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Inside the P.L. 86-272 Talks: The Draft Internet Section

Posted on Feb. 4, 2020

The thing about trying to provide state tax guidance in the fast-changing world of internet commerce is how seemingly critical components of such transactions can become obsolete overnight.

A Multistate Tax Commission work group has spent the past year discussing how and whether to update national guidance on P.L. 86-272 to address internet activities. Prompted by the Supreme Court’s “virtual contacts” language in South Dakota v. Wayfair Inc., the MTC’s Uniformity Committee questioned whether the sales and use tax decision has implications for income tax nexus and for P.L. 86-272 purposes and assigned a work group to revisit the national “Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272.” 

One of the more controversial aspects of the talks involves whether an internet seller’s use of cookies, software, apps, and other coding during its website interactions defeats its P.L. 86-272 immunity from net income taxation by a customer’s state. Now — just as the work group is nearly ready to submit its recommended draft changes to the Uniformity Committee — comes word that Google plans to phase out its support for the use of third-party cookies on its Chrome internet browser.

“Our intention is to do this within two years,” wrote Justin Schuh, director of Chrome Engineering, in a January 14 post

Google’s plan is spurred by privacy issues and the company’s desire to build the infrastructure of “a more private web” for internet users. While the company plans to test a variety of other ad-supported mechanisms for internet marketers, make no mistake: The post’s title describes the change as “a path towards making third party cookies obsolete.” 

What does that mean for the work group’s latest draft section on internet activities? Probably not much.

“The P.L. 86-272 analysis we’ve been using doesn’t at all rely on in-state physical presence,” Michael Fatale, deputy general counsel for the Massachusetts Department of Revenue, said during a work group teleconference last year. “The thing about cookies and software is they perform activities that you can then attribute back to the vendor,” who has a property interest in the cookies or software, he said. 

Still, it's fair to say there has been ongoing confusion among practitioners and state tax administrators about the work group’s analytical approach. Part of the confusion almost certainly stems from the fact that while there is a clear majority approach on the work group, there is also an alternative analysis, and while members often reach the same conclusion about whether an internet activity is protected by P.L. 86-272, they are getting there through different reasoning. But that tension lies beneath the surface of the draft language and is for another article. 

It’s the work group’s position on cookies and software that continues to generate attention.

“’Interactive’ Website Will Defeat P.L. 86-272 Immunity If the MTC Has Its Way,” read the headline of a November 2019 client alert by Mike Le of Pillsbury Winthrop Shaw Pittman LLP. Le cited examples of interactive website activities that the MTC work group at that point agreed exceed P.L. 86-272 protection “even if the company has no other contact with the customer’s state.”  

Among the draft examples Le cited were scenarios involving an internet seller, including:

  • placing cookies on the computers or devices of in-state customers;

  • contracting with a marketplace facilitator that maintains the seller’s inventory in various states where customers buy the seller’s products through the marketplace platform;

  • providing post-sale assistance through online chat or email accessed by the customer through the seller’s website;

  • soliciting and receiving online applications for the company’s branded credit cards;

  • remotely fixing products over the internet or through Wi-Fi; and

  • inviting website visitors to apply through the site for jobs at the company.

“Having one of the listed internet activities — by itself — would cause a company that has limited its in-state activities to solicitation to lose its P.L. 86-272 immunity according to the draft guidance,”Le wrote. “In effect, the MTC’s draft guidance would eviscerate P.L. 86-272 protection given today’s digital economy.”

Joe Huddleston of EY had expressed similar concerns during a work group teleconference a few months earlier. “Basically what you’re saying is in the internet age, 86-272 is meaningless,” said Huddleston, a former MTC executive director.

Then, at the MTC’s annual meeting in August 2019, Jeffrey A. Friedman of Eversheds Sutherland (US) LLP called the work group’s exercise “a very significant overreach.”

“The business community is of the view that this is a not-so-thinly veiled attempt to obliterate P.L. 86-272,” Friedman said.

Friedman handed the baton to Karl Frieden of the Council On State Taxation, who said COST hasn’t weighed in much on the project because P.L. 86-272 doesn’t affect large multistate businesses in the way it does smaller businesses. Frieden called the MTC’s exercise “pretty legalistic and nitpicking” in reducing P.L. 86-272 protections. Businesses understand the allure to states of adopting economic nexus for all tax types, he said, but added that it was apparent from looking at the emerging list of unprotected activities that the MTC and states are strongly resisting application of the federal statutory preemption.

Should an updated statement of information reinterpret what Congress intended “by basically eviscerating” P.L. 86-272 protection, states might attract congressional attention, Frieden said. He acknowledged that with national politics as they are today, it’s impossible to say when Congress would ever again agree on a state tax matter. And yet e-commerce is the only issue that has prompted Congress to intervene in state taxation on a broad basis over the last 20 years, Frieden said, referring to telecommunications sourcing regarding cell phones and the Internet Tax Freedom Act. 

Given all this, it might come as a surprise that under the work group’s approach, an internet seller doesn’t automatically lose its P.L. 86-272 immunity by placing cookies or other software on a customer’s device. The work group has made this explicit by including two examples involving cookies to its draft section on internet activities.

Jared Walczak of the Tax Foundation noticed, and on January 24 posted screenshots of the work group’s latest draft examples to Twitter

“The distinction on cookies is worth noting,” Walczak wrote. “A cookie that remembers your account and cart information doesn’t defeat PL 86-272 protections per MTC, but if your search info can be used to adjust prices, inform inventory decisions, etc., that activity establishes nexus.”

That nuance could be important, or it might change no one’s opinion about the MTC effort. In any event, this article describes the work group’s latest draft section on internet activities and, where relevant, circles back to Fatale’s articulation — over several meetings last spring — of the analysis the work group’s majority has been applying to the hypothetical scenarios. 

The Term ‘Static’

The work group’s latest draft recommended section on internet activities opens by saying that determining whether an internet seller of tangible personal property has P.L. 86-272 immunity requires the same analysis used in making that determination for traditional sellers. That is, the internet seller’s only business activity in a customer’s state is the solicitation of orders for sales of tangible personal property, is ancillary to solicitation, or is de minimis. Also, for P.L. 86-272 protection to apply, any resulting orders must be sent outside the customer’s state for approval or rejection, and if approved the order must be shipped from a point outside the customer’s state.

The draft opening also contains this statement:

As a general rule, when a business interacts with a customer via the business’s website or app, the business engages in an activity within the customer’s state. Presenting static text or photos on a website does not in itself constitute an activity within those states where customers are located.

All earlier draft versions of the section attempted to convey that an internet seller engages in business activity in a state when a customer or potential customer in that state interacts with the seller’s website or app. The first several draft versions clarified that the customer “does more than view a presentation on the website or app.” 

From the beginning, the work group has listed the posting of “static FAQs” on the seller’s website as a protected activity. By December 2019 the work group was also including the word "static" in the draft opening to the section on internet activities: “Presenting static text or photos on a website does not in itself constitute an activity in those states where customers are located.”  

While meant to provide clarity, the word “static” arguably has shaped much of the public’s understanding — possibly misunderstanding — of the work group’s approach to analyzing whether an internet seller loses or maintains its P.L. 86-272 immunity. This is especially so given that the draft language appears to suggest that static views are the limit of what types of website functions would be protected. Yet work group members early on discussed how almost all internet companies that are selling products over their websites today are doing more than just showing visitors static photos of those products or, for example, requiring customers to write down their orders on paper and mail them to the company. That is, work group members have acknowledged that this is not the reality of most internet transactions today.

The disconnect might be in pieces of the work group’s analysis that don’t appear in any of the draft revisions, but that seem obvious when pointed out.

First, MTC Counsel Brian Hamer has discussed in his updates to the Uniformity Committee that in determining whether P.L. 86-272 applies to business activities conducted over the internet, the work group first determines whether that activity constitutes the solicitation of orders for tangible personal property. If the activity is something more than the solicitation of sales, the work group then determines where that internet activity is taking place; this is because the seller will not lose its P.L. 86-272 immunity if the non-solicitation activities are occurring entirely outside the customer’s state. Hamer said determining where internet activities take place might be a more difficult question than whether the activities constitute solicitation.

In his memos to the Uniformity Committee, Hamer described in further detail the consensus that has developed among work group members that is mentioned in the draft opening language to the internet section: If a customer interacts with an internet seller’s website, that business has engaged in activities in the state. Hamer wrote that this reasoning is based on the following considerations: 

(1) When a customer engages a seller’s website, the website transmits software or code to the user’s computer, which is stored in the user’s computer for some period of time. The code serves to facilitate the interaction between the customer and seller.

(2) The interaction between the customer and the seller’s website is substantial in nature.

(3) The analysis in South Dakota v. Wayfair Inc. speaks to the “continuous and pervasive virtual presence of retailers” in the states where their customers are located.

There is one more missing piece. The stated general rule is that an internet seller is engaging in business activity in the customer’s state when the customer interacts with its website or app, and Hamer explained that the reasoning behind this position is based partly on the seller’s transmittal of software or code that enables interaction between the seller and customer.

“The transmittal of code to the customer’s state is not the end of the analysis,” Fatale said last spring. The next question is whether that software-enabled business activity in the customer’s state constitutes the solicitation of sales of tangible personal property, is ancillary to solicitation, or is de minimis. Of course, if the activity falls into any one of those categories and the seller has no other contacts with the state, it is still protected by P.L. 86-272. The work group applied this additional P.L. 86-272 step in its analysis of each of the hypothetical internet scenarios.

Fatale was addressing Ray Langenberg, the Texas comptroller’s special counsel for tax litigation, who had not been involved in the work group’s earliest discussions of P.L. 86-272’s application to hypothetical internet scenarios but became concerned that the group was heading in the wrong direction. Langenberg said his impression was that the work group seemed to be differentiating activities based on the amount of physical presence in the state, which he argued “is obsolete post-Wayfair” and results in arbitrary distinctions between interactions that have the same business purpose but are conducted through different mediums.

This is when Fatale said the reason the work group spent so much time discussing internet sellers that place cookies or software on a customer’s device is the business activities that those cookies or software enable in the customer’s state. Those business activities can be attributed back to the internet seller, Fatale said, because of the property interest the seller has in the cookies or software.

Whether an internet seller’s property interest in cookies, software, or apps constitutes physical presence in a state is a question separate from an examination of whether P.L. 86-272 protection applies, Fatale said. He added that not even Massachusetts considers cookies to be physical presence; it’s the seller’s property interest in the cookies that was at the heart of the state’s cookie nexus regulation.

Whether software or code is physical presence for sales and use tax purposes is its own question, Fatale continued. Under the Massachusetts cookie nexus rule, it matters, he said, but for purposes of examining whether P.L. 86-272 protection applies, it doesn’t.

Langenberg was insistent. “Even though you may give lip service to the idea that physical presence is not the test, in fact the committee was drawing lines based on the extent to which an activity resulted in the company having some sort of a physical presence in the state,” he said.

Two of the work group’s members publicly admitted that — as Langenberg had suspected — they had been thinking in terms of physical presence in the earliest straw votes on whether internet sellers would be protected by P.L. 86-272 under various hypothetical scenarios. That is, the members said they had been asking themselves whether a given hypothetical scenario involved the internet seller placing cookies or code on a customer’s computer, and hadn’t been thinking in terms of the business activities that such coding enables.

The work group immediately went back and conducted a new set of straw votes on each scenario. In fact, it almost continuously revisits various hypothetical scenarios to check whether work group members have changed their minds, either about the position they are taking or on whether the example should be included in the draft statement of information.

This brings us to the examples in the latest draft version of the section on internet activities.  

Internet Examples

Two of the examples in the draft internet section specifically address cookies. The internet seller would lose its P.L. 86-272 immunity under one cookie scenario but would retain the federal protection in the other.

The example defeating P.L. 86-272 immunity has been in earlier draft versions but contains some additional information. It involves an internet seller placing cookies on a customer’s computer or other device to gather the customer’s search information “to adjust production schedules and inventory amounts, develop new products, or identify new items to offer for sale.” The draft language explains that such functions do not constitute, and are not entirely ancillary to, the in-state solicitation of orders for tangible personal property.

However, placing cookies on a customer’s computer or other device to gather information for purposes “entirely ancillary to the in-state solicitation of orders for tangible personal property” would be protected, the draft says. This is the new addition highlighted by Walczak — a “plain vanilla” example, as the work group put it, illustrating when an internet seller of tangible personal property places cookies on a customer’s computer and retains its P.L. 86-272 immunity. The types of cookie functions that the draft language cites as ancillary to solicitation include remembering items that customers have placed in their shopping cart; storing personal information that customers have provided so that they don’t need to input that information again when they return to the website; and reminding customers which products they considered during previous sessions.

Another newly added example involves an internet seller streaming videos and music to customers' devices for a charge. The draft language says this business activity would defeat P.L. 86-272 immunity because streaming is not the sale of tangible personal property. The MTC and supporting states have long taken the position in the statement of information that the solicitation of sales of services or intangibles is not protected activity, nor is the leasing or licensing of any property in a customer’s state.

All the internet examples enumerated by Le in his November alert appear in the latest draft. In the example involving an internet seller losing its P.L. 86-272 protection when it contracts with a marketplace facilitator that maintains the seller’s inventory in various states, the latest draft references the MTC statement of information’s long-standing section on independent contractors.  

The latest draft says providing post-sale assistance through web chat or an email initiated by customers clicking on a link on the company’s site would defeat the seller’s P.L. 86-272 immunity because the business activity “does not constitute, and is not entirely ancillary to, the in-state solicitation of orders for tangible personal property.” So would soliciting and receiving online applications for the company’s branded credit cards that generate interest income and fees for the business, for the same cited reason.

Another example defeating the internet seller’s P.L. 86-272 protection is offering and selling extended warranty plans over its website. The draft language says this activity is disqualifying because it constitutes the sale of a service rather than of tangible personal property. In work group meetings, members also argued that an extended warranty is neither part of nor ancillary to the initial solicitation and any standard warranty packaged with the initial sale; this additional reasoning is not included in the draft language. 

The draft language says enabling visitors to apply through the website for jobs other than sales positions is business activity in the visitor’s state that “does not constitute, and is not entirely ancillary to, the in-state solicitation of orders for tangible personal property.” Remotely fixing products previously purchased by a customer by transmitting code over the internet or through other means also “does not constitute, and is not entirely ancillary to, the in-state solicitation of orders for tangible personal property.” 

The work group has tentatively scheduled three more teleconferences, should it need them. The dates are February 7, 12, and 20.

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