UNDERSTANDING THE INTERNET TAX FREEDOM ACT.

Byline: Bill LaVere

I was very interested in the article written by Paul Krugman titled ``Why not tax the Internet?'' which appeared in the Opinion section of the Feb. 15 Daily News. It is obvious from the article that Krugman never read the Internet Tax Freedom Act of 1998, or even a summary of it. Nor did he take the time to understand the act, prior to writing his article. Krugman has badly misrepresented what the Internet Tax Freedom Act of 1998 regulates and what it does not.

The Internet Tax Freedom Act of 1998 does not prohibit a state from imposing a sales or a use tax collection obligation on any seller that is physically present within the taxing jurisdiction. The sales tax treatment to which Krugman complains, i.e. that remote sellers are not required to collect the tax, arises from the Commerce Clause of the United States Constitution, not the Internet Tax Freedom Act.

The constitutional issue is a jurisdictional one which is not unique to Internet commerce. The jurisdictional issue exists whenever there is a remote seller in a transition. The jurisdictional issue has been addressed by the U.S. Supreme Court on numerous occasions, most recently, in the case of Quill Corporation vs. North Dakota, 504 U.S. 298 (1992).

Krugman's premise that a ``basic principle of taxation is that different ways of doing the same thing should face more or less the same tax rates'' is simply a fallacy. There are many areas of the tax code that intentionally provide for different tax results of the same basic way of doing business.

Take, for example, operating a business in corporate form vs. partnership form. If a corporation earns a dollar profit, it pays a corporate level tax on that profit. When the corporation distributes the remainder of the after-tax profits to its shareholders in the form of dividends, the shareholders pay a second tax on the same corporate profits. If the same business operated as a partnership, there would be no tax at the primary level since the partnership is treated as a pass-through entity by the tax code, only the partners would be taxed on their share of the distributed profits.

There appears to be much confusion over the logic of why a local retail seller must collect the sales tax while some sellers do not. To clarify why there is a rational basis for what appears to be differential treatment, one need only consider the following example.

Let's assume that you walk into a local bookstore in California to purchase a book to give as a gift to a friend who is located in New York. At the time of purchase you requested the bookstore to ship the book directly to your friend in New York as part of the sales transaction. If the bookstore ships the book using a common carrier (i.e. U.S. mail, Federal Express, UPS, etc.), the bookstore is not required to collect the California sales tax, since the sale occurs in interstate commerce. New York use tax is still due on the transaction, but the California bookstore will be treated as a remote seller and therefore not subject to a New York use tax collection obligation provided the bookstore has no physical presence in New York.

If, on the other hand, the California bookstore has a physical presence in New York, it would be required to collect the New York tax. This result is rational from a tax administration perspective since the California bookstore is only required to comply with the tax laws in the state (or states) in which it is physically present.

As you can see from the example, the tax collection issue is not unique to e-commerce.

The battleground from a state's prospective is that states claim it is administratively difficult to collect the use tax from the ultimate in-state user, therefore, the state would prefer to impose the collection burden on remote sellers. But the U.S. Supreme Court has interpreted the Commerce Clause of the U.S. Constitution to require the physical presence of the seller in the taxing state before a collection obligation can be properly imposed (in the Quill case cited previously).

What the Internet Tax Freedom Act of 1998 prohibits is the imposition of new taxes on Internet access charges. It does not prohibit the collection of any taxes that existed prior to the imposition of the act. Internet sellers are required under current law to collect sales tax in any states in which they have physical presence just as the traditional brick and mortar sellers.

By supporting the principles of the Internet Tax Freedom Act, I believe that Sen. John McCain supports the concept that there should not be a government toll charge (in the form of a tax) imposed on access to the information superhighway. What's wrong with that? Nothing.