In Directive 17-1 (Directive), the Massachusetts Department of Revenue (DOR) announced that it will impose an economic nexus standard in determining whether out-of-state vendors have a sales or use tax collection obligation for transactions with Massachusetts customers, starting July 1, 2017.

The new standard, which was announced on April 3, 2017 and which applies only to "internet vendors," is based on a bright-line test that takes into account the dollar value of sales in Massachusetts and the number of transactions with customers in the commonwealth. Of particular concern, the Directive suggests that the new nexus standard may be applied retroactively to out-of-state internet vendors that have nexus under the new rule, but do not begin collecting on July 1, 2017.¹

Bright line nexus rule

The Directive provides that an out-of-state internet vendor will be considered to have nexus during "each calendar year beginning with 2018 if during the preceding calendar year it had in excess of $500,000 in Massachusetts sales and made sales for delivery into Massachusetts in 100 or more transactions." From July 1, 2017 through December 31, 2017, the same test will be applied for the period beginning July 1, 2016 and ending June 30, 2017. Critically, the bright line test does not function as a safe harbor, given that out-of-state internet vendors that otherwise establish nexus will be required to collect sales and use taxes even if they do not have the dollar volume of sales or the requisite number of Massachusetts customers.

Although it adopts a bright line test, the Directive makes clear that the DOR is asserting an economic nexus rule based on the broad nexus standard set out in statute,² which contains no bright-line nexus test. Rather, the DOR states that it is adopting the bright-line test to avoid having to apply the economic nexus rules "on a case-by-case basis." If the bright-line nexus test is met, the Directive does not provide any method for out-of-state internet vendors to show that they fall outside the statutory nexus rules.

The DOR's economic nexus theory

The Directive notes that the Massachusetts sales and use tax statutes set out a very broad definition of nexus. Specifically, the statute imposes a sales and use tax collection duty on vendors "engaged in business in the commonwealth." A vendor is considered engaged in business in Massachusetts when (among other activities) it: (i) "regularly or systematically solicit[s] orders for the sale of services to be performed within the commonwealth or for the sale of tangible personal property for delivery to destinations in the commonwealth"; (ii) "otherwise exploit[s] the retail sales market in the commonwealth through any means whatsoever, including, but not limited to, salesmen, solicitors or representatives in the commonwealth … [and] computer networks or … any other communications medium"; or (iii) is "regularly engaged in the delivery of property or the performance of services in the commonwealth."³

The language employed in the statutory nexus standard can be broadly applied to support an assertion of economic nexus, as the purported nexus-creating activities listed do not require physical presence in Massachusetts.

The US Supreme Court, however, confirmed in 1992 that states cannot require out-of-state vendors (i.e., mail order vendors) to collect sales or use tax unless the vendor has a physical presence in the taxing state.⁴

In the Directive, the DOR takes the position that the existing US Supreme Court precedent addresses the imposition of nexus to out-of-state mail order vendors only and not out-of-state internet vendors. Thus, the DOR asserts, the precedent is distinguishable and need not be followed. Secondly, the DOR states that many out-of-state internet vendors have downloaded software (e.g., apps and cookies) onto Massachusetts customers' computers, tablets, and phones. The DOR concludes that this software constitutes a presence in the state for internet vendors via the ownership and use of software in the state. Finally, the DOR states that out-of-state internet vendors frequently contract with in-state service providers — including content distribution networks — for use of in-state servers in order to accelerate in-state customers' access to the internet vendors' websites. Such arrangements, the DOR concludes, serve to establish and maintain the internet vendor's Massachusetts market and, therefore, may be attributed back to the vendor.

Implications

For the new economic nexus standard to prevail against a likely legal challenge, the DOR will need to win the argument that the existing US Supreme Court precedent does not apply to internet vendors (either because the precedent is distinguishable or because the precedent is no longer valid), and that the bright-line test is supported by the Massachusetts statute. Although the DOR points to activities enumerated in the statute as the basis for imposing economic nexus, the bright-line nexus test does not attempt to determine whether the activities do, in fact, occur.

It is not clear whether the new Massachusetts sales and use tax nexus standard for out-of-state internet vendors is permissible under the US Constitution, or comports with the specific terms in the Massachusetts statutory nexus definition. Current US Supreme Court precedent requires sales and use tax nexus to be based on physical presence. Although the Massachusetts statute can be read to impose nexus based on economic presence, it does not currently apply any bright-line nexus tests. It is therefore possible that the courts could invalidate this new nexus standard established by the Directive if it is challenged. Any such litigation, however, could take years to resolve. In the meantime, out-of-state internet vendors must consider how to treat Massachusetts sales for tax registration and collection purposes in light of the new nexus standard set forth in the Directive, which becomes effective July 1, 2017.

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ENDNOTES

¹ In Footnote 2, the Directive states, "In any instance in which an Internet vendor's only contacts with the state in prior tax years were those referenced in section IV.b.ii.(B) of this Directive and that vendor complies with the terms of this Directive, the state will not seek back tax filings pursuant to this Directive." This language suggests that the DOR will seek back filings from internet vendors that do not comply with the Directive.

² See Mass. Gen. Laws ch. 64H,Section 1, defining "engaged in business in the Commonwealth." This provision, enacted in 1989, is the Massachusetts "anti-Bellas Hess" law.

³ Id.

⁴ See Quill Corp. v. North Dakota, 504 U.S. 298 (1992).