As retail patterns have shifted away from in-person purchases in brick-and-mortar stores towards online shopping, states have been struggling with how to recoup the sales tax revenue lost to those online sales. That was the driving force behind several moves the government of Massachusetts made recently to try and compel out-of-state retailers with no physical presence in the state to collect and remit sales tax on purchases made by Massachusetts customers.
The current regulation was the result of a court challenge to the state’s initial attempt at collecting sales tax from online sellers. This was Directive 17-1, and it was issued in April of 2017. The directive stated that retailers with no physical presence in the state would still have to register to collect and remit sales tax if they made more than $500,000 in online sales to Massachusetts customers in the preceding 12 months, and that those sales occurred in 100 or more discrete transactions.
The directive was to have taken effect in July of 2017, but it was challenged in court before it could be implemented. The court eventually ruled that this type of dramatic change in a sales tax policy could not be accomplished in a directive. In response, the state revoked Directive 17-1 and instead issued a new regulation, 830 CMR 64H.1.7.
The Cookie Tax: 830 CMR 64H.1.7
This new regulation, which went into effect on October 1, 2017, sets the same bar for sellers who are required to collect Massachusetts state sales tax. The $500,000 in sales and 100 separate transactions thresholds both apply, and the rationale the state used for claiming authority over those sales involves the software and ancillary data that the sellers store on the buyer’s computers, phones, and other internet-connected devices.
What that really amounts to, critics say, is saying that internet cookies and smartphone apps constitute a physical presence in Massachusetts, which is similar to an argument the Supreme Court has rejected before. Another criticism of this regulation is that it appears to treat online sellers differently from offline or catalog sellers, which is prohibited under the federal Internet Tax Freedom Act.
In addressing these concerns, the state argues that online sellers are different from catalog sellers, in part because of the use of apps and internet cookies, but also because they wind up using servers based in the state, as well as other in-state services to operate their business and reach Massachusetts customers.
Quill Corp v North Dakota
What this regulation is pushing back against is the 1992 Supreme Court decision in the case of Quill Corp v North Dakota. That case involved the use of proprietary software that Quill Corp’s customers used to place their orders with the company, which had no physical place of business in North Dakota. The state argued that the software constituted a physical presence and entitled the state to collect sales tax, but the Court rejected that rationale.
Since the Quill decision was handed down, however, the internet has assumed a much larger role in the retail marketplace, and so several states have enacted laws meant to challenge and hopefully overturn that decision. This new Massachusetts regulation is part of this general trend, although it’s the first to use internet cookies as justification for extending the state’s jurisdiction to tax online retailers to those based out-of-state, thereby possibly circumventing the Quill decision rather than overturning it.
There is no question that this Massachusetts law will quickly be challenged in court. The broader issue, though, is that states are not going to give up the fight to reclaim revenue lost to out-of-state online sellers. Not only is it in the interest of the state government itself, but it also benefits brick-and-mortar businesses operating in the state, many of whom feel that they’ve been at a disadvantage for a long time because they have to collect sales tax and online retailers often don’t.
The gross receipts threshold for this new law is relatively high, especially compared with some of the "economic nexus" laws that have been passed by other states recently. Those typically require sellers with more than $200,000 in sales in the state per year to register to collect and remit sales tax. Regardless of the specific threshold level, however, the main goal of states is to collect sales tax revenue from companies making a significant number of sales to in-state customers rather than to impose a blanket tax on all online sales.
It remains to be seen how the fight over these laws plays out in the courts over time. The fact that companies like Amazon have begun voluntarily collecting and remitting sales tax on purchases made by customers in all 45 US states that have a sales tax, even when they have no physical presence there makes it seem as though the trend towards taxing online purchases will only continue to gain momentum.