- As a part of regulations drafted after New York’s 2015 tax reform, the New York Department of Taxation and Finance (the “Department”) expanded the list of activities considered unprotected under Public Law 86-272 to include a whole host of activities conducted electronically, such as via a chatbox on a website.
- The New York Supreme Court (a trial level court in New York’s court system) rejected the American Catalog Mailers Association’s (“ACMA”) substantive challenge to these changes.
- The court did side with ACMA that the Department’s changes, which were finalized in 2023, could not be applied retroactively to 2015, as doing so would violate the due process clause.
Background
P.L. 86-272, codified at 15 USC §§ 381-384, was enacted in 1959 in response to a taxpayer’s loss at the United States Supreme Court. It provides protection from net income taxes for certain in-state activities related to the solicitation of orders for sales of tangible personal property. Over the course of more than sixty years, this provision has been interpreted by varying authorities to provide protection for certain activities but not others.
Forvis Mazars Insight: In many respects, the law is a relic of a time when the domestic economy was goods-based and does not reflect the more service-based modern economy.
The Internet
One of the flaws of the myriad interpretations of P.L 86-272 is that it has not addressed technological changes in the way that goods are purchased in this country since its enactment – that is, the purchase of goods vie e-commerce over the internet. In recent years, that has changed. The Multistate Tax Commission, an interstate tax agency whose mission, according to its website, is to preserve, “…the authority of states to determine their own tax policy within the limits of the U.S. Constitution”, drafted a Revised Statement of Information in 2021 addressing what e-commerce activities would be considered unprotected under P.L. 86-272. The Revised Statement of Information is substantively similar to the New York regulations at issue here, and this approach has been adopted by (and subject to litigation in) multiple states, including New Jersey, California and Massachusetts.
Forvis Mazars Insight: The New Jersey and Massachusetts adoption is of relatively recent vintage; ACMA won a challenge in California that its adoption of this approach in a Technical Advice Memorandum violated the California Administrative Procedures Act.
The New York Regulation
In April 2022, the Department published a revised regulation, 20 NYCRR 1.2-10, “Foreign corporations – Public Law 86-272”, in response to New York’s 2015 tax reform. It addressed the applicability of P.L. 86-272 to “…the solicitation of orders via the Internet in New York State for sales of tangible personal property.” 20 NYCRR 1.2-10(i) provided examples of activities that would be considered protected and unprotected in New York State under P.L. 86-272. Unprotected activities conducted via a website included: post-purchase customer assistance via email or chatbot; branded credit card solicitation; employee recruitment; placement of “cookies” on customer devices (unless those cookies are used entirely for activities ancillary to the solicitation of orders of tangible personal property); remote customer service operations; sales of extended warranties; and streaming music or video. It also provided that contracting with a marketplace provider who facilitates the business’ online sales activity and who maintains inventory in New York State would be unprotected.
The relatively small list of protected activities in these examples included the maintenance of a static frequently asked questions (“FAQs”) on the website or the solicitation of orders for sales of tangible personal property in New York State through a bare-bones web presence.
Although the April 2022 draft regulations said that the draft should not be relied upon, when the regulations were enacted in December of 2023 the Department provided for retroactive application to the effective date of the 2015 New York tax reform legislation.
Cross Motions for Summary Judgment
ACMA and the Department both filed cross-motions for summary judgment. ACMA’s motion included an affidavit from a Virginia based retailer that used cookies for its internet sales for various purposes, email and chatbot interactive functionality and other additional services. It argued that the New York regulation effectively required it to limit its out-of-state activities to the solicitation of orders for the sale of tangible personal property – which is not required under P.L. 86-272.
The Department’s motion referenced the United States Supreme Court’s decision in South Dakota v.Wayfair, Inc., 585 U.S. 162 (2018), which provided that a state could require sales tax collection if sufficient economic activity, in the absence of a physical presence in the state, was nonetheless directed at the state. Its motion argued that the Wayfair decision meant that a business could lose the protection of P.L. 86-272 through internet activities.
The New York Supreme Court Decision
The court’s decision begins with a discussion of the three constitutional limitations on the state in the instant case: the Due Process Clause, the Commerce Clause, and federal preemption via the Supremacy Clause. It noted that the Due Process Clause, as interpreted by the U.S. Supreme Court, requires a definite link or minimum connection between the state and the person, property or transaction that it seeks to tax. Its Commerce Clause analysis includes a discussion of the dormant Commerce Clause, which implies a limitation on a state’s ability to impose a tax that would unfairly burden interstate commerce even if Congress has not acted with respect to the subject matter of the tax. It concluded its constitutional analysis by noting that the Supremacy Clause has been interpreted to include three types of preemption: express preemption by Congress, field preemption (where Congress has legislated in so comprehensive a manner such that there is no room for state law); and conflict preemption (where a state law conflicts with the federal in such a way that compliance with both or the local law would hinder the federal goals of the legislation). In the context of P.L. 86-272, it noted that the law serves as a floor below state income taxes may not descend.
The court found that the proposed regulation did not subject out-of-state sellers to a risk of duplicative or unfair taxation in violation of the Commerce Clause. It concluded that Wayfair established that nexus for Commerce Clause purposes can exist without physical presence through virtual contact, and that P.L. 86-272 did not prohibit a state determination as to what activities exceed the solicitation of orders threshold. As a result, the court concluded that the proposed regulation was not preempted by P.L. 86-272.
It did find that the retroactive application of the regulation to the 2015 date of tax reform to be violative of the Due Process Clause. New York had traditionally applied a three-pronged test to assess the validity of a retroactive tax statute: the taxpayer’s notice of a change and the reasonableness of its reliance on pre-change law; the length of the retroactive time frame; and the public purpose of the retroactive application. The focus of this test, according to the court, is fairness. The opinion said that, in light of the April 2022 warning that the draft regulations were not to be relied upon, the December 2023 retroactivity provision did not provide sufficient warning of potential retroactive application to periods where taxpayers thought that their activities were exempt under P.L. 86-272. Finally, it noted that the length of the retroactive period was excessive as it was likely that taxpayers had reasonably expected protection for the activities in question given the length of retroactivity.
Forvis Mazars Insight: The court’s decision rests, in part, on an artificial construct as to where certain electronic activities are deemed to occur. For example, conversations via chatbot or email are definitionally two-way, but the regulation concludes that those activities occur in New York rather than elsewhere for New York based customers.
Imagine a resident of New York City who commutes to an out-of-state job on a daily basis accessing streaming video. The regulation likely assumes that this activity occurred in New York when it may have occurred on his commute, on his lunch break at the office, or while on vacation out of the country. These may appear to be outliers, but to a certain extent they represent a fundamental flaw to such a broad-based approach.
This fundamental change in the approach to P.L. 86-272 seems to be headed in one of two directions: congressional action amending the law to provide protection for these activities or a subset thereof, or a showdown in the U.S. Supreme Court as to the constitutionality of these provisions as it is virtually certain that adverse taxpayer decisions in this context will be appealed to exhaustion.
How Forvis Mazars Can Help
Forvis Mazars can aid you in considering which of your e-commerce activities are vulnerable to attacks as unprotected activities under P.L. 86-272 from states like New York, California, New Jersey and Massachusetts. Additionally, we can keep you apprised of legislative and regulatory developments (both positive and negative) in other states with regard to e-commerce activities and P.L. 86-272. Finally, we can update you on cases such as these as they proceed through the judicial system.