Tax Litigation Update: ‘Cookie Nexus’ and More

The outcome of some tax litigation cases can have long-term effects on tax policymaking and subsequent compliance. This is certainly the case in the U.S. where states and companies continue to square off over matters related to post-Wayfair economic nexus expansion, marketplace taxation rules, retroactive tax levies and much more. Four and a half years after the landmark case, states continue to adjust or modify their regulations, in an attempt to bolster revenue collections.  This often leads to more tax controversy.

For example, in the noted case of U.S. Auto Parts Network v. Massachusetts Department of Revenue the state continues to argue whether that state’s so-called “cookie nexus” regulation (also known as the Internet Vendor Rule) means that the California-based online retailer (which now goes by CarParts.com) must pay retroactive sales taxes to Massachusetts. That’s a highly condensed summary. As in most retroactive tax application cases, the actual case involves pre-Wayfair rules, the “dormant” Commerce Clause, due process,  and the question of whether apps and tracking cookies can establish a company’s physical presence in a state, thus triggering economic nexus

Back to my point on the tax policy impacts of certain court cases: U.S. Auto Parts Network, Inc. v. Commissioner of Revenue also will determine if the Massachusetts Commissioner of Revenue possessed the legal authority in 2017 -- prior to the U.S. Supreme Court’s Wayfair ruling – to require CarParts.com and 45 other online companies to collect sales taxes on online sales. 

That’s one of many important cases; others include Quad Graphics Inc. vs. North Carolina Department of Revenue as well as the Supreme Court’s consideration of National Pork Producers Council vs. Ross.  Although not a tax case as such, many keenly await SCOTUS decision on National Pork Producers, as this particular case will certainly have some fiscal ramifications, which are bound to affect taxpayers around the country.  The fundamental question of whether a state can “regulate” beyond its borders (extra-territoriality), thus having an economic impact in other states that can impede commerce, has a long and tangled history with taxation.

As I monitor these and other notable court cases whose outcomes will have consequential impacts on fiscal policy and taxation, here’s what I find valuable to keep in mind:

• State tax litigation has been increasing since before the pandemic: Since the Supreme Court’s Wayfair ruling in June 2018, states have been expanding economic nexus through a broad collection of actions. These include passing new regulations, modifying economic thresholds, attempting to retroactively tax pre-Wayfair transactions under different standards (e.g., click-through nexus, attributional nexus, cookie- nexus, etc.), taking extra-territorial measures (beyond their borders), and pursuing challenges in state courts.   
• The commerce clause and due process loom large: Many current state tax challenges involve the dormant Commerce Clause, a significant Clause included in the Constitution, and/or the Due Process clause of the 14th Amendment. Both clauses tend to crop up in U.S. tax litigation because these constitutional barriers established a check on the fiscal power of both state and federal governments.
• Litigation outcomes drive tax policy changes, which increase compliance complexity: Again, all of the cases we’re tracking will undoubtedly impact tax policymaking, over the short-term and/or the long term. These changes will give rise to new compliance challenges inside tax groups.

 Accordingly, tax leaders and taxpayers should stay informed on these developing tax cases and how retroactivity or extraterritoriality can impact revenue collection and tax compliance and keep tabs on how the “cookie” (nexus) crumbles along with other litigation outcomes.