Massachusetts: Litigation begins over new nexus regulation

The Bay State has had a bit of a time getting its new nexus regulation up and running. The rule provides for the taxation of internet sales when an out of state vendor installs in-state software, also referred to as “apps,” and ancillary data, including cookies, on in-state customers’ devices. The Department of Revenue first launched its effort, by way of Directive 17-1, in April, but soon called it back for lack of compliance with the public notice requirement that is part of the standard rule-making process.

When we last addressed the subject we noted that the Department of Revenue had corrected the situation and the Vendors Making Internet Sales regulation was set to take effect on Oct. 1, 2017.

A number of entities oppose the regulation, including internet retailers represented by Netchoice, a trade association of e-commerce businesses, and the American Catalog Mailers Association (ACMA). They characterize laws that seek to tax remote sellers when they have no physical presence in a given state as “blatantly unconstitutional.” Netchoice and the ACMA sued Massachusetts over Directive 17-1 for its lack of public notice compliance, and have filed other legal challenges in Indiana, South Dakota, Tennessee, and Wyoming.

But now that the Vendors Making Internet Sales regulation is in place, it is a different stakeholder, Crutchfield Corp., that filed the first complaint, on Oct. 24, 2017, posted online by Bloomberg. Crutchfield is a Virginia based corporation that sells audio and video equipment for cars and homes, and is asking the court to declare that Massachusetts’ new regulation violates the commerce clause of the U.S. Constitution, and the Internet Tax Freedom Act (ITFA), which the suit alleges preempts any state regulations that violate its prohibitions.

A Sept. 14, 2017 letter from the Massachusetts Commissioner of Revenue prompted the suit. It alerted the company that it was “likely to meet the thresholds described in” the new regulation. The firm has filed a suit in the circuit court of Albemarle County, Virginia. The commissioner’s letter also warned Crutchfield that it would be subject to accrued statutory penalties and interest for its failure to “timely register and file the required returns with the required tax payment.”

Crutchfield Corp. may sound familiar to some, because it, along with two other internet retailers, sued in Ohio for taxes, interest and penalties amounting to more than $200,000 that the Buckeye State imposed under its commercial activity tax (CAT). The plaintiffs lost in the Ohio Supreme Court in November 2016, and they tried to obtain relief in the United States Supreme Court. As we explained in April, the parties ended up settling, the plaintiffs dropped their lawsuit, and ultimately paid their CAT obligations.

The claims that Crutchfield puts forward are not new for these kinds of lawsuits. The commerce clause allegations invoke the physical presence test that the United States Supreme Court established in 1992 in Quill v. South Dakota. In its complaint, the company alleges that the regulation runs afoul of the Quill precedent, because it has no physical presence in Massachusetts. Crutchfield acknowledges that for the period at issue, Oct, 1, 2016 to September 30, 2017, it met the sales and transaction thresholds of $500,000 and 100 or more transactions contained in the regulation. Even so, it contends that the Department of Revenue “lacks the authority to enforce [the regulation]…because it imposes an undue burden on interstate commerce under the Commerce Clause.”

As for the other count, the plaintiff alleges that the Internet Tax Freedom Act “prohibits a state from imposing a discriminatory tax on electronic commerce,” and that “any tax…on electronic commerce that…imposes an obligation to collect or pay that tax on a different person or entity than in the case of transactions involving similar property, goods or services…” is discriminatory. Crutchfield reasons that because the Massachusetts regulation distinguishes between vendors who sell their good electronically, rather than by some other means, like “catalog, mail order, television infomercial, or toll free telephone number,” it is unlawful.

Beyond this, the complaint alleges that the regulation’s reliance on electronic contacts associated with internet sales as its basis for taxation is discriminatory, and is in direct conflict with ITFA’s intention of “prohibiting states and localities from using internet-based contacts as a factor in determining whether an out of state business has substantial nexus with the taxing jurisdiction.” Accordingly, they argue, the supremacy of the U.S. Constitution over state laws like the one at issue preempts the regulation.

In our early September piece, we pointed out that the ACMA had established a Quill Defense Action Fund to fight nexus laws like the new one in Massachusetts. Bloomberg revealed that the ACMA and Netchoice “have been attempting to pull together $250,000 from their respective members and others to file their own lawsuit in Massachusetts against the new regulation.”