The Massachusetts Department of Revenue (DOR) has proposed a regulation that would impose a modified bright-line nexus standard for purposes of determining nexus and sales or use tax collection responsibilities for out-of-state internet vendors. The proposed regulation, 830 CMR 64H.1.7 (Proposed Internet Seller Regulation), would adopt nexus rules that are slightly more narrow than the broad, bright-line nexus standard previously set out in Directive 17-1 (issued by the DOR on April 3, 2017), which the DOR repealed before it went into effect with Directive 17-2 (issued on June 28, 2017). Once approved, the Proposed Internet Seller Regulation would apply for sales starting on October 1, 2017. This Alert summarizes the rules in the Proposed Internet Seller Regulation and the pertinent changes from those rules originally set out in the since repealed Directive 17-1.

The DOR will hold a public hearing on the Proposed Internet Seller Regulation on August 24, 2017.

Modified bright-line nexus rule

The Proposed Internet Seller Regulation adopts a bright-line nexus rule, with exceptions. Under the Proposed Internet Seller Regulation, the DOR would assert nexus over an out-of-state internet vendor for "each calendar year beginning with 2018, if during the preceding calendar year it had in excess of $500,000 in Massachusetts sales from transactions completed over the internet and made sales resulting in a delivery into Massachusetts in 100 or more transactions." From October 1, 2017 through December 31, 2017, the same test will be applied using Massachusetts sales and transactions occurring during the prior 12-month period (i.e., the period from October 1, 2016 through September 30, 2017).

Basis for asserting nexus

The Proposed Internet Seller Regulation asserts that the DOR is not adopting a broad economic presence standard. Rather, it states the DOR is basing nexus on the following in-state activities¹:

— Property interests in or the use of in-state software (e.g., "apps") and ancillary data (e.g., "cookies") which are distributed to or stored on the computers or other physical communications devices of an internet vendor's Massachusetts-based customers, and may enable the vendor's use of such physical devices

— Contracts or other relationships with content distribution networks resulting in the use of Massachusetts-based servers or the receipt of other related Massachusetts services or

— Contracts or other relationships with online marketplace facilitators or delivery companies resulting in the provision of Massachusetts sourced services, including, but not limited to, payment processing and order fulfillment, order management, return processing or otherwise assisting with returns and exchanges, the preparation of sales reports or other analytics and consumer access to customer service

The Proposed Internet Seller Regulation states that interstate vendors with large volumes of Massachusetts sales "invariably" engage in one or more of these activities.

Specific nexus creating activities

In the Notice of Hearing issued along with the Proposed Internet Seller Regulation, the DOR sets out a list of common activities that it views as creating nexus under the rules above. These activities are:

— The presence of the vendor's software or cookies on computers and smart-phones owned by Massachusetts customers. The Proposed Internet Seller Regulation confirms that the DOR views these items as tangible personal property that creates a physical presence for an out-of-state vendor in Massachusetts.

— The presence of contractual relationships with content distribution networks that provide services to out-of-state vendors in Massachusetts. The DOR asserts that out-of-state internet vendors frequently contract with in-state service providers for the use of in-state servers in order to accelerate in-state customers' access to the out-of-state vendors' websites.

— Participation in on-line market places where an in-state service provider lists the out-of-state internet vendor's products for sale and may provide order processing, payment processing, return processing and other related services. The DOR apparently views such service providers as agents or representatives of the out-of-state internet vendor.

— The use of enhanced delivery services in the state. The DOR asserts that out-of-state internet vendors frequently contract with service providers that provide enhanced delivery services that may include logistics, storage, order management, return management and other services in Massachusetts.

Application to non-internet vendors

The proposed regulation specifically addresses internet vendors. The bright-line test established under the Proposed Internet Seller Regulation does not apply to other types of vendors. Nevertheless, the Proposed Internet Seller Regulation states that the nexus creating activities noted above would also create nexus for other taxpayers.

Exceptions to modified bright-line test

Unlike Directive 17-1, the Proposed Internet Seller Regulation provides certain exceptions to the bright-line test. These exceptions appear intended to protect internet vendors whose websites can be accessed from Massachusetts but that have no other direct or indirect contacts with the commonwealth and who do not have any of the nexus-creating activities listed above. As such, the exceptions provide the nexus rule in the Proposed Internet Seller Regulation with firmer grounding in the Massachusetts statutes than the rule set out in Directive 17-1.

The exceptions are as follows:

— First, internet vendors will not be subject to nexus if their only contact with Massachusetts is the ability of Massachusetts' customers to access the vendor's out-of-state website.

— Second, internet service providers will not be considered agents or representatives of out-of-state vendors for purposes of establishing nexus with such vendors "solely as a result of: (1) the display of such vendor's information or content on the provider's out-of-state server, or (2) the processing of orders through the provider's out-of-state computer server."

The statute imposes the 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."²

These statutory provisions do not include a bright-line nexus test and generally require some conscious effort on the part of a vendor to "solicit sales" or "exploit" the retail sales market in Massachusetts.³ Thus, the Proposed Internet Seller Regulation appears to respond to the conditions of the statute by excluding out-of-state vendors that maintain out-of-state websites on out-of-state servers and have no other activity in Massachusetts.

Effective date

The Proposed Internet Seller Regulation would apply to sales starting in October 2017. The prior 12-month period would be used to measure Massachusetts sales and Massachusetts transactions. Out-of-state internet vendors that have nexus under the new rules, but not otherwise, would not be considered vendors for any prior periods. However, if an internet or non-internet vendor established nexus under the prior rules in previous periods, the DOR will apply the tax retroactively under the generally applicable look back rules.

Differences with Directive 17-1

The main difference between the Proposed Internet Seller Regulation and the since repealed Directive 17-1 is that the Proposed Internet Seller Regulation provides a way to rebut the presumption that $500,000 of Massachusetts sales and minimum 100 transactions creates nexus. Directive 17-1, on the other hand, set out a bright-line test with no exceptions. Other than that, the Proposed Internet Seller Regulation provides a more detailed discussion of the legal authority that the DOR views as supporting the commonwealth's position.

Implications

When implemented, the Proposed Internet Seller Regulation will expand the Massachusetts sales and use tax collection duty to apply to a large number of vendors that previously did not have nexus. Although the nexus rule in the Proposed Internet Seller Regulation is narrower than the one previously announced in Directive 17-1, the new rule will likely be more difficult to apply. By providing exceptions to the bright-line nexus rule, the DOR gave the rule a firmer grounding in the Massachusetts statute, but also added the kind of factual determinations that bright-line rules are intended to avoid. It will be relatively easy to determine whether an out-of-state vendor has $500,000 or more of Massachusetts sales in 100 or more transactions. But it will be harder to determine whether the fact-based exceptions apply. Given that the DOR thinks vendors meeting the bright-line thresholds "invariably" have additional nexus-creating contacts, the DOR will likely take a narrow view of the exceptions. This could lead to new controversies between taxpayers and the DOR.

In addition, it is not clear whether the proposed rules meet applicable US Constitutional requirements. The US Supreme Court has decided that states cannot require out-of-state vendors to collect sales or use tax unless the vendor has a physical presence in the taxing state.⁴ The activities that the Proposed Internet Seller Regulation lists as nexus creating contacts do not necessarily entail in-state physical presence on the part of an internet vendor. Further, it is not clear that such activities conducted by an in-state service provider on behalf of an out-of-state vendor can be attributed to the vendor.

Because the additional tax revenue from nexus expansion has been included in the commonwealth's budget for the current fiscal year, the DOR may seek to promulgate a final version of the Proposed Internet Seller Regulation as quickly as possible. Thus, out-of-state vendors should expect the new nexus rules to go into effect on October 1, 2017, as provided in the Proposed Internet Seller Regulation, or shortly thereafter. Similar rules have been challenged in other states (e.g., Alabama, South Dakota and Tennessee). Thus, it is possible that the Proposed Internet Seller Regulation also may be subject to a legal challenge. Any such litigation, however, would likely take years to resolve. In the meantime, out-of-state internet vendors should evaluate their Massachusetts filing profile in light of the proposed new nexus standard set forth in the Proposed Internet Seller Regulation.

———————————————

———————————————
ENDNOTES

¹ See Proposed 830 CMR 64H.1.7:(1)(b)(ii)(a-c)

² All language in quotes is set out in Mass. Gen. Laws c. 64H, Section 1 (definition of engaged in business in the commonwealth).

³ The constitutionality of the statutory language imposing nexus on vendors that deliver tangible personal property into Massachusetts may be challenged; however, the Proposed Internet Seller Regulation does not rely on that language to assert nexus.

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