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National Tax Association
Communications And Organizing Documents (OD-3) REPORT NO. 1 OF THE DRAFTING COMMITTEE James Eads November 1997 TABLE OF CONTENTS
This is the first of what we expect will be a series of reports of the Drafting Committee of the National Tax Association's Communications and Electronic Commerce Tax Project. Like all of the reports that we anticipate issuing over the succeeding months (except, perhaps, the last one), this report is very much a work in progress. It reflects our tentative and preliminary thinking on the direction that a statute addressed to taxation of electronic commerce might take as well as our first cut at some statutory provisions designed to implement these initial thoughts. After describing the underlying principles and assumptions that are guiding our effort, we set forth a number of draft provisions, often in the form of legislative alternatives, along with our explanation of the purpose of the particular provision. We also set forth some of our proposals in narrative form. In addition, our report discusses tax collection and administration issues that need to be considered in any effort to deal with the problem of state and local taxation of electronic commerce. It also considers the constitutionality of federal legislation that would be required to implement some (but not all) of the proposals we have advanced. Two introductory caveats are in order. First, what follows should not be viewed as even the skeleton of a statute addressed to the problems of taxation of electronic commerce. It would more appropriately be characterized as protoplasm. Second, we have written this report, and we have developed the proposals it contains, in our individual capacities and as members of the Drafting Committee, not as representatives of the companies or institutions with which we are associated. Accordingly, neither the report, nor any of the proposals it contains, should be attributed to these companies or institutions. There will be ample opportunity for such companies and institutions to embrace, reject, or modify the proposals contained in this report as they see fit. A number of guiding principles and assumptions are informing our effort to draft statutory provisions designed to address the problems raised by state taxation of electronic commerce. Some of them are simply the standard desiderata of a "good" tax system that one finds in virtually any serious discussion of tax policy. Others bear more specifically on the project at hand. Among them are the following.
In drafting provisions that might be used as a model for taxing electronic commerce, we are not suggesting (nor is it our province to suggest) that electronic commerce should or should not be taxed. We understand our limited charge from the Steering Committee to be confined to the drafting of provisions that will provide a vehicle for a focused discussion of the policy issues surrounding state taxation of electronic commerce. These issues include the question whether electronic commerce should be taxed at all. One might suggest that the question whether electronic commerce should be taxed ought to be resolved before one undertakes the effort of drafting provisions designed for taxation of such commerce. The Steering Committee, however, at its September 4, 1997 meeting determined that it would advance fruitful consideration of the policy issues surrounding state taxation of electronic commerce to have the Drafting Committee prepare suggested provisions that can serve as the catalyst for consideration of these issues. It is in that spirit that the Drafting Committee has undertaken the drafting effort.
This principle is closely related to the first principle set forth above but warrants separate statement. For the reasons stated above, we view ourselves as technicians and not policy makers. We have therefore attempted, insofar as time and energy permitted, to offer one or more alternative statutory proposals for dealing with the various issues that we have addressed. In addition, we have provided explanatory comments elaborating on the purpose underlying the provisions we have drafted. We hope that this will facilitate the Steering Committee's deliberations over the draft provisions.
Our drafting efforts are intended to suggest practical solutions to practical problems. As a consequence, some of our proposals may sacrifice theoretical purity for a "second-best," but potentially workable, solution to a particular problem. In other words, one of our guiding principles is "Don't let the perfect drive out the good."
No matter how consistent draft legislation may be with various normative criteria, it will be of little use if it is not politically acceptable. Although we cannot know what type of legislative proposal, if any, will ultimately pass political muster, we have some sense of the type of the legislative proposals that will fail to do so. We have therefore attempted to avoid suggestions that we believe are unlikely to command broad political support.
While the problems raised by state taxation of electronic commerce have implications for a wide variety of state and local tax levies (including income, property, and local franchise taxes), we have limited our initial efforts to state and local retail sales and use taxes.1 The rationale for addressing sales and use taxes first is that the problems in this area are especially acute and immediate.
In approaching our task, we have tried to be faithful to a number of commonly accepted tax policy objectives, which we describe briefly below. It must be recognized, however, that it is often impossible to satisfy all these objectives at once. For example, a sales tax that systematically assigned the tax base to the state of "consumption" would be consistent with the policy underlying a sales tax, which is designed to tax consumption. But such a rule might be inconsistent with the policy that a tax should be administrable, if the state of consumption cannot readily be identified.
There is general agreement that state taxes on electronic commerce should maintain competitive equality between similarly situated economic actors. This principle suggests 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. It also suggests that goods and services sold or delivered through electronic commerce should receive the same tax treatment as goods and services sold or delivered in conventional commerce.
There is likewise general agreement that state taxes on electronic commerce should be uniform. This means, among other things, that the states should adopt uniform definitions of key terms, that the standards for determining jurisdiction to tax should be the same in every state, and that the substantive taxing provisions bearing on electronic commerce should be uniform. We recognize that the achievement of such uniformity may be possible only through federal legislation.2
There is also widespread acceptance of the proposition that state taxes on electronic commerce should be administrable. "No matter how perfectly a taxing system may comport with other requirements of tax policy, if a tax is difficult to understand, if compliance burdens are excessive, and if the costs of administering the tax are unreasonable, the tax will fail to serve its basic function as an effective raiser of revenue."3 Accordingly, if electronic commerce is going to be taxed, such taxes should be "clear and consistent" so that "taxpayers can comply with the rules and take them into account for purposes of business decisions."4 State tax organizations, no less than business groups, fully embrace the "goal[] of . . . administrat-ive ease and efficiency"5 in taxation of electronic commerce.
We recognize that some of our proposals create rules that states could not implement independently without violating existing federal constitutional restraints on state taxation. Consequently, as we discuss at greater length below, we believe it would be necessary for Congress to consent to some of the legislative proposals we have drafted in order for those proposals to apply in a constitutional manner. We also address on a preliminary basis the question whether, even with congressional consent, such proposals might be subject to constitutional attack.
We are acutely aware of the fact that the provisions we have drafted represent only several of the many approaches that one could take to the problems raised by state and local sales and use taxation of electronic commerce. For example, Wade Anderson has offered an innovative approach to these issues, involving wide-ranging federal legislation that would give the states jurisdiction over any seller which exploits a state's markets, apply world-wide combination to companies making sales of personal property or services over the Internet, and allow the states to require Internet sellers to collect tax based on a single national tax rate.6 CommerceNet and the Silicon Valley Software Industry Coalition have suggested that states could deal with the problems raised by taxation of electronic commerce by becoming part of the electronic community and establishing web sites that would calculate and collect the tax from the buyer, using the same payment mechanism that the buyer uses for the purchase, and would digitally sign and send to both buyer and seller a tax receipt.7 It may well be that, after the members of the Project have had an opportunity to review the provisions we have drafted, the Steering Committee will advise us to direct our drafting efforts towards implementing one of these proposals or to others that may be offered.
The proposals that we have advanced here are not intended to result in a data base maintained by any governmental authority to determine who is buying what electronically.
We firmly believe that any effort to resolve the problems raised by sales and use taxation of electronic commerce must apply to local as well as to state taxation of such commerce. In this section, we set forth definitions that might be used in a statute directed to state and local sales taxation of electronic commerce. Not all of the definitions are relevant to all of the proposals we have considered, and some of them would no doubt have to modified to fit the needs of a particular statute under consideration. We nevertheless thought it would be useful to attempt to define some of the terms that are likely to play a central role in efforts to legislate in this domain.
Comment The purpose of this provision is to define the type of exaction to which our drafting efforts are directed, i.e, the retail sales tax. We have deliberately broadened the scope of our definition beyond the classical definition of a retail sales tax, namely, a tax that in intent and design falls only on the final consumer, because we recognize that there are a number of state taxes that arguably do not fall squarely within the retail sales tax category, but which nevertheless have a number of features that generally justify classifying them as retail sales taxes, e.g., Arizona's transaction privilege tax, Hawaii's general excise tax, and New Mexico's gross receipts tax). In our judgment, these taxes should be treated along with other states' more traditional sales taxes, and most observers classify them in that manner. See, e.g., John F. Due & John L. Mikesell, Sales Taxation 3 (2d ed. 1994). We thought the most straightforward way to deal with this issue was specifically to identify the "covered" taxes (but in a nonexclusive manner), and we have done so in paragraph 2. At the same time, we wanted to make it clear that our drafting efforts are not directed at general business gross receipts taxes, such as Washington's business and occupation tax, and similar levies at the local level. We have expressed that intent in paragraph 3. We have defined the term sales tax to include sales of services as well as all personal property (not just tangible personal property), because sales of information, data, and the like might be characterized either as the sale of services or as the sale of intangible property.
Comment The definition of a taxpayer's principal place of business is relevant largely to the "throwback" concept that we employ as one alternative means of dealing with the problem of sales whose destination cannot readily be identified. Since a significant portion of a taxpayer's sales may be subject to a "throwback" rule, we thought it would be appropriate to assign those sales to a state with the strongest claim to such sales. That state may not be the taxpayer's commercial domicile, however proper it may be to assign a portion of the taxpayer's tax base to such jurisdiction when the tax base is being assigned on residence basis. We nevertheless define a taxpayer's principal place of business as its commercial domicile (as that term is defined in the Uniform Division of Income for Tax Purposes Act [UDITPA]) as one alternative definitional approach. A second alternative, which may more fairly distribute a taxpayer's sales tax revenues (if they are to be thrown back to a particular state), is to assign the sales to the state in which the taxpayer conducts most of its business, as determined by UDITPA. From a fairness standpoint, however, both of these alternatives may be inferior to a "throwaround" rule that effectively spreads the sales among the states in which the taxpayer makes taxable sales according to the relative proportion of sales in each state. See discussion below. In both of these alternative definitions of principal place of business, we raise the question, through the bracketed references to electronic commerce, whether the definitions should be limited to the portion of the taxpayer's business that relates to electronic commerce. Although such a limitation theoretically may be more attractive, it also creates additional administrative problems.
Comment We have taken this definition from the Federal Communications Act of 1934, as amended, 47 U.S.C. § 153(4). If a uniform statute addressed to state and local taxation of electronic commerce is intended not to apply to state and local taxation of telecommunications, it will be necessary to distinguish between "transmission," on the one hand, and "content," on the other. A definition of telecommunications is a necessary element of such a statutory construct.
Comment The definition of "billing address" is central to any tax regime that uses the billing address concept as the cornerstone of a situsing mechanism for a consumption-based tax. Its relative simplicity is also essential to a tax regime that will not create serious administrative burdens on the vendor, who will be required to make reasonable efforts to determine that address. In addition to the axiomatic requirement that a billing address be the address to which the purchaser's bills are sent, we have set forth in brackets one possible additional requirement, namely, that a portion of the electronically transmitted information or services for which the bill is sent be transmitted to, or used in, a location in the state. This additional requirement is designed to limit the ability of purchasers to establish tax-haven addresses in states in which they neither receive nor use electronically transmitted information or services. On the other hand, because there may be no billing address for many transactions under the more limited definition, it would result in additional sales being taxed (or not taxed) according to whatever default regime was created for sales without identifiable billing addresses. The following set of draft statutory provisions is designed to implement a taxing regime in which nexus is generally established over the out-of-state vendor of electronically transmitted information and services in the state of the purchaser's billing address; the out-of-state vendor is required to make reasonable and good faith efforts to determine such address, but is otherwise absolved of any responsibility to determine such address or to pay a tax to the "destination" state; and, in circumstances in which it is not possible to determine the purchaser's billing address on the basis of reasonable and good faith efforts, a default rule applies that would assign the sales and use tax base to a state (or states) where the vendor is taxable.
Comment One of the key problems raised by state sales and use taxation of electronic commerce is the arguable absence of nexus, at least in many circumstances, over the out-of-state vendor and the consequent difficulty of enforcing the sales tax in the absence of such nexus. The problem is compounded by the fact that the vendor of electronic information or services often may not know the location of the person to whom it is selling such information or services. One approach to this problem, as reflected in the foregoing provision would establish nexus over the out-of-state vendor in the state of the purchaser's billing address. We believe that such an approach is consistent with the underlying purposes of a sales tax, which is to tax consumption where the consumption occurs. In order for such an approach to be administrable and to preserve the states' ability to capture the sales tax revenue from such transactions (assuming that they have decided, as a policy matter, to impose sales taxes on transactions in electronic commerce), we believe that a number of related provisions would need to be enacted, and we set these forth below. We recognize that this approach cannot be implemented with respect to all types of electronic sales without congressional consent to remove any bar that the dormant Commerce Clause may presently create to such legislation. We also recognize that, even with congressional consent, one could argue, at least under some circumstances, that the Due Process Clause would prevent the application of such a provision.8
Comment In the interest of administrability, a vendor would be required to ascertain the purchaser's billing address only if such address could be obtained with reasonable and good faith efforts.
Comment This provision is designed to protect a vendor from any further sales or use tax collection or payment obligations, if it makes a payment on the basis of reasonable and good faith efforts to identify the billing address of the purchaser. In other words, the vendor will not bear the risk that the purchaser is divulging false information, so long as it has made reasonable and good faith efforts to determine the billing address and in good faith believes that the information provided by the purchaser is correct. The bracketed provision is designed to deal with the situation in which the billing address is in a jurisdiction which does not tax the sale or use of electronically transmitted information or services. If, as a policy matter, it is determined that it would be appropriate to subject such transactions to tax, perhaps to avoid the incentive to create billing addresses in tax havens, then one could deal with such transactions under the throwback or throwaround rules set forth below in connection with sales to purchasers whose billing address cannot be identified by reasonable and good faith efforts. If, on the other hand, it is determined that taxation of such a transaction would be inappropriate, because it is subjecting to tax a sale that the state of the purchaser's billing address chose not to tax, then this provision should not be included.
Comment The purpose of this provision is to assign the sales tax base to a state where it is taxable9 under circumstances in which the purchaser's billing address cannot reasonably and in good faith be determined, or in which such an address does not exist,10 so that there is no "destination" state to which the sales tax base can readily be assigned (even assuming the vendor has nexus with such state). 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.
The "throwaround" rule provides an alternative to the throwback rule. It serves the same function as the throwback rule, but, rather than assigning the tax base to the single state in which the taxpayer's principal place of business is located, it assigns it to all of the states in which the vendor makes taxable sales of electronically transmitted information or services, in the same proportion as the taxpayer's sales receipts were from electronic commerce were distributed among the states during the preceding calendar year. The throwaround rule is admittedly a novel concept, which could be criticized on a number of grounds, including the establishment of an "arbitrary" tax rate for the sales and the assumption that all sales are taxed rather than merely taxable. The principal virtue of the rule is that, by comparison to the throwback rule, it results in a more equitable distribution of sales tax revenues than a 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 electronic commerce, due to the difficulty in many cases of identifying the billing address of the purchaser, it may make sense at least to think about the possibility of spreading the tax base among the states in which the electronic information or services of the taxpayer are generally "consumed" rather than assigning them to a single state that does not correspond to the state in which the taxpayer's information or services are consumed. The throwaround rule is also a practical solution to a difficult administrative problem11---a solution that assumes that sales with unknown destinations occur in the same pattern as sales with known destinations---and, on that assumption, it reflects the constitutional principle that sales must occur within the taxing state to be taxable.
The throwback or throwaround rules described above could be extended to sales into tax haven jurisdictions (i.e., jurisdictions in which the purchaser's billing address does not correspond to a state in which it conducted any significant business activity). One would, of course, have to define the meaning of "tax haven jurisdiction" and consider the question whether the decision of a state not to tax sales in electronic commerce or sales generally should lead to its characterization as a "tax haven." As in other portions of this report, we are not suggesting that this is necessarily an appropriate approach to the problems raised by state taxation of electronic commerce. It may, however, be an option to explore in considering the difficulties raised by the specter of taxpayers establishing "tax haven" billing addresses.
Comment We have included a de minimis rule to exempt vendors whose gross receipts do not exceed a specified level (which we have not specified) from the general situsing rules of the proposed statute. The thought is that for the small enterprise making relatively modest sales into a number of states, the compliance burden of determining the billing addresses of its customers may be too great. As a consequence, we have offered such enterprises an election to treat all of their sales during the succeeding calendar year as sales made to a purchaser in the state of the vendor's principal place of business. The rule would offer such small enterprises a simple compliance rule that would require it to collect and remit sales tax as if all the sales had been made to purchasers in the vendor's principal place of business. See III(C) above (defining "principal place of business"). In addition to a national threshold for application of the billing-address regime, one might also consider imposing a threshold on a state-by-state basis, relieving a vendor of the obligation to comply with the billing-address methodology in states in which its level of sales were de minimis. Finally, if a de minimis rule were adopted, some consideration should probably be given to a rule that would treat certain affiliated vendors as a single vendor for purposes of the threshold in order to avoid the possibility that taxpayers would seek to take advantage of the threshold (perhaps on a selective basis) by creating single-state subsidiaries. Concluding Comments Regarding Billing Address Regime The proposed nexus rule and sourcing rules under the billing-address regime suggested by the foregoing provisions has some obvious virtues. First, it is simple. The vendor need know only the purchaser's billing address in order to determine the scope of its tax obligations. Second, the rule protects the vendor so long as it makes reasonable and good faith efforts to ascertain the purchaser's billing address. Third, the rule protects the sales tax base (at least viewed from a national perspective) in the event that the vendor cannot determine the purchaser's billing address, on the assumption that the statute incorporated the throwback or throwaround rule. The proposed billing-address regime, however, has weaknesses that are no less apparent than its strengths. First, it may be quite difficult for the vendor to obtain the purchaser's billing address (or other locational data), in which case the default regime using the throwback or throwaround concept would be the rule rather than the exception.12 Under those circumstances, the sales and use tax, which ought to be a levy on consumption, and thus a tax imposed at the state of destination where consumption is ordinarily deemed to occur, ends up more closely resembling either an origin-based tax, if the throwback rule is employed, or a form of quasi-national sales tax, distributed among the states based on a prior year's transactions. Second, the rule may be vulnerable to manipulation. For example, purchasers might establish "billing addresses" in states without sales taxes.13 Third, one may object to the concept of a throwback rule, especially in the sales tax context, as changing tax attribution rules "in middle of the stream" for reasons that cannot be justified by the underlying purposes of a retail sales tax.14 Whatever its shortcomings, the billing-address regime for imposing and collecting sales and use taxes may serve as a useful focus for further discussion of legislative solutions to nexus and situsing issues raised by sales and use taxation of electronic commerce.15
The following legislative proposal is designed to create a regime that would facilitate the collection of state and local use taxes on electronic commerce through enhanced enforcement of existing use tax laws. As a practical matter, state and local governments historically have been largely unable to collect use taxes directly from consumers when they are barred by federal constitutional constraints from requiring the out-of-state vendor to collect the tax. Moreover, the states have thus far found Congress unwilling to require interstate sellers, who lack the requisite nexus under existing constitutional doctrine, to collect and remit use tax on sales effectuated through interstate commerce. The legislative proposal outlined below would enhance the ability of states to collect use tax from consumers, i.e., it would facilitate the enforcement of laws that exist today. Such legislation would need to be enacted by Congress in the exercise of its power to regulate interstate commerce.
A person who sells tangible personal property or delivers services16 in interstate commerce by means of the Internet and who does not maintain a physical business presence in the state or local jurisdiction into which sales are made would be required to report information relative to such sale to the State Tax Information Clearinghouse. This proposal applies only to transactions with respect to which no sales or use tax has been collected or paid.
The required reports to the State Tax Information Clearinghouse would include the following information relative to each transaction:
The reports to the State Tax Information Clearinghouse would be due not later than the 20th day of April for sales made during the preceding months of January, February and March; the 20th day of July for sales made during the preceding months of April, May and June, the 20th day of October for sales made during the preceding months of July, August and September, and the 20th day of January for sales made during the preceding months of October, November and December.
Any seller who did not have at least $400,000 in gross receipts from sales in the preceding calendar year would not be required to submit reports to the State Tax Information Clearinghouse for the following year. Once a seller was required to file a report, however, it would have to continue making reports unless it gave written notice to the clearinghouse of its intention to stop reporting.
The State Tax Information Clearinghouse would be a corporation organized and funded by the states. It would be governed by a Board of Directors consisting of seven members elected for five-year terms. Members of the Board of Directors would be elected by representatives of the states participating in the clearinghouse. The chief tax official of each participating state would be representative of that state for purposes of electing the Board of Directors.
Sellers subject to the proposed act would be required to request such information as is required to be on the report that is known only to the purchaser. If a purchaser refused to provide that information, the seller would be required to collect sales tax from the purchaser at the state sales tax rate applicable to sales made at the operating headquarters of the seller and to remit the collected tax to that state (or, perhaps, to the clearinghouse for equitable division among the states).17 If the operating headquarters state has no sales tax, the seller would add five percent of the sales price as a processing fee and remit that amount to the clearinghouse for distribution to participating states on a proportionate basis.
Any information that identified either a specific seller or purchaser, including the reports and information contained therein, could not be divulged by the clearinghouse or any employee, contractor or agent of the clearinghouse to any person except a duly authorized person or agency charged with the duty of collecting sales or use taxes in a participating state. Any person who violated this prohibition against unauthorized release of information would be guilty of a federal crime.18
A seller subject to the reporting requirements of the proposed legislation could be examined as to the sufficiency of its compliance with the act by the state in which the seller's operating headquarters is located. The results of such examination would be made available to the states participating in the clearinghouse.
Sellers of goods and services that believed they were not taxable in one or more states based on the nature of goods or services sold could petition the clearinghouse for a ruling to be made by the particular state or states in question that no reports are due as to those sales.
Sellers of goods and services who complied with the provisions of this act in those states in which they had no physical business presence would be deemed to have fully discharged their obligation as to compliance with that state's state or local sales or use or any similar tax.
Compliance with the act would not be considered in the determination as to whether a seller of goods or services has established nexus in any state or local jurisdiction. Comment Although it would not need to be a part of the federal enactment, the states could establish a threshold amount below which they would not seek collection from an individual consumer. This would be a state decision. Although political concerns may have prevented states from collecting consumer use taxes in the past, if every state were enforcing its laws, the competitive pressure for non-enforcement arguably would be diminished. The arguments the states have advanced that enforcement against consumers has not been economically feasible should be substantially diminished by this mechanism.
The two preceding proposals addressed to sales and use taxation of electronic commerce would clearly require congressional legislation for implementation, at least under current constitutional restraints on state tax power. The following proposal, by contrast, assumes that no federal legislation has been enacted to overcome possible existing constitutional restraints on the states' power to impose a sales or use tax on transactions occurring through electronic commerce. It is therefore designed to create a tax regime that could be implemented consistently with existing constitutional restraints on state tax power. We recognize that there may be room for debate as to whether every application of the regime proposed below would be constitutional under the existing constitutional doctrine in this area, given the uncertainty over the precise implications of some of that doctrine. Nevertheless, we believe that these provisions provide a reasonable starting point for examining such a regime, and that they do not clearly require congressional consent for implementation, as do the proposals set forth in Sections IV and V above. Having said that, we wish to emphasize that there are clear parallels between the regime proposed in this Section and the regime proposed in Section IV (and, to a lesser extent, in Section V). Indeed, we might have combined Sections IV and VI, and simply indicated in appropriate instances where congressional consent would clearly be necessary for implementation of the provisions at issue. Specifically, we believe that a number of the provisions suggested below that deal in much more detail with situsing issues than do the provisions set forth in Section IV might easily be incorporated in the proposal set forth in Section IV. By the same token, the throwback and throwaround concepts that are developed in some detail in Section IV might easily be incorporated into the proposal that is set forth below. Nevertheless, because we developed each of the proposals separately, and because we are still at an early stage of articulating our ideas, we thought it preferable to present the two proposals separately at this juncture, if only to emphasize the various alternative approaches that might be taken to sales and use taxation of electronic commerce. Once the pros and cons of the various approaches have been aired, we will be in a position to determine which features of the various approaches appear to be the most desirable. At that point, it may be appropriate to develop a single model set of statutory provisions.
This proposal has two situsing rules. One rule applies to purchases for personal consumption and purchases not known to be by businesses registered in the taxing state. The other situsing rule applies to purchases by businesses that are known to be registered in the taxing state. The justification for adopting the two rules is that business purchases might otherwise be subject to manipulation by arrangements designed to ensure that the situs of the sale would be in a state not taxing the sale of electronically transmitted information or services. In addition, business purchases, unlike purchases for personal consumption, are more likely to be for multiple points of use, a circumstance that may require the application of a unique situsing principle to apply a sales or use tax fairly and without economic distortion. Finally, registered business purchasers are obligated and prepared to self-report and self-assess sales and use taxes to the taxing states (a direct pay concept). This status allows self-reporting and self-assessment for registered business purchasers that will avoid considerable complexity in the reporting and payment obligations of the retailer who will not necessarily have access to all information necessary to situs sales properly.
The U.S. Supreme Court apparently continues to believe that a constitutionally taxable "sale" must occur within the taxing state before that state may impose a "sales" tax on that transaction. McLeod v. J.E. Dilworth Co., 322 U.S. 327 (1944). At the same time, the Court has recognized that a state may impose a use tax on property that is subject to a nontaxable out-of-state sale. General Trading Co. v. State Tax Commission, 322 U.S. 335 (1944). In principle, then, the Court has permitted a state to impose a uniform tax on in-state consumption, even if the sale with respect to which the consumption occurs has been effectuated outside the state. Despite the intended functional equivalence of sales and use taxes, difficulties can arise with respect to use taxes in the multijurisdictional context that may prevent them from always operating as the perfect compensating analog for a state's inability to impose a sales tax at the time of the sale. The separate categorization of sales and use taxes therefore imposes challenges for the development of a proper method of taxation that would not exist if a state could apply and effectively enforce a single transactional tax that embodied the conceptual underpinnings of both a sales tax and a use tax. A factor that mitigates these limitations arising out of the formal (and sometimes constitutionally significant) distinction between a sales and use tax is the U.S. Supreme Court's willingness to apply a flexible concept of a sale that is constitutionally taxable by a state. Indeed, the Court's view of a sale even contemplates the possibility of a sale occurring in two places simultaneously, e.g., the state of the service address and the state of the billing address. See Goldberg v. Sweet, 488 U.S. 252 (1989). It has not yet been established as a matter of federal constitutional law, however, that a sale can occur simultaneously in the states where the purchaser intends the sold product to be put to immediate use.19 (An example of this circumstance is a business purchasing data that it loads on to its server in a single state with the intent that the data be put to immediate use by the purchaser's separate offices in the several states.) If one cannot support a determination that a constitutionally cognizable sale occurs in these states of immediate use, and that its collection can be assured regardless of the vendor's physical presence within the state, then application of a use tax may be the only available mechanism to ensure that the states of immediate use receive their fair, non-distortive share of the transactional tax applied to sales of information or services in electronic commerce. Enforcement of the use tax, however, is not necessarily assured in light of the possibility that the electronically delivered information or services may be accessed from outside the state, and there may be no practical means of collecting the tax from the purchaser in the absence of jurisdiction over the vendor.
Comment Scope of electronic commerce. This provision assumes electronic commerce involves the sale of electronically transmitted information or services. The word "sale" refers to any transaction that is subject to a transactional tax, e.g., a license. Defining electronic commerce in this fashion could raise questions regarding the conceptual limits of "information" and "services," e.g., a credit report from a credit bureau or completed engineering drawings. However, the terms are broad enough that, at least when used as alternative bases for taxation, would include most transactions that fall under the rubric of electronic commerce. Alternative presumptions of situs. The provision sets forth four alternative presumptions that are applied separately in order to determine the state of the sale. The state that first meets one of the alternative rules is presumed to be the state of the sale. Limitation of provision to nonregistered purchasers. The provision is limited to persons not known to be registered under the taxing state's sales and use tax. Sales involving personal consumption are the most obvious example of sales falling within this provision. A separate alternative provision establishes a principle for determining the situs of sales to persons known to be registered businesses. See Subsection (b) below. Separate treatment of these two categories of sales will allow different tax reporting rules to be established for each category. This treatment anticipates that the retailer will be relieved from collecting and paying the sales tax for sales involving persons known to be registered (a direct pay concept) in the taxing state. A retailer will likely know that its purchaser is registered in those circumstances where there is a more formal contractual relationship than merely accessing a web site on an unannounced basis. Registered business purchasers will report their own sales. The registered business purchaser presumably will properly report and pay the sales and/or use tax attributable to their own electronic purchases. Separate reporting by registered purchasers will avoid considerable complexity for the retailer. The registered purchaser will have available to it the necessary information to report its tax obligation without having to burden the retailer with amassing this information. For example, a registered business purchaser that loads proprietary data from an information service provider onto its own server for use by several locations of the purchaser's business will be able to "prorate the sale," a concept that this proposal suggests in other parts, in its tax reporting. See Comment to Subsection (b)(2) below. A state will also prefer auditing the registered purchaser, the entity that has the most accurate records to make the determination as to proper reporting. Ability to determine locational information with respect to sales in electronic commerce. Some examination must be made of the claim that locational information is not determinable for a large number of sales occurring in electronic commerce. There are suggestions that this assertion is overly broad, especially since electronic vendors themselves have a business interest in capturing this information for business/marketing purposes. If locational information can reasonably be captured, then many of the problems this paragraph addresses would resolve themselves without added complexity. Presumption 1: Situs based on retailer's business records regarding purchaser's location. The first preference for determining the presumptive situs of the sale references the business records of the retailer. Actual location is defined to be first the service address or the physical location of the purchaser if either is reflected in the business records of the retailer. In the absence of this information, actual location is defined by reference to the billing address of the purchaser as determined by the retailer's business records. There should be some assessment of the administrative burden of keeping time-sensitive business records as to the purchaser's location or billing address. Although the situs of the sale and nexus over the out-of-state retailer should correspond in order to assure that the retailer can be required to collect the tax, no requirement is stated that the retailer must be physically present in the taxing state. Insofar as federal constitutional restraints would bar a state from requiring a retailer to collect a tax on a sale that is deemed to occur within a state, federal legislation would be necessary to overcome that prohibition. As noted at the outset of the discussion of this proposal, however, we are assuming no federal legislation to overcome possible constitutional objections in connection with this proposal. Presumption 2: Situs based on purchaser's affirmative representation as to location. The second preference is for any location the purchaser may affirmatively give at the time of the sale. The second preference is inapplicable if the retailer has the purchaser's actual location or billing address in its business records. There should be some assessment of whether this presumption is an invitation to fraudulent misrepresentation. Closely related to this inquiry is the degree to which contemporaneous on-line changes to the business records of the retailer should be recognized. Concurrent changes to the business records of the retailer more than likely should be recognized given the mobility of persons. Although the situs of the sale and nexus should correspond, no requirement is stated that the retailer must be physically present in the taxing state. See the comments with respect to Presumption 1 above elaborating on the implications of this approach. Presumption 3: Situs based on third-party financial intermediary's identification of purchaser's location. The third preference is for a purchaser location determined from a necessary financial intermediary. Note also the obligation of inquiry flowing from the use of a necessary financial intermediary. See Subsection (e)(1) below. Although the situs of the sale and nexus should correspond, no requirement is stated that the retailer must be physically present in the taxing state. See the comments with respect to Presumption 1 above elaborating on the implications of this approach. Presumption 4: Situs based on where the sale is completed. This provision states the last alternative, the state from which the sale is completed. It is analogous to the throwback rule discussed in Section IV above. While as a matter of policy the retailer's commercial domicile or principal place of business might be a more appropriate state to receive the throwback sales than the state of origin, given the ability to manipulate the state of origin in the context of electronic commerce, throwing the sales back to the latter states could raise constitutional concerns, even assuming congressional approval.
Comment This Subsection establishes the rules for determining the situs of sales to a registered business purchaser. Sales occurring entirely within the taxing state are attributed to that state. Multiple point sales that are both within and without the taxing state are treated as taxing state sales on a prorated basis. Further consideration needs to given to the question whether as a practical matter and, in the absence congressional legislation, as a constitutional matter, a multiple point sale can be prorated among the states.
Comment This Subsection establishes the location of use in order to administer a use tax on electronically transmitted information and services. The first rule ensures that an unregistered business purchaser that should have been registered at the time of sale will incur use tax liability if the lack of registration prevented the application of the rules of Subsection (b). The rule defines the situs of taxable use in the state where the information or services are available for use or are actually used. The definition is intended to reach the taxpayer's storage of information in one state that is accessed by the taxpayer from another state. Some may question the constitutionality of this rule in the absence of congressional legislation approving it. The proviso is designed to avoid imposition of a use tax in those circumstances where someone with access to information accesses the information on temporary visit to the taxing state.
Comment Any of the presumptions can be overcome by clear and cogent evidence. This safety valve may be constitutionally required, since taxing the sale or use of information or services which, by clear and cogent evidence are not within the state, would constitute extraterritorial taxation. The clear and cogent standard is used because the U.S. Supreme Court has held that proof of extraterritorial taxation must be established by clear and cogent evidence. This provision assures, as a matter of principle at least, that the statute as applied would not result in extraterritorial taxation. If taxpayers can demonstrate that a significant number of transactions fall outside the situsing rules delineated above based on clear and cogent evidence of "actual facts to the contrary," it may well be necessary to rethink the rules proposed above.
Comment An obligation is imposed on a retailer to secure necessary locational information. It is unclear what sanctions should or could be imposed for failure to secure the information. If the retailer is unable to secure the information in Subsections (a)(1) - (a)(3), then the throwback rule will apply.
Comment The definitions are self-explanatory. This section of the report addresses issues related to the administration and collection of the retail sales and use tax in an electronic environment. Its purpose is to identify the key aspects of the sales tax administration system and to identify options that could simplify the tax and/or reduce the burden imposed on a seller to comply with the tax.20 The backdrop to the discussion is the belief that, however the substantive issues regarding sales and use taxation of electronic commerce are resolved, and particularly if current nexus rules are to be altered along the lines suggested in Section IV above, there will need to be substantial simplification and considerably increased uniformity in the administration of the sales tax to make compliance for remote sellers on a multistate basis both practical and acceptable.21
Taxpayers argue that complying with the laws, rules, and regulations in each of the 46 sales tax states22 is a difficult and burdensome task. This is particularly true for remote sellers who do not have face-to-face contact with the customer in some settings and who are making sales in each of the jurisdictions on a regular basis. The compliance burden, in the estimation of the retailers, comes in three areas:
For their part, state and local governments indicate that a number of efforts have been made, on both an individual and multistate basis, to simplify the administration of the sales tax and a willingness to participate in further ventures to achieve that result. They indicate a greater ability to deal with issues involving process and administration than those involving the definition of the tax base because of the impact that changes in the latter have on taxpayers other than remote sellers and their implications for sovereignty of the states. Local sales tax issues are important, but must be addressed carefully because of the growing importance of sales taxes as part of the local government revenue structure in many states.
Currently, each seller with responsibility (or voluntarily accepting the responsibility) to collect sales tax on behalf of the state is required to register with the state for purposes of evidencing the obligation and establishing the appropriate accounts and files. This is accomplished by completion of a registration form with certain demographic information about the seller, its principal officers, and other operations in the state. This is done individually with each state, and increasingly involves registration with other appropriate agencies in the state, e.g., unemployment insurance agency, other tax agencies, Secretary of State. Some states require the posting of a bond or other insurance to insure collection.
Options for modifying this process include: [i] Status quo. The status quo could be maintained. This is a one-time filing by each seller that serves multiple purposes within a state. Any change will have a limited, one-time impact. [ii] Uniform registration form. A system could be developed under which a uniform or standard registration form would accomplish registration in all states. A single form, containing the information required by each state (or supplemented for certain states if necessary) could be developed and used. [iii] Single registration form. A system could be developed under which a seller could complete a single registration form that would be filed with a single entity which would, in turn, provide the required information to all other jurisdictions. This single entity could be a third-party agent/instrumentality23 authorized to act on behalf of all states or it could be a single state chosen by the seller (e.g., home state or base state.)24 Depending on the manner in which states chose to operate, the registration information could be provided to all states or retained centrally.
At the present time, each registered retailer is required to file a return individually with each state in which it is registered and to make remittances of the tax collected and due to each of those jurisdictions. Returns are commonly filed on a monthly basis and contain entries for gross sales, exempt sales, taxed due on consumed goods, net taxable sales, tax due, tax remitted, etc. The returns (where appropriate) also contain a schedule breaking down local sales and use tax collected by the jurisdiction in which (or for which) it was collected.25 Most large retailers are required to make remittances by Electronic Funds Transfer (EFT) in most states. Remittances are required monthly in most cases, but more frequently in some cases. Remittances sometimes must include an estimate for part of the "current month" and a reconciliation for the prior month. Several states have established electronic sales tax filing programs for both returns and remittances, but with a couple of exceptions, participation is not widespread at this point.
Options for modifying this process include: [i] Status quo. The status quo could be maintained. [ii] Uniform return and remittance. A system could be developed under which a uniform or standard tax return and remittance form would be used in each state. The return would presumably need to provide for the attachment of supplemental schedules as necessary to accommodate local option sales taxes.26 This approach could also include uniformity or standardization of the tax return due dates, etc. [iii] Single return and remittance. As with registration forms, a system could be developed under which a seller could complete a single return and remittance that would be filed with a single entity which would, in turn, provide the required information to all other jurisdictions.27 Options for the nature of this entity are the same as outlined in Section VII(B)(1) above for Taxpayer Registration.
Under current practice, taxpayers are subject to audit in each state in which they are registered to determine that the appropriate amount of tax (no more and no less) has been collected and remitted. Methods of audit selection and audit techniques vary among the states. As expressed by taxpayers, their primary concern with the audit process is that they are subject to audit by multiple states, which is a time consuming and burdensome process.
Options for modifying this process include: [i] Status quo. The status quo could be maintained. [ii] Single or joint audits. A system could be adopted which would require states to cooperate in the audit process and limit the number of audits to which any individual tax period of an individual seller is subject. The limit could be one audit per period or some other number. The joint audits could be conducted by a single state on behalf of all states, a group of states on behalf of all, or a third-party on behalf of all states.28
There are other administrative issues which should be considered in assessing mechanisms to reduce the burden associated with sales tax compliance.
Currently about one-half of the sales tax states allow retailers who make timely returns and remittances to retain a portion of the tax collected as partial compensation for the costs of collection. These allowances are generally expressed in percentage terms (usually less than two percent), and often capped at a certain dollar amount so as to be relatively more beneficial to small retailers.
Widespread use of electronic technologies for filing returns and remittances and the like can serve to reduce the compliance burden. Any simplified system should look to maximize the use of electronic technologies in the tax administration process.
Taxpayers contend that a significant part of the burden associated with complying in multiple states derives from differences in the tax base, particularly those associated with differing exemptions, differing definitions for goods that are commonly exempted, and differing procedures for documenting exempt transactions. The importance of this issue is likely to increase in an electronic environment as more sellers transact business on a multistate basis and interstate sales of services (where there is greater variety among the states in terms of tax imposition) become more prominent. Defining a uniform retail sales tax base is considered beyond the scope of this project (at least at this juncture). Short of this, however, there are several options available that could be considered to reduce the burden of exempt transactions in a multistate, electronic, remote selling context.
Steps could be taken to develop uniform definitions for commonly exempted items such as food and/or clothing.29 The same process could be applied in reverse in the "electronic service" area. States desiring to tax certain electronically delivered services could be required to use a uniform definition of the covered services. The thought would be that a state could choose whether or not to offer the exemption (or to tax the service), but if it did, it would define the exempt or taxable items and services in the same fashion as other states. This should serve to reduce the compliance burden to some degree.
Beyond exempting various goods and services from the sales tax, states also exempt certain types of entities from tax on certain purchase they make.30 Generally, sellers must retain some documentation received from the buyer indicating that the purchase is being made tax exempt and the reason for the tax exemption. There is some variety in the types of documentation required, and the sheer handling of multiple exemption forms from multiple states creates a burden for sellers. This burden could be reduced by developing uniform procedures for documenting exempt transactions of this nature and establishing uniform standards for acceptance and retention of the documentation.31
In some states---the precise number is unknown---there are differences between the state sales tax base and the local sales tax base. This apparently exists not only in situations where local taxes are locally administered but also where they are administered by the state, i.e., in certain "home rule" cities. The lack of consistency creates compliance burdens for remote sellers.
Options for modifying this process include: [i] Status quo. The status quo could be maintained. [ii] Complete harmonization. It could be required that the state and local sales tax base be made coterminous for all types of sellers. [iii] Partial harmonization. It could be required that the state and local sales tax base be made coterminous only for sellers without traditional nexus in a locality, e.g., one subject to the "billing address" nexus rules suggested above.
In several states (principally Alabama, Arizona, Colorado, and Louisiana) local option taxes are administered individually by the local governments. This compounds the issues identified in Section VII(A) above by exposing the seller potentially to registration, return and audit requirements in each individual local government administering the tax. For sellers with widespread operations, the number of returns can exceed several hundred each month, sometimes with relatively minimal liabilities.
Options for modifying this process include: [i] Status quo. The status quo could be maintained. [ii] Centralized local administration. A system could be developed which would require local governments in these states use a single entity (potentially the state or a consortium of local governments) to process a single return for all local governments. [iii] State administration. Local governments could be required to have the local tax administered along with the state tax for sellers without traditional nexus in a locality, e.g., one subject to the "billing address" nexus rules suggested above.
Currently, about 34 states authorize local governments to impose local sales taxes, and of these, 26 authorize local use taxes. In a majority of states, these are local option taxes, and the individual local units of government determine whether the tax should be imposed and at what rate (within certain bounds established in state law). As a result, there is a "patchwork" nature to the imposition of taxes and the tax rates within a state and across the country. While there is sales tax compliance software that attempts to deal with the local taxes, it requires specific street address information, is subject to errors and is not inconsequential in terms of cost.
Options for modifying this process include: [i] Status quo. The status quo could be maintained on the basis that the software in the market place to handle local sales tax is adequate (or that the marketplace would fill the need once the need is better established.) If inadvertent errors are a concern, certain acceptable "safe harbors" could be established.32 [ii] Improved information. State and local governments could take steps to improve the availability of local tax information. They could periodically publish a certified rate on a jurisdiction-by-jurisdiction basis and make such information available electronically on Websites. [iii] One rate per state approach. A requirement could be imposed that sellers without traditional nexus would be required to collect at only one rate (combined state and local) in each state.33 If the simplified, uniform sales tax is implemented by means of federal legislation, that legislation could presumably (if desired) authorize imposition of a statewide tax rate that was, for example, equal to the average state and local tax in the state even though it would be higher than the actual tax in some jurisdictions. Otherwise, such a system (if implemented by state law) would presumably run afoul of the U.S. Supreme Court's decision in Associated Industries of Missouri v. Lohman, 511 U.S. 641 (1994).
Presumably, the sales tax simplifications would be implemented through the same vehicle as the remainder of the model proposal. If that vehicle is federal legislation (or an interstate compact approved by Congress), it could be structured to insure that the uniformity provisions are implemented. For example, it could be structured such that the "billing address" nexus or tax regime is imposed only in those states which meet the uniformity standards agreed upon and established in the bill. Thus, a state could choose not to adopt the uniform sales tax provisions, but it could not require sellers without traditional nexus to collect tax on goods and services sold into the state. Any effort to design legislation establishing uniform rules for state taxation of electronic commerce must consider the constitutional concerns that such legislation might raise. The states, of course, are restricted by the Commerce and Due Process Clauses in exercising their taxing power over interstate commerce and out-of-state taxpayers. While some of the statutory provisions set forth above might pass muster under existing constitutional restraints, others plainly would not. For example, the provision creating a use 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 Corp. v. North Dakota.34 More fundamentally, if one of the principal purposes of the creation of a uniform taxing statute is to establish clarity and certainty in an area currently beset by confusion and doubt, the last thing we need is a statutory regime that will trigger significant constitutional controversy. For that reason, the wiser course in attempting to implement any significant restructuring of the present pattern of state taxation of electronic commerce may be to seek congressional approval.35 The question that such an approach raises, however, is whether congressional action in this domain---whether through consent to legislation that the states develop on their own initiative or by affirmative federal legislation that is thrust upon unwilling states---can resolve the Commerce and Due Process Clause difficulties that such legislation might otherwise raise. The answer to half of this question is easy. It is apparent Congress possesses ample power to remove any Commerce Clause impediment to legislation of the type described above. Thus Congress may consent to state legislation affecting interstate commerce that would be unconstitutional under the so-called "dormant" Commerce Clause in the absence 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,"36 subject only to the limitations that the Constitution imposes on Congress's own power. Since the legislation under consideration indisputably has a substantial effect on interstate commerce, there can be no serious question of any Commerce Clause bar to such legislation, if Congress either consents to it or affirmatively enacts it.37 The answer to the other half of the question is more difficult. That question is whether congressional consent to (or enactment of) legislation of the type described above would eliminate any due process objections to such legislation or its application. The question must be answered in two parts. First, would the foregoing draft legislation authorize violations of the Due Process Clause and, if so, does Congress have the power to eliminate the due process bar. The answer to the first part of the question depends on whether a state would have the "definite link" or "minimum connection" that the Due Process Clause requires "between a state and the person, property or transaction it seeks to tax."38 If one assumes that the Court's analysis in Quill applies to this question, then the "link" or "connection" need no longer be physical: "The requirements of due process are met irrespective of a corporation's lack of physical presence in a State."39 What is required is that the out-of-state taxpayer "purposefully direct" its activities towards residents of the taxing state.40 Whether a billing-address nexus standard would satisfy this criterion is open to question and might require resolution on a case-by-case basis. One might also contend that the very fact that a sale occurs within a state---based, for example, on the confluence in the state of factors such as the purchaser's billing address and delivery of some of the electronically transmitted information or services in question41---should be sufficient to establish due process jurisdiction to tax the seller. The argument in response would be that jurisdiction over the sale does not automatically create jurisdiction over the seller.42 This inquiry, too, might require resolution on a case-by-case basis. The answer to the second part of the question is likewise subject to debate. The Court in dicta has declared that "while Congress has plenary power to regulate commerce among the States and thus may authorize state actions that burden interstate commerce, it does not similarly have the power to authorize violations of the Due Process Clause."43 Nevertheless, 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.44 Under this theory, Congress can authorize what would otherwise be federalism-based violations of the Due Process Clause but not Due Process violations of individual rights. It has also been suggested that Congress may have power under Section 5 of the Fourteenth Amendment to expand state taxing powers beyond what they would be in the absence of implementing federal legislation.45 In the end, it seems unlikely that the U.S. Supreme Court would hold that the framers of the Constitution and the Fourteenth Amendment left the nation powerless, short of a constitutional amendment, to legislate an administratively workable solution to the problem of state taxation of electronic commerce, despite the joint exercise by Congress and the states of their respective powers under the Constitution.46 1We define "retail sales taxes" (and the scope of our drafting efforts) below in the portion of the report that sets forth the draft provisions. 2The legislation could be flatly preemptive, establishing such uniformity as a matter of federal law, or it could create an incentive for the states to achieve uniformity on their own, by providing for federal uniformity at a specified future date only if the states failed to enact their own uniform law. 3Information Highway State and Local Tax Study Group, Supporting the Information Highway: A Framework for State and Local Taxation of Telecommunications and Information Services (undated), reprinted in State Tax Notes, July 3, 1995, pp. 57, 61. 4Karl A. Frieden & Michael E. Porter, The Taxation of Cyberspace: State Tax Issues Related to the Internet and Electronic Commerce, State Tax Notes, Nov. 11, 1996, pp. 1363, 1393. 5Multistate Tax Commission, Statement of Direction on Electronic Commerce Issues (Jan. 17, 1997), p. 2. |