Global E-commerce Taxation
Benjamin M Musau, Lawyer, Nairobi, Kenya
In this article, Benjamin Musau discusses the relevant issues addressed in the article : The myth of tax free Internet sales
( an abstract)
….” It has been a long held belief by most online shoppers that out of state internet purchases are tax free. I have to admit that I believed this for a long time myself, but unfortunately it’s not the case.
Just to dispel any theory dissolving that old ‘Death and Taxes’ quote, internet purchases are not tax free. That’s right. As the wording goes, most internet companies don’t have to collect out of state sales tax. However, consumers, businesses and any end users still must pay a “Use Tax” on non-taxed purchases that they make through mail-order or online.
Most states currently have Use Tax which specifically requires consumers to pay their state sales sales tax on purchases they make online that are not taxed by the business. There are some exemptions for certain types of products and for states that do not have any sales tax, but for the most part taxes on these purchases are required to be paid to your state government. With the exception of very large purchases, use tax is rarely if ever monitored, as it would simply be an impossible feat for any state government to handle. However, we can all be sure that states are losing out on millions if not billions in uncollected taxes, so if you aren’t paying them, enjoy the free ride while it lasts……”
http://www.ecommerce-blog.org/archives/the-myth-of-tax-free-internet-sales/
Benjamin Musau’s Article
With the Internet, tax free shopping is taken to a new level. The myth of a no-tax shopping has created an opportunity for retailers to hook consumers on click-and-charge buying.
The truth is that some Internet sales are subject to sales (use) tax. When a particular site does not collect tax, the consumer has to beware as certain state or country laws will invariably have vested on the consumer the burden of remitting any e-unpaid sales tax on online purchases directly to the state or country.
Based on the permanent establishment rule as enunciated by the US Supreme Court in 1992, if an online vendor (retailer) has a physical location or presence in a particular state (country), such as a shop, office, warehouse, or store, the vendor must collect sales tax from customers in that state or country. However, if a retailer does not have a physical presence in a particular state, the business is not required to collect sales tax from customers in that state.
In Quill v. NorthDakota, the U.S. Supreme Court ruled that retailers are exempt from collecting sales taxes in states where they have no “nexus” (i.e. physical location) such as a store, office or warehouse. The case dealt with a catalog mail order company, and has since been applied to all remote sellers, including online retailers. The Court said that requiring these companies to comply with the varied sales tax rules and regulations of 45 states and some 7,500 different local taxing jurisdictions would burden interstate commerce.
The Court suggested that Congress could change this policy by enacting legislation requiring all retailers to collect sales taxes without running afoul of the Constitution. However, Congress has so far failed to extend sales tax collection to online retailers. Amazon.com, which opposes extending sales tax to online retailers on the grounds that it would be “horrendously complicated”, collects sales taxes nationwide for Target as part of its management of the chain’s online business.
The following are the consequences of failure by Congress to extend sales tax collection to online retailers:
- It disadvantages local businesses. Exempting online retailers from having to collect sales tax, as regular stores must, gives these companies a 4 to 9 percent price advantage over local stores — a sizable competitive advantage in retailing.
- It undermines state and local governments by reducing tax revenue for schools, police, and other services. This revenue loss that will only grow as internet sales continue to displace in-store sales. Currently, 45 states assess sales taxes, from which they receive about 25 percent of their total revenue each year. A 2009 University of Tennessee study estimated that uncollected sales taxes on e-commerce cost states $7.7 billion in 2008.
- It makes a regressive tax more regressive, because only those with internet access, a credit card, and a home or workplace where they can accept daytime deliveries are able to take advantage of the tax exemption.
It is important to note that, while remote sellers are not required to collect sales taxes, the tax is still owed by the individual who made the purchase. Individuals are suppose to keep track of these purchases and pay an amount equivalent to the sales tax as a “use” tax on their state tax returns. Few people do, however, and the use tax is almost impossible to enforce, which effectively exempts these purchases.
The Main Street Fairness Act
There are two primary strategies that states are pursuing to move toward a level playing field in which all retailers are subject to the same sales tax requirements.
One involves persuading Congress that collecting sales taxes for numerous state and local jurisdictions is no longer a burden for remote sellers. As noted above, software makes complying with state and local sales tax rules much simpler than when the Supreme Court issued its 1992 ruling.
To further simplify things, the National Governors Association established the Streamlined Sales Tax Project, a multi-state effort to simplify and align sales tax policies. As of July 2010, 44 states and the District of Columbia had approved an interstate agreement that establishes uniform sales tax rules and definitions, and 24 states had taken the next step of passing implementing legislation. Those 24 states are: Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin, and Wyoming.
Under this legislation, states and cities still have the authority to determine what goods are taxed at what rate, but must adhere to rules governing such things as how and when they can change tax rates, as well as uniform definitions (e.g., whether marshmallows are considered food or candy for tax purposes).
Having aligned and greatly simplified their sales tax policies, states are hoping to persuade Congress to pass the Main Street Fairness Act, introduced in 2009 by Senator Mike Enzi and Representative Bill Delahunt. The bill would authorize those states that have implemented the Streamlined Sales Tax to require large online and catalog retailers to collect sales taxes. Small online and mail order retailers would still be exempt.
Clarifying Nexus
The second strategy states are pursuing does not rely on Congressional action, but instead uses existing state authority to clarify what constituents “nexus” for the purposes of sales tax liability. Under the Supreme Court’s ruling, only retailers that have a physical presence, or nexus, in a state must collect sales tax on purchases made by that state’s residents.
In the past, many national chains, despite having nexus in every state by virtue of their stores, claimed their e-commerce sites were distinct legal entities, unrelated to their bricks-and-mortar stores and therefore were exempt from collecting sales taxes. This practice is known as “entity isolation.
State action in recent years has sharply curtailed the number of so-called “clicks-and-mortar” retailers using entity isolation to skirt collecting sales taxes on their online operations. In 2001, California became the first state to issue an administrative ruling against the practice of entity isolation when its Board of Equalization ruled that Borders.com was not a separate entity, but the online extension of the chain Borders Books & Music and therefore must collect sales taxes on sales to California residents.
In the following years, several states amended their sales tax laws to clarify that the e-commerce arms of national chains still have nexus and that entity isolation does not absolve them of their obligation to collect sales tax.
Increasingly concerned about the threat of court action by states and the potential liability, as well as the complexity and inefficiency of attempting to treat the e-commerce side of their operations as a separate company, in 2003 most national chains cut a deal with the states in which they were forgiven all of their back taxes in exchange for collecting sales taxes online from that point forward. Although most national chains now collect sales taxes on online orders, there remain a few that do not.
In 2008, New York became the first state to further extend the definition of nexus to cover some web-only retailers, including Amazon.com. The legislature passed a bill, accompanying its budget, that said that web retailers have nexus in New York and must collect sales taxes if they have sales affiliates in the state that generate a combined total $10,000 a year or more in revenue for the retailer. Sales affiliates are individuals or organizations that are paid commission for linking to the online retailer’s web site. Amazon.com has thousands of sales affiliates nationwide, as do many other online retailers. In all, more than 30 companies are covered by New York’s provision.
Now, several other states are considering legislation modeled on New York’s.
On November 4, 2010, a New York state appellate court ruled that New York’s law does not violate the commerce or due process clauses of the U. S. Constitution. The case was brought by Amazon.com and Overstock.com, which argued that the state did not have the authority to require online retailers to collect sales tax based on the nexus provided their in-state sales affiliates. The court said that two of the online retailers’ claims could be reinstated for further review. The claims dealt with the question of whether the retailers’ affiliates solicit sales or are simply advertisers. The court said that there was not sufficient evidence in the record to make a determination on this question. However, the rest of the ruling suggests that Amazon.com and Overstock.com are unlikely to succeed on these points during further proceedings.
References:
- http://www.newrules.org/retail/rules/internet-sales-tax-fairness. Retrieved on March 4, 2011.
- E-fairness (www.e-fairness.org) represents retailer organizations lobbying Congress for equal taxation. Retrieved on March 4, 2011.
- The Sales Tax Institute (www.salestaxinstitute.com) provides a range of services and links associated with sales tax. Retrieved on March 4, 2011.
- The Streamlined Sales Tax Governing Board (http://www.streamlinedsalestax.org) maintains a website detailing the organization’s progress. Retrieved on March 4, 2011.
Benjamin M Musau
May 4, 2011
I am a Kenyan Advocate and the Managing Partner of B M Musau & Co., Advocates, a position I have held since 1999. My work encompasses regulatory reforms, reduction of administrative burdens, the structure of business entities, joint ventures, acquisitions, banking, foreign investment and other general corporate areas
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