Locke Lord QuickStudy: UPDATE: Massachusetts Department of Revenue Revokes Directive Requiring Large Out-of-State Internet Vendors to Collect Massachusetts Sales Tax

July 14, 2017
Our previous QuickStudy published on April 14, 2017, detailed Directive 17-1, issued by the Massachusetts Department of Revenue (“DOR”), which would have required all out-of-state internet vendors that in the prior taxable year had greater than $500,000 in Massachusetts sales and had 100 or more sales transactions with delivery in Massachusetts to collect and remit sales and use tax on their Massachusetts sales beginning on July 1, 2017.

The DOR issued Directive 17-2 on June 28, 2017, revoking Directive 17-1 effective immediately. Directive 17-2 indicated that while the DOR was revoking Directive 17-1, it expected to issue proposed regulations that, if adopted, would require large out-of-state internet vendors to collect Massachusetts sales and use taxes under similar standards, and relying on a similar legal rationale, as those present in Directive 17-1.

Directive 17-2 resulted from a court challenge to Directive 17-1 brought by remote retailers who would have been affected by Directive 17-1. The suit requested the court to issue an injunction preventing Directive 17-1 from going into effect on July 1, arguing that the Directive (i) was procedurally invalid because it was issued in violation of the Massachusetts Administrative Procedure Act, M.G.L. c. 30A (“APA”) and (ii) was substantively invalid because it violated the United States Constitution and the federal Internet Tax Freedom Act. The Massachusetts Superior Court on June 28, 2017 ruled that Directive 17-1 was invalid on procedural grounds because in substance it was a regulation that the DOR had issued without following the notice and comment procedures applicable to agency regulations under the APA. Memorandum of Decision and Order Entering Declaratory Judgment on Count I of Plaintiffs’ Verified Complaint, American Catalog Mailers Association and Netchoice v. Michael J. Heffernan, Suffolk Superior Court Civil Action No. 2017-1772 BLS1 (June 28, 2017), Slip Op. at 10. The court stated that persons and businesses affected by new regulations must have the opportunity for notice, input, and debate before new rules are effective, and Directive 17-1 did not provide any such opportunity.

While the DOR’s forthcoming proposed regulations may satisfy the APA requirements, if the regulations as promulgated mirror Directive 17-1 it seems likely that large out-of-state internet vendors will again bring suit to challenge the constitutionality of the regulations. As discussed in our prior QuickStudy, one potential attack could come on the law’s presumption that out-of-state vendors of a certain size always utilize particular software and cookies that creates an in-state presence, when this may not always be the case. Affected retailers could also attack the law’s assumption that relatively minor software code or cookies are, in fact, a sufficient in-state physical presence to satisfy the requirements set by the Supreme Court in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). It is also possible that the regulations would violate the Internet Tax Freedom Act, designed to prevent state governments from discriminatorily taxing e-commerce by imposing a higher tax burden on internet sales when compared to sales made by other means. Since mail-order retailers would presumably not be subject to the regulations, arguably the regulations could violate the Act by discriminating against internet retailers in favor of other types of remote vendors. Overall, it seems clear that for now the DOR is prepared to stand behind the legal rationale detailed in Directive 17-1, despite an initial set-back on procedural grounds.