues. First, the work group considered whether activity conducted over the Internet “constitutes solicitation for tangible personal property” under P.L. 86-272.12
Second, the work group addressed whether activities conducted by an Internet seller that exceed solicitation are “business activities conducted within [the taxing] state.”13
The work group spent most of its time considering the second issue and “concluded that if the business activities conducted by the Internet seller extend beyond solicitation and are deemed to be in the taxing state, then the Internet seller’s activities are not protected by P.L. 86-272.”
In his report, the hearing officer addressed a variety of written statements that generally supported the revisions, but disagreed with written and oral comments that opposed the revisions.14
The hearing officer explained that “[b]ecause P.L. 86-272 does not define ‘business activity,’ the statute is subject to different construction or interpretation.”15
According to the hearing officer, “[t]he Revisions’ interpretation of business activity to include interactive Internet activity is rational; it distinguishes between active communication between the seller and its customer and passive receipt of information by the customer.” Finally, the hearing officer concluded that P.L. 86-272 does not pre-empt states from adopting an interpretation of “business activity” to include interactive Internet activity. On November 20, 2020, the MTC’s Executive Committee accepted the hearing officer’s report and as a next step, will survey the Compact and Sovereignty Members.16
The MTC’s decision to accept the hearing officer’s recommendation to adopt the proposed revisions is an important step in the process of updating the statement that interprets P.L. 86-272. The hearing officer considered comments from noted tax professionals, scholars and associations when analyzing the proposed revisions to the statement. The proposed revisions are particularly significant because they are the first revisions in nearly 20 years and address the application of P.L. 86-272 to Internet transactions. As summarized by the hearing officer, the work group determined that if an Internet seller’s activity in the customer’s state was merely solicitation, the seller is protected by P.L. 86-272. Internet activity that exceeds solicitation is “unprotected business activity” in the customer’s state. The hearing officer explained that the conclusion that interactive Internet activity constitutes business activity in the customer’s state is the source of the objections raised in the written and oral comments.
The hearing officer also considered the 11 factual scenarios that were proposed by the work group to illustrate the application of P.L. 86-272 to Internet transactions. In 10 of the scenarios, the Internet seller would otherwise be protected by P.L. 86-272 because it operates a website that only sells tangible personal property and the orders are approved and shipped from locations outside the customer’s state. Each scenario then includes additional activities that may change whether the seller is protected by P.L. 86-272. The hearing officer noted that the most controversial scenarios are the six that involve the following types of interactive Internet delivery of services: (i) post-sale assistance (scenario 2); (ii) sale of online credit cards (scenario 3); (iii) application for non-sales employment (scenario 4); (iv) cookies to gather customer information (scenario 5); (v) instructions to fix or upgrade products (scenario 7); and (vi) sales of extended warranties (scenario 8). In all six of these scenarios, the MTC concluded that the seller’s activities defeat the P.L. 86-272 protection. Also, another scenario involving the streaming of videos and music of vendors is not immune under P.L. 86-272 because the transaction does not constitute the sale of tangible personal property.
A significant portion of the hearing officer’s report addressed the written and oral comments from Professor Philip M. Tatarowicz and the Council on State Taxation (COST) objecting to the proposed revisions. According to Professor Tatarowicz, interactive Internet communication with customers in the taxing state is interstate service activity immune under P.L. 86-272 rather than business activity. Professor Tatarowicz contends that the proposed revisions exceed an interpretation of P.L. 86-272 and establish new policy that violates the law’s intent and purpose. Furthermore, Professor Tatarowicz argues that the revisions would discriminate against Internet business and produce market inefficiencies. In response, the hearing officer explained that “[t]he ultimate question is whether states can define business activity to include interactive Internet activity in the customer’s states; that is, whether P.L. 86-272 preempts states from doing such.” The hearing officer agreed with the work group’s conclusion that states are not preempted by P.L. 86-272 from making this determination.
The hearing officer also rejected COST’s argument that interstate sellers with websites, but no physical presence in the customer’s state, will lose P.L. 86-272 protection. According to COST, Congress rather than the states has the power to provide that interactive Internet activity constitutes business activity in the customer’s state. The hearing officer concluded that COST’s position is not supported by the plain meaning and legislative history of P.L. 86-272.
While an argument can be made that Congress rather than the states should determine the application of P.L. 86-272 to Internet transactions, Congress has not taken recent opportunities to craft legislation that addresses these important aspects of state income taxation. Instead, the MTC has proceeded down the path of modernizing the reach of P.L. 86-272 through its own interpretation. The MTC’s proposed revised statement is relatively likely to be approved by states during the survey. Assuming that the MTC’s Executive Committee eventually approves the revised statement, the states will need to individually decide whether, and if so, to what extent they will adopt the principles of the revised statement, typically through regulatory action. However, given the importance of this issue and the likelihood of future challenges by affected businesses, we have not heard the last word on how P.L. 86-272 should be applied to electronic commerce.
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