D&H Distrib. Co. v. Comm'r Revenue

• Decision Date: 31 July 2017
• Docket Number: SJC-12260
• Parties: D & H DISTRIBUTING COMPANY v. COMMISSIONER OF REVENUE.
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court

477 Mass. 538

79 N.E.3d 409

D & H DISTRIBUTING COMPANY

v.COMMISSIONER OF REVENUE.

SJC-12260

Supreme Judicial Court of Massachusetts, Suffolk.

Argued April 3, 2017

Decided July 31, 2017

Philip S. Olsen, Boston, (Jonathan A. Block also present) for the taxpayer.

Julie E. Green, Assistant Attorney General, for Commissioner of Revenue.

Present: Gants, C.J., Lenk, Hines, Gaziano, Lowy, Budd, & Cypher, JJ.

CYPHER, J.

If a consumer enters his or her neighborhood sporting goods store in Massachusetts and purchases a baseball glove, the store, as the "vendor," collects the Massachusetts sales tax owed from the consumer and remits it to the Department of Revenue (department). See G.L.c. 64H, §§ 1, 2. This case evaluates a more complex transaction in which a Massachusetts consumer instead finds a hypothetical baseball glove online, and purchases it from an out-of-State retailer who then orders the glove from a Massachusetts wholesaler and directs the wholesaler to deliver the glove directly to the doorstep of the Massachusetts consumer. In that more complicated transaction, known as a "drop shipment sale," the wholesaler is considered to be the vendor, and is obligated to collect sales tax and remit it to the department.

The taxpayer, D & H Distributing Company (D & H), is a company in the position of the hypothetical wholesaler just described. It appeals from a decision of the Appellate Tax Board (board) in which the board concluded that under a provision of the Massachusetts sales tax statute known as the "drop shipment rule," D & H was responsible for collecting and remitting the sales tax due on products it sold to the out-of-State retailers and then delivered to consumers. G.L.c. 64H, § 1. We agree with the board's conclusion, and also reject D & H's argument that the statutory drop shipment rule violates the dormant commerce clause of the United States Constitution. Accordingly, we affirm the decision of the board.

1. Statutory framework . a. Sales tax . General Laws c. 64H distinguishes between retail sales transactions and sales-for-resale transactions. Retail sales of goods and services are subject to tax in Massachusetts. G.L.c. 64H, § 2. In contrast, sales for resale—that is, sales of goods by a wholesale supplier to a retailer that will ultimately sell to an end consumer—are not subject to tax; only the subsequent retail sale is. See G.L.c. 64H, § 1 (defining "retail sale" as "a sale of services or tangible personal property or both for any purpose other than resale"); G.L.c. 64H, § 2 (imposing sales tax upon "sales at retail").

The statute also distinguishes between a retailer that is engaged in business in Massachusetts and one that is not. Where a retailer is engaged in business in Massachusetts but purchases the goods it sells a Massachusetts consumer from a wholesaler, sales tax is charged on the final sale to the customer, and the retailer is the "vendor," G.L.c. 64H, § 1, responsible to pay the tax. G.L.c. 64H, § 2. However, if a retailer is not engaged in business in Massachusetts in the sense that the retailer does not have any in-State physical presence, Massachusetts cannot require the retailer to collect and remit sales tax. See Quill Corp . v. North Dakota , 504 U.S. 298, 314-315, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992) (retailers without in-State physical presence may not be compelled to collect State sales tax); National Bellas Hess, Inc . v. Department of Revenue of Ill ., 386 U.S. 753, 758, 87 S.Ct. 1389, 18 L.Ed.2d 505 (1967) (same).¹ In light of the Supreme Court's physical presence requirement, in the previously described hypothetical, if the out-of-State retailer of the baseball glove purchased online by the Massachusetts consumer had no physical business presence here, it could not be compelled to collect Massachusetts sales tax.

b. Use tax . The use tax, under G.L.c. 64I, was designed to prevent loss of sales tax revenue from such out-of-State retail purchases. Commissioner of Revenue v. J.C. Penney Co ., 431 Mass. 684, 687, 730 N.E.2d 266 (2000). The use tax obligates consumers to remit tax to the Commissioner of Revenue (commissioner) "upon the storage, use or other consumption in the commonwealth of tangible personal property or services purchased from any vendor," G.L.c. 64I, § 2, that was not subject to sales tax upon the original sale. G.L.c. 64I, § 3. In practice, however, consumers seldom remit use tax of their own volition, and are not likely even to be aware of the requirement. See Tenczar, DOR to Taxpayers: Don't Forget Use Tax, Commonwealth Mag. (Winter 2014) (Massachusetts 2012 use tax compliance rate estimated at under two percent; commissioner believes "people don't pay because they really don't understand how the use tax works").²

States that rely on use tax lose substantial tax revenue. See Direct Mktg. Ass'n v. Brohl , ––– U.S. ––––, 135 S.Ct. 1124, 1127, 191 L.Ed.2d 97 (2015) (low compliance with use tax leads to significant revenue loss).³

c. The drop shipment rule . The drop shipment rule, G.L.c. 64H, § 1, offers an alternative to the consumer-reported use tax scheme. The rule applies to a sales transaction such as the hypothetical online baseball glove purchase. When the wholesale supplier is engaged in business in the Commonwealth but the retailer is not, the drop shipment rule requires the Massachusetts wholesale supplier to collect and remit the sales tax due on the ultimate retail sale to the consumer. G.L.c. 64H, § 1.⁴ Because the sales and use tax schemes are "complementary," Town Fair Tire Ctrs., Inc . v. Commissioner of Revenue , 454 Mass. 601, 605, 911 N.E.2d 757 (2009), transactions subject to tax under the drop shipment rule, as retail sales, are exempt from use tax. G.L.c. 64I, § 7 (a ).

The commissioner has consistently interpreted and enforced the statutory drop shipment rule in the manner just described since the sales tax statute became effective in 1968, following the Supreme Court's National Bellas Hess decision that the Court reaffirmed in the Quill case. See, e.g., Letter Ruling 79-43 (Oct. 25, 1979); Letter Ruling 80-76 (Oct. 27, 1980); Letter Ruling 81-85 (Sept. 17, 1981); Letter Ruling 84-26 (Apr. 27, 1984); Letter Ruling 85-35 (Feb. 27, 1985); and Technical Information Release 04-26 (Oct. 21, 2004), 1 Official MassTax Guide, at PWS-112, PWS-451, PWS-481, PWS-521, PWS-640, PWS-696 (Thomson Reuters 2017). See also National Bellas Hess, Inc ., 386 U.S. at 758, 87 S.Ct. 1389. The rule is undergirded by the separate statutory presumption that a sale is a taxable retail sale, with the burden of proving otherwise placed upon the vendor. G.L.c. 64H, § 8 (a ).⁵

2. Background . D & H sells consumer goods to retailers at wholesale and delivers the goods to Massachusetts consumers and others on behalf of those retailers. D & H appeals from a decision of the board rejecting its claim to abate sales taxes assessed by the commissioner pursuant to the drop shipment rule for the period from September 1, 2006, to March 31, 2009. D & H challenges the manner in which the commissioner applied the rule to its business, arguing that the drop shipment rule required the commissioner to prove, for each challenged sale transaction, that the out-of-State retailer was not engaged in business in the Commonwealth and thus not itself compelled to collect sales tax. For the reasons that follow, we conclude that the commissioner and the board correctly determined that D & H was responsible as the vendor for collecting and remitting the sales tax due on products it sold to the out-of-State retailers and then delivered to consumers where it failed to meet its burden of proving that the retailers were engaged in business in Massachusetts. Accordingly, we affirm the decision of the board.

a. Facts . We summarize the findings of fact made by the board. See G.L.c. 58A, § 13 ("The decision of the board shall be final as to findings of fact"). D & H is a wholesale supplier of consumer products, including computer products, home electronics, and sporting goods, which it sold primarily to retailers like "big box stores" and their electronic commerce equivalents. At all times relevant to this case, D & H was incorporated and headquartered in Pennsylvania and had six warehouse distribution centers throughout the country. It employed a sales representative who lived and worked in Massachusetts. D & H considered this presence sufficient to establish nexus for sales tax purposes.⁶

Before contracting with retailers to sell and deliver goods, D & H required that all retailers submit a customer application. As part of that application, retailers were required to list all States in which they did business, and to provide copies of resale certificates swearing that all goods were purchased for resale, with sales tax to be collected by the retailer on ultimate sale to the end consumer. See G.L.c. 64H, § 8. The terms and conditions of the application stated that retailers would be billed sales tax until they furnished such certificates. This was an attempt by D & H to ensure that sales by D & H would not be characterized as taxable sales.⁷

The drop shipment transactions at issue were structured as follows. First, a Massachusetts consumer purchased a product from an out-of-State retailer. Second, the out-of-State retailer purchased the product from D & H. Finally, at the retailer's direction, D & H packaged and shipped the product directly to the Massachusetts consumer. Neither D & H nor the retailer collected sales tax on these drop shipment sales.

The commissioner conducted an audit of D & H records for the years 2006-2009, focusing on drop shipment transactions. The auditor identified the drop-shipment transactions as those with a ship-to address (i.e., the address of the end consumer) in Massachusetts but a bill-to address (that of the retailer) outside Massachusetts. From this group, the auditor first eliminated sales to retailers known to be engaged in business in Massachusetts, such as Best Buy and...