Convergence Tax Forum

National Tax Association Communications And
Electronic Commerce Tax Project

HOW DO WE IMPOSE AND COLLECT SALES AND USE TAXES ON ELECTRONIC COMMERCE?

AN ANALYSIS OF THREE SUBSTANTIVE SUGGESTIONS

Kendall L. Houghton
General Counsel
Committee On State Taxation
©1997

Committee On State Taxation
122 C Street, N.W.
Suite 330
Washington, D.C. 20001
Phone: 202/484-5215
Fax: 202/484-5229

BACKGROUND: WHY IS THIS QUESTION IMPORTANT?

Introduction

Technology and its applications to commerce have evolved tremendously in the past 5 years, and there will be an explosion in the utilization of new technologies to provide goods and services. Examples include

Telecommunications: cellular/wireless, fiber-optic, competition among long-distance and regional carriers, new entry into market of cable companies pursuant to Telecommunications Reform Act of 1996.

Electronic Data Interchange: EDI enables paperless transactions between businesses; other developments in information technology include purchasing cards and electronic filing of returns and payment of taxes.

Electronic commerce: Internet, the former tool of U.S. government and academics, is used in millions of households and businesses to procure the transfer of digitized goods and services; World Wide Web enables commercial transactions including "mail-order" sales; intranet proprietary networks and commercial online services abound, and electronic payment systems are being developed.

Convergence of industries and "level playing fields": Once-distinct industries are now offering identical services, or are making the same end-product (be it information, services, or goods) available by different means of transmission:

Diverse companies such as AT&T, Microsoft and America Online offer Internet access.

Cable companies will soon compete directly with "telephone companies" to provide telecommunications services, while long-distance carriers will soon compete to provide local service, and local carriers are offering wireless service.

Books, movies, and music compact discs, as well as software, are available both through traditional retail outlets and through on-line outlets. This has been true for some time with respect to certain information services and publications.

The Tax Implications of Electronic Commerce

In their article, "The Taxation of Cyberspace: State Tax Issues Related to the Internet and Electronic Commerce," Karl A. Frieden and Michael E. Porter note that state taxation of electronic commerce raises several of the most controversial issues that impact state taxation of more traditional entities and transactions, including:

Nexus: Should nexus rules be extended so as to apply to remote sellers with minimal physical presence, economic presence, intangible property presence, or attributional presence (i.e., activities or presence of third parties attributed to the taxpayer)?

Sourcing/situsing: Should sourcing rules for corporate income tax purposes be revised with regard to the sourcing of the sales of services or intangibles? And, as a related matter, how is the situs of many "on-line" transactions to be determined?

Classification of transactions as taxable: Should services be subject to sales and use taxes as extensively as tangible personal property? If so, what rules should be applied to the complex fact patterns of many services -- particularly electronic services? [For article, see State Tax Notes (Nov. 11, 1996).]

Questions also arise concerning where, and how, the international, federal and state and local taxation of electronic commerce will intersect:

Should there be alignment of the policies and the specific features of the federal and state and local tax systems? The Department of Treasury suggests that residence-based sourcing rules may work best for federal income tax purposes, but many states (market states) resist this approach.

Could our status quo state and local tax system -- with its rampant inconsistencies and the resultant significant compliance burdens on multistate taxpayers -- adversely impact the interest of foreign companies in entering the United States markets? Or could it adversely impact the structure, operations and overall profitability of U.S. companies that must compete on an international basis?

The Corporate Taxpayers' Perspective

Within the business community, there are four distinct interest groups that are actively engaged (or have the potential to be so engaged) in electronic commerce, and thus will be directly affected by the evolving manner in which state and local jurisdictions choose to tax electronic commerce:

Telecommunications: This group is comprised of long-distance, regional, and "new" carriers such as cable companies, cellular/wireless companies, etc.

Online and Internet service providers: This group is comprised of businesses that market access to the Internet or intranet systems, as well as web site providers.

Content Providers: This extremely broad group is comprised of various industry segments, including media/publishing, mercantile, information service providers, advertisers, and the financial services providers that enable consummation of commercial transactions via electronic commerce.

Infrastructure [Hardware/Software] Companies: This group develops the technologies that enable electronic commerce to exist, and many developers offer and deliver their products via the Internet.

Taxpayers are seeking certainty — which reduces the cost of compliance and permits effective business planning — and a reasonable degree of fairness, both with respect to the total tax burden being placed on them and with respect to their comparative tax treatment (i.e., are all providers of functionally equivalent services being taxed the same way?).

The State and Local Taxing Jurisdictions' Perspective

State and local tax administrators and governments also desire more certainty regarding the taxation of electronic commerce. They ask:

Will current tax revenues disappear, if existing tax nexus and situsing/sourcing rules cannot easily be applied to electronic transactions?

Will electronic commerce become a haven for tax evaders?

What is the role of the Quill holding in the arena of electronic commerce, where the activities of sellers may be viewed in certain circumstances as differing from those of traditional mail order sellers?

Do current transactional taxes (e.g., telecommunications, information and other services taxes) have application to Internet access and Internet-based transactions, or do new taxes have to be designed to target these activities and services?

Certain jurisdictions have taken targeted approaches toward specific types of technologies and electronic commerce, in an attempt to answer questions as they arise; the issuance of ad hoc rules, however, may create confusion and inconsistency. The question arises whether existing taxes are being applied in a general and non-objectionable manner, or in a targeted (discriminatory) manner.

The Massachusetts DOR announced in Spring 1997 its intention to apply its telecommunications sales tax to Internet access charges under a 1990 law, possibly on a retroactive basis. The Massachusetts Internet Service Providers Coalition responded that (1) a law formed before such services were offered cannot have application to the service, and (2) the retroactive application will cause double taxation of telecommunications services utilized by ISPs to provide Internet access to customers, and (3) Massachusetts ISPs will not be able to complete with neighboring New York ISPs, which enjoy nontaxability by virtue of that State's recent administrative rulings. Acting Governor Paul Cellucci announced on August 7^th that he was implementing a moratorium on state taxation of Internet access charges. And, as a result of the Department's aggressive position, H4608 was passed into law which exempts Internet and related services from sales tax for at least a 24 month period.

Iowa issued Rule 701-18.20 (effective Feb. 19, 1997), explaining that Internet access charges, as gross receipts, are subject to the sales tax when access is facilitated by a local or in-state long-distance number and the predominant service offered is two-way transmission and receipt of information from one site to another. Iowa Governor Terry Branstad announced that he will ask the next legislature to repeal the tax on Internet access.

Connecticut's Department of Revenue Services stated in its DRS Tax News bulletin (Vol. 8, No. 5, Dec. 1996), that Internet access charges are taxable as computer and data processing services if the computer terminal is located in Connecticut. The Department requires that the service provider determine whether its customer's computer terminal is in-state. Additionally, the bulletin states that computer and data processing services are defined as the provision of any access, or links to access, to any type of computerized information or database, including but not limited to Internet, e-mail and electronic publications.

Texas is perhaps the best known actor in the electronic commerce arena. As Wade Anderson, the Tax Policy Director for the Texas Comptroller has indicated both in testimony before the U.S. Congress and in papers on this topic, Texas has an unusual amount of pressure on it to apply its various sales and use taxes on goods and services to electronic commerce, because the State does not impose a personal income tax, and relies instead on broad-based transaction taxes. In considering how Internet access was to be taxed, Texas first concluded that its broadly worded telecommunications services tax covered Internet access; only later, after extended consideration of the nature of the Internet and the benefits it afforded consumers, did Texas recharacterize Internet access as a taxable information service (coincidentally, both services were already subject to sales taxation). Texas continues to articulate some of the most aggressive tax policies concerning electronic commerce.

Other jurisdictions have attempted to convene experts on tax policy/ administration and representatives from affected businesses to examine the broad range of tax issues raised by electronic commerce. Their stated goals have been to impose an integrated system of taxation that is neutral as to means of transmission, and which distinguishes between content-based and transmission-based services.

New York's Report, "Improving New York State's Telecommunications Taxes," makes several recommendations regarding restructure of telecom taxes. It also concludes that (1) Internet access services are exempt from sales taxation or gross receipts excise taxation (because not telecommunications, nor otherwise included within the Tax Law), and (2) nexus with the State is not created merely by having a non-New York entity's advertising appear on a New York server or through a New York-based Internet service provider. New York is currently addressing the taxability of online service fees, which are charged for services in addition to Internet access (e.g., most online service providers create their own content for subscribers).

Florida's task force was convened by order of the Governor, and surprised many by recommending that the current multi-level, multi-tax telecommunications taxation scheme be scrapped and a unified tax be substituted, which the State would collect on a broad variety of services. The State would then distribute revenues to the municipalities according to formula. While the legislature did not act on this set of recommendations during its regular session, there is still discussion of how the Florida system can be improved.

A VARIETY OF INITIATIVES HAVE BEEN UNDERTAKEN TO EXPLORE HOW BEST TO ANSWER THE MANY QUESTIONS RAISED

Federal-Level Initiatives

U.S. Treasury Paper: Selected Tax Policy Implications of Global Electronic Commerce

The Treasury Paper was the first piece of policy analysis, in the electronic commerce arena. In it, the Treasury noted that it was specifically not addressing its remarks to the state and local tax structure; nevertheless, certain tentative conclusion in the paper (i.e., that residence-based sourcing rules for income taxation might work more effectively in the electronic commerce arena than market-based sourcing rules) upset several state tax administrators (i.e., those who advocate a market state's interests).

Bruce Cohen of the Treasury Department has since been consulting with state and local tax organizations and professionals, in order to better understand the ramifications of the Treasury paper for the state and local tax community, and the special SALT-related concerns that do not have an analog in the federal and international tax systems.

The Treasury indicated during testimony before the Senate Commerce Committee on the Internet Tax Freedom Act (S. 442) (discussed below) that it supports the goals and objectives of the Internet Tax Freedom Act, though the bill requires certain revisions in order to satisfy Treasury's technical concerns.

The White House Paper

The Clinton Administration on July 2nd released its white paper, "A Framework for Global Electronic Commerce," which addresses the many diverse policy ramifications of electronic commerce. Federal agencies including the Department of Treasury and the Internal Revenue Service are already examining the international implications of electronic commerce tax policy, and considering adjustments to existing federal residency and sourcing rules; but the White House paper also indicates the Administration's vested interest in defining the appropriate parameters of state and local taxation of global electronic commerce. Ira Magaziner, Senior Advisor to the President for Policy Development, met with a variety of taxpayers, taxpayer representative organizations and state representative organizations to explore their various concerns, and the paper reflects a balancing of these concerns.

The paper specifically states with respect to state and local taxes on electronic commerce that: "The Administration is also concerned about possible moves by state and local tax authorities to target electronic commerce and Internet access. The uncertainties associated with such taxes and the inconsistencies among them could stifle the development of Internet commerce. The administration believes that the same broad principles applicable to international taxation, such as not hindering the growth of electronic commerce and neutrality between conventional and electronic commerce, should be applied to subfederal taxation."

Internet Tax Freedom Act

The United States Supreme Court acknowledges the power of Congress under the U.S. Constitution to regulate interstate commerce whenever it so chooses, much less in the face of a complete lack of uniformity and certainty regarding state and local taxation of interstate electronic commerce. As one commentator has noted, "Congress may consent to state legislation affecting interstate commerce that would be unconstitutional under the so-called ‘dormant' Commerce Clause in the absent of such consent, and it may preempt state legislation that would be constitutional under the dormant Commerce Clause in the absence of such preemption. Because it has plenary power over the channels of interstate commerce, ‘Congress may keep the way open, confine it broadly or closely, or close it entirely,' subject only to the limitations that the Constitution imposes on Congress's own power."

On March 13^th, Senator Wyden (D-OR) and Representative Cox (R-CA) introduced the Internet Tax Freedom Act (ITFA) legislation. The stated goal of the legislation is "[t]o amend the Communications Act of 1934 to establish a national policy against State and local interference with interstate commerce on the Internet or interactive computer services, and to exercise congressional jurisdiction over interstate commerce by establishing a moratorium on the imposition of exactions that would interfere with the free flow of commerce via the Internet. . . ."

The legislation imposes a moratorium on the imposition, assessment or attempt to collect any tax on the Internet or online services (including access to, use of or communications and transactions that occur through the Internet or online services) by states or political subdivisions thereof. Additional features, as well as several of the suggested revisions to the draft legislation, are discussed below.

Three major exceptions to the moratorium were carved out in the original version of the bill, permitting the following types of taxation:

taxes imposed on or measured by net income derived from the Internet or online services;

fairly apportioned business license (i.e., gross receipts) taxes, imposed on business having a physical business location in the taxing jurisdiction; and

sales and use taxes on electronic commerce-based transactions, where the tax (including the rate) is the same as that generally imposed on similar sales and transactions when effected through traditional means of commerce (e.g., mail order sales), and where the tax obligation is placed on the same party in the case of each of the functionally equivalent transactions.

The bill calls for a consultative group of federal, state and local government officials, businesses, representative organizations and other informed and interested parties to meet for two years subsequent to enactment, in order to consider domestic and international taxation of electronic commerce, to explore avenues of resolution and to provide the President with policy recommendations. [The original Senate bill has since been revised to specify that the National Conference of Commissioners on Uniform State Laws (NCCUSL) and the National Tax Association-sponsored Communications and Electronic Commerce Tax Project will be included in the Consultative Group. See subsection B., below.]

The moratorium did not have an ending date in the original Senate and House bills, because the drafters of the bill contemplated that the recommendations of the consultative group would form the basis for additional federal legislation or for other steps that would obviate the need for the moratorium.

In addition, taxpayers feared that if the moratorium was brief in duration, certain state and local jurisdictions would decide to "wait it out" until the ending date, and then resume or begin taxing electronic commerce in whatever fashion they desired.

However, state and local governments and tax administrators reacted extremely negatively to this open-ended moratorium. They cite the fact that another such federal preemption of state taxing sovereignty, Public Law 86-272, was enacted with an open end-date; P.L. 86-272 was to be repealed once certain actions had been taken to mitigate taxpayer burdens. In fact, Congress never acted to repeal P.L. 86-272 and it is still the law. As a result, they view the bill as a permanent preemption, rather than a moratorium.

In response to this message, the Senate version of the bill has been revised to reflect an ending date of January 1, 2003 (presumably creating roughly a five-year moratorium). The House version still stands without an ending date.

Since the bill's introduction before the Commerce Committees of both houses of Congress and the Judiciary Committee of the House of Representatives, three hearings have been held on the bills and certain revisions have been suggested and/or agreed to by the co-sponsors, in an attempt to reduce the level of concern with the moratorium that has been expressed by state and local governmental interests.

Subsequent to a Senate Commerce Committee hearing on the bill, the language of the Senate version was revised to curtail a number of unintended effects of the moratorium. The process of revision continues, however, and both the House and Senate bills may be revised. Suggested additional state and local tax preservation clauses include:

preservation of taxes paid by an Internet or online service provider as a consumer of goods and services not otherwise excluded from taxation pursuant to the Act (and, presumably, not otherwise appropriately subject to exemption from the tax in question);

preservation of property taxes imposed or assessed on property owned or leased by an Internet or online service provider (presumably, covering real, tangible and intangible personal property taxes);

preservation of taxes imposed on a common carrier, as defined in the Communications Act of 1934, acting in its capacity as a common carrier;

preservation of fees, charges or limitations imposed by a state on a telecommunications carrier pursuant to the Communications Act of 1934; and

preservation of franchise fees imposed by a local franchising authority on a cable system pursuant to the Communications Act of 1934, for the provision of cable services.

State- and Local-Level Responses

National Conference of Commissioners on Uniform State Laws

The National Conference of Commissioners on Uniform State Laws (NCCUSL) is currently considering the viability of a project to develop model uniform legislation prescribing the manner(s) in which states will tax electronic commerce. NCCUSL is the group that has produced the Uniform Commercial Code and the Uniform Division of Income for Tax Purposes Act (UDITPA), and it is perhaps uniquely equipped and structured to generate uniform legislation of this type.

The Conference Commissioners are comprised of state legislators, academicians, and practicing attorneys from each of the states, and the public is invited to participate in their drafting efforts through the submission of comments on every draft. However, the Commissioners retain the final right to approve or disapprove any proposed uniform legislation. In response to letters from COST and other interested parties, NCCUSL has formed a committee to study the advisability and scope of such a uniformity project.

The National Tax Association-Sponsored Communications and Electronic Commerce Tax Project

The National Tax Association has agreed to serve as the neutral convener of a state- and local-level dialogue among any and all persons, businesses, public agencies and organizations with an interest in state and local taxation of electronic commerce. The purpose of this Electronic Commerce Tax Project is to: (1) educate all parties regarding the nature of the technologies and transactions that constitute the essence of electronic commerce, (2) identify common understandings of relevant tax principles and definitions, and (3) subject to the consensus of the participants, develop tax policy recommendations and implementing model legislation.

Initial organizational meetings of core self-identified interested parties took place in February and March, and a Steering Committee has been established to oversee a number of public forum working sessions of the Tax Project. The opportunity exists for similar "stakeholders" (whether they fall into the constituent categories of "business," "government" or "other") to participate in this project at a number of levels, including as a Steering Committee member, on a Working Group, or via submission of public comments or attendance at public forum working sessions. The philosophy of the multi-party Tax Project is that all of its work product must be the result of a completely open process.

Related Initiatives:

The Direct Marketing Association has been negotiating a Limited Contacts Taxpayer Agreement with certain states' administrations, and with the informal technical advice of the Federation of Tax Administrators and Multistate Tax Commission. This agreement is designed to address the long-standing tug-of-war between states that are not collecting use taxes from their own residents and mail order sellers who have successfully avoided having nexus thrust on them, for purposes of collecting these same use taxes on sales they make into states where the mail order sellers are not physically present. The Direct Marketing Association has indicated that if states and localities offered mail order sellers the right incentives — in the form of simplified collection and reporting obligations, and a compliance safe harbor for substantial compliance with state and local use tax laws — then those sellers would in large part voluntarily come forward and register to collect taxes. This draft agreement will embody the terms on which voluntary collection would ensue. Other businesses besides mail order sellers insist that they have access to the same agreement (on Equal Protection grounds), and the participating states are taking this fact into account in negotiating terms. Clearly, this agreement could have relevance to any resolution to the sales and use tax controversy that is arising in the context of electronic commerce.

The Multistate Tax Commission convened a Public Participation Working Group (PPWG) in April 1997, to consider the MTC's revised Constitutional Guideline for Application of a State's Sales and Use Tax to an Out-of-State Business. Work proceeds in that group, but it has refocused somewhat. Several participants have indicated interest in expanding the scope of the project to consider electronic commerce ramifications, and to consider whether the above-described Limited Contacts Taxpayer Agreement (being negotiated between certain states and the Direct Marketers Association) would have application in a nexus guidelines dialogue. More important, the group has agreed to move away from a discussion of abstract nexus theory, and instead will concentrate its efforts on developing policies and procedures that may not extend state jurisdiction as far as the Constitution might permit, but will represent reasonable resolutions of many nexus questions that exist today (e.g., what is de minimis nexus, when dealing with trade shows? Presence of temporary employees?). This process, known as Phase II, will incorporate examination of the DMA agreement and any other practically oriented nexus-related policies that states have implemented to create more certainty and incentivize taxpayers to voluntarily register and collect use taxes.

SUBSTANTIVE APPROACHES TO STATE AND LOCAL TAX POLICY FOR ELECTRONIC COMMERCE

Three Proposals Have Emerged: Three individuals have taken a step beyond the processes described above, to actually suggest substantive approaches to the state and local taxation of commerce conducted on-line. While their proposals will be discussed without reference to the developing authors, these state tax professionals deserve recognition for expounding ideas to which the various interested parties can react, and which will certainly serve as catalysts for further creative thought in this arena. This section briefly introduces each proposal; in the following sections, the proposals are outlined in detail, and are discussed by reference to four critical concerns that pertain to state and local taxes:

Application of Constitutional principles,

Structural features (complexity, technology required to implement, and practical concerns regarding ability to administer or comply with the tax), and

Political concerns (particularly relevant where uniformity is a goal of the proposal).

Jim Eads, Tax Counsel, AT&T: Require Taxpayers to Assist States Collect Use Taxes on Electronic Commerce Transactions by Providing Customer Information to a Central Clearinghouse

Mr. Eads presented a paper to an April 1997 Harvard Law School-sponsored symposium on taxation of electronic commerce, where he participated on a panel that presented a businessperson's perspective on electronic commerce and tax policy.

The Eads proposal for uniform and effective taxation of electronically consummated sales of goods and services is simple: enforce existing use tax laws on consumers based on information furnished by sellers.

As Mr. Eads has stated, "Such a system would address the current disarray and uncertainty for many taxpayers and tax collectors by requiring compromise, action and sacrifice by both tax collector and taxpayer that should not be unreasonably burdensome to either. Simple solutions based on some measure of quality of sacrifice seem ‘fair' over time." Paper presented by Mr. Eads to Multistate Tax Commission's 30^th Annual Meeting Seminar (August 7, 1997).

Professor Walter Hellerstein, University of Georgia: "Reverse-Engineer" Nexus Through the Design of a Collection Mechanism for Existing Transaction Taxes

Professor Hellerstein wrote a paper for an April 1997 presentation to a Harvard Law School-sponsored symposium on taxation of electronic commerce, wherein he accommodated a request to provide "one alternative scheme" to ensure effective state taxation of electronic commerce. His proposal specifically addresses the taxation of electronically transmitted taxable services.

Professor Hellerstein's proposal also requires some adjustments to the current state and local taxing structure; perhaps the most notable of these is the proposed departure from the Commerce Clause sales/use tax nexus standard that was enunciated in Quill. If, as Professor Hellerstein suggests, we "reverse-engineer" a nexus rule so as to ensure collection of existing use taxes, then the nexus rule necessarily departs from the physical presence Quill standard and hinges instead on the exploitation of the market through the making of a sale to a state resident.

Wade Anderson, Tax Policy Director, Texas Comptroller of Public Accounts: Enact a Uniform, Nationally Assessed and Collected Sales Tax on Interstate Electronic Commerce Transactions

Mr. Anderson has testified on behalf of the State of Texas at several Congressional hearings on the Internet Tax Freedom Act, and has made presentations to a variety of electronic commerce tax audiences (including the Harvard symposium).

As Mr. Anderson has stated in "Thoughts on Taxing Internet Commerce," an unpublished thought piece (August 15, 1997), "It is apparent that traditional taxation is on the way out for a substantial portion of products sold. Sales over the Internet are daily reducing the states' traditional sales tax bases because states have no effective way to either know about these sales or collect tax on them from individuals. While the percentage of sales over the Internet is quite small presently (estimated at approximately 2% of gross sales of personal property and services(, it is anticipated that this percentage will increase dramatically over the next ten years (some estimates are as high as 30% of gross sales of personal property and services)."

Subsequent to studying both Professor Hellerstein and Mr. Eads' proposals, Mr. Anderson has offered up a proposal of his own. Mr. Anderson's proposal might be characterized as the most creative or the most radical of the three, depending upon the perspective of the reviewer. It departs from any nexus standard which the Supreme Court has addressed, and includes a number of structural features that do not yet exist in either the federal or state and local tax systems. Although the proposal is arguably more wide-ranging and complex than the other two, its purpose is to address taxation of electronic commerce at the international — not just state and local — level.

RELY ON DUE PROCESS NEXUS TO REQUIRE TAXPAYERS TO PROVIDE CUSTOMER INFORMATION TO A CENTRAL CLEARINGHOUSE, AND LET STATES COLLECT ALL USE TAXES

The philosophy underlying this proposal is simple: Enforce existing state regimes without tremendous new compliance, collection and remittance obligations on the part of sellers. This approach evidences a belief that the system does not necessarily require wholesale change, in order to be workable in an electronic commerce environment. Rather, the introduction of slight adjustments in each party's expectations, obligations and financial burdens can de-pressurize the use tax collection controversy that has raged ever since out-of-state sellers won the National Bellas Hess decision.

Detailed description: While this proposal has not been accompanied by a great deal of detail concerning how it would work, the basic operational features are summarized below:

Sellers would be required by federal law to furnish information on sales to customers located in each state to that state, or to a central clearinghouse. If the existing sales tax schemes of states are to be enforced without other changes, the information provided by sellers would have to include:

name or identity of customer;

address (see discussion of situs, below) of the customer, and/or the drop shipment address of the third party recipient of goods;

identification of goods or services purchased, with adequate detail to determine whether any state sales tax/exclusions/ exemptions applied;

amount of consideration paid, and (depending on state requirements) whether to be paid in installments;

additional charges to the customer, e.g., shipping, handling, warranties, etc.; and

whether a resale or other exemption certificate has been provided by the purchaser.

Nexus:

This proposal assumes that current understandings of constitutional nexus will be preserved, with respect to the right of a taxing jurisdiction to impose a use tax on an interstate transaction, when the use of the good or service can be demonstrated to occur within the jurisdiction.

In addition, it does not attempt to disturb the effect of the Quill holding, insofar as it does not force out-of-state sellers without physical presence in a state to collect the use tax from its in-state customers and remit the tax to the state.

The unique nexus aspect of this proposal inheres in its requirement that an out-of-state seller without physical presence in the taxing state take a step not discussed or required in Quill, i.e., provide its customer information to the state, so as to enable the state to collect the use tax directly from its residents. See discussion of constitutional criteria, below, for Commerce Clause analysis.

Situsing of transactions:

For sales of tangible personal property, situs would be established based on "ship to" locations;

For sales of information services provided directly to a computer, situs would be established based on information requested by the vendor.

Processing of Information and Collection of Tax:

A multistate clearinghouse may prove most efficient; in the alternative, states could require customer information to be supplied directly to their tax and revenue agencies.

States can use the information to directly bill their residents for use taxes owed; in the alternative, they could contract with a third party (including the clearinghouse) to collect taxes on behalf of the state agency:

Notification of taxes due could be sent with or made on other tax forms mailed to those taxpayers;

A de minimis limit can be established below which collection would not even be attempted.

Analytical Criteria

Constitutional Considerations:

This proposal will be examined by reference to the Commerce and Due Process Clauses, when out-of-state vendors without physical presence in the taxing jurisdiction are required to take some affirmative action, short of collecting the tax, that will cause them to incur expenses.

Does the Commerce Clause prohibit this requirement? Quill only prohibits a use tax collection duty; does the information provision requirement nevertheless impermissibly burden interstate commerce?

Does the Due Process prohibit this requirement? A lesser "minimum contacts" and fairness analysis applies, in this case; and, in Quill, the mere fact that a market was being exploited by the out-of-state seller was adequate to establish Due Process nexus.

Several states concluded, in the aftermath of Quill, that a less invasive requirement of providing customer information would, in fact, fall within the Due Process/Commerce Clause; these states contacted out-of-state sellers that were not collecting use tax and requested the provision of customer lists.

Of course, if the requirement of customer information is a federal law requirement, then the dormant Commerce Clause analysis is no longer relevant (because it only applies in cases where Congress has not acted to regulate interstate commerce).

Structural Considerations:

Do sellers have the ability to compile the specialized customer information lists contemplated above? Although software may not be available to create this special product, such a software application could be developed. Should cost be a consideration?

How would a clearinghouse be organized, and could it handle multiple accounts while maintaining statutorily mandated privacy for taxpayers? How would a billing and collection system be set up (i.e., similar to existing systems in state revenue agencies, or different)

Will residents of a state regard the bills as "real" and pay them? What if they are billed by having a line-item on their income tax returns?

Will there be opportunities to manipulate the situs of transactions, so as to "place" a transaction in a state that does not impose sales/use taxes? What if a customer refuses to provide information on location for purposes of collecting tax on an information service?

How will the scheme be enforced? If the mandate is federal, there are a variety of significant enforcement measures; however, if the mandate is a state-level mandate, what are the sanctions that would be imposed on out-of-state sellers that do not provide the requisite customer information?

Political Considerations:

Will the states "buy into" this scheme, where the duty to actually collect the use taxes falls on them? On the one hand, one reason the states have tried so hard to force out-of-state sellers to collect use taxes is that they feel it is politically infeasible to collect these taxes. On the other hand, this scheme permits them to collect substantially more use tax revenues than they effectively can at this point in time.

Will taxpayers be willing to "buy into" this proposal? Will they need assurance that the result in Quill (i.e., a physical presence "substantial nexus" standard for use tax collection obligations) will be ratified by Congress, in the process of implementing this requirement? If not, Quill could later be overturned, and the balance this proposal seeks to introduce between taxpayers and tax administrators might be undone by a less stringent sales/use tax nexus standard.

Will Congress be willing to intervene in this manner?

"REVERSE-ENGINEER" NEXUS THROUGH THE DESIGN OF A COLLECTION MECHANISM FOR EXISTING TRANSACTION TAXES

This proposal is based on three principles: economic neutrality, uniformity and administrability. In addition to these principles, discussed below, the author is sensitive to concerns with both double taxation and "full" taxation through throwback. For instance, the author would prefer that taxpayers not be treated unfairly by having a single transaction subjected to multiple jurisdictions' taxes. Similarly, the author states: [i]t makes little sense...to assign the sales, use or income tax base to a state in which the taxpayer is not taxable, or to assign the sales or use tax base to a state in which the vendor cannot be required to collect the tax."

Economic neutrality means that "those who provide goods or services in electronic commerce should be taxed no differently from those who provide goods or services in conventional commerce." Thus, electronic commerce sellers and their customers should be subject to the same taxes that are imposed on their conventional commerce counterparts. Also, the neutrality concept dictates that the sale and delivery of property by electronic means should be taxed in a like fashion as traditional selling and delivery mechanisms.

Uniformity translates to a uniform approach from state to state of taxing electronic commerce. As the proposal indicates, uniformity is a goal espoused by the Multistate Tax Commission and is incorporated in the Uniform Division of Income for Tax Purposes Act, which was drafted by the National Conference of Commissioners on Uniform State Laws and which has been adopted by approximately half of the states.

A chief complaint of those charged with significant transaction tax obligations is the cost associated with administering the taxes. These costs are associated with preparation and filing of tens, hundreds or thousands of sales and use tax returns. As a result, accuracy and compliance with sales and use tax laws suffers. Thus, this proposal suggests that taxation of electronic commerce should be "clear and consistent" and state tax organizations should embrace the goal of administrative ease and efficiency.

Detailed Description: This proposal includes suggestions and new approaches for nexus, and analyzing transmission versus content.

Nexus:

"Any statutory solution to the problems raised by state taxation of electronic commerce is going to have to tackle the issue of nexus if it is going to be of much practical benefit to industry and the states." The "reverse-engineering" of the nexus standard is the cornerstone principle of this proposal. Establishing nexus over an out-of-state seller in the purchaser's state, defined by reference to the purchaser's billing address or other locational information (e.g., the area code and local exchange from which the purchaser accessed the seller's web site), should result in a nexus standard that is administrable and lend itself to a high degree of certainty.

In essence, the nexus standard embraced by this proposal is an economic nexus standard, whereby if the seller exploits a state market, federal law or uniformly adopted state laws will compel the seller to collect the use taxes for that state (subject to situsing rules). Note that a nexus finding over an out-of-state vendor based on the in-state presence of a purchaser represents a substantial departure from current nexus principles. See discussion of constitutional considerations, below.

Situsing Transactions and the Throwback Rule:

As a first priority, the proposal adopts the existing destination-based situsing rule, whereby the customer's billing address establishes the situs of the sale. The seller must make reasonable, "good faith" efforts to obtain this information from its customers.

As a second priority, the proposal utilizes a throwback rule similar to the rule often used for income tax apportionment purposes. Under this default mechanism, where a customer's billing address is not available or undeterminable, the seller's state — described as the state of the seller's "principal place of business" — has the right to tax the transaction.

Several bases exist for establishing the "principal place of business" of a seller. The headquarters or commercial domicile are traditional bases. Given the electronic commerce premise, it might be appropriate to consider the "principal place of business" of an online information service provider to be its information storage location, the location where transmission of the information is conducted, or the location where the information is compiled and processed.

In any event, the default throwback situsing rule departs from the traditional notion that sales and use taxes are consumption-based taxes, and instead seem to tax the production of goods and services.

A credit will be provided for taxes paid to other jurisdictions. Thus, the reverse-engineered nexus standard in conjunction with the throwback rule and credit provision should result in nearly full taxation but prevent the hazard of double taxation.

Distinguish Transmission from Content:

Under this proposal, "transmission" (e.g., the underlying telecommunications and/or Internet access services) and "content" (e.g., the information conveyed electronically) must be taxed separately. Thus, sales of transmission services will be taxed separately from electronically transmitted content-based services if the charges for telecommunication services are separately stated.

Failure to separately state transmission services on the bill for electronically transmitted content-based services will result in the taxation of transmission services along with the sale of content-based services.

Analytical Criteria

Constitutional Considerations: This proposal provides an analysis of constitutional considerations implicated by the suggested nexus standard contained in the proposal.

Does the Commerce Clause prohibit the implementation of this proposal? The author notes that "a tax collection responsibility for an out-of-state vendor of electronically transmitted services based solely on the existence of a purchaser with an in-state billing address would clearly be unconstitutional under Quill." Given this, Congress must legislate a new nexus standard under its plenary Commerce Clause authority. See section II (A)(3), above.

Does the Due Process Clause prohibit the implementation of this proposal? The author concludes that it is unclear whether Due Process nexus principles confer tax jurisdiction based on an in-state billing address. Does a billing address nexus standard result in minimum connection with the taxing state? Cf. Bensusan Restaurant Corp. v. King, 937 F.Supp. 295 (S.D.N.Y. 1996); CompuServe Inc. v. Patterson, 89 F.3d 1257 (6^th Cir 1996); Zippo Mfg. Co. v. Zippo DOT COM Inc., 952 F.Supp. 1119 (W.D. PA 1997). If not, can Congress alter the Due Process nexus standard through federal legislation?

Structural Considerations:

Do electronic commerce sellers have the ability to comply with this tax collection scheme? Contained within a footnote of the proposal is a discussion of the potential difficulty of complying with this tax methodology. Obtaining purchaser billing information from electronic commerce transactions may be nearly impossible because of security concerns related to the use of credit cards. The author recognizes that a possible solution is to require third party intermediaries, such as credit card companies, to reveal billing address information to vendors. Nevertheless, frequent failures in acquiring billing information will result in origin states capturing the sales tax base rather than destination states. Thus, the exception may swallow the rule.

Will this scheme lend itself to taxpayer manipulation? The billing address nexus rule may lend itself to manipulation. For example, the proposal states that purchasers might establish billing addresses in states without sales taxes. However, the purchaser would presumably owe use tax to the jurisdiction in which the purchased item is used. Another area of potential manipulation, also identified by the author, relates to the taxation of transmission versus content. Sellers may have an incentive to overstate the charges for transmission or content (with a corresponding deduction for the other component) depending on how these two elements are taxed, if at all.

Will terms such as "billing address," "transmission" and "content" be difficult to define and result in litigation? The vast majority of purchasers today have a single, discernable billing address. As electronic payment mechanisms evolve and financial institutions continue to expand their geographic presence, it may be difficult to determine a billing address of an electronic commerce consumer. Further, the author declined to undertake the task of defining transmission and content, noting the gray areas associated with enhanced services such as Internet access.

Political Considerations:

Will the states "buy into" this tax methodology? This tax scheme addresses what appears to be the central state concern: it protects the sales and use tax base from erosion as electronic commerce grows in popularity. Further, states will no doubt appreciate a more liberal nexus standard than the one provided by the Supreme Court in Quill. However, depending on the availability of billing addresses, there may be a tax base shift from states where consumers reside to states where vendors reside. As a result, some states may view this proposal more favorably than others.

Will taxpayers "buy into" this tax methodology? Taxpayers will view favorably any proposal, including this one, that promotes certainty, reduces the frequency of double taxation, and simplifies reporting responsibilities. However, taxpayers that are not taxable in many states may resent the expanded nexus principles contained in the proposal while large, multistate taxpayers may not be concerned with it. Further, the nexus standard suggested in the proposal will likely lead to a more substantial tax compliance burden.

Can Congress intervene in this manner? As discussed in section V(C)(1)(b) above, it is unclear whether the billing address nexus standard contained within the proposal is in accordance with Due Process nexus principles. If this standard does in fact exceed Due Process limitations, Congress cannot legislatively alter this constitutional standard. Nevertheless, the author states, "a strong case can be made that Congress has power to consent to violations of the Due Process Clause so long as they are not restraints by which Congress itself is bound."

INVOLVE THE FEDERAL GOVERNMENT AS CENTRAL AGENT OF COLLECTION OF STATE AND LOCAL TAXES, AND PREMISE NEXUS UPON A PRESENCE, DIRECT OR INDIRECT, OF THE SELLER IN THE UNITED STATES

Four distinct justifications for this proposal are offered:

"This is not just a national problem, but an international one. It is necessary to create a solution which will cause the creation of an international answer to this new way of doing business."

"While the states are concerned about the erosion of their tax bases, local vendors are justifiably concerned as well. Not only are they placed at a competitive disadvantage because of the tax, but as states' tax bases shrink, the states will make up the losses by raising taxes on those taxpayers within their states. Thus, the local retailer will take a double hit which will place the retailer at an even greater disadvantage."

"At present, a vendor may not know where a sale of intangible property or service is made. In fact, the vendor may not even know who the purchaser is."

"Suggestions have been made that service providers, banks, or even telecommunications companies might be made responsible for collecting tax on sales over the Internet. It is my opinion that the responsibility for collecting and remitting the tax should remain with the persons primarily benefitting from the sales. Therefore, it is appropriate that vendors selling personal property and services should be responsible for collecting tax."

Detailed Description

Nexus: A federal law would establish federal and state government jurisdiction over any seller having a substantial presence in the United States, either directly or indirectly (e.g., through relationships with third party representatives that are present), which is exploiting the states' markets.

Apply worldwide (unitary) combination to companies making sales of personal property or services over the Internet.

Failure to set up this nexus standard could mean that a company has the opportunity to avoid any tax obligation by setting up a subsidiary to transact sales over the Internet, and locating the sub in a country where no attempt is made to tax it.

Single National Tax Rate on Sales: A federal law would allow states to require Internet sellers to collect sales/use tax based on a single national tax rate, which would be the average of all sales and gross receipts taxes collected by the states which elect to be combined into the national tax rate.

Calculation:

Determine the rate by dividing the numerator by denominator.

NUMERATOR: tax collected plus tax that would otherwise be excluded on resales and export sales by those states participating in the national tax rate program.

DENOMINATOR: gross sales made within the United States of personal property and services.

Three factor will drop the effective national average tax rate that is applied to interstate sales, under this proposal:

The taxable sales made in or into participating states will be fewer than total sales (i.e., some will be exempt); therefore, the use of gross sales as the denominator has the effect of dropping the effective average state tax rate below the actual average state tax rate.

Although few states impose broad sales taxes on services, the gross sales of services will be included in the denominator. Again, this drops the effective national average rate further. [The reason these sales are included in the denominator is that the national average tax rate will be applied to all Internet sales, including Sales of services. Thus, while the national tax rate drops, it is being applied to a broader sales tax base.]

Likewise, the denominator includes the gross sales made within states that do not choose to participate in the national tax rate program, and which do not impose a sales tax. Again, the effective national tax rate drops.

Exemptions: The only exemptions allowed would be for sales into other countries (assuming the country imposes a tax itself), and for sales for resale. All other exemptions — e.g., manufacturing, exempt organizations, pollution control equipment, etc. — appear to be disallowed for sales subject to the national tax rate.

Liability for Payment/Collection of National Sales Tax: The sellers will be liable for payment of the national sales tax; therefore, they are expected to build the tax into the sales price for its goods and services, as a cost of doing business. Product prices may be adjusted according to the distribution proportions of taxable and exempt/foreign non-taxable sales being made. If a purchaser supplies a resale exemption or proves the transaction is otherwise not taxable, the seller can reduce the purchase price by the amount of the embedded tax.

Role of Financial Organizations in Implementation of Program: If the country location of the purchaser is not known, then the tax cannot be applied properly to transactions.

National Location Identification Number: Financial organizations including credit card companies doing business within the United States will be required by federal law to identify the national location of customers on any transfer of funds. A corresponding ban will be placed on acceptance of funds transfers that are not accompanied by a national location number, indicating the nationality of the account holder. The financial organizations must provide these location number to sellers.

Use of Location Numbers: Sellers who receive the location number will be able to identify sales as United States-based or foreign-based.

Monitoring Compliance: This component of the tax structure must be created, in conjunction with the existing federal agencies that regulate financial institutions. An existing or new agency would be charged with certification, monitoring and decertification of financial organizations based on their compliance or (intentional) noncompliance.

Seller's Choice to Collect Actual State Sales Taxes or National Average Tax Rate:

Even if a state participates in the national sales tax program, a seller can choose to remit the actual state sales/use tax due on a sale to a customer in that state, if the seller knows the customer resides there.

As noted above, sellers are directly liable for the national sales tax charged on applicable interstate sales. It appears that for interstate sales where the seller chooses to collect the existing state and local use taxes (e.g., in the case of sale of tangible goods, where the seller knows the exact location of the customer and can process the transaction easily), the liability for payment and collection of the tax will be determined by reference to the laws of the taxing jurisdictions. Therefore, the seller may not be directly liable for payment of the tax in those instances.

Distribution of Taxes:

State Taxes: The national sales taxes that are collected by a federal agency (the IRS? or a new agency?) will make distributions to participating states based on the following formula: divide the state's taxable sales by the total taxable sales of all states participating in the national sales tax program.

Local Taxes: Each participating state will be required by federal law to make distributions to localities of tax, based on a percentage developed by comparing the tax received by each local jurisdiction to all tax collected within the state (at the state and local level).

Credit on International Sales: If the property or services are delivered into another country, the sales into that country will not be subject to the national sales tax, provided the foreign country asserts the right to impose a "similar tax" on the transactions. If the foreign country does not assert this right, the national sales tax will be imposed on the sale. However, instead of utilizing a UDITPA-style throwback rule for purposes of distribution to the states, the United States government will be entitled to retain the national sales tax collected on such transactions (i.e., the throwback concept is applied here, but the tax stays in the hands of the federal government). The revenues thus collected and retained by the federal government will serve as an offset to the expense the government incurs in administering this program.

International Tax Court: In order to settle disputes on an international level, an international tax court should be formed. Disputes might concern the following matters:

Enforcement of the national sales tax duty by participating states or the United States against sellers that are not themselves physically present in the United States; and

Judgments as to whether a foreign country has asserted its right to impose a "similar tax" for credit purposes.

Analytical Criteria

Constitutional Considerations:

Almost every technical tax feature of this proposal warrants close scrutiny under the Commerce, Equal Protection and Due Process Clauses. Indeed, general notions of federalism and the Tenth Amendment reservation of powers to the States may be raised as objections to the proposal. In addition, unrelated issues of privacy rights may be implicated by the requirement of country location numbers on private financial accounts. This section will identify a few of the concerns that may be raised.

Nexus:

Under the dormant Commerce Clause, this "economic presence within the United States" standard would not rise to "substantial nexus." Of course, Congress could change the Commerce Clause nexus standard, if it so chooses. The use of worldwide unitary and attributional nexus principles are also subject to constitutional challenge, absent Congressional legislation (albeit, this proposal requires just such action).

Is the Due Process nexus requirement of "minimal connection" to a particular state satisfied, where (1) a particular seller may not have economic presence in all participating states, but (2) all participating states receive a general distribution of funds, some of which may be considered to have been charged to the seller in question? In other words, does this proposal satisfy Due Process fairness/substantial justice concerns, where each participating state will inevitably receive funds that were collected from non-nexus taxpayers, as opposed to receiving funds from sellers proven to have adequate Due Process nexus with those states? [This would be a matter of equal concern for Commerce Clause purposes, under a dormant Commerce Clause analysis.]

Financial Organizations' Bookkeeping and Reporting Duties: Do the requirements placed on the financial organizations — which are admittedly not a direct party to the transactions being taxed — valid under the Commerce Clause and the Due Process Clause? What about placing those requirements on foreign financial organizations, that have mere economic presence in the United States?

Equal Protection: The comparative burdens placed on in-state and out-of-state sellers must be carefully analyzed. See section VI. (C)(2)(e), below.

Structural Considerations:

Can the worldwide system contemplated by this proposal actually be made to work? The proposal notes that "because a country would not have a way to enforce its taxes against a vendor exploiting its market, the only way to enforce an obligation to collect taxes in market countries would be through an international agreement. A specialized court created by international treaty would be one way to address this. International treaties upholding a country's right to have its judgments enforced in the country where the company is located, if certain basic elements were proved to establish the liability, would be another way."

The technological capacities, and the banking systems themselves, of different countries vary widely. The coordination of banking systems so as to implement the country location number system is mind-boggling.

A central federal agency, or federal clearinghouse, or a state organization designated by consensus, is required to administer the national sales tax program. Assuming the United States government discharges this function, will the revenues retained by the government on foreign sales for which no credit was allowed adequately cover the expenses it incurs? If not, the system must be made to pay for itself.

Audits: Would the central agency conduct a single audit, on behalf of all participating states? And, what if the electronic seller both collects and reports actual state and local use taxes, but also pays over the national sales tax rate on other transactions; how will the audits be conducted then? What kind of record keeping requirements will be imposed, in these instances?

Will there still be planning opportunities for out-of-state sellers to reduce their state tax compliance and payment burdens, compared to in-state sellers? If the national sales tax rate is higher/lower than a particular state/local combined rate, the exercise of choice as to which tax to collect could perpetuate some degree of disparity between "Main Street" and out-of-state retailers. On the other hand, if this system results in a disproportionate burden being placed on out-of-state retailers, whose direct tax liability for national sales taxes is higher than the local sellers' burdens to collect and remit (or owe) state/local sales taxes, the remote sellers may have an Equal Protection argument.

Political Considerations:

Will the states "buy into" this tax methodology? Clearly, this proposal advocates an extreme departure from state sovereignty, but it does so in the name of increased tax revenues realization, at both a state/local and federal/international level.

Will taxpayers "buy into" this tax methodology? In some respects, it promises the simplicity, and arguably could import greater certainty, both of which are hallmarks of a system that taxpayers will support. On the other hand, this is so radical and so invasive in some respects, that the business community that will be subject to this regime (as opposed to local sellers) may oppose it.

Can Congress intervene in this manner? The entire concept requires as much concerted effort, and coordination between federal and state agencies, and international organizations and governments, as to make it appear too ambitious and too complex for many in Congress, who tend to favor more discrete approaches to problem-solving.

CONCLUSION: THERE WILL BE OTHER SUGGESTIONS

Certainly, these are but the first of many substantive ideas that will be aired for public scrutiny and comment. Whether they are the product of specific individuals or of working groups, whether they are proposed by business, government, academic or other sources, these proposals are the necessary fuel to drive the process of tax policy development.