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Document 14 of 142.

June 29, 2000, Thursday

SECTION: PREPARED TESTIMONY

LENGTH: 4393 words

HEADLINE: PREPARED TESTIMONY OF MARK E. NEBERGALL PRESIDENT SOFTWARE FINANCE AND TAX EXECUTIVES COUNCIL

BEFORE THE HOUSE COMMITTEE ON THE JUDICIARY BEFORE THE SUBCOMMITTEE ON COMMERCIAL AND ADMINISTRATIVE LAW,

BODY:
Mark Nebergall is president of the Software Finance and Tax Executives Council (SoFTEC), the voice of the US software industry on finance and tax policy issues. SoFTEC's members are vitally interested in the area of taxation of Internet transactions because they make the software that enables the Internet to operate and they use the Internet and an efficient and cost effective channel for distribution of their products.

SoFTEC believes that Congress, in considering legislation dealing with state taxation of electronic and other forms of remote commerce, should be guided by three principles: such legislation should (1) encourage a process for developing a simplified and uniform state sales and use tax system which process gives equal voice to both business and government, and asks that the National Conference of Commissioners on Uniform State Laws (NCCUSL) lead the drafting process; (2) preserve Congressional authority under the Commerce Clause to regulate interstate commerce and not confer upon the states any additional authority to enforce sales and used tax collection obligations against remote vendors unless and until it is certain that the states in fact have made their tax systems simple and uniform; and (3) establishes bright lines that appropriately limit taxable presence for business activity tax purposes. The three bills before the Subcommittee, HR 4267, HR 4460 and HR 4462, all contemplate a process for developing a simplified and uniform state sales and use tax system. However, none of those bills provides a mechanism for drafting a system that gives equal voice to both business and government. In addition, while HR 4267 and HR 4460 mention the involvement of NCCUSL, they relegate it to a secondary role with governments leading the process. To be effective, legislation in this area should have NCCUSL lead the effort with business and government having equal roles as advisors.

The three bill also do not provide appropriate mechanisms for Congress to evaluate whether the states have effectively enacted simplified and uniform sales and use tax systems and whether it would be proper for Congress to exercise its power under the Commerce Clause giving the states additional authority to expand sales and use tax collection and remittance obligations against remote vendors. To be effective, any legislation in this area should provide for close congressional scrutiny of any simplified, uniform sales and use tax system, and any affirmative exercise of its power under the Commerce Clause should come only after Congress is certain that the system in place no longer imposes undue burdens on interstate commerce.

All three bills address the issue of taxable presence for business activity tax purposes. However, HR 4460 and 4462 contemplate retaining the current standards while lowering the standards sales and use tax collection and remittance. Only HR 4267 adopts and approach that would achieves a proper balance between the taxable presence standards for sales and use tax collection and the standards for business activity taxes.

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STATEMENT OF MARK E. NEBERGALL PRESIDENT SOFTWARE FINANCE AND TAX EXECUTIVES COUNCIL

before the house COMMITTEE ON THE JUDICIARY SUBCOMMITTEE ON COMMERCIAL AND ADMINISTRATIVE LAW

thursday, JUNE 29, 2000

HEARINGS ON: H.R. 4267, THE "INTERNET TAX REFORM AND REDUCTION ACT OF 2000"

H.R. 4460, THE "INTERNET TAX SIMPLIFICATION ACT OF 2000"

H.R. 4462, THE "FAIR AND EQUITABLE INTERSTATE TAX COMPACT SIMPLIFICATION ACT OF 2000"

Good morning Mr. Chairman and members of the Subcommittee. My name is Mark Nebergall. I am the President of the Software Finance and Tax Executives Council. My members and I thank you for the opportunity to present our views on the various Internet tax bill currently pending before your subcommittee.

SoFTEC is an organization comprised of the major software companies of the United States and its mission is to provide software industry focused public policy advocacy on tax and finance issues. Taxation of electronic commerce is an issue in which software companies have long held a keen interest. We make the software that enables the Internet to operate efficiently and also use it as a low-cost mechanism to distribute software to customers worldwide.

SoFTEC advocates policies that promote fair and efficient interstate and international taxation of goods and services contracted for and delivered using the Internet. We believe hat the cornerstone of these policies must be neutrality of tax treatment. Because the three bills that are the subject of this hearing go to the heart of these policies, SoFTEC has been following them very closely.

Before discussing the pending legislation, I would like to explain the criteria that SoFTEC uses to evaluate each of the bills.

A. Criteria Used to Evaluate Internet Tax Legislation

The first criterion is: does the legislation create a suitable environment in which simplification and unification of state sales and use tax systems can occur. This criterion has two components: (1) whether the legislation suggests a process by which a simplified system is developed that facilitates equal input by both business and governments, and (2) whether the legislation sufficiently identifies the issues that must be addressed in order to achieve meaningful simplification and unification at the state level.

SoFTEC firmly believes that any process for developing a simplified and unified sales and use tax system must involve both the tax administrators and the businesses that will be asked to comply with such a system. We reject any notion that the states are somehow in a better position to know which measures will lead to simplification and which will not. There are many businesses today that have a physical presence in several states and are already burdened by a plethora of multistate sales and use tax collection obligations. SoFTEC will not support any legislation that does not afford business an equal voice with state governments in the development of a simplified and unified sales and use tax system.

The business community has had much experience in dealing with state and local government in efforts to devise simpler sales and use tax system. We know full well that whenever such discussions take place in an environment that gives neither side control of the process that consensus is difficult to achieve. To increase the probability of consensus, SoFTEC believes that any process that gives business and government equal voice in the development of a simplified sales and use tax system requires the appointment of some neutral third-party decision maker.

We believe that the National Conference of Commissioners On Uniform State Laws (NCCUSL) is the body best suited to perform the functions of neutral third-party in such a process. NCCUSL is a body that is over 100-years old and has given us uniform state laws such as the Uniform Commercial Code and the Uniform Trade Secrets Act. NCCUSL's forte is the development and enactment of uniform laws at the state level. SoFTEC is comfortable that NCCUSL's procedures ensure equality of voice between business and government. In addition, NCCUSL's expertise in drafting and enacting uniform state laws could prove useful in the effort to draft a simplified and uniform state sales and use tax system.

On the issue of substance, SoFTEC believes that any federal legislation aimed at reducing the current burdens on interstate commerce imposed by the differing state sales and use tax systems should address the issues for which simplification is needed. Simplification issues include first and foremost a reduction in the number of different tax rates and uniform definitions of items that a state might include in its tax base. While some attempt to catalog the issues for which simplification is desirable, care must be taken to ensure that those charged with the task of developing a simplified and unified system have flexibility in addressing other issues that might come to light during the process. In other words, the drafting process must not be hamstrung with a rigid list of issues that at first appears complete but later is found lacking.

The second criterion that SoFTEC uses in evaluating Internet tax legislation is: does the legislation set forth an appropriate process for Congressional consideration of whether a sufficient number of states have simplified and unified their tax systems to the extent that the undue burden on interstate commerce is relieved and an expansion of the duty to collect and remit taxes is justified? As you know the Supreme Court repeatedly has ruled that the current system could entangle interstate business in a virtual welter of complicated and burdensome interstate obligations to state and local jurisdictions and that this is a domain where Congress alone has the power of regulation and control.

SoFTEC firmly believes that if Congress is to give consideration to expanding the states' authority to impose a tax collection and remittance obligation on out-of-state vendors, it should first require the states to develop and implement a simplified and uniform system and then study the experience of multistate taxpayers operating under it. Only then will Congress have available to it evidence against which to judge whether the burdens on interstate commerce found by the Supreme Court have been relieved to the degree that an expansion of the duty to collect and remit sales taxes is warranted.

The third criterion used by SoFTEC in evaluating Internet tax legislation is: does the legislation include protections against aggressive business activity tax claims by state governments. Many states impose an income tax or other business activity tax such as a franchise tax or business license tax on firms that do business in their state. Businesses with a taxable presence in more than one state are required to apportion their income among those states and pay a business activity tax on the income apportioned to each state.

In this regard, it is important to keep in mind the distinctions between the sales and use tax and the business activity tax. In the sales and use tax context, the taxpayer is the customer of the vendor and the vendor merely collects that tax from the customer and remits to the state. The business activity tax is levied directly against the business that earned the income. Many businesses that operate from a single physical location nevertheless find themselves subjected to claims by other states for business activity taxes. These claims often result in costly and time-consuming litigation. Many times, state revenue departments visit novel taxable presence claims against small business that lack the resources necessary to finance expensive tax litigation, forcing these businesses to pay a questionable tax liability.

A few examples of the novelty of the claims state revenue departments make to support their contention that an out of state business has a taxable presence in their state reveal the lengths to which the states will go to assert taxing jurisdiction against an out of state company. New Jersey has asserted that because an out-of-state software company licensed its products to New Jersey customers instead of selling its products, the software company was obligated to file a New Jersey income tax return and to pay an income tax. New Jersey also asserted against the same company that taxable presence was triggered because New Jersey customers could receive technical support by telephone from the out-of-state software company. In another case, Tennessee asserted that an out-of-state credit card issuer had a taxable presence because it retained legal ownership of the credit cards used by its customers in Tennessee. Because the New Jersey case was against a small company, the case was never litigated. The Tennessee Supreme Court ruled against the state tax authorities in the credit card case.

If Congress were to exercise its power under the Commerce Clause and grant states expanded power to require out of state vendors to collect and remit sales or use taxes, then those states will come into possession of accurate information regarding the volume of sales the out of state vendor is making into a state. The states make no apologies that they will use this information in order to assert business activity tax claims against out of state businesses. The states will have greater incentive to make these kinds of claims, which we consider questionable, described above in the New Jersey and Tennessee cases. Unless Congress enacts some bright line tests regarding taxable presence for business activity tax purposes, businesses will be subjected to the same sort of undue burden that motivated the Supreme Court to limit states authority in the sales tax cases.

The states vigorously oppose any clarification of the standards for determining when a business has a taxable presence. They claim improper infringement of states rights. However, the Constitution gives the Congress plenary power in this area. Indeed, Congress exercised that power in the area of income taxation of multistate business when it enacted P.L. 86-272 in 1959 (15 U.S.C. Sec. 381). This statute prohibits states from imposing an income tax obligation against an out of state vendors whose only contacts within a state amount to the solicitation of orders for sales of tangible personal property where the order are sent outside the state for approval and if accepted, the goods are shipped into the state by common carrier. Given the states' continued abuse of their taxing power by making questionable claims against nonresident taxpayers, we believe it appropriate for the Congress to intervene and set bright line standards. Thus, we believe that any federal legislation in this area should include provisions that establish bright lines for purposes of business activity taxable presence.

That concludes the discussion of the criteria SoFTEC uses to evaluate Internet legislation. I now will turn to an examination of the three bills in light of those criteria.

B. Application of Criteria to Internet Tax Legislation

Currently pending in the House of Representatives are three separate Internet tax bills: H.R. 4267, the "Internet Tax Reform and Reduction Act of 2000," H.R. 4460, the "Internet Tax Simplification Act of 2000" and H.R. 4462, the "Fair and Equitable Interstate Tax Compact Simplification Act of 2000." Application of the criteria to each of these bills reveals that none of them meets all of the criteria. Some of the bills meet some of the criteria to differing degrees.

1. Simplification Process:

The first criterion to be addressed is whether the legislation suggests an adequate process for achieving a simplified and unified sales and use tax system. In order for the particular legislation to satisfy this criterion, it must give equal voice to both business and government and it must contain an adequate specification of the issues on which simplification would be desirable. SoFTEC also recommends that the legislation appoint NCCUSL as a neutral third-party for drafting the proposed system.

All three bills propose a process for developing a simplified and uniform sales and use tax system. HR 4462 cedes to state and local governments the task of drafting the system. HR 4462 seems to suggest that business should have no voice in this process. In fact, after specifying a number of simplification issues that the system should address, it goes so far as to provide that the system should include only those other provisions that states deem warranted. In addition, the findings section of HR 4462 contains provisions that plainly provide that the states should take the lead in this area.

HR 4267 and 4460 are somewhat better than HR 4462 in that they both provide for NCCUSL participation in the drafting process and neither contain findings suggesting that the states are somehow in a better position to craft the system than the business community.

Nevertheless, neither HR 4262 nor 4460 make any express provision for business participation in the drafting process. Also, neither bill places NCCUSL in charge of a process that employs its usual procedures for drafting and enacting uniform state legislation. SoFTEC believes that the usual NCCUSL procedure will give equal voice to both business and government and will not give undue weight to the desires of either.

We would suggest language along the lines of:

It is the sense of Congress that the National Conference of Commissioners on Uniform States Laws, with the advice of and in consultation with representatives of State and local governments, business, and taxpayers, should develop a simplified and uniform sales and use tax system that would be adopted by the States and that contains the following:

All three bills contain provisions that detail the issues on which simplification is desirable. Generally, while some fine tuning of some of the specific provisions might be in order, the list of simplification criteria in each bill should lead to the development of a simplified and uniform sales and use tax system that should go a long way to relieving the undue burdens on interstate commerce that currently exist.

2. Process for Congressional Consideration of Expanding the Duty to Collect and Remit Sales Taxes

SoFTEC fully understands that state and local governments want Congress to use its power under the Commerce Clause to expand the states' power to require out of state vendors to collect and remit sales and use taxes. SoFTEC does not oppose Congressional consideration of this issue. However, SoFTEC believes that Congress should not consider exercising its constitutional power in this area unless and until it is satisfied that the burden imposed on interstate commerce is drastically reduced.

HR 4267 would replicate the Advisory Commission on Electronic Commerce established by the Internet Tax Freedom Act for the purpose of reviewing the "Uniform Sales and Use Tax Act" which is this bill's version of a simplified and uniform sales and use tax system. This second commission would make a recommendation to Congress as to whether any state should be permitted to expand out of state vendors' obligation to collect and remit sales and use taxes. This recommendation is due 180 days after NCCUSL finishes drafting the proposed Uniform Sales and Use Tax Act.

First, SoFTEC does not support the creation of a second commission to study the issues and provide a recommendation to Congress. SoFTEC believes that the usual committee referral and hearing process should accompany any Congressional consideration of these issues. Enactment of a federal law that permits states to conscript out-of-state vendors as tax collectors is significant legislation. Congress should hear the evidence first hand rather than delegate the fact-finding process to a commission.

Also, SoFTEC believes it appropriate to allow for a test period whereby the putative simplified and uniform system is used by taxpayers that currently have multistate sales and use tax compliance obligations. Only after it is clear that the simplified and uniform system drastically reduces the compliance burdens of multistate business should there be any consideration to expanding it to all other business. The 180-day period specified in HR 4267 is insufficient. SoFTEC respectfully suggests that a test period on the order of 2-years would be appropriate.

HR 4460 merely provides for a certification by the Secretary of the Treasury that a Streamlined Uniform Sales and Use Tax Act meets the simplification criteria specified in the bill. Once a state has adopted the "streamlined" system (apparently regardless of whether the Treasury Secretary has certified it) that state will automatically be authorized to compel out of state vendors to collect and remit transactions taxes. This, in our view, constitutes an inappropriate transfer of Congress' power under the Commerce Clause to the states. SoFTEC respectfully suggests that the Subcommittee request the views of the Attorney General on whether such a mechanism is constitutional before it considers approving such legislation.

HR 4462 does contemplate some form of congressional consideration of the simplification measures taken by the states before states are authorized to enforce an expanded duty to collect and remit sales taxes. The schema contemplated by this bill would authorize the states to form an interstate compact for sales and use tax purposes. When 20 states have joined the compact, the President would be authorized to submit a report to Congress certifying that the terms of the compact conformed to the requisite simplification criteria. Then, using a fast-track procedure modeled on the 1974 Trade Act, Congress would be required to pass a resolution that disapproved of the President's finding. If Congress failed to pass a resolution disapproving of the President's finding, then the states that had joined the compact would automatically be granted authority to enforce sales and use tax collection obligations against remote vendors.

SoFTEC has several problems with the approach taken in HR 4462. First, we believe that there may be a constitutional problem with Congress delegating to the states the authority to draft an interstate compact. Our understanding is that whenever Congress approves an interstate compact, it approves the precise language. There may be an issue whether Congress has the authority to delegate its power in this area. This is another area where the opinion of the Attorney General might provide some guidance.

Also we find the "disapproval resolution" procedure dubious. We find astonishing a provision that abdicates completely Congress authority to regulate commerce between the various states by providing for automatic approval of expanding states' collection authority if Congress does not affirmatively deny their request. We firmly believe that the future cannot be predicted with the accuracy sufficient for Congress to say today that the simplification criteria set out in the bill are all that is needed to eliminate the current burdens on interstate commerce, or that the states will effectively implement a simplification program. Therefore, Congress must retain control of the debate and the authority in this area.

In fact, if history can serve as a portal to the future, the states have been on notice for over 30-years that their tax systems are overly complex. In that time, instead of moving towards more simple systems, they have made their systems more complex. For example, we see states adopting sales tax holidays where certain consumer goods are sales tax free during certain times of the year. In those states, in addition to all of the other complexity, it matters what time of the year an item is purchased whether it is subject to the sales tax.

The "disapproval resolution" procedure of HR 4462 displays too much confidence in the states' ability to simplify their tax systems. SoFTEC believes that Congress should demand hard proof that a system is simple and uniform in practice before it even considers exercising its powers under the Commerce Clause in this area.

Congress should jealously guard its power under the Commerce Clause and should not transfer it to the states on their promise that they will simplify and unify their tax systems.

To summarize, none of the three bills under consideration provide a suitable mechanism for Congress to examine the effectiveness of the states' tax simplification efforts. While SoFTEC does not oppose congressional consideration of allowing the states authority to enforce interstate sales tax collection obligations, we feel strongly that it should do so only after a sufficient foundation has been established.

3. Taxable Presence for Business Activity Tax Purposes:

The last criterion to be discussed is whether any of the legislative proposals seek to establish bright lines for taxable presence in the area of business activity taxation. There is a direct link between allowing states authority to require out of state vendors to collect and remit sales and use taxes and the current authority of the states to apply their income and other business activity taxes directly against that out of state vendor. As noted above, the former arms the state revenue departments with an arsenal of information that could be used to assert direct tax claims against out of state business with no connection to the state other than the existence of in-state customers.

All three bills contain language that could be construed as impacting taxable presence for business activity tax purposes. Both HR 4460 and HR 4462 contain language that makes clear that the authority granted in the sales and use tax area has no impact on the taxable presence rules for any other tax purpose. These two bills would merely preserve the current taxable presence rules for business activity tax purposes and fail to recognize the definite link between the sales and use tax rules and the business activity tax rules. When the bar for sales and use taxes is lowered, it is necessary to raise the bar for business activity tax purposes. These two bills would leave the bar unchanged.

HR 4267 contains provisions that effectively raise the taxable presence bar for business activity tax purposes. Many of the provisions contained in HR 4267 either are current law or draw lines that otherwise are appropriate. While one may be able to argue about the details of the bright lines contemplated by HR 4267, we believe it charts the right course in reigning in overly aggressive state revenue departments in an environment where the sales tax collection thresholds have been lowered. SoFTEC supports the approach taken by HR 4267 in this area.

C. Conclusion

SoFTEC believes that each of the three bills before this have provisions promote simplification of state sales and use tax systems. However, each also has provisions that either are inappropriate or deficient. We hope that when the Subcommittee moves towards a mark-up of Internet tax legislation it makes use of the criteria we have set out in our testimony.

On behalf of SoFTEC's members, I thank the Subcommittee for the opportunity to present this testimony.

END

LOAD-DATE: July 6, 2000

Document 14 of 142.


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