National Tax Association Communications And
Electronic Commerce Tax Project

Organizing Documents  (OD-11) REPORT BY THE SUBCOMMITTEE ON SOURCING TRANSACTIONS

Final Report

Situs and Sourcing Subcommittee

National Tax Association Communications and Electronic Commerce Tax Project

April 10, 1998

Executive Summary
Situs and Sourcing Subcommittee Report
National Tax Association Communications and Electronic Commerce Tax Project

Background Understandings
The appropriate frame of reference is a "traditional" sales and use tax where transactions are sourced to and taxed in the state of destination or use. The "billing address" of the buyer is an acceptable proxy for actual knowledge of the destination where that destination is not known or cannot be determined by the seller. Where, however, there is knowledge of the actual "ship to" address (e.g., in cases of sales of tangible goods), the "ship to" address would trump a billing address as the indicator of state of destination.

Level of Sourcing
The Subcommittee recommends that transactions should be sourced only to the "state" level and not to any substate or local level. The Subcommittee believes it is reasonable to expect that sellers will have an ability to source transactions to this level either from information available to them in the normal course of business or from information that can be obtained during the transaction. To go beyond this level, however, introduces unnecessary and potentially insurmountable complexity.

Obligations Imposed on Sellers
Sales of Tangible Goods. The Subcommittee recommends that in the case of tangible goods, the "ship to" address should be used to determine the destination of the good and the state in which it is to be used. Such information should be available to the seller in the normal course of business.

Sales of Electronic Commerce. For sales of information or services in electronic commerce where the actual state of destination or use may not be made available to the seller, the seller will default to determining the Billing Address of the buyer. A seller engaging in a transaction must make a good faith effort to determine the state where the customer has his/her Billing Address when the seller does not have knowledge of the actual state of destination or use for the purchased product or service.

Business Purchases. The Subcommittee believes that the necessary information to source to the state of use will be available to the seller in the normal course of business when dealing with a business customer, i.e., through normal billing and other service arrangements.

Non-business Purchases. In the case of individuals, there is a greater likelihood that a seller will not have the buyer's place of use or Billing Address information in the his/her records. In these instances, the Billing Address, as a default situs rule, must be determined at the time of the transaction.

  • The Subcommittee believes that customers making advance payment must be advised to include the applicable tax for the destination state shown on the financial instrument provided by the customer.
  • In the case of credit/debit card, the Subcommittee believes, based on its investigation, that the Billing Address information needed [i.e., state of billing] can be verified through the current transaction authorization processes without additional information and without a violation of privacy concerns.
  • In the case of prepaid cards or cybercash, the Subcommittee believes it is necessary to work with that industry to require the encoding of Billing Address information on the card or in the account information.

Good Faith Safe Harbor
The Subcommittee believes that where a seller makes a good faith effort to obtain billing address information and relies on any of several types of information provided by the buyer, the seller should be protected from further liability.

Transactions where the State of Destination and Billing Address are Not Known or Knowable
The Subcommittee believes it is important to have a rule for dealing with transactions where both the state of destination or use and the billing of the address is not known or unknowable. A "default" rule to deal with these transactions could take the form of either a "throwback" rule [i.e., assigning the sale to a single state associated with the seller (e.g., principal place of business)] or a "throwaround" rule [i.e., apportioning the sale among the states in which the seller make sales with a known destination or billing address.]

The Subcommittee believes a simplified "throwaround" rule is appropriate for dealing with transactions in which the state of destination or the billing address of the buyer is not known. Under the subcommittee recommendations, such sales would be subjected to a single tax rate that is the same for all sellers in all states. The tax would be paid to the seller, and the revenues would be distributed among the states in proportion to the revenues reported for sales with a known destination. Remittance of the tax by the seller and distribution among states would occur under whatever system is ultimately adopted for other remittances and filings of sellers.

Sales into States without a Sales Tax
The Subcommittee recognizes that there may be a problem with purchasers establishing billing addresses that do not correspond to their actual location in order to avoid sales tax. The Subcommittee does not believe it is appropriate, at this point, to apply the "default" rule for sales into jurisdictions that have chosen not to impose a sales tax and recommends deferring consideration these issues until we have a better understanding of the scope of the "tax haven" problem under whatever regime is ultimately adopted.

Information Used in Multiple Locations
One characteristic of electronic information services that complicates sales tax administration is that a single sale or delivery of a service or data base can be used by multiple persons in multiple locations. The Subcommittee recommends the tax on such sales should be apportioned among the states in which the users are present according to some reasonable, supportable basis. The Subcommittee further believes that the information required for such apportionment is likely to be available during the normal course of the business transaction or can be reasonably be obtained during the transaction. A procedure for obtaining such information is proposed. In addition, the Subcommittee believes that an expanded use of direct pay can facilitate compliance with its recommendations.

Conclusion
The Subcommittee believes it has designed a system for sourcing sales for tax purposes that achieves a realistic and workable balance between the objectives of maintaining a destination-based sales tax and reasonable administrative burdens being imposed on sellers. It has designed a system that: (1) relies upon information customarily available to the seller and upon existing business processes; (2) provides reasonable "safe harbors" for vendors who exercise due diligence in discharging their duties; and (3) deals with certain, new issues that are raised by electronic commerce. The Subcommittee stresses that implementation of this system is in many ways dependent on other simplifications in the sales tax system, particularly the adoption of a system that eliminates the need to source sales to any level other than to a "state."

Final Report
Situs and Sourcing Subcommittee
National Tax Association Communications and Electronic Commerce Tax Project

Introduction
The Situs and Sourcing Subcommittee was formed at the February 4, 1998, meeting of the Steering Committee. The purpose of the Subcommittee was to examine the issues involved in the situs of a sale in electronic commerce and sourcing that sale to the appropriate jurisdiction for tax purposes and to recommend a solution to those issues for transactions in electronic commerce.

The Subcommittee consisted of Karen Boucher, Wally Hellerstein, Paull Mines, Andy Ottinger, Bruce Reid, Jim Schroeder, Peter Weiss and Harley Duncan, Chairman.

Background
Based on discussions at the February 4 Steering Committee meeting, the Subcommittee started from the following basis in defining the appropriate sourcing rules.

  • The appropriate frame of reference is the model of a "traditional" sales and use tax where transactions are sourced to and taxed in the state of destination or use. At this point, a substantial departure from the principle of taxation in the state of destination is not contemplated. It may be that taxation in the production state for some [smaller] sellers makes sense, but the primary rule is that sales should be subject to taxation in the state of use.
     
  • Where the state of use is not known and cannot be reasonably determined by the seller, the "billing address" of the buyer is an acceptable surrogate or proxy. Where, however, there is knowledge of the actual "ship to" address (e.g., in cases of sales of tangible goods), the "ship to" address would trump a billing address as the indicator of state of destination.

 

From this premise, the Subcommittee proceeded to organize its inquiry around several questions, including:

  • To what level (state/substate) should a transaction be sourced, i.e., how finite should the billing address or ship to address requirement be?
     
  • How should billing address be defined?
     
  • What obligations should be imposed on sellers to obtain the requisite sourcing information from the buyer?
     
  • What safe harbors should be available to a seller who makes a good faith effort to obtain the appropriate billing address information of the buyer?
     
  • How do the requirements posed by the Subcommittee square with current processes for handling electronic transactions, particularly those involving credit card purchases over the Internet?
     
  • How should transactions where the billing address of the buyer is not known or not "knowable" at the time of the transaction be handled?
     
  • What should be the treatment of sales into states without a sales tax where there is a potential tax haven situation?
     
  • How should sales of electronic information services intended for use by multiple persons in multiple locations be handled?
     
  • What should be the role of direct pay permits in electronic commerce transactions?

 

Level of Sourcing
The Subcommittee recommends that transactions should be sourced only to the "state" level and not to any substate, local jurisdiction, or street address level. [Accordingly, this means that the tax rate applied to the transactions would of necessity be statewide tax rates, a position which is consistent with the recommendations of the Tax Rate Subcommittee.] The Subcommittee believes it is reasonable to expect that sellers would have an ability to source transactions to this level either from information available to them or from information that can be obtained during the transaction. To go beyond this level, however, will increase the difficulty of obtaining the necessary information, compromise the accuracy of the sourcing by introducing difficulties of matching addresses or other indicators of destination to tax rates and increase substantially the likelihood that the buyer will provide clearly erroneous information.

Definition of Billing Address
The Subcommittee adopts the definition of "billing address" contained in Report No. 1 of the Drafting Committee. That definition purports with common understandings of the term and should present no issues. The proposed definition is: 1

"Billing Address" means the address to which:

  1. the vendor of the transmitted information or services or,
     
  2. when the vendor looks to a third party financial intermediary for payment for electronically transmitted information or services, such intermediary,

sends the bill for payment for such information or service.

Obligations Imposed on Sellers
Sales of Tangible Goods. As noted, the Subcommittee recommends that in the case of tangible goods, the "ship to" address should be used to determine the destination of the good and the state in which it is to be used.

Knowledge of the actual state of destination or use is deemed to be possessed by the seller where the seller possesses address information provided by the customer in the ordinary course of business that is used in conjunction with the delivery or provision of the product/service and establishes legal rights or duties for the customer in a particular state as to the product/service being sold. Linking the address used for sourcing to the establishment of legal rights or duties for the customer in a particular state is meant to ensure that the address provided by the customer is a valid address. That is, it is more likely that a customer will provide a valid address where, for example, advising the vendor the product will be used in Colorado then subjects the vendor to Colorado law requiring notice of a product recall.

Examples of address information used in conjunction with the order for product/service that establish legal rights or duties in a particular state include, without limitation, a shipping address, bill of lading, license agreement, warranty registration, confidentiality agreement, a customer response to a request from the seller for the state where the product/service will be used for customer service purposes.

Sales of Electronic Commerce. For sales of information or services in electronic commerce where the actual state of destination or use may not be available, the seller will default to determining the Billing Address of the buyer. A seller engaging in such a transaction must make a good faith effort to determine the state where the customer has its Billing Address when the seller does not have knowledge of the actual state of destination or use for the purchased product or service.

Business Purchases. The Subcommittee believes a significant difference in the availability of such information exists as between business customers and individuals. It is expected that in business purchase situations, information will be provided which will allow a sourcing of the transaction to the state of use in the normal course of business. Business customers can be generally assumed to have established some form of business arrangement that includes state-specific information. That is, where a business customer is involved, we expect to see pre-transaction agreements and post-transaction billing arrangements. Sourcing information can be obtained from this information as it is obtained in the normal course of business. That is, unlike the case of a non-business, it can be anticipated that normal business practices will provide sufficient information to allow a transaction to be sourced to the state of use from billing information.2

Non-business Purchases. In the case of individuals, i.e., non-business customers, billing and payment for product or services will often occur contemporaneously with the delivery of the product/service. That being the case, there may be no verifiable destination or billing address information in the seller's records. In these cases, the Billing Address must be determined at the time of the transaction.

  • Advance payment by check or money order poses a special problem since the only Billing Address information available is on the financial instrument making payment for the product/service. The Subcommittee believes that customers making advance payment must be advised through the price sheet, catalog, vendor service representative, i.e. 800 number representative, or other marketing medium to include the applicable state rate for the Billing Address shown on the financial instrument provided by the customer.
     
  • In the case of credit card, debit card or vehicle for payment provided by a third-party financial intermediary for either business or individuals, it is the Subcommittee's belief that assuring an accurate Billing Address and, consequently, virtually eliminating anonymous transactions can be best accomplished by the seller verifying necessary Billing Address information with the third-party financial intermediary as part of the transaction authorization process. Even though some industry representatives have indicated otherwise, the Subcommittee believes that verification of the Billing Address information needed [i.e., state of billing] should not pose a privacy or confidentiality threat. The Subcommittee further believes that the verification of this information can readily be accommodated within the current processes involving credit/debit card transactions and that there should not be a need for additional information or augmented processes. [See discussion of current processes below.]3
     
  • In the case of prepaid cards or cybercash, the Subcommittee believes it is necessary to work with that industry to require the encoding of Billing Address information on the card or in the account information so that when a cybercash account is accessed for funds by a seller, the account can be identified as having been established by a person with a Billing Address in a particular state.

Credit/Debit Card Transactions
To ascertain the impact of its recommendations on current processes for handling credit/debit card transactions, the Subcommittee inquired of representatives of MasterCard and VISA, about the information flows in a credit card transaction. Particularly we questioned the ability of the credit card processing systems to verify and/or provide information about the billing address of the buyer/card holder to a seller at the time of a credit card transaction. We obtained somewhat different (but not necessarily irreconcilable) answers that are discussed below.

VISA System. VISA indicates that they have what they call an "Address Verification Service" (AVS) available to sellers for transactions where there is "no card present." In AVS, a seller can, at the time he/she is seeking approval/authorization of the transaction, submit to the system the billing address supplied by the buyer for verification. This includes street number, name, city, state and Zip Code. This data is bounced against the Master File of the "issuing bank" and a verification is provided to the seller if the information provided by the buyer matches the records of the issuing bank. If there is not a match, a series of codes is used to denote what mismatches are present.

The ability to participate in this type or level of AVS is contingent on the ability of the vendor to pass alpha and numeric data to the processor/issuing bank at the time of the transaction. If the seller is able to transmit only numeric data, he/she can participate in a "partial" AVS where the numeric data is verified. An increasing number of sellers are acquiring the ability to transmit both alpha and numeric data It is believed that most E-commerce sellers would have such abilities, i.e., they would be using computers in the Order Entry system.

Sellers are provided incentives to use the AVS in two ways. First, there is a "reduced discount rate", i.e., they are charged a lower rate by the processor and merchant bank for dealing with the transaction. Second, if they undertake verification and correction of unmatched data fields, they are protected against "chargebacks" if it turns out to be a fraudulent transaction. It is our understanding that if there are mismatched fields, the vendor can proceed with the transaction, but there are increasing costs/risks to doing so, depending on the degree of mismatch.

MasterCard System. According to information received from Master Card, its processing system only verifies numeric items, and not alph items such as street name, city name, state name, etc. Further, they do not verify the full address, but only the first 5 digits of the street address and the Zip Code. Accordingly, they can verify state-level sourcing through the five-digit Zip Code.

In addition, both companies indicated that for fraud protection and privacy reasons, they are not willing to share or provide information directly, but do verify in today's environment. As we proceed, there are likely to be some issues regarding the need for a "second" transaction if sales tax is added to a transaction amount after the initial purchase is approved.

While the stories are different, we think the difference might be that MasterCard was describing the "retail/individual consumer" system, whereas VISA was describing their "Commercial Product" system [as well as the direction things were headed.] In any event, it appears that there is an ability to verify a state-level indicator that is provided by a buyer at the time of the transaction without additions to or substantial modifications of their current processes.

Good Faith Safe Harbor
The Subcommittee believes several good faith safe harbors must be established for sellers.

  • Where a customer provides the seller with address information that is used in conjunction with the order for product/service and establishes legal rights or duties for the customer in a particular state as to the product/service that is sold, the vendor may rely on such information for collecting sales tax on the transaction. In such a case, the seller will collect sales tax based on the state of destination or use and need not make any inquiry as to Billing Address.
     
  • In the event a seller has conflicting information as to the actual state of destination or use, no seller will be held liable for failure to collect when the seller chooses one of the states in question and collects tax based on that state.
     
  • If the seller does not have knowledge of the actual state of destination or use, the seller must make good faith efforts to determine the Billing Address.
  • In the case of business customers, a seller may rely on address information found in established billing arrangements (i.e., invoices, contracts, license agreements, warranty registration, confidentiality agreement, letterhead) with the customer in determining the Billing Address.
     
  • In the case of business customers or individuals making payment in advance of transfer of the goods/service, address information found on checks, billing remittances or other documents used to effect the transaction can be relied on by the seller.
     
  • In the case of payment being effected by use of a third-party financial intermediary, the seller may rely on Billing Address information verified by the third-party financial intermediary as part of the transaction authorization process.
     
  • In the case of payment being effected by use of a third-party financial intermediary where sufficient Billing Address information cannot be verified by the third-party financial intermediary, the seller must make an inquiry of the customer, at the time the transaction is effected, to identify the Billing Address.
  • Where the seller requests Billing Address of the customer, the seller may rely on information provided by the customer in response to the request.
     
  • Where the customer refuses to provide the information or provides unresponsive information, the sale will be handled as a transaction where the state of use and the state of the Billing Address are not known or knowable as described under the "throwaround rule" below.

 

Transactions where the State of Use and State of Billing Address are Not Known or Knowable
General Considerations and Assumptions. The Subcommittee believes that it is important to have some rule for dealing with transactions where the destination of the sale is unknown or unknowable. In such cases, it is not possible to attribute the sale to the actual state of destination or to the billing address as a surrogate for the actual state of destination. If no such "default" rule were adopted, then all such sales with unknown or unknowable destinations would presumably go untaxed. If the magnitude of such sales is significant, the revenue consequences of excluding such sales from the tax base would likewise be significant. On the other hand, the consequences of leaving such "nowhere" sales as untaxed may be tolerable if the magnitude of such sales is de minimis and the "default" rule for dealing with such sales is regarded as either burdensome or theoretically unsound. Because we presently have no empirical data as to the magnitude of such transactions, however, we are operating on the assumption that the problem of unknown or unknowable sales is potentially significant and therefore warrants the Subcommittee's efforts to address the problem.

The Subcommittee believes that the design of a "default" rule could take the form of either a "throwback" rule or a "throwaround" rule. A "throwback" rule would assign sales made to unknown or unknowable destinations to the state of the origin of the sale. This is analogous to the throwback rule under UDITPA § 16, in which sales of tangible personal property, which are normally assigned to the destination state in the sales factor of the tax apportionment formula, are "thrown back" to the state of origin when the taxpayer is not taxable in the destination state.4 Alternatively, a "throwback" rule might assign the sale to the retailer's principal place of business or commercial domicile to avoid the incentive of creating "shipping centers" for goods, services, or information in states without sales taxes. The alternative, however, may be regarded as objectionable because the retailer's principal place of business or commercial domicile may have no connection with the sale.

In contrast, a "throwaround" rule would assign sales to unknown or unknowable destinations to the jurisdictions in which the vendor made sales with known destinations. The "throwaround" rule serves the same function as the "throwback" rule, but rather than assigning the tax base for all sales to unknown or unknowable destinations to a single state,5 it assigns the tax base to all of the states in which the vendor makes sales. The Subcommittee believes the "throwaround rule" results in a more equitable distribution of sales tax revenues than a rule (like the "throwback" rule) that assigns such revenues to a single state.

If the "default" regime of a "throwback" or "throwaround" rule is to play a significant role in a sales and use tax regime directed to remote sellers, the Subcommittee believes that it makes sense to explore the possibility of spreading the tax base among the states in which taxpayers consume the goods, services, or information they purchase rather than assigning the tax base to a single state that may not correspond with traditional sales tax principles. For that reason, the Subcommittee has attempted to refine the "throwaround" rule first suggested in Report No. 1 of the Drafting Committee in order to remove some of its objectionable features and to offer it as a viable proposal for further Steering Committee consideration.6

Design and Implementation of a "Throwaround" Rule. In principle, a "throwaround" rule should be designed to treat sales to unknown destinations to the extent possible in the same fashion as sales to known destinations. The essential problem, as is so often in the case, is the trade-off between theoretical purity and administrative workability. For example, if administrative considerations were not a concern, one could implement a "throwaround" rule by treating each sale to an unknown destination as if it were a sale made to all states in the same proportion as known sales were made to states for the preceding reporting period. For example, if electronically transmitted information were sold for $100 to an unknown destination, the retailer would collect tax (and remit to the states) the tax due, if any, on the percentage of the $100 of receipts that reflected the proportion of sales to known destinations that the seller made during the preceding reporting period. In effect, each sale to an unknown destination would be treated as if it were a series of smaller sales to known jurisdictions. Insofar as sales were made during the preceding reporting period to states without sales taxes or to states that exempted the sale of such information, no tax would be due or collected.

The Subcommittee recognizes, however, that such a transaction-by-transaction approach to sales with unknown destinations is administratively unworkable. The seller would be required to apply a changing "weighted average" rate on such transactions and would be faced with significant reporting burdens. The Subcommittee therefore believes it is important to explore alternative mechanisms for implementing a "throwaround" rule that may not reflect the academic tidiness of the regime described above, but will instead offer an approach that is easier to implement.

For a "throwaround" rule to be administratively workable and acceptable to all concerned parties, the Subcommittee believes that it must be imposed at a single rate in all states and paid to a single state or clearing house, which would distribute the revenues collected among the states. The single common rate would be determined by the states.

Although the Subcommittee takes no position on what the common rate should be, it notes the following policy justifications for three possibilities: the lowest statewide rate; a blended rate; and the highest statewide wide. The lowest statewide rate could be defended as a rate designed to encourage transactions in electronic commerce and other remote selling and to assure that such transactions suffer no discrimination vis-ą-vis other forms of commerce. A blended rate could be defended as an effort to treat transactions in electronic commerce and other remote selling as equivalent to "average" transactions not involving remote selling.7 The highest statewide could be defended as an incentive for purchasers to provide information regarding the destination of the sale (whether the actual sales destination or billing address information), because the failure to provide such information would result in a tax at the highest statewide rate.

The taxes collected on sales to unknown destinations would be distributed to the states in the same proportion as the revenues reported by the vendor for sales with a known destination. The remittance of tax and distribution of revenues for unknown sales should be handled in the same manner as for other tax revenues of the seller.8

The Subcommittee recognizes that the simplified approach to a "throwaround" rule suffers from the conceptual flaw that taxes will be imposed on some transactions that in fact are not taxable (i.e., sales to unknown destinations that in fact are destined for states without sales taxes or states that exempt the sale in question).9 The Subcommittee nevertheless believes that its suggestion for an administratively simplified alternative to the theoretically ideal regime suggested above is worthy of serious consideration. The Subcommittee believes that the suggested alternative provides the framework for a practical solution to a difficult administrative problem,10 and that there are circumstances when "[t]he administrative costs of conceptual rigor are too great."11

Sales into States without a Sales Tax
The Subcommittee recognizes that there may be a problem with purchasers establishing billing addresses that do not correspond to their actual location in order to avoid sales taxation under a tax regime in which the destination of sales is determined by the default rule of the purchaser's billing address. The Subcommittee does not believe it is appropriate, at this point, to apply a special rule for sales into jurisdictions that have chosen not to impose a sales tax as a means of regulating the possible use of "tax haven" billing addresses. We recommend deferring consideration these issues until we have a better understanding of the scope of the "tax haven" problem under whatever regime is ultimately adopted.

Information Used in Multiple Locations
One characteristic of electronic information services that complicates sales tax administration is that a single sale or delivery of a service or data base can be used by multiple persons in multiple locations. This occurs when a service or data base is sold and delivered to a customer and subsequently made accessible to multiple employees of that purchaser through a "client-server" or "intranet" arrangement. This also occurs when a single subscription to an electronic data base is sold to a subscriber and the data base is subject to access by multiple users from multiple locations over the Internet. Similarly, a program might be sold by delivery of a "master disk" from which the buyer makes individual disks for use by its employees in different locations.

The question then becomes how should this sale which is subject to multiple users in multiple locations be sourced for tax purposes. The Subcommittee recommends the tax on such sales should be apportioned among the states in which the users are present according to some reasonable, supportable basis. The Subcommittee further believes that the information required for such apportionment is likely to be available during the normal course of the business transaction or can reasonably be obtained during the transaction. In addition, the Subcommittee believes that an expanded use of the direct pay concept can facilitate compliance with its recommendation that the information service should be proportionately taxable where it is used.

Proposal. The proposal of the Subcommittee for dealing the sales of information services involving multiple users in multiple locations follows.

Identifying Sales for Multiple Points of Use. If the purchaser knows at the time of a sale of a service or intangible property by electronic commerce that the product being purchased will be used in more than one State ("sale for multiple points of use"), then the purchaser must complete, under normal penalties for veracity, and deliver to the seller at or before the sale the uniform disclosure of sale for multiple points of use form ("UDSMPU form"). The UDSMPU form will disclose, among other things, the States in which the electronic product will be used, extent of such use, and data then known that will allow the tax base of the sale for multiple use to be apportioned among the States of use on a uniform and consistent basis. In determining the extent of use in the various states, the purchaser may use any reasonable method for allocation that is supported at the time of sale by business records.

Election of Direct Pay. Upon the filing of the UDSMPU form, in lieu of the seller collecting or paying and then remitting the sales and/or use tax applicable to the sale, the purchaser may elect to report and pay the sales and/or use tax applicable to the sale to the States in which the product will be used for the period for which the sale covers. The purchaser's timely and proper election will relieve the seller from any obligation to collect or pay and then remit sales and/or use tax for the sale or sales to which the election pertains.

Mechanics of Direct Pay Election. The purchaser will elect to make this direct reporting and payment as follows: The purchaser will complete and deliver at or before the time of the sale the uniform election form under normal penalties for veracity to be treated as the party responsible for paying the sales and/or use tax applicable to the sale for multiple points of use. Copies of the uniform election form will be delivered to [specify the central administrator for receiving uniform forms that apply to all States] and to the seller. A uniform election will be binding in all States in which [identify the uniform sales and use tax that must be in place for States to have taxing power with respect to electronic commerce] is then in effect and will govern all sales for multiple points of use between the seller and the purchaser from and after the election until the purchaser delivers written revocation of the election to [specify the central administrator for receiving uniform forms that apply to all States] and to the seller.

Situsing Sales for Multiple Points of Use. The situs of a sale for multiple points of use will be determined as follows:

  1. The situs of a sale for multiple points of use will be those States in which the electronic product will be used as known at the time of the sale. The situs of a sale for multiple points of use will not be determined by the location of the sale.
     
  2. The situs determination will remain in effect for the period of time covered by the sale, even if the total gross receipts of the sale is paid periodically.
     
  3. A new situs determination will be made at the time of a new sale of the same electronic product that was the subject of a previous determination of situs.

Rationale. Key elements of the reasoning underlying the Subcommittee's recommendations in this area include:

  1. Direct pay is a concept where the purchaser of a product assumes responsibility for paying the applicable sales or use tax under a permit system of the taxing State(s). (The proposal above finesses determination of which tax is being paid, a sales tax or a use tax. These complementary taxes are apparently subject to different U.S. constitutional limitations.)
     
  2. In order for direct pay to operate successfully in the electronic commerce environment, the direct pay system must operate nationally and the underlying sales and use tax must be simple and uniform. (State level situsing is one aspect of simplification and uniformity.)
     
  3. Direct pay by its nature is limited to business purchases. (If direct pay would work for consumer purchases, there would be little need for the NTA project, since the consumers would self assess and self-pay the tax that would be owed by their purchase, consumption or use of the products sold by electronic commerce.)
     
  4. Direct pay is not needed for purchases of tangible personal property made by electronic commerce. Acceptable situsing on a destination basis is achievable when goods must be shipped to a particular jurisdiction. The location to which goods are delivered is comfortably treated, both constitutionally and practically, as the destination of the sale. While direct pay is not needed for electronic purchases of tangible personal property, holders of valid direct pay permits are entitled to use such permits for purchases of tangible personal property made by electronic commerce. Moreover, direct pay authority can ease some compliance problems that arise under the current sales tax system when processes such as purchasing cards and evaluated receipts settlement are used.
     
  5. Because sales of electronic products can be placed in any jurisdiction without in most cases impacting the utility of the purchase, acceptance of the location to which electronic products are delivered as the destination of the sales may not be acceptable in determining where the product is actually being used.
     
  6. Direct pay is useful when the complexities of the purchase would potentially impose a high administrative burden on the seller of an electronic product to know how to situs the sale properly on a destination basis. (The seller may not have reasonable access to information on where the purchaser intends to use the electronic product.)
     
  7. Direct pay is particularly appropriate for consideration in the context of situsing sales of electronic services and/or intangible personal property where the product purchased will have multiple points of use.
     
  8. A sale involving multiple points of use should be identified at the time the electronic product is first delivered for use by the purchaser. If the purchaser informs the seller of intended multiple points of use at or before the first delivery of the electronic product, then the sale should so be classified. Otherwise, sales involving multiple points of use where the multiple points of use develop after first delivery should not be treated at the time of the sale as sales involving multiple points of use.
     
  9. Tax reporting for sales involving multiple points of use should be based upon facts that are reasonably known at the time the sale occurs.12 A vendor may rely on representations of the purchaser that are received by the vendor in the ordinary course of its business unless these representations are facially suspect. Tax reporting to reflect multiple points of use that develop after the sale will be the responsibility of the purchaser.

Conclusion
The Subcommittee believes it has designed a system for sourcing or situsing sales that achieves a realistic and workable balance between the objectives of maintaining a destination-based sales tax and not imposing unreasonable administrative burdens on sellers. To the maximum extent possible, the system relies upon information customarily available to the seller in the normal course of business and upon existing business processes for obtaining or verifying that information. It provides reasonable "safe harbors" for vendors who exercise due diligence in discharging their duties. At the same time, the Subcommittee recommendations address certain, new issues that are raised by electronic commerce such as sales where the requisite sourcing information may not be known and the access to electronic data bases by multiple users in multiple locations in a fashion which should not unduly burden electronic commerce vendors. The Subcommittee wishes to stress, however, that implementation of this system is in many ways dependent on other simplifications in the sales tax system, particularly the adoption of a system that eliminates the need to source sales to any level other than to a "state."

1 Billing address is used as a sourcing indicator only for electronic transactions involving the delivery of digital products, information services or other services (i.e., nontangible products). As noted in the second premise above, where tangible goods are involved, the state contained in the "ship to" address would determine the state of taxability.

2 This general rule is modified and amplified for business purchases involving the purchase of information that will be used in multiple locations. See discussion below.

3 Should additional information or processes become necessary, the Subcommittee understands that the financial intermediaries would require reimbursement of their costs through either a direct "vendor" compensation arrangement or a market-driven arrangement.

4 In the case of a sales tax, of course, the question is whether the vendor is subject to the jurisdiction of the purchaser's state so that the purchaser's state may require the vendor to collect the sales or use tax. Jurisdiction over the taxpayer---the purchaser---is not usually at issue.

5 Namely, the state to which the sales are "thrown back," however that state may be determined.

6 In attempting to refine the "throwaround" concept, the Subcommittee does not wish to be taken as rejecting the "throwback" concept. It may well be that the "throwaround" concept will prove to be unworkable or unsatisfactory, in which case the "throwback" concept may be the more appropriate approach to developing a "default" rule. Because the mechanics of a "throwback" rule are relatively straightforward, the Subcommittee did not feel it was necessary at this time to devote further energy to elaborating on the implementation of that concept.

7 A blended rate would presumably reflect the fact that some sales are made to states without sales taxes and that some sales are exempt: such sales would be zero-rated. The rate could be constructed by taking the total amount of sales taxes collected from sales to known destinations during the preceding period and dividing this figure by the total amount of sales made to known destinations during preceding period. The denominator would include sales on which no tax was due and would thus lower the blended rate to reflect the fact that some sales are not taxable. Alternatively, the blended rate could be the simple, unweighted average of state sales tax rates. There are obviously other alternatives for constructing a blended rate.

8 This issue is being addressed by the "Simplification of Filing Subcommittee.

9 As noted above, the rate to be applied to such sales could reflect the existence of exempt sales, even though it will not do so on a transaction-by-transaction basis.

10 Cf. Goldberg v. Sweet, 488 U.S. 252, 264-65 (1989) (recognizing, in the context of sales taxation of telecommunications, that the question of fair apportionment "is essentially a practical inquiry" and approving the tax regime there at issue because it represented "a realistic legislative solution to the technology of the present-day telecommunications industry").

11 Encyclopedia Britannica v. Commissioner, 685 F.2d 212, 217 (7th Cir. 1982) (Posner, J)

12 The proposal defines the occurrence of a sale as follows—
A sale of a service or intangible property by electronic commerce occurs at the moment that the following events occur: the parties have entered into a contract for sale (even where the contract provides for evaluation and/or possible return) and the commencement of the receipt of the service or of the delivery of the intangible property has begun

 

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