Spend and Tax?

To tax or not to tax Internet purchases -- that is the question.

How important is the issue of tax, specifically sales and use tax, vis-a-vis electronic commerce? To listen to those on both sides of the argument, sales and use taxation of items bought over the Internet will make or break not only e-commerce, but also traditional bricks and mortar retailers and state and local governments. One side says e-commerce is why the economy is blooming, and that to tax it in its current embryonic state will spell doom. The other side is populated primarily by retailers and state and local governments. Retailers maintain that not taxing Internet purchases gives e-tailers a significant competitive advantage. State and local governments claim that if e-commerce isn't taxed, their coffers will dwindle, leaving houses to burn, criminals free to roam the streets and children to go uneducated.

The primary issue at stake is "nexus." Simply put, nexus implies a minimum contact with a state to trigger a tax collection responsibility on behalf of the merchant selling the goods in State A from the purchaser in State B. Current law is lenient on the requirements that cause a merchant to have nexus. That means, for the most part, sales tax is due only on remote purchases made where the customer and merchant are in the same state. Of course a purchaser in State A who buys online from a merchant in State B owes State A a use tax on the purchase, assuming State A imposes such a tax (currently 46 states do). But only a small percentage of consumers comply with state use tax laws, which are difficult to enforce.

In October 1998, Congress enacted the Internet Tax Freedom Act (ITFA) as part of the fiscal 1999 omnibus spending bill. The act imposes a three-year moratorium on the taxation of Internet access, and on multiple or discriminatory taxes on e-commerce. In theory, ITFA's enactment closed a nearly two-year effort to prohibit multiple and conflicting taxation of the Internet while allowing states and the business community to craft a more uniform taxation policy. Note that this act didn't restrict the sales and use taxation of remote sales made via the Internet,

The act also called for the creation of the Advisory Commission on Electronic Commerce. Its 19 members include the secretaries of Commerce and Treasury, the U.S. Trade Representative, eight representatives of state and local governments and eight representatives of the e-commerce industry. Its charge is to conduct a thorough study of federal, state, local and international taxation and tariff treatment of transactions using the Internet and Internet access and other comparable intrastate, interstate or international sales activities. It's to send a report on its findings, including legislative recommendations, to Congress as this issue goes to press. Any recommendation is to be tax- and technology-neutral and apply to all forms of remote commerce.

Because of a disagreement over the issue of nexus, no final findings emerged from the ACEC's last public meeting, in Dallas in March, save some non-substantive provisions dealing with the digital divide and privacy. Instead, the so-called Business Caucus Proposal -- developed by business members of the ACEC (including AT&T, Time Warner, Inc., Charles Schwab and Company, America Online, MCI Worldcom and Gateway Inc.) -- passed. The commission rules were amended at the end of the meeting to allow for a full commission vote via public teleconference in the (unlikely) event that a consensus is reached before its imminent report to Congress. However, the report may only include a finding or recommendation if it's approved by two-thirds of the commissioners. Thus, the Business Caucus Proposal will be presented as part of the commission's work product, not as a recommendation to Congress.

To summarize, the Business Caucus Proposal says Congress should enact legislation to:

* Extend the current moratorium barring multiple and discriminatory taxation of electronic commerce and prohibit taxation of sales of digitized goods and products and their non-digitized counterparts for five years.

* Make permanent the current moratorium on any transaction taxes on the sale of Internet access, including taxes that were grandfathered under the Internet Tax Freedom Act.

* Clarify that the specified factors would not establish a seller's physical presence in a state for purposes of determining whether a seller has sufficient nexus with that state to impose collection obligations.

* Clarify that, in determining if a seller has sufficient nexus with a state to be required to meet business activity and income tax obligations of that state, specified factors would not be taken into account.

* Encourage state and local governments to work with and through the National Conference of Commisioners on Uniform State Laws in drafting a Uniform Sales and Use Tax Act within three years after the expiration of the current ITFA moratorium (Oct. 21, 2004) that would simplify state and local sales and use taxation policies to create and maintain parity of collection costs (net of vendor discounts) between remote sellers and comparable single-jurisdiction vendors that don't offer remote sales.

* Establish a new advisory commission responsible for oversight of the progress of NCCUSL's efforts to create a Uniform Sales and Use Tax Act and recommend to Congress whether to impose a tax collection duty on remote sellers.

* Encourage state and local governments to work with and through the NCCUSL in drafting a Uniform Telecommunications State and Local Excise Tax Act within three years. The act would require states to follow one of two simplified models.

* Eliminate the federal excise tax on communications services.

* Encourage state and local governments to eliminate the excess tax burden on telecommunications by eliminating telecommunications industry-specific and higher transaction tax rates; eliminating the excess tax burdens on telecommunications real, tangible and intangible property; and affording similar treatment of telecommunications infrastructure in states that exempt purchases of certain types of business equipment from sales and use taxes.

* Establish a process for states to adopt the Uniform Telecommunications State and Local Excise Tax Act and to remove excess and multiple taxation of telecommunications.

So what does this mean for e-commerce merchants, traditional retailers and state and local governments? For one thing, state and local sales and use tax systems will likely undergo a major overhaul, resulting in tax systems that are easier to administer and easier to comply with. The ACEC also reached supermajority votes on issues such as consumer privacy and the digital divide, so businesses can expect more people to buy online. And for now, Internet purchases are to be taxed just as they've always been -- like catalog or other forms of remote sales.

Will tax issues make or break e-commerce? Our crystal ball says no, or maybe "try again later." Congress will have as much difficulty addressing the issue of nexus as the ACEC did, and the states also will struggle with nexus when simplifying their sales and use tax systems.

Joseph R. Crosby is national director of state and local tax legislative services and

James A. Samans is manager of state and local tax legislative services at Ernst & Young.