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IN THIS ISSUE NOVEMBER 2000
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Internet
Taxes: Congressional Efforts to Control States' Ability to Tax the
World Wide Web Mr. Smith is an Assistant Instructor at Westminster College, Salt Lake City, Utah. He earned his J.D. from the University of South Dakota, School of Law in 1996. Mr. Smith earned his B.S. from Eastern Montana College in 1992 and his M.S.A.S. from the University of South Dakota in 2000. Mr. Smith has worked in a variety of legal settings within the private sector. This article has been reprinted in edited form with the permission of The Richmond Journal of Law & Technology. The complete article can be found at: Kevin J. Smith, "Internet Taxes: Congressional Efforts to Control States' Ability to Tax the World Wide Web," 7 RICH. J.L. & TECH. 3 (Fall 2000), at HTTP://WWW.RICHMOND.EDU/JOLT/V7I1/ARTICLE3.HTML. Every year, increasingly more people use the Internet to purchase goods and services. Internet purchases are expected to exceed $20 billion per year in the near future. By the year 2003, industry experts predict Internet purchases by businesses alone will reach $1.3 trillion. Presently, the majority of Internet sales transactions flow through business to business sites. Internet purchases by consumers are expected to reach $144 billion by the year 2003. The growth of Internet-based sales concerns many Main Street merchants. In a recent survey of state tax administrators, many relayed concerns that they had received from local merchants. For example, Secretary of Revenue, Gary Viken, stated that after talking to many "Main Street merchants in South Dakota, and without exception, they have expressed the need to treat remote sales and Main Street sales equally for purposes of sales taxation." Wyoming's Director of the Department of Revenue stated that Wyoming merchants would like to see an Internet sales tax instituted, because "[t]hey truly feel they are at a disadvantage now." State and local governments are also increasingly concerned about their ability to raise revenues. Currently, forty-five states impose general sales and use taxes. Thus, every time a person buys a compact disc on the Internet instead of at the mall music store, the state and local government most likely loses revenue. State and local governments rely on sales taxes for approximately thirty-five percent of their revenues. As a result of uncollected taxes, it is estimated that state governments lost more than $500 million in sales tax revenue. Nevertheless, are these losses of real concern? The National Conference of State Legislatures published a report stating that, according to a fiscal survey of the fifty states for 1998 and 1999, states collected $11.3 billion in revenue for 1998 and $7.5 billion in 1999. Surpluses for states sales taxes totaled $2.3 billion in 1998 and $2.2 billion in 1999. In addition to these surpluses, state tobacco settlements are expected to bring $206 billion in additional state revenue over the next twenty-five years. What would be the impact of having to collect sales taxes from potentially more than 7,600 different jurisdictions? According to Ernst & Young, the burden of collecting sales taxes for a small in-state retailer amounts to 7.2 cents for every $1 of sales taxes collected. For a large firm that operates in fifteen states, the cost rises to 8.3 cents per tax dollar. Collecting Internet taxes dramatically increases the total costs of collecting sales taxes. For a large firm, the cost of collecting sales tax dollars increases to fourteen percent, i.e., it costs the business $0.14 to collect $1.00 in sales tax. A medium firm spends $0.48 to collect that same tax dollar, while a small retailer would be forced to spend $0.87 for every dollar of sales tax it was required to collect on sales through the Internet. States may receive their taxes but only at the expense of the continued viability of their small businesses. In the Fall of 1999, both houses of Congress approved a non-binding resolution encouraging President Clinton to seek a permanent international ban on tariffs on electronic commerce. The resolution ". . . the Commission's purpose was to examine a broad set of international, state, and local tax issues involving electronic commerce." additionally called for "an international ban on bit, multiple and discriminatory taxes" on electronic commerce and the Internet. The resolution urged the President to conduct negotiations with the World Trade Organization (WTO) and the Organization for Economic Cooperation and Development (OECD). It also "calls upon the WTO to enact a permanent moratorium on electronic commerce tariffs." In addition, the resolution encourages the OECD "to accept the principle of no multiple or discriminatory tariffs on the Internet." Finally, the resolution "condemns the United Nations' recent `bit tax' proposal, and calls for a permanent ban on such Internet-specific taxes." Congress also amended the Year 2000 appropriation for the United Nations by including a ban against using any of the appropriations to promulgate or enforce any tax measure relating to the Internet. The Senate and House of Representatives have introduced and passed numerous tax proposals regarding the Internet. The most important Internet tax law is the Internet Tax Freedom Act. THE INTERNET TAX FREEDOM ACT In 1997, the Internet Tax Freedom Act (ITFA) was introduced to both Houses of Congress. The original purpose of the legislation was to establish a national policy against states interfering with interstate commerce on the Internet. The ITFA was initially met with strong opposition from organized groups such as the National League of Cities, the National Governor's Association, and others. After eighteen months of debate, Congress finally passed the 1998 ITFA. Though the enacted version of the ITFA was a watered-down version of the original, its passage was supported by many state and local governments and business organizations. The ITFA bars three specifically identified categories of tax levies: (1) taxes on Internet access, (2) multiple taxes on electronic commerce, and (3) discriminatory taxes on electronic commerce. The ITFA is essentially a holding action to give Congress more time to consider a long-term solution. At first glance the ITFA appears to have a lot of teeth. However, there are many exceptions and limitations to the Act. First, the ITFA is only a moratorium on new taxes. The moratorium exists for a three-year period that ends October 1, 2001. After the moratorium ends, Congress may either renew the moratorium or choose not to renew it, thus allowing states to tax the Internet once again. "A grandfather clause is included in the Commission's report . . ." The plain meaning of the ITFA is to prevent Internet taxes, not generate, encourage, or authorize them. Section 1204 expressly states, "this law is not to be construed to expand the duty of any person to collect or pay taxes beyond that which existed immediately before" the law was enacted. Additionally, a State or local government's tax that is not prohibited by the provisions of the ITFA, would not be valid if it constituted an undue burden on interstate or foreign commerce. During the moratorium period, the ITFA authorizes the creation of a temporary Advisory Commission on Electronic Commerce to study the complex tax issues implicated by the growth of electronic commerce. This commission has nineteen members including: three federal officials (the Secretaries of Commerce and Treasury, and the U.S. Trade Representative), eight state and local government representatives, and eight business and private interest representatives. The National Governor's Association sought to include a "Main Street" business representative on the Commission. In general, the Commission's purpose was to examine a broad set of international, state, and local tax issues involving electronic commerce. It studied state and local government taxation of Internet access, consumption taxes in other countries, and more. Many of the issues involved ways to clarify, reduce, or simplify current tax laws as they apply to electronic commerce, Internet-related activities, and telecommunications services. Congress asked the Commission to make legislative recommendations by no later than April 21, 2000. Any recommendations, including proposed legislation, required agreement by at least two-thirds, or thirteen, committee members. The Commission released its report in April 2000 with three recommendations and six policy proposals limited by a Grandfather Clause: Recommendation 1: Digital Divide. This recommendation calls for federal assistance in providing Internet access to needy families through matching funds and tax credits. Within days after the Commission's report, President Clinton pledged up to two billion dollars in tax incentives to bridge the digital divide. In addition, more than a dozen nonprofit groups, corporations, and federal agencies have created partnerships with low-income schools across the country to provide computer technology and training to poorer students. Recommendation 2: Privacy Implications of Internet Taxation. This recommendation focused upon privacy issues involving the collection and administration of taxes on electronic commerce. Also of concern is the cost implications of any new system of revenue collection. Recommendation 3: International Taxes and Tariffs. This recommendation suggests imple-mentation of a permanent standstill on tariffs at the earliest possible date. Despite this, other countries have begun the process of collecting taxes on internet transactions. Policy Proposal 1: Sales and Use Taxes. This proposal calls for extending the ITFA's moratorium for five more years, and also calls for prohibition of sales taxes on digitized goods and products and their non-digitized counterparts. Also clarified are which factors would constitute a physical presence of an Internet seller in determining whether the seller has a sufficient nexus with a State to impose a sales tax collection obligation. Policy Proposal 2: Business Activity Taxes. The Commission calls for clearer standards to determine when a seller created a sufficient nexus with a State and would be required to report income tax and owe an obligation to the State. Policy Proposal 3: Internet Access Taxes. This proposal calls for making the ITFA's moratorium on any new Internet access taxes permanent. It also calls for making the grandfather clause permanent. Policy Proposal 4: Taxation of Telecommunications Services and Providers. The Commission calls for the elimination of the three percent federal excise tax on communication services. Congress established the three percent tax in 1898 to assist with the financing of the Spanish-American War and continued the tax for the same purpose for World War I. Although Congress scheduled this tax for elimination many times, it is still in effect. Moreover, the Commission wants to eliminate excess tax burdens on telecommunications real, tangible and intangible property. Finally, this proposal asks States and local governments to work with the NCCUSL to formulate a uniform telecommunications excise tax act. Policy Proposal 5: International Taxes and Tariffs. This proposal calls for a permanent extension of the current WTO moratorium on tariffs and duties for electronic transmissions. Policy Proposal 6: Knowledge of International Implications of Internet Commerce. The Commission calls upon Congress to increase its oversight of the international ramifications of domestic Internet commerce decisions. A grandfather clause is included in the Commission's report and is presented as a permanent section of the Internet Taxation Freedom Act. The National Governor's Association attempted to ensure that the ITFA provided a grandfather clause that allowed the States dependent upon Internet access taxes to retain the taxes. For example, the Act does not apply to any state tax that "was generally imposed and actually enforced prior to October 1, 1998." This is shown either by demonstrating that the tax had been authorized by statute and known to the Internet provider, or by public proclamation that the state interpreted the statute to apply to Internet access services. Under this determination, the state tax must have been authorized by statute. However, few States can meet this qualification because few States made proclamations and rulings on these taxes. Another way to qualify the state tax for the grandfather clause is if the State generally collected such a tax on charges for Internet access. This determination can prove difficult since States and local governments often follow unpublished guidelines on what is and what is not subject to taxation. If there was no public announcement of their rules, State and local governments could encounter significant problems establishing that taxes are generally collected. However, a State can choose not to continue to tax Internet access. Presently there are twelve States that ITFA has permitted to continue taxing Internet access: Connecticut, Hawaii, Iowa, Nebraska, New Mexico, North Dakota, Ohio, South Carolina, South Dakota, Tennessee, Texas and Wisconsin. The rest of the States have either specifically prohibited Internet access taxes, or as a result of ITFA, have done nothing at all. The grandfather clause discussed above applies only to taxes on Internet access. The clause does not apply to discriminatory and multiple taxes that are included within the moratorium. Thus, even if a State's tax on Internet access meets the grandfather exception, the tax still may be barred if it is imposed in a manner that would make it fall within the definition of a multiple tax or a discriminatory tax. Internet access taxes are not the only concern of the ITFA. The Act addresses concerns over sales taxes as well. Currently forty-five States tax the sale of goods over the Internet. For software that is downloaded, thirty States impose a tax. Twenty States tax the downloading of information. Thus, the issue of Internet taxes reaches far beyond Internet access. That is probably why the authors of the ITFA included the provisions for discriminatory and multiple taxes. These provisions may not eliminate Internet taxation, but they prohibit any further taxation of the Internet. Thus, States that currently do not tax either sales of goods or downloaded software or information cannot do so in the future. Existing Internet taxes can be neither discriminatory nor cause multiple taxes. Each of these terms, as might be expected, carries its own definition. WILL THE ITFA BECOME PERMANENT? Early in 2000, both Senator Wyden (D-Or.) and Rep. Cox (R-Cal.), the same two congressmen who introduced the ITFA, called for the ITFA to be permanently extended. They said they would introduce the Internet Non-Discriminatory Act (INDA) that will make the ITFA permanent. Within a week after the Commission released its recommendations and proposals, the Report stimulated the introduction of bipartisan legislation that would prevent States from forcing out-of-state businesses to collect sales tax on their behalf. Introduced to Congress this year, the "New Economy Tax Simplification Act" sponsored by Senators Judd Gregg (R-NH) and Herb Kohl (D-Wis.), has already been referred to the Senate Finance Committee. One of the problems surrounding Internet taxation is the nexus problem. The bill introduced to Congress goes "directly to the heart of the Internet tax debate" and sets up clear nexus standards for the 21st century. However, that bill may be complicated by a proposal by Senator Ernest Hollings (D-SC). Senator Hollings introduced a proposal that would create a national retail sales tax on Internet sales to be collected by the IRS. The bill was introduced on July 26, 1999, but no action has been taken on it. Nonetheless, the bill proposes a 5 percent sales tax for all Internet purchases. If this bill passes, the results could be dramatic for electronic commerce. A survey of 7,000 on-line purchasers was conducted in which 75 percent said they would buy less on-line if a sales tax is instituted. In addition, nearly half said they would not have made their most recent purchase if it had included a sales tax. To counter Senator Hollings' proposal, Representative John Kasich (R-Ohio) proposes to amend the current ITFA by making the moratorium permanent. Thus, he calls his proposal the Internet Tax Elimination Act. Representative Kasich is not alone in trying to make the ITFA's moratorium permanent. Senators Bob Smithm (R-NH) and John McCain (R-Ariz.) have also introduced proposals that would make the ITFA's moratorium permanent. Thus, the momentum in Congress is to make the moratorium permanent along with the Commission's proposal to make Internet access taxes a thing of the past. |
