Internet Taxation

GOVENOR JOHN CROSS

FROM: INTERNET TAXATION RESEARCH COMMITTEE MEMBERS

SUBJECT: MEMORANDUM TO GOVENOR'S OFFICE REGARDING PROPOSED INTERNET SALES TAX

DATE: 5/17/2007

The advent and expansion of the Internet have brought the issue of the application of state and local sales taxation to Internet, telephone, catalog, and other "remote sales" to the forefront of the policy debate. Under current law, states cannot require corporations without a substantial presence within their borders to collect and remit sales taxes. While all states do require residents to remit the taxes owed in the form of use tax payments, few people send in use tax forms, rendering remote sales essentially tax-free. The revenue loss due to the lack of taxation on Internet sales has been minimal thus far; however, states are concerned that the growth of the Internet will lead to a substantial drain on revenue. After extensive research and consideration, the committee recommends against implementing a tax on Internet sales transactions. Reasons are discussed below.

Background

In 1999, the National Conference of State Legislatures (NCSL) and the National Governors Association tasked state revenue departments with the responsibility of evaluating the sales-tax system, as it existed at that time and to radically simplify the system (Field, 2005). Online retailers have long fought against such moves. They have done so both because of the aforementioned complexity of the various states tax codes and because whichever company would first require its customers to pay sales taxes would face a competitive disadvantage (eWeek, 2003).

According to ( )"Both sides in this debate point to a pivotal U.S. Supreme Court decision in 1992, which essentially said that states cannot force businesses to collect sales tax from customers unless that business has a "physical presence" in the state where that customer is based. Note that the high court's decision was in 1992, a full two years before the commercial Web existed. The states argue that it is legally easier for them to go after the Web sites. And therein lies the implicit threat and the only stick the states hold: They are making a not-so-subtle threat to start suing e-commerce sites unless they start collecting state sales tax. The SSUTA group set Oct. 1 as a target date for states to start enforcement. The legal standing that the states would have to force e-commerce sites to comply is weak at best, but it's the classic lawsuit threat: "We may lose, but you'll be forced to spend tons of money for lawyers and appearing in courtrooms and giving depositions. And, heck, there's always a chance that we'll win, so you might as well do what we want now and not take any chances"

Argument Against Internet Sales Taxes

Remote Sales and Taxation Issue

In a series of opinions, the Supreme Court has ruled that states cannot compel firms without a substantial nexus" within the taxing state to collect and remit use taxes. The most important cases are National Bellas Hess, Inc. v. Department of Revenue of Ill. and Quill Corp. North Dakota. "Substantial nexus" has been interpreted to mean a physical presence, and precludes states from requiring vendors whose only connection to the state is by mail, phone, or Internet to remit taxes. In their 1992 decision in Quill, the court ruled that requiring out-of-state vendors to collect the use tax created an unconstitutional burden on interstate commerce because "the many variations in rates of tax, in allowable exemptions, and in administrative and record-keeping requirements could entangle National's (the plaintiff) in a virtual welter of complication obligations." At the same time, the ruling indicated that such taxation is not unconstitutional per se and would be permissible if authorized by Congress. The Supreme Court's decision in Quill related to the ability of states to compel vendors to collect and remit use taxes.

Uniformity

Before any taxation is imposed upon any e-business, there should be uniform definitions of exactly what types of sales are to be taxed and what is not. Currently, the 45 states that tax sales have several differing (and sometimes conflicting) definitions on what constitutes a sale that should be taxed. In the Internet environment, there would be entirely too much confusion and administrative burden with audits, etc for e-businesses to have to collect sales taxes for every sale made. If consumers will be taxed on sales, that taxes should show up on the consumers total sale amount. For instance, it would be unfair for consumers to have already paid by credit card for a purchase online that is then not sent (held hostage) unless the consumer pays yet more--in the form of sales taxes--to complete their purchase.

One simple example was seen in a Washington State consumer purchasing a used CD from Amazon.com. The used CD actually was being sold from a small business in Washington State. The consumer paid a total price for the CD on Amazon via credit card. Then two days later, while expecting the CDs to arrive in the mail, the consumer instead received an email regarding a requirement to pay sales tax on one of the CDs because the seller and consumer were both in WA State. The consumer was quite frustrated with this sales tax request because it should be that all costs were noted at time of sale online. This is a specific case where the sales tax issue must be resolved and taxing isn't always the answer. Does the state want to limit where and to whom many small business e-businesses will sell? Without a doubt, taxation of e-businesses and/or e-consumers will result in a greater tax administrative burden, and "stifle innovation," as Aspen Publishers of Telecommunications Report states it. Most likely the largest impact will be on the small e-businesses in both business-to-business and business-to-consumer transactions. It would be extremely difficult for taxation to be fully implemented on e-commerce at this time, with