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Organizing Documents  (OD-12) INTERIM REPORT OF THE TASK FORCE ON SIMPLIFIED FILING

Progress Made To Date By The Task Force On Simplified Filing

Harley Duncan, Gerry Bair, Kaye Caldwell, Andy Ottinger, and I comprise the Task Force on Simplified Filing ("Task Force"). Our meetings and independent research have led us to a high degree of consensus, and to the recognition that much work still remains for the group which will flesh out our initial recommendation.

Our recommendation is that the sales tax regime proposed by the NTA Tax Project be modeled after one which has recently been implemented for the collection, payment and administration of highway fuel taxes. The fuel tax system was initially adopted in 1991, and became mandatory for all states in 1996, after a 5-year phase in period. It is in use today, it has been accepted by each of the states, and it provides us with both a design and a working model. Hopefully our task will be easier because of the work that has been done in creating what this report will refer to as the "Base State System."

The balance of this report discusses the general outline of the Base State System, considers how some of its features might be adapted to the NTA Tax Project's sales tax regime, and offers an initial view regarding its constitutionality.

The Base State System In General

Basic Premise. The primary goal of the Base State System is to limit, to the maximum extent possible, a taxpayer's contact for sales tax administration and compliance purposes (whether for registration, returns, remittances, administration, audit or appeals) to a single state, presumably its principal place of business. The base state, in turn, becomes responsible for communicating information, transferring funds, performing enforcement and administrative functions, etc. on behalf of the taxpayer with other states participating in the agreement.

Coverage. One initial question is to which vendors or taxpayers should our Base State System be applied. That is, in the terminology of the Scope Task Force, should it apply to Option 1, 2, 3 or 4. Our strong recommendation is that we should select Option 3, "all remote commerce," as the population to which the Base State System would apply.

There are trade-offs between the type of simplification which will reduce the taxpayers' burden, and the states' ability to implement the system. If our goal were merely the optimal and maximum "burden reduction," the system should be applied to all commerce (i.e., Scope Option 4), regardless whether it is intrastate or interstate, and regardless of whether the vendor has physical presence in the jurisdiction. However, our Task Force may have objectives that differ from those of the Scope Task Force. We call on the members of the Scope Task Force to reflect on our recommendation, and to identify any competing considerations they believe are equally important.

We note that the Base State System is most easily applied (and perhaps limited) to situations in which the tax at issue is relatively uniform from state-to-state. For this reason, we believe the imperatives of a simplified system should in fact determine the Scope decision. Since simplification is the essential quid pro quo for the participation in this effort by many members of the business community, we must propose a system which places one of its highest priorities on achieving what has been dubbed "total simplification."

Our reasons for advocating "all remote commerce" as the system's scope relate to the risk and the difficulty of applying a Base State System to Main Street retail sales. A significant proportion of the tax revenue of many localities depends on the smooth flow of sales tax collections from Main Street commerce. We see no compelling reason to change the way that system functions today. The broader the application of our new system, the greater is the burden on us to insure that neither the businesses' nor the states' cash flow is seriously disrupted. We are concerned that by adding the additional volume of Main Street commerce to our scope, we might seriously compound the difficulty of stabilizing the cash flow, without providing any significant improvement or financial benefit to anyone.

Registration. In our proposed Base State System a vendor should be required to register with only the base state, generally the state in which its principal place of business is located. Information required on the registration form will need to be coordinated among states to insure that all legitimate information needs are addressed. Two questions important to the government entities are: (1) whether a surety bond or other similar "protective resource" is required of taxpayers; and (2) what sanctions can be taken against a vendor who is noncompliant in some fashion. Given that a single registration will confer on a vendor the authority to operate in all states, sanctions against that authority will be of the utmost importance.

Returns. A vendor should be required to file a return with only the base state, but that return would need to include relevant data on the vendor's operations in all states for the reporting period. The base state would be responsible for providing the return information to other states. The uniform return would need to include agreed-upon information. If there is to be only a statewide tax rate with no sourcing to individual local governments, the development of a uniform return should be relatively straightforward. If there are local variations in the rate, the procedures become much more complex. For this reason, we strongly recommend that a single statewide rate of tax be applied to all transactions within the scope of the Base State System.

One complicating factor may be the desire/need to obtain information on exempt sales. Another complicating factor may be the manner in which it is determined that "direct pay" permit holders (discussed in more detail below) should be handled, i.e., should the direct pay use tax be included on the sales tax return? These procedures are yet to be determined.

Remittances. A single remittance to the base state would be required. The handling of money and getting it to all participating states would be handled by a National Clearinghouse, which is discussed in more detail below.

Funding. We propose that under the new Base State System, funds transfers are handled in a manner that resembles that adopted by the Regional Processing Center ("RPC") employed in the fuel tax system. In the RPC, all returns of participating jurisdictions are "netted" against one another. A state needs only to make one funding remittance to the RPC to meet its obligations to all states instead of making a remittance to each jurisdiction. In our sales tax Base State System, a state would have to make only one payment (or receive one check) that is the net of all activities of all vendors in the state, rather than reconciling its liabilities with each state individually.

It may help to understand the netting to visualize a spreadsheet with names of the taxpayers down the side and the states across the top. Each cell would have an entry for the amount of tax owed from each taxpayer to each state. The last column would be the total owed by the taxpayer to all states, and the last row would be the total owed the state by all taxpayers.

The manner in which this is done in the RPC model is that each participating state must submit a file to the RPC within a specified period of time after each filing period. The file shows the taxpayer, amounts due each state from the taxpayer and the amount paid to the state. On an overnight basis, the files from the various states are consolidated, and a netting summary is prepared. Each state is then provided with a notice of the amount it must fund to the RPC or the amount it is due from the other states. States with a net liability are given 24 hours to make their cash settlement. The RPC then provides funds to each state with a net receivable, and all accounts are reconciled. All payments and notices are done electronically through e-mail, EFT and electronic downloads/uploads of data.

Exceptions It will be important to have clear, enforceable rules governing exceptions from the normal process, e.g., "partial pays," "no remits," nonfilers, late payments, etc. The fuel tax regime has detailed rules which should be helpful in this regard.

Audits, Assessments and Appeals.

Audits. Our goal is to propose a system which will permit one consolidated audit on behalf of all jurisdictions for each tax period. The NTA Tax Project's decisions in other areas will determine whether this is feasible.

A single audit system would be possible if the Base State System applies only to a relatively small group of relatively homogenous vendors. If the Scope decision is "all remote commerce" or "all electronic commerce," we believe a single audit system is possible. However, if the Base State System is applied to all commerce, the magnitude and complexity of a single audit system would likely become prohibitive.

A single audit system could be implemented in either of two ways. One possibility is that the base state's audit agency would audit the vendor on behalf of all states. This option, referred to as the "Base State Audit," is the model generally employed in the fuel tax system. An alternative would be the "Outsourced Audit," where responsibility is contracted to a single organization to perform audits on a national basis for all states. With some variations, the present MTC Audit program could provide a model for this system. In either case, the vendor would be relieved of the burden of multiple audits of the records for a tax period.

Audit. Under a Base State Audit system, the base state selects the taxpayers to be audited, subject to agreed coverage rules that apply to all states. The states would agree in advance on the coverage rules, and a peer review function would be implemented to assure quality and consistency of each state's audit function.

Under the outsourcing approach, the audit candidates are selected through a process whereby each participating state can nominate and vote on specific taxpayers to be audited. The contractor would convene an Audit Committee which consists of members of the audit agency of each state. The Audit Committee would selectively monitor the quality and consistency of the contractor's audits.

Appeals. This subject will require thorough consideration by the state tax administrators. Our initial inclination is to say that under the Base State Audit system, the vendor's appeal should be made to the base state. But, if an adjustment involves an interpretation or application of the law of a second state, it seems more reasonable (and in fact necessary for control of the tax policy of the second state) that such an issue should be appealed and adjudicated in that state. This is the model followed with MTC joint audits.

Re-audits. The suggestion is made by government representatives that there will be some cases where it is necessary to allow states other than the base state to examine working papers and conduct re-audits. The business representatives are opposed to this concept, since it defeats the purpose of having a single audit. Further debate is required on this point.

Other Administrative Matters

Administration By A National Clearinghouse. As is the case with the new fuel tax system, we believe it will be necessary to have some central administrative entity as part of the new Base State sales tax system. At a minimum, the duties of this entity would include: (1) administering the peer review program (necessary to assure states that each is faithfully meeting its audit obligations; (2) providing interpretations of any organizing documents establishing the system and defining the rights and obligations of both vendors and states; (3) coordinating the selection and conduct of audits; (4) operating the funding process and other information processing systems; (5) maintaining any tax compliance software employed by vendors; and (6) developing, refining and insuring adherence to the various uniformity requirements of the new system.

In the case of the International Fuel Tax Agreement, this role is played by IFTA, Inc., a dedicated not-for-profit corporation controlled by all the states. The procedures for governance and operation of this entity are quite lengthy and specific, and could serve as a model for our Base State System. In addition, we have access to several expert information sources, including Bob McKee, currently the head of IFTA, Inc. in Phoenix, and Roger Tew, a Utah attorney and formerly Utah's head administrator for fuel tax matters.

Direct Pay. This term refers to taxpayers which are now exempt from paying sales tax on their purchases since they accrue and remit use tax directly to all jurisdictions in which they are Direct Pay taxpayers. Generally, such taxpayers use Direct Pay on all their purchases. Direct Pay is especially useful for purchases of information services and other intangible products that may be downloaded or maintained at a single location for later use in multiple jurisdictions.

The Sourcing Task Force did not recommend the adoption of a "Universal Direct Pay" system for all business purchases, but it did recommend that Direct Pay facilities should be maintained and used at the option of the taxpayer.

Thus, our proposed Base State System will have to include the ability to deal with Direct Pay taxpayers that are exempt from paying sales tax at the time of purchase. Further study is required to develop this ability.

Our questions will include the following: (1) do Direct Pay taxpayers register with only a single state; (2) do they file with a single state; and (3) is there a separate system for Direct Pay taxpayers or are they "folded into" the sales tax Base State System. In other words, just about every question asked for a sales tax vendor is also applicable to a Direct Pay permit holder.

Vendors Based in States Without a Sales Tax. We still need to develop a means to deal with vendors based in states without a sales tax. These vendors should not be "orphaned" by a Base State System and required to deal with multiple states. They could be "adopted" by some other state for purposes of the Base State System, or they could be assigned as a responsibility of the National Clearinghouse.

Legal and Constitutional Considerations

The fuel tax model should provide a means of dealing with the legal and constitutional concerns discussed in the First Report of the Drafting Committee. It should also satisfy the political requirement of being "consistent with the traditional concepts of federalism."

In the proposed Base State System, federal legislation would first be enacted declaring the sales and use taxation of remote sellers to be a matter of national interest, and one in which Congress has elected to use its powers to regulate interstate commerce. Then, the general outline of the Base State System would be promulgated by Congress, and each state would be put on notice that after some implementation date, they would only be allowed to levy a sales or use tax on remote commerce if it is done pursuant to the new Base State System.

In the fuel tax case, the U.S. Department of Transportation was authorized to spend federal government funds to establish IFTA, Inc. and to take other actions which might be necessary to implement the program. Similar appropriations by Congress to the Treasury or Commerce Department would be very helpful in assuring that the new system and the new National Clearinghouse are properly created and administered.

In response to the federal legislation, each state would then be required to adopt conforming state legislation empowering state officials to comply with the new system. In the case of our proposed Base State System for sales taxation, some states will also require time to amend their constitutions to conform.

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