SALES & USE TAX SYSTEM IN NEED OF SIMPLIFICATION?

For the occasion of the second meeting of the Advisory Commission on Electronic Commerce, September 14­15 in New York City, Ernst & Young released a study contending that the current state and local sales and use tax systems are overly complex and burdensome for multistate retailers. The study discusses the features of the current system and estimates the magnitude of the costs required for a business to properly comply with these tax systems.

Congress created the 18-member commission as part of the 1998 Internet Tax Freedom Act. Its task is to study e-commerce tax policy and issue a formal recommendation to Congress by April 2000. Its report will not dictate future U.S. tax policy toward the Internet but is presumed to shape the debate. Part of its research, such as the Ernst & Young study, entails taking a look at the current taxation system that e-commerce entities, increasingly national and transnational in scope, are faced with.

The Ernst & Young study emphasizes that collection costs could prove prohibitive for small and mid-size businesses hoping to use the Internet to achieve broader distribution. The study estimates that it would cost a single-state small retailer ($250,000 in annual sales) 7% of its sales taxes paid to collect the sales taxes. With collection responsibility in 15 states, the collection costs rise to 45%; in 46 states, the burden reaches 87%. A large company, however ($10 million in annual sales), would incur only 14% of sales taxes paid to make the collection effort involving 46 states.

"Clearly, these unacceptably high costs will slow the growth not only of larger e-commerce companies, but they will also seriously hinder the smaller, more specialized companies looking to broaden their market by using the Internet," said Robert Cline, Ernst & Young's national director of state and local tax policy economics.

This compliance complexity stems from a web of regulations emanating from different states, a number of unanswered questions that have been raised by the new technologies of e-commerce, and the stance taken by the Federal government, as evidenced by the Internet Tax Freedom Act's three-year moratorium on new Internet taxes. The uncertainty over what, if anything, Washington will do to regulate interstate Internet transactions in the future has left some states jockeying for position in this revenue vacuum. Some states lacking a sales tax have positioned themselves as e-commerce friendly. Others, highly reliant upon the revenue provided by sales taxes to operate public services, have tried to recoup whatever they can.

The existing taxes applied to Internet sales are fairly well established from experience with mail-order businesses: sales taxes are generally only applied to intrastate sales. A business is generally considered to exist within a state if it has a "nexus," or physical presence, such as a factory, warehouse, or retail store, within that state. Technology, however, has blurred the idea of nexus: Is a server containing a copy of the retailing website a "physical presence?" Is the local ISP transmitting order data considered to be acting on behalf of the retailer? The answer to these questions is generally considered to be no, but that has not kept some jurisdictions, such as Texas, from trying to collect. The collection of use taxes from consumers is inconsistent and has generally proven unwieldy.

"The federal government should not create an elite class of merchants that Congress exempts from collecting transaction taxes just because some part of that transaction takes place on the Internet," said Randy Johnson, former president of the National Association of Counties, at the ACEC meeting. "Local government and state government cannot run on an empty tank."

Should electronic commerce continue its impressive rate of growth, the noncollection of sales and use taxes will certainly have an effect on the coffers of state and local governments. Though e-commerce may be the engine of economic growth, that does not excuse it from legal obligations, much less traditional civic responsibilities. Public services provided by local governments would, by necessity, need to be reduced if major sources of revenue were indeed eclipsed. Admittedly, a tax system with nearly 7,500 jurisdictions is overly complex, but software solutions exist today that can make compliance less burdensome.

Where does this leave the state of Internet taxation? A public opinion poll conducted on the eve of the ACEC meeting by the Information Technology Association of America reports that American voters feel that the growth of e-commerce is more important than the preservation of state and local tax revenue, and a majority opposed the taxation of electronic purchases. And Congress seems to be listening: At press time, two bills under development, one sponsored by presidential candidate John McCain, would permanently ban taxation of Internet sales and encourage international organizations to follow suit.

In these boom times, the collection of what is still relatively incidental tax revenue may not be a major concern of state governments. But does it make sense to charge sales tax to customers who enter a physical premise to purchase an item and not subject a cyberspace purchaser in a like manner? As e-commerce becomes a major site of commercial retailing, the issue may well be urgent for some jurisdictions. *

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.