The future of E-commerce tax liability.

In this age of rapidly developing technology, many consumers think they can avoid paying sales tax simply by buying merchandise online, through catalogs or out-of-state. However, 45 states have adopted use taxes as counterparts to their sales taxes; most have been on the books since the late 1940s. Generally, the use tax is the same rate as the sales tax, and helps the state recoup the revenue lost by not collecting taxes on sales. The burden is on the consumer to report out-of-state purchases to his or her home state's revenue department. As more and more sales are being conducted over the Internet, some states are becoming more dependent on the use tax as a source of revenue.

Development of the Use Tax

States have relied on sales taxes as an important source of revenue for a number of years. A sales tax is collected on the sale of personal property and some services in most states, similarly to the Canadian Goods and Services Tax and the European value-added tax (VAT). While sales tax is levied on consumers, the dealer (seller) is required to collect and remit it.

As state residents began buying big-ticket items (such as cars and furniture) out-of-state, most states added a use tax. This tax is defined generally as one on the use or consumption of tangible property or services when no sales tax has been collected. For a few goods and services, collecting a use tax is easy; states collect this tax on cars when the new owner tries to obtain registration. For purchases of other property and services out-of-state, however, states generally have to rely on voluntary compliance by the buyer. Most states require consumers to report taxable property or services on use tax return forms. Further, most give credit for taxes paid to another state, and allow an offset for tax liability purposes, with some exceptions (such as cars and boats).

Cases: To Constitutionally require the dealer to collect and remit sales tax under the Commerce Clause, the U.S. Supreme Court found, in Quill Corp. v. North Dakota, 504 US 298 (1992), that the dealer must have physical presence (nexus) in the state.

In Quill, a dealer sold $1 million worth of office supplies through direct-mail advertising to 3,000 North Dakota residents. The corporation's only presence in the state was software that it licensed to customers. All of the corporation's products were delivered by common carrier, which the court found was not a physical presence. Thus, the Quill Court reaffirmed National Bellas Hess, Inc. v. Dept. of Rev. of IL, 386 US 753 (1967). While the Quill Court did not define nexus specifically, it found that the presence of a small sales force, plant or office could be nexus. The definition of nexus must be determined by researching the law in each jurisdiction. In Tennessee, for example, nexus cannot be established through the actions of affiliates; see J.C Penney National Bank v. Johnson, 19 SW3d 831 (1999). However, in another Tennessee case, Pearle Health Services, Inc. v. Taylor, 799 SW2d 655 (1990), a remote vendor was held to have a presence in the state through its franchisees, which routinely sent representatives to check the quality of its products. The determination of nexus becomes more complicated as sales are conducted over the Internet.

In Complete Auto Transit, Inc. v. Brady, 430 US 274 (1977), the Supreme Court enumerated a test for determining how state taxation of interstate commerce is affected by the Commerce Clause. This test involved an analysis of four factors: (1) substantial nexus with the state, (2) fair apportionment of the tax, (3) nondiscriminatory effect of the tax and (4) fair relationship of tax to services provided by the taxing state. Further, the Court found that whether the goods came to rest in the taxing state is not relevant to determining nexus.

Application of the Complete Auto test to Internet sales is difficult, because such transactions involve a unique set of problems not envisioned by the Court. Further, enforcement of use taxes for Internet sales is also difficult. However, if the state does not have a sufficient nexus with the dealer, it may collect a use tax from the consumer.

ITFA 

While many consumers believe that the Internet Tax Freedom Act (ITFA) exempted Internet sales from sales and use taxes, it actually placed a three-year suspension (renewed and currently scheduled to expire in 2007) on three specific taxes. This includes no (1) taxes on Internet access, unless a jurisdiction imposed and enforced the tax prior to Oct. 1, 1998; (2) tax on electronic commerce, defined as "any tax that is imposed by one State or political subdivision thereof on the same or essentially the same electronic commerce that is also subject to another tax imposed by another State or political subdivision thereof ... without a credit ... for taxes paid in other jurisdictions"; and (3) discriminatory taxes. Thus, the ITFA restricts states from requiring a remote seller without nexus with the state to collect sales and use tax. This restriction also applies to Internet service providers.

The ITFA established an Advisory Commission on Electronic Commerce to "conduct a thorough study of Federal, State, and local, and international taxation and tariff treatment of transactions using the Internet and Internet access and other comparable intrastate, interstate or international sales activities." The commission was composed of 19 members, including three members of the Federal government, eight members from state and local governments and eight members from e-commerce industry appointed by the majority and minority leadership of the House and Senate. The Commission issued a report at the end of its 18-month term.

SSTP 

After Quill, a number of states recognized the need for a uniform application of the sales and use tax and developed a Streamlined Sales Tax Project (SSTP); see www.streamlined salestax.org. The SSTP is defined as "an effort created by state governments, with input from local governments and the private sector, to simplify and modernize sales and use tax collection and administration." At press time, the following states were in full compliance with the Streamlined Sales and Use Tax Agreement: Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, New Jersey, North Carolina, North Dakota, Oklahoma, South Dakota and West Virginia.

According to the SSTP's steering committee, the following are key features: (1) uniform definitions within tax laws, (2) rate simplifications, (3) state-level administration of all state and local sales and use taxes, (4) uniform sourcing rules, (5) simplified exemption administration for use--and entity-based exemptions, (6) uniform audit procedures and (7) state funding of the system.

While state taxes are a creature of their own legislation, uniform definitions will hopefully allow for more common tax bases. States will offer online databases to check their simplified state and local rates, and provide united management for all state and local taxes. Out-of-state vendors will be induced to collect sales tax by offers of amnesty on past taxes they failed to collect, thus providing a more even playing field for in-state vendors as they vie with out-of-state vendors for consumers.

One of the most important features of the SSTP is the "sourcing" rule. Instead of collecting sales and use tax at the vendor's original location, taxes will be assessed at the destination of the goods, where the purchaser takes possession or initially uses the services. This will eliminate the incentive for establishing businesses in lower-sales-tax states.

A burden will be placed on purchasers claiming incorrect exemptions, and they will be responsible for paying tax, interest and penalties. Further, vendors will have their choice of three different technology models to use; audits will depend on the type of system that they adopt. States will help vendors with the funding of some of these models.

Implications for International Trade

Since 1967, most Western European countries have been using VATs, under which a company is taxed only on the value it adds to a product. VATs are rebated to exporters in many countries, and are used as a basis for determining border taxes (the purpose of which is to put local goods and imports on the same competitive basis). This is very similar to what the U.S. hopes to accomplish with the SSTP. As consumers become more savvy, a larger volume (and possibly, proportion) of online purchases will be made internationally. To achieve a truly global market, many countries' laws and regulations must be coordinated.

FROM PATRICIA S. WALL, J.D., MBA, ED.D., CPA, MIDDLE TENNESSEE STATE UNIVERSITY, MURFREESBORO, TN (NOT AFFILIATED WITH CPAMERICA INTERNATIONAL)