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Massachusetts ATB rejects ‘cookie nexus’ for pre-Wayfair periods

December 2021

In brief

‘Cookie nexus’ does not constitute physical presence for Commerce Clause purposes in pre-Wayfair periods, the Massachusetts Appellate Tax Board (ATB) stated in its finding of facts and report released on December 7. The ATB also rejected the Department of Revenue’s alternative argument that the Wayfair decision should be applied retroactively.

In so ruling, the ATB abated use tax assessed to an out-of-state retailer making sales through its website and mobile device applications. The finding of facts and report provide background and rationale for the ATB’s summary judgment granted to the taxpayer in January (view PwC’s Insight here).

[U.S. Auto Parts Network, Inc. v. Commissioner of Revenue, Mass. Appellate Tax Board, Docket No. C339523, 12/7/21]

For consideration: The ATB does not analyze the technical functioning of website ‘cookies’ and ‘apps,’ and therefore its ruling may not be helpful in considering whether such ‘virtual presence’ might be deemed to constitute in-state business activity for income tax purposes under P.L. 86-272. Further, the Department of Revenue is expected to appeal this ruling, and taxpayers should consider their options for preserving their refund rights in light of Massachusetts’ statute of limitations and abatement procedures.

In detail

U.S. Auto Parts sold products primarily through three websites and delivered the products by common carrier to Massachusetts customers from locations outside the state. It did not own or lease any offices, facilities, inventory, or equipment in Massachusetts and had no employees or representatives in Massachusetts.

To facilitate its internet sales, U.S. Auto Parts used certain electronic tools, including ‘cookies,’ mobile applications (‘apps’), and content delivery networks (‘CDNs’). The Appellate Tax Board made certain findings of fact, including that

  • Cookies are data files transferred from U.S. Auto Parts websites to customer computers.
  • Apps likewise are “electric or magnetic strings of data” stored on customer mobile devices.
  • CDNs are third-party entities with interconnected servers located in Massachusetts and throughout the world that help facilitate and improve customer access to U.S. Auto Parts websites.

Massachusetts’ ‘cookie nexus’ regulation

Under the Massachusetts Department of Revenue’s Vendors Making Internet Sales regulation (830 CMR 64H.1.7, effective September 22, 2017), nexus applied if an out-of-state seller had

●     $500,000 in Massachusetts sales from transactions completed over the internet,

●     100 or more transactions resulting in delivery into the state, and

●     Certain in-state contacts including those discussed below.

The regulation stated that “internet vendors with a large volume of Massachusetts sales invariably have [certain] contacts with the state that function to facilitate or enhance such in-state sales and constitute the requisite in-state physical presence[.]” This included having in-state “property interests in and/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 a vendor's in-state customers, and may enable the vendor’s use of such physical devices[.]”

Observation: This so-called ‘cookie nexus’ theory of physical presence due to apps and data on in-state customers’ computers or smartphones became moot when the US Supreme Court invalidated the Quill physical presence standard in South Dakota v. Wayfair, Inc. 138 S.Ct. 2080 (2018).

Observation: The Vendors Making Internet Sales regulation also listed in-state “contacts and/or other relationships with online marketplace facilitators and/or delivery companies resulting in in-state services” as creating physical presence. However, this activity was not considered by the ATB.

Further, effective October 1, 2019, the Vendors Making Internet Sales regulation was replaced with a Remote Retailers and Marketplace Facilitators regulation (830 CMR 64H.1.9), which dropped the 100 or more transactions prong of the nexus threshold and lowered the sales threshold to $100,000 in Massachusetts sales.

ATB finds Wayfair characterization of e-commerce technology dispositive

The ATB found that U.S. Auto Parts’ purported “in-state contacts” did not constitute physical presence as that standard was articulated in Wayfair. The ATB noted that the Department relied on its ‘cookie nexus’ regulation in determining that U.S. Auto Parts’ use of cookies, apps, and CDN servers constituted sufficient physical presence to assess tax for pre-Wayfair periods. However, the ATB pointed to multiple instances in which the Wayfair court characterized e-commerce, such as that engaged in by U.S. Auto Parts, as constituting a ‘virtual presence’ and not a ‘physical presence’ as contemplated under Quill.

For example, the US Supreme Court in Wayfair stated:

  • A business with one salesperson in every state must collect sales tax in each state, whereas “a business with 500 salespersons in one central location and a website accessible in every State need not collect sales tax on otherwise identical nationwide sales.”
  • A business with a small warehouse in a taxing jurisdiction must collect and remit tax on all its sales, whereas another vendor with a sophisticated website accessible in every state does not collect or remit tax on its sale of the same goods despite its “pervasive Internet presence.”
  • Modern “e-commerce does not analytically align with a test that relies on the sort of physical presence defined in Quill.”
  • “A website may leave cookies saved to the customers’ hard drives, or customers may download the company’s app onto their phones….Between targeted advertising and instant access to most customers via any internet-enabled device, ‘a business may be present in a State in a meaningful way without’ that presence ‘being physical in the traditional sense of the term.’” (quoting Direct Marketing Assn. v. Brohl, 135 S.Ct. 1124 (2015))

“Based on the above language and analysis in Wayfair, it is clear that the Court did not view whatever 'physical aspect’ of modern technology, such as those on which the subject assessment was based, that may be present in a taxing jurisdiction as satisfying the physical presence rule under Quill,” the ATB concluded.

Because the ATB found that the Wayfair court provided “clear analysis concerning the failure of a retailer’s virtual presence to satisfy the physical presence rule,” it rejected the Department’s argument that it should be allowed discovery “on the nature and extent of U.S. Auto’s virtual presence.” 

No retroactive application of Wayfair

Further, the ATB rejected the Department’s alternative argument that Wayfair overturned the Quill physical presence rule retroactively. Both decisions cited by the Department (Harper v. Va. Dep’t of Taxation and James B. Beam Distilling Co. v Georgia) involved situations where taxpayers were being taxed under a scheme that had been declared unconstitutional in prior US Supreme Court cases, the ATB noted.

“In contrast, the facts of the present appeal are the converse of those at issue in Harper and Beam….Nothing in Harper and Beam supports the notion that a taxing authority may apply a court ruling retroactively against taxpayers who were acting consistently with then-current law.”

The ATB also noted that (1) the Department’s cookie nexus regulation by its terms contemplates in-state physical presence within the meaning of Quill, (2) retroactive application of Wayfair would require U.S. Auto Parts to pay from its own resources a tax designed to be collected from its customers, and (3) the Wayfair court emphasized the non-retroactive application of the South Dakota statute at issue.

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