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Massachusetts Says In-State Apps and Cookies are a Physical Presence

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Massachusetts has joined the growing number of states that have implemented a sales tax collection obligation for out-of-state retailers. On April 3, 2017, the Massachusetts Department of Revenue issued a directive announcing that the Department is adopting an “administrative bright-line rule” for sales tax collection requirements for Internet vendors (Directive 17-1). Effective July 1, 2017, an Internet vendor with a principal place of business located outside of Massachusetts is required to collect the state’s sales tax if it had in excess of $500,000 in Massachusetts sales or 100 or more transactions with Massachusetts customers in the preceding 12 months.

On its face, the Directive appears to continue the trend of requiring remote sellers to collect sales tax merely due to a certain threshold of in-state sales being met. Besides Massachusetts, the most recent state to adopt a bright-line “economic nexus” standard for sales tax collection is Wyoming, where Gov. Matt Mead signed a bill establishing a sales tax collection threshold of $100,000 of annual sales or more than 200 sales to Wyoming customers. Similar rules have been passed in Alabama, South Dakota, and Tennessee, with the South Dakota rule likely headed to the state’s highest court.

However, Massachusetts’ strategy appears to be slightly different from the others states. Legislation passed in the other states require sales tax collection by retailers with no in-state physical presence, which is clearly at odds with the nexus standard established by the U.S. Supreme Court in the 1992 case of Quill Corporation v. North Dakota. The presumed strategy of the states enacting such provisions is to have the issue taken up by the courts in light of the failed attempts by Congress to address the issue through federal legislation.

Rather than attacking Quill head on, Massachusetts is attempting to distinguish what constitutes a physical presence for a mail order retailer as opposed to an Internet retailer. The ruling in Quill addressed the sales tax collection obligation of a mail order retailer, and concluded that the court’s bright-line “physical presence” standard was not met by a retailer whose only connection with customers in a taxing state is by common carrier or the United States mail. The Massachusetts Directive reasons that the business activities of Internet retailers are factually distinguishable from the business of mail order retailers because Internet retailers do not limit their contacts with the state to mail and common carriers. The directive concludes that Internet retailers have a physical presence in Massachusetts because (1) retailer-owned software is affirmatively downloaded through the use of “native” or “mobile” apps or downloaded by a customer’s general use of the retailer’s website; and (2) retailer-owner proprietary cookies are placed on their customers’ computers and devices.

The troubling nature of the Directive is it seems to ignore that the Quill decision concluded that a sufficient physical presence was not established through mailings made into the state that were owned by the retailers. The in-state mailings did establish some existence of a physical presence for the mail order retailer, but it was not sufficient in the eyes of the Court.  Any software and cookies that are downloaded by an in-state customer seemingly serve the same purpose as a mailed catalog. The analogous nature of mailed catalogs and downloaded software arguably should result in the same non-sufficient physical presence as concluded in Quill. Whether online retailers abide by this directive is yet to be seen. If the developments in other states are any indication, the issue of remote seller sales tax collection could very well be litigated in Massachusetts in the near future. It seems that it is only a matter of time before the U.S. Supreme Court will be forced to address the issue again.

If you have any questions regarding your sales tax collection obligations, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.

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New Tax for D.C. Employers Would Fund Paid Family Leave

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The D.C. Council has proposed legislation that would provide most D.C. workers 16 weeks of paid leave after the birth or adoption of a child, to recover from an illness, to recuperate from a military deployment, or to tend to an ill family member.  The benefits would be funded by a new tax on employers, similar to a state unemployment tax.  The legislation, if it passes, would make the District the most generous jurisdiction in the nation when it comes to paid family leave benefits.

According to the legislation (the Universal Paid Leave Act of 2015), employees working at least 50% of the time for a District employer would be eligible for 16 weeks of paid leave.  Employees making up to $52,000 a year would receive 100% of their pay.  Employees who earn more than that would be eligible for $1,000 a week plus 50 percent of their additional income, up to a maximum of $3,000 per week.  Residents of the District employed by the federal government can opt into the system for a small fee.

D.C. employers would fund the family leave coverage through a payroll tax.  Although the tax is structured somewhat similar to an unemployment tax, there are two key differences that many employers could find controversial.  First, instead of a flat rate applying to all wages paid by an employer, the tax rate increases for highly paid employees.  Secondly, there is no taxable wage-base for the proposed tax.  The tax brackets are as follows:

  • Employers pay nothing for employees earning less than $10,000 a year;
  • Employers would pay 0.5% for employees earning between $10,000 and $19,999 a year;
  • Employers would pay 0.6% for employees earning between $20,000 and $49,999 a year;
  • Employers would pay 0.8% for employees earning between $50,000 and $149,999 a year; and
  • Employers would pay 1.0% for employees earning $150,000 or more a year.

It seems likely that some form of the legislation will pass, as the initial version of the proposal is supported by half of the Councilmembers.  The proposal is arguably somewhat in contrast to recent legislation in the District that reduced income tax rates for businesses in the District.  Still, some proponents of the bill claim that the legislation, if enacted, will make the District even more competitive.

If you have any questions about the proposal or any other D.C. tax issues, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6298. 

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Alabama Sales Tax Regulation Ignores U.S. Supreme Court

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A new sales tax regulation in Alabama directly contradicts the bright-line physical presence nexus standard created by the U.S. Supreme Court in Quill Corp. v. North Dakota.  While Congress has debated (and been unable to enact) multiple versions of federal legislation that would limit the application of the physical presence nexus standard for certain retailers, the Alabama Department of Revenue has ignored these impediments by promulgating its own “economic nexus” rule.

The new regulation, which takes effect on January 1, 2016, establishes a bright-line sales threshold for nexus that is similar to Alabama’s recently enacted statute defining when a corporation is doing business for income tax purposes.  However, Alabama is the first state to apply such a bright-line rule for sales tax.

The regulation provides that “out-of-state sellers who … are making retail sales of tangible personal property into the state have a substantial economic presence in Alabama for sales and use tax purposes and are required to . . . collect and remit tax . . . if the seller’s retail sales of tangible personal property sold into the state exceed $250,000” in a calendar year.  The regulation also requires some form of activity that reflects purposeful availment to the Alabama market by a retailer.  However, most of the activities listed in the regulation that will trigger the collection of tax do not require a physical presence in the state.  These activities include solicitation of sales through television or print advertising, such as the distribution of catalogs.  These are the exact types of activities that have been deemed not to create a “physical presence” under the current sales tax nexus rules established by the U.S. Supreme Court.

The Department’s expectation with respect to this new regulation is unclear.  Most retailers meeting the requisite $250,000 sale threshold that do not have a physical presence in Alabama will likely not follow the new rule given its apparent inconsistency with federal law.  It will be interesting to see if the Department of Revenue seeks to enforce the rule against non-compliant retailers, especially given the U.S. Supreme Court’s recent hinting at its willingness to reconsider the rule established in Quill.

If you have questions about your company’s sales and use tax obligations, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6298. 

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Uncertainly in Alabama on the Taxation of Electronically Delivered Information

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Alabama has revoked a twenty-year-old sales tax ruling, and in doing so has ruled that electronically transmitted information is taxable tangible personal property for sales tax purposes.  The notice issued by the Alabama Department of Revenue on September 3, 2015 cites advances in technology and analogous expansions of the definition of “tangible personal property” to canned (i.e., prewritten) software and electricity as support for it decision.  Alabama’s decision seems troubling when considering the otherwise limited application of it sales tax and the means by which it has expanded its sales tax in the past.

The application of a state’s sales tax to what most states consider a service (i.e., an information service) is typically accomplished by the enactment of a statute that specifically enumerates the service as being subject to sales tax.  Alabama’s informal memorandum (which seems to be the best characterization of the document issued by the Department) is a prime example of a significant change in tax policy being established by an administrative agency.  Other states have issued similar informal guidance, for example, by ruling that sales tax applies to software-as-a-service (SaaS).  However, states that have administratively concluded that SaaS is taxable have largely already had an enacted statute stating that canned software is taxable regardless of the method of delivery.  In such case, the taxing authority is arguably making a reasonable interpretation of existing law.  Here, Alabama does not otherwise tax information services.

The expansion of Alabama’s tax base to canned software was accomplished through an Alabama Supreme Court case in 1996, which held that canned software is “tangible personal property.”  The Department of Revenue subsequently promulgated a regulation addressing the taxation of computer software in more detail.  Thus, in the case of software, the Department had a decision of the state’s highest court that it was interpreting.  The Department’s reliance on that very case, which addressed the narrow issue of whether canned software is subject to sales tax, to support its conclusion that electronically transmitted information is also tangible personal property is quite a stretch.

This is especially the case given the fact that Alabama does not otherwise tax information services.  How expansive are taxpayers to interpret this pronouncement?  Is all electronically transmitted information now taxable?  Can sales tax be avoided if the information is delivered in hard copy because the application of the “true object” test, which Alabama applies, results in the principal purpose of the sale being a nontaxable transfer intangible property?

Essentially, Alabama’s notice leaves taxpayers, both those providing information services online and in a tangible form, with a significant amount of uncertainty.  Still, this is not terribly surprising, given the slow nature of state legislatures to react to new methods by which products and services are delivered.  Tax administrators across the country are routinely faced with similar questions requiring them to fit a square peg into a round hole.  Unfortunately, the conclusions are anything but uniform; leaving taxpayers, especially those offering products and services online to customers in multiple states, with a certain level of risk.

If you are interested in learning more about how states are taxing technology companies, please join us for our upcoming webinar series: Taxing Tech.   If you have questions about the application of sales tax on your products or services, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.

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