LEXIS-NEXIS® Congressional Universe-Document

Search Terms: internet W/10 sales W/10 tax, House or Senate or Joint

Document 49 of 142.

View Related Topics

May 16, 2000, Tuesday

SECTION: PREPARED TESTIMONY

LENGTH: 5337 words

HEADLINE: PREPARED TESTIMONY OF HARLEY DUNCAN EXECUTIVE DIRECTOR THE FEDERATION OF TAX ADMINISTRATORS

BEFORE THE HOUSE COMMITTEE ON WAYS AND MEANS SUBCOMMITTEE ON OVERSIGHT

SUBJECT - INTERNET TAX ISSUES

BODY:
Mr. Chairman and Members of the Committee:

My name is Harley Duncan. I am Executive Director of the Federation of Tax Administrators. The Federation is an association of the principal state tax administration agencies in the 50 states, D.C., and New York City. Thank you for the opportunity to appear before you today on the general subject of the state and local tax issues involved with electronic commerce.

The policy of our organization in this area has been established generally in two resolutions adopted by our members at the June 1999 Annual Meeting in Milwaukee, Wisconsin. The first resolution advocates simplification of state sales and use tax structures and administration as a prelude to requiring collection of sales and use taxes by all sellers above a de minimis sales volume threshold, regardless of whether they have a physical presence in the taxing jurisdiction. The second resolution contains a general position against federal preemption of state tax sovereignty and tax authority. In this testimony, I would like to achieve five goals: Provide a high-level overview of the essential features of state and local sales and use taxes;

- Outline the primary state and local tax issues associated with electronic commerce; Identify the expected revenue impact on states and localities of electronic commerce; Outline a general approach to an appropriate resolution of the issue; and Review the reasons that many state and local officials have called on Congress to reject the so-called 'majority report' of the Advisory Commission on Electronic Commerce.

Basics of State and Local Sales and Use Taxes

Forty-five states plus the District of Columbia levy a sales and use tax. In addition, local governments in approximately 30 states are authorized to impose a local sales tax. In all but four states (Alabama, Arizona, Colorado and Louisiana), these local taxes generally "piggyback" on the state tax base and are collected by the state tax administration agency on behalf of the local government.1 Sales tax rates range from 3 percent to 7 percent at the state level; local option rates generally run from 1 to 2 percent. The "average" state and local tax rate in the U.S. is roughly 6.0-6.5 percent.

Every state with a retail sales tax also levies a "compensating use" tax, often simply referred to as the use tax. A use tax is levied on all taxable goods and services that are used and consumed in the taxing state if there has not been paid an appropriate sales tax. Thus, goods and services on which no sales tax has been collected are subject to the compensating use tax.

The sales tax is a consumption tax that is applied on a destination basis, meaning the tax is applied in and remitted to the jurisdiction in which delivery of the good or service is taken or where it is to be used or consumed. (Receiving goods at the time of sale is considered taking delivery. The point of delivery is presumed to be the jurisdiction in which consumption occurs.) Goods and services travelling through multiple jurisdictions or involving multiple jurisdictions are still taxable only in the state of consumption or use.

A seller may not be required to collect use tax on goods shipped to a buyer in another state unless there is a sufficient "nexus" or level of contact between the seller and the state of the buyer. The U.S. Supreme Court has held that for an out-of-state seller to be required to collect use tax on goods and services sold into a state, the seller must have some physical presence in the state of the buyer, either directly or through the activities of a representative.2 If the sales or use tax is not collected by the seller because of the lack of a requirement to do so, the buyer is still responsible for payment of the use tax directly to the state in which the good or service is used or consumed.

Tax Issues Raised by Electronic Commerce

Collection of Tax on Remote Electronic Commerce Sales

In terms of potential revenue effect, the largest and most immediate issue raised for state and local governments is, by far, the potential increased sales tax base erosion caused by the explosion in electronic sales/3 on which no sales or use tax is collected because the seller has no nexus with the state in which the buyer resides. In many ways, electronic commerce can be likened to the long-standing issue of mail order or catalog sales in which state and local use tax is not collected because the seller has no physical presence or nexus with the state. This is particularly true of the sale of tangible goods where it is only the medium through which the transaction is conducted that differs, not the nature of the product.

The remote sales tax collection issue arises because of the U.S. Supreme Court decision in Quill Corp. v. North Dakota (1992), upholding its decision of 25 years earlier in National Bellas Hess v. Illinois Department of Revenue (1967). The Court held that, under the Commerce Clause, a taxing state could not require an out-of-state seller whose only contacts with the state were the solicitation of orders by catalog and shipping goods by common carder or U.S. mails to collect use tax on goods shipped into the state. Without such a physical presence, the Court held, requiring a seller to comply with the sales tax laws of each jurisdiction and the large number of local tax rates would create an undue burden on interstate commerce.4 The combination of the Quill physical presence rule with the advent of electronic commerce exposes state and local sales tax system to a potentially large erosion of the tax base. A hallmark characteristic of the Internet is its ability to allow a seller to market directly to individual consumers on a worldwide basis while, at the same time, minimizing the physical facilities necessary to undertake such efforts. As a consequence, the exposure of state and local sales tax systems to remote sales is magnified exponentially.

The issue is not limited only to purchases by individual consumers. State and local sales and use taxes generally apply to purchases by businesses where the item purchased is for use and consumption by the business itself, rather than for resale or incorporation into an item being resold to another consumer. Where tax is not collected by the seller (because of nexus reasons), the purchaser is to accrue and remit tax on its purchases. Use tax compliance among businesses is substantially better than among individuals because many of them routinely accrue tax and they are routinely subject to audit. Nonetheless, the noncompliance in the area of business purchases should be.expected to increase as more sellers use the Internet to accomplish what once took sales personnel and in-state facilities.

The consequences of a rapidly growing volume of retail transactions going effectively untaxed (even though the tax is owed by the consumer) are several: (1) Erosion of the retail sales tax base and revenue stream; (2) Violation of a principle of tax neutrality because sales of identical goods are taxed differently based only on the location of the seller; (3) Unfair competition with Main Street and other businesses required to collect tax on their sales; (4) Growing concerns about the long-term viability of the sales tax as a mainstay in the state and local tax structure.

That is to say, the issue goes well beyond that of the amount of revenues available to states and localities although that too is an important issue. There is an important issue of the competitive disadvantage faced by fixed-base retailers and others who are required to collect tax. The threat to their survival from this built-in, government-sanctioned disadvantage is real. Likewise, the long-term threat to the sales tax as a whole cannot be overstated. If a tax is seen as increasingly unfair because some have to pay and some do not (and the only reason for the difference is the manner in which a purchase is made), the end result may be demands to repeal the tax for everyone.

Complexity of the Current System

Another effect of electronic commerce has been to shine a spotlight on the complexity of the current sales and use tax system and its administration for sellers, particularly those operating on a multistate basis. As efforts to address the remote sales issue are undertaken, they run headlong into the complexity of the current system, and the "undue burden" it places on sellers required to comply. Discussions of the state and local tax issues associated with electronic commerce naturally include a discussion of ways in which the current system can be simplified and made more uniform across states.5 Likewise, any resolution of the remote sales issue will necessarily entail substantial simplification of the tax.

The complexity arises from the simple fact that the sales tax has been developed as a stand-alone tax in each state without a great deal of regard for the degree to which it conforms to similar taxes in other states. This is natural since when sales taxes were developed, most retail activity was confined to a single state. As a result, there are differences in tax bases across states, differences in administrative laws and procedures as well as differences in filing, returns and remittances.

Another aspect of complexity in the current system is the extent to which local option sales taxes are used. Over the last 30 years, in an effort to reduce reliance on property taxes, states have increasingly authorized local governments to levy sales taxes (often only after approval by the voters). Local governments in 30 states now levy sales taxes. While the base and administration are generally piggybacked on the state sales taxes, the rate varies across some localities. The result is considered complex by multistate sellers that are required to identify the jurisdiction into which an item is being sold, determine the appropriate tax rate, and account for tax collected in each local jurisdiction.

Impact of Electronic Commerce on State and Local Tax Revenues

There have been several studies done of the impact of electronic commerce on state and local revenues.6 The most comprehensive has been prepared by Donald Bruce and William Fox, two University of Tennessee economists.? Bruce and Fox use forecasts of electronic commerce sales into the future (2003) to look at the expected near-term magnitude of the impact. They also try to estimate the impact in both the business- to-consumer (B2C) and the business-to-business (B2B) markets. They also account for the current impact of mail order sales on state revenues and the substitution of e-commerce sales for mail order as well as the "natural" decline in state tax bases due to a shift to services in the economy.

The results of the Bruce and Fox analysis can be summarized as follows. In 2003, the total amount of state and local sales and use taxes going uncollected due to electronic commerce is projected to be $20.1 billion. The 'incremental' (i.e., sales newly shifted to electronic commerce) impact is estimated at $10.8 billion, of which about 70 percent is from B2B sales. On a state-by-state basis, the projected total state and local revenue impact due to ecommerce ranges from $31.8 million in Vermont to $2.8 billion in California. The expected impacts exceed $1 billion in each of New York, Texas and Florida. Expressed in terms of total tax revenues, the revenues not collected due to e-commerce range from 4.9 percent of total taxes in Texas to 1.5 percent in D.C. It is over 4 percent in each of Florida, Nevada, South Dakota, Tennessee and Texas. On average, states would have to raise their sales tax rates by 0.5- 0.75 percentage points to maintain constant revenues in 2003, i.e., to offset the impact of e-commerce on tax receipts.

Potential Solution To Remote Sales)Use Tax Collection

Policy Objectives

Congressional activity to address the issue of electronic commerce and remote sales should, in my estimation, focus on several policy objectives, including: Ensure that the tax system is neutral across all types of sellers, regardless of the channels through which they choose to market; Preserve the sovereignty of states to design their tax systems to fit their own circumstances, particularly as to the taxes employed, items to be taxed and tax rates; Promote substantial simplification and greater uniformity across states so as to minimize the burden imposed on sellers to comply, particularly smaller retailers; Foster the use of advanced technology in administration of and compliance with the sales tax system; and Protect the privacy rights of consumers

Expanded Duty to Collect

From a tax administrator perspective, the answer to the potential erosion of the sales tax base by electronic and other remote commerce seems clear. Congress should use its authority under the Commerce Clause to authorize states to require sellers without a physical presence in the state to collect use taxes on goods and services sold into the state. Included within the authorization should be a requirement that states accomplish meaningful simplification of the sales tax and its administration as well as a de minimis threshold stated in terms of a dollars-denominated sales threshold below which a seller would not be required to collect tax for multiple states.8

There are at least two types of federal legislative vehicles that could be used to implement a system such as that outlined here. First, Congress could pass a law simply authorizing those states that modified their sales tax law to meet certain standards to require remote sellers above the de minimis threshold to collect tax. Congress has considered similar legislation in recent years.

Alternatively, Congress could authorize states to form an interstate sales tax compact and authorize states that join the compact to require remote sellers to collect tax on goods and services sold into the state. A requirement of participation in the compact would be to adopt a sales and use tax law that met certain standards of simplification and uniformity that Congress considered necessary. Such a compact could achieve the same or greater simplification and uniformity objectives as federal legislation and leave a greater proportion of the details to the states. It could also provide a framework for ensuring continued uniformity and simplification over time.

The Federation has not expressed a preference for one vehicle over another. We would urge the Congress to include an examination of the appropriate vehicle as it considers this issue.

Simplification and Uniformity B Streamlined Sales Tax Project

States and localities recognize that concomitant with any expanded duty to collect use taxes there must be a significant simplification and improvement in uniformity in state and local sales taxes and their administration. In an economy that is increasingly multi- jurisdictional, it is necessary for states to cooperate in the design and administration of their taxes so as to facilitate commerce and to reduce compliance burdens for the increasing number of multistate sellers. Simplification also has rewards for fixed-base retailers.

States have initiated a project called the "Streamlined Sales Tax System for the 21st Century." The Project is intended to overhaul the existing sales and use tax system to better accommodate interstate commerce, especially the changes presented by electronic commerce. The Project is aimed at developing a substantially simplified sales and use tax system while employing emerging technologies to remove or reduce the burden on sellers for collecting the taxes, with the states contributing substantially to the financing of the streamlined system. There are approximately 30 states participating in the Project at this time. Further information on the Project membership and organization is available at <www.streamlinedsalestax.org>.

There are four key aspects to the Streamlined Sales Tax system being developed.

Strategic Simplifications. The Project is developing a series of simplifications that will substantially reduce the burden associated with sales and use tax collection. Among the primary simplifications are uniform definitions of items that may be included in a tax base, simplified and uniform exemption administration, repeal of the "good faith acceptance" rule for exemption certificates, uniform sourcing rules, limitations on local tax rate changes, simplified returns and remittances and centralized registration. The simplifications being addressed are primarily those that have been identified as most critical by fixed-base and electronic commerce retailers.

Use of Advanced Technologies. A second major component of the project is the use of emerging technologies to reduce the burden on sellers. A number of companies provide technology and services to assist sellers in calculating the taxes due on a given sale. The range of services offered varies from a simple tax calculator to compiling and filing returns and tax remittances. The aim of the project is to "certify" qualifying technology vendors as offering a service that meets the requirements of state sales tax law. Sellers that use certified technology would then be provided a "safe harbor" against future audit assessments for any failure attributable to the certified software.

Paying for the system. The project is committed to financing as much of the system as it reasonably can for sellers. The primary method of financing sellers' participation will be through vendors' compensation i.e., allowing sellers, or their tax service providers, to retain a portion of the sales and use tax collected as compensation for collection of the tax.Privacy concerns. Provisions will be included in all aspects of the project's work to ensure that personal information is not unnecessarily gathered and is not improperly used by persons engaged in the tax administration process. Tax administration agencies will not come into possession of personal identifying information for an individual paying tax at the time of a transaction. Tax calculation service providers will be prohibited from using personal information for any non-tax-administration purpose.

Rationale Beyond the protection of the state and local revenue base, an expansion of the duty to collect sales and use tax under a simplified administrative system promotes several tax policy goals and strengthens federalism. It promotes neutrality in the tax system by treating all purchases of the same or similar products similarly, regardless of the seller. It will promote equity among sellers and eliminate an 'unfair' competitive advantage now enjoyed by remote sellers who are not required to collect tax compared to the Main Street/shopping mall seller who is required to collect. It recognizes that the current approach of each state independently administering its own tax is inefficient and imposes undue burdens on multistate sellers. It recognizes that multistate cooperation and uniformity are required to promote simplification and avoid other more dire consequences such as federal intervention. By strengthening the sales tax, it will also strengthen our system of federalism. If the largest single state and local revenue source is crippled, the strength of states and localities as partners in that federal system is weakened.

"Majority Report" of the Advisory Commission on Electronic Commerce The Internet Tax Freedom Act created the Advisory Commission on Electronic Commerce (ACEC). The Commission was to be a balanced representation of the public and private sector interests at stake in the issue of taxation of electronic commerce. Its mission was to undertake a thorough study of the federal, state and local tax issues associated with the taxation of electronic commerce and to make recommendations to Congress for ways to resolve those issues. Any recommendations to Congress were required to have the support of two thirds of the Commission members.9

Shortcomings of the Report

Many state and local officials have been forced to conclude that the Commission fell woefully short of its goal. Forty-two governors have written to the leadership of the Congress asking that they reject the Commission report? Over 100 academic economists have also signed a letter criticizing the report as reflecting inappropriate and misguided tax policy. State and local officials see four major shortcomings in the ACEC report.

Unlevel Playing Field. Rather than promoting neutrality across marketing channels and creating a level playing field for all retailers, the ACEC recommendations further tilt the playing field against fixed-base retailers and others currently carrying the state and local tax burden. The ACEC recommendations would open many new opportunities for fins to actively engage in business in a state without incurring tax obligations. As such, they exacerbate, not eliminate, the competitive disadvantage faced by fixed-base retailers and other taxpayers.

Failure to Address Remote Sales. The ACEC report fails to address in any meaningful way the remote sales tax collection issue outlined earlier. The report would have required states and localities to develop and implement a series of mandated simplifications, which process would have been followed by an elongated, inconclusive and likely negative review of whether tax collection obligations should be extended to remote sellers.

Preemption of State Sovereignty. If adopted, the recommendations of the ACEC would constitute a frontal assault on the sovereignty and authority of states to determine their own tax structures. It would have, for the first time in our nation's history, placed nearly complete authority over the details of state tax law in the hands of the U.S. Congress. As such, the report showed little understanding of federalism or the role of the states in the federal system.

Unwarranted Tax Preferences. The report recommends, with little or no justification in most instances, that Congress preempt state tax authority in several key areas. These areas include an exemption for Internet access charges and all digitally delivered goods and services as well as their tangible counterparts. In addition, the report calls for Congress to enact a federal law mandating that a series of activities (commonly carded on by electronic commerce firms) could not be considered to constitute nexus for sales and use or business activity taxes. Taken together, these nexus carve-outs would enable electronic commerce firms to engage in a wide range of activities within a state without being required to meet tax obligations in the state and would exempt a considerable portion of their content and activities from tax. Estimates are that the combination of the tax preferences included in the ACEC report, discussed in more detail below, would reduce current law state and local tax revenues by as much as $25-30 billion per year.

Further Discussion

Internet access.

The majority report recommends making permanent the Internet Tax Freedom Act's moratorium on any transaction taxes on the sale of Internet access, including taxes that were grandfathered under the ITFA. At present, the following 11 states impose the sales tax (or a similar gross receipts tax) on such charges: Connecticut, Hawaii, New Hampshire, New Mexico, North Dakota, Ohio, South Dakota, Tennessee, Texas/11, Washington State and Wisconsin.12 In each case, the tax is part of a broader based tax (e.g., sales tax) and is not a levy targeted specifically at Internet charges. The impact of this repeal of the grandfather clause is approximately $75 million per year, according to information submitted by the states to FTA.

There are three additional issues that must be considered in any permanent or long-term moratorium: (1) Dealing with other services that may be bundled with access; (2) The addition of substantial mounts of content to a package including access; and (3) Apparent competitive issues that arise as Internet telephony technology improves and takes hold.

Digitized goods and their counterparts. The majority report recommends a tax exemption for "sales of digitized goods and products and their non-digitized counterparts." Such preemption would do substantial damage to the tax base of a number of states. Twenty-eight states currently consider downloaded software to be taxable, and nineteen states consider downloaded information to be taxable. About fifteen states tax a broad category of "electronic information services."

An exemption for "digitized goods and products" would logically apply to all subscriptions to on-line databases and information services, on-line publications, on-line photos and movies, and a variety of services that produce digitized products (e.g., photo finishing). And, if taxing the "non-digitized counterparts" of digitized goods and products were also preempted, states and localities would lose the ability to tax all sales of newspapers, books, music and CDs, periodicals, photos, software, movies, cable services, etc.

In one estimate, including the states of Florida, Texas, Washington and Wisconsin, this provision would reduce state and local sales tax revenues by over $1 billion per year in just these four states. Another estimate sets losses of state and local tax revenues at $5.7 billion per year.

Nexus standards. The majority report purports to attempt to "clarify" the circumstances under which a seller has a sufficient nexus, or connection, with a state to be required to collect and remit sales and use taxes and to report and pay business activity taxes to that state, by listing nine activities that, individually or in combination, would not establish nexus for that seller in the state. The net effect of these nexus "carve-outs" would be to allow a firm, especially electronic commerce firms, to engage in a wide range of activities in the state, either directly or indirectly through affiliates and representatives, without incurring a direct tax obligation or a sales/use tax collection responsibility. As such, they would further tilt the playing field against fixed-base retailers.

Space does not allow a full explication of all the potential ramifications. A few examples should, however, suffice to demonstrate the issues. The report would prohibit the consideration of the relationship between an out-of-state seller and an affiliate with a physical presence in the taxing state as a basis for establishing nexus, which opens up the potential for an "Internet kiosk" arrangement. That is, a seller could establish kiosks in the stores of an affiliate through which goods are ordered from the seller and, if the goods were delivered from outside the state, the seller would not be required to collect tax. (For example, a barnesandnoble.com kiosk inside a Barnes and Noble store.) The report would prohibit the consideration of the use of telecommunications services from an in-state provider in making a nexus determination. This prohibition would create a safe harbor by which a telecommunications provider could be acting as the representative of a seller, a situation that would create nexus under current law. In addition, the prohibition creates opportunities for resellers of telecommunications to operate in the state without establishing nexus. The report would prohibit states from considering the ownership of intangibles in the state as a factor in determining income tax nexus, as states now do. With this restriction in place, a financial services company could conduct its entire menu of operations with every person in a state - i.e., it could make loans, hold accounts receivable, finance purchases, etc. - without tax obligations. In addition, to the extent that a physical presence was considered desirable, it could use an affiliate to perform the services and still avoid any tax liability for the income arising from that state.

Conclusion

Any serious effort to address the state and local tax issues associated with electronic commerce must confront the issue of sales/use tax collection by remote sellers. State tax administrators believe that the exercise of congressional authority to require remote sellers with sales in excess of a specified threshold to collect tax on goods and services sold into a state is appropriate and necessary for the long-term survival of the sales/use tax. It also represents sound tax policy that promotes neutrality in the treatment of similarly situated taxpayers and eliminates a competitive disadvantage faced by retailers that currently collect tax.

States recognize that an expansion of the duty to collect must be accompanied by substantial simplification and improved uniformity in the sales tax and its administration. They have begun in earnest to address that task through the Streamlined Sales Tax Project.

The Report of the Advisory Commission on Electronic Commerce unfortunately, in the opinion of most state and local officials, does not further the goals of sound tax policy and administration in this area. Instead, it contains recommendations for substantial preemption of state tax authority that are not only detrimental to the fiscal position of states and localities, but will likewise cement into place the unlevel playing field facing fixed-base retailers and other current taxpayers.

FOOTNOTES:

1 In these 4 states, local governments administer their sales taxes independently of the state. There may be differences in the state and local tax base, and returns, remittances, etc. are filed directly with the local governments.

2 Quill Corporation v. North Dakota, 504 U.S. 298, 112 S.Ct. 1904, 119 L.Ed.2d. 91 (1992); National Bellas Hess, Inc. v. Dept. of Revenue of Illinois, 386 U.S. 753, 87 S.Ct. 1389, 18 L.Ed.2d. 505 (1967).

3 This includes sales of both digital products and, more importantly, tangible goods via electronic means.

4 Some observers argue that the Quill and Bellas Hess decisions require a seller to have a "substantial physical presence" in the taxing state before it can be required to collect tax. The Quill decision does not use the phrase "substantial physical presence"; it requires a "substantial nexus" with the taxing state, and says that nexus is satisfied if the seller maintains a physical presence in the taxing state.

5 For an extensive discussion of the types of simplifications that have been discussed, see the Final Report, National Tax Association Communications and Electronic Commerce Tax Project, supra.

6 See, for example, Robert Cline and Thomas Neubig, "The Sky is Not Falling." (published by the E-Commerce Coaliton) which projects that in 1998, the net impact of electronic commerce was to reduce state and local revenues by about $170 million. Forrester Research estimates that the comparable number for 1999 was $500 million. Both of these analyses examine only business-to-consumer sales.

7 Donald Bruce and William F. Fox, "E-Commerce in the Context of Declining State Sales Tax Bases," (mimeo) February 2000. (To appear in a forthcoming edition of the National Tax Journal.)

8 Sellers below the threshold level might be required to collect only on sales within the state(s)in which they operate or simply remit tax on all sales to that state. Such an approach would avoid placing undue burdens on the smallest sellers. A sales threshold de minimis would eliminate a large amount of litigation that occurs currently regarding what constitutes nexus and the required level of contact with a taxing state.

9 The Commission's report was presented to Congress in April 2000. It is available at the Commission Web site <www.ecommercecommission.org>.

10 See testimony of Gov. Michael O. Leavitt before the Committee on Commerce, U.S. Senate, April 12, 2000.

11 Tax is imposed only on amounts over $25 per month.

12 Certain cities in Colorado and Arizona also apply their tax to such charges.

END

LOAD-DATE: May 18, 2000

Document 49 of 142.


Search Terms: internet W/10 sales W/10 tax, House or Senate or Joint
To narrow your search, please enter a word or phrase: