(c) 2004 West Legal Studies in Business A Division of Thomson Learning 1 U.S. Constitution has Two...

(c) 2004 West Legal Studies in Business A Division of Thomson Learning

1

U.S. Constitution has Two Parts Which Have a Bearing on State

Taxation of Internet Sales

• 1. Art. 1, Sec 8 the right of the federal government to regulate interstate commerce

• 2. 14th Amendment due process clause


2

Art. 1, Sec. 8 “to regulate interstate commerce”

• Based on the concept of whether the state regulation is good for the national economy

• Federal government has this right, but

• Federal government does not deny the State right to pass laws which regulate interstate commerce – As long as the law does not unduly burden interstate commerce.– That means the state can tax interstate commerce as long as

the tax does not unduly burden interstate commerce.


3

14th Amendment due process clause

• Based on concept of fairness to the selling business

• If the seller has no connection (nexus) with the state - - no physical presence in the state, then the state cannot make the seller collect taxes for it.– The “nexus” with the state proves that the seller is

using the state facilities: police, fire fighters, emergency services, roads, bridges, airports, all the infrastructure,

– In return for use of the infrastructure, the state has taxing jurisdiction = authority to make it collect the states taxes on every sale


4

States Levy

• Sales taxes

• Use taxes


5

Sales tax

• Is levied on tangible goods bought or leased within a state that has a sales tax.

• Must be collected by the merchant or leasor and remitted to the state – Only if the merchant has “nexus” with the

state (See below)

• Charged on the gross amount


6

Use tax

• Is levied on the consumer for tangible goods purchased out of state for use within the taxing state, if they paid no sales tax in the state where and when they bought it

• Live in one state, buy in a state with no sales tax, still have to pay a use tax to the state you live in

• Usually consumers do not pay this tax


7

Some Sales are Not Taxed

• Food

• Clothing

• Nontangible transactions such as services


8

Who taxes?

• 45 states have sales tax on businesses that have “nexus with the state” – 5 states do not have any sales tax on or off Internet

• Alaska, Delaware, Montana, New Hampshire, Oregon

– 11 of the 45 were taxing internet access before the Moratorium may continue

• Connecticut, Wisconsin, Iowa, North Dakota, South Dakota, New Mexico, South Carolina, Tennessee, Texas, and Ohio

• Counties (parishes) and municipalities also have sales and use taxes


9

Mail Order: Catalog, Direct Marketing, Cable TV Sellers

• Do these sellers have “nexus” with the taxing state?

• 1967 National Bellas Hess, Inc. v. Dept. of Rev. of the State of Ill., – Facts: Mass. mail order house had no property,

office, outlets, or any sales representatives in Illinois – Reasoning: no physical presence or “nexus” in the

state– Judgment: Do not have to collect sales taxes for

sales in Illinois because had no nexus with Illinois


10

Local Main Street Retail Stores

• Do have physical presence and “Nexus”

• Do have to collect sales taxes

• Feel this is unfair to them ( 20 billion estimated to be lost by the states in 2003)


11

Web Sales That Are Made on the Internet- Like Mail Order?

• No physical presence?

• Do Web sellers have to collect sales or use taxes?


12

1992 Quill Corp. v. North Dakota

• N.D. District Court judgment: because the state had not spent any of its tax money on Quill, there was no nexus and N.D. could not require Quill to collect a use tax

• N.D. Supreme Court judgment: reversed and said the state could require Quill to collect a use tax from N.D. buyers – Reasoning: because the mail order business was so huge, and

computers made it easier for interstate sellers to keep track of the different taxes it must collect in the different counties and states

• U.S. Supreme Court judgment: reversed the N.D. Supreme Court- cannot require Quill to collect a use tax


13

U.S. Supreme Court

• Due Process Clause and the Commerce Clause are both applicable to a state’s taxing power over interstate commerce.

• But - the two Constitutional protections are analytically distinct.


14

How are They Different?

• Congress may allow a state to burden interstate commerce under the commerce clause

• Congress may not allow a state to violate due process under the due process clause!

• Due process and the commerce clause do not have the same requirements


15

Due Process Requirements Have Been Met by Quill

• Due process does not require physical presence

• Due process is concerned with notice so as to provide fairness to the individual

• So, what it really requires for due process is not physical presence, but:– purposeful direction of the seller’s activities at the state’s

residents,– A magnitude of contacts, even if not physical presence.– The tax is related to the benefits that the seller receives from the

state• These requirements have been met by Quill.


16

However, Commerce Clause requirements have Not Been Met

by Quill• The Commerce Clause requirement of

“substantial nexus” for taxing is not the same nexus that is “minimum contacts” required for due process

• The Commerce Clause is not concerned with fairness to the individual, but rather with structural concerns about the effects of state regulation on the national economy


17

Commerce Clause

• The Articles of Confederation hindered and suppressed interstate commerce – framers of the Constitution wanted to fix this problem

• The Commerce Clause prohibits discrimination against interstate commerce.


18

U.S.S.Ct. Overruled the North Dakota Supreme Court

• Found that Quill could not be taxed, not because of due process, but because of the commerce clause: the tax nexus requirement was not met– The Commerce Clause asks whether the tax is for the

good of the whole structure of the economy

• But the Court told Congress that they were free to overrule the Court with legislation that allowed the states to tax mail order houses because Congress is in control of the national economy


19

The Protection Given in Quill Created a Zone = Drew a Line

• The line is called the “Bright Line”around an area where an interstate vendor is free from taxation

• Bellas Hess created a protected zone = this line around this area is the “Bright Line”

• The Bright Line in Bellas was drawn around vendors “whose only contact with the customers in the taxing state was by common carrier or the U.S. mail.”


20

So When Is There a Sufficient Nexus for the Commerce Clause?

• Not mail-order• A retail store in the taxing state• Renting an office or a warehouse in the taxing state• Holding trade shows where employees or agents take

orders from customers in the taxing state• Working with a server in the taxing state• Maintaining inventory in the taxing state• Licensing software to licensing a taxing state• Hiring agents in the taxing state• Falling under the Market Maintenance theory


21

Is Nexus Created When a Business Hires Agents in the Taxing State?

• Scripto, Inc., v. Carson– Independent contractor, not employee in

taxing state– Court said this was enough for Commerce

clause nexus


22

Market Maintenance Theory

• Vendor’s state activities are significantly associated with the taxpayer’s ability to establish and maintain a market in the state for its sales– Tyler Pipe Industries, Inc. v. Dept. of

Revenue:• Through sales contacts, sales reps maintained the

name recognition, market share, goodwill, and individual customer relations of the company and therefore, subjected themselves to tax jurisdiction


23

Internet Tax Freedom act of 1998 (ITFA)

• Prevents federal, state, and local governments from imposing any new taxes on the Internet sales for a period of three years

• Can still tax is they have nexus, this is only if they do not have nexus

• 11 states already doing it were OK

• Created the Advisory Commission on Electronic Commerce– Who have recommended that the moratorium be extended for 5 years.– It was extended until November 2003


24

"3-year moratorium on special taxation on Internet access

• Bars state or local governments from taxing Internet access (i.e. the $19.95 or so that many Americans pay monthly to America Online, CompuServe, Erol's, or other similar services to access the Internet) from October 1, 1998 until October 21, 2001.

• A limited "grandfather" clause permits the handful of states already taking steps to tax Internet access--Connecticut, Wisconsin, Iowa, North Dakota, South Dakota, New Mexico, South Carolina, Tennessee, Texas, and Ohio--to continue to do so if they can demonstrate that their taxes had already been "generally imposed and actually enforced" on Internet access providers prior to October 1, 1998.

• Nevertheless, it is not expected that all of these states will in fact choose to tax Internet access: Connecticut and South Carolina, for instance, have already indicated they intend to abide by the national moratorium.“


25

Advisory Commission

• Could not come to a supermajority

• Recommended that the moratorium be renewed for 5 years until 2006


26

Governors Conferences and State Legislature Conferences

• Lobbying “big time” in favor of Internet sales tax

• Need the revenue, don’t want an extension of ITFA


27

Sales Tax and the Dormant Commerce Clause

• Wilson v. Black-bird Creek March – Even when Congress does not regulate

interstate commerce, the power given to Congress is dormant, and states may not regulate interstate commerce

• New Energy Co, of Ind. v. Limbach

• Santa Fe Natural Tobacco, Inc. v. Spitzer


28

A New Sales Tax System: The Stream Line Sales Tax Project

(SSTP)• An e-business doing business in all states has a

potential sales tax obligation in over 7,500 taxing jurisdictions, each with its own laws

• STSP: simplify and modernize sales and use tax collection and administration for remote online and offline sales transactions.– Two phases

• Uniform Sale and Use Tax Administration Act (USUTA) = model state legislation to bring states into uniformity

• Streamlined Sales and Use Tax Agreement (STUTA) = Agreement

• 29 States have adopted both phases of SSTP


29

SSTP – Makes the following uniform from state to state

• Definitions

• Exemptions

• Rates

• Returns

• Remittance Schedule

• Audit Procedures

• Payment to the merchant


30

3 Technology Models

• Model I. Certified Service Provider

• Model II Certified Automated System

• Model III Internal System Certified by the State


31

Internet Tax Moratorium and Equity Act

• Introduced in the 107th Congress

• Congress may facilitate equal taxation regarding a traditional retail establishment with mail order, telephone, or the Internet, consistent with Quill


32

International Internet Taxation

• Organization of Economic Cooperation and Development Initiatives– 30 member countries– Developing a framework for international

taxation– Committee on Fiscal Affairs Report, 1998

outlined a number of general principles


33

The Permanent Establishment Problem

• Source-based taxation principle – tax income where it originates

• Residence-based Taxation Principle – tax business’ income where the business lives

• Must define “Permanent establishment” of a business– Web site alone is not enough– Acting as hosting server is not enough – ISPs are not– Software /data is not, and server equipment is– Fixed computer equipment is– No need for human intervention to be a place of permanent

establishment


34

Other Countries’ Taxing Laws and Policies

• Germany• India• United Kingdom• European Union Value-Added Tax on Internet

Sales (VAT)– Effective July 1, 2003– Non-EU vendors must collect and remit a value-

added tax when selling electronic goods such as music and software in EU member states

– U.S. sellers must figure out the buyer’s country, what the tax is, remit it to country

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