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Taxes may be as inevitable as death in the brick-and-mortar world, but not in cyberspace.
In fact, just engaging in the electronic commerce tax debate is a little like wrestling an octopus: Every time you think youve got the thing pinned, another tentacle appears and latches onto your neck.
Its got international intrigue, Supreme Court decisions, Washington politics, forbidding bureaucracies, rancorous state legislatures, up-in-arms retailers, a diverse thicket of lobbyists and enough warring rhetoric to solve the energy crisis.
“This is a very sticky wicket to get through,” says Barry Piatt, spokesman for U.S. Sen. Byron Dorgan, D-N.D., who, along with Sen. Ron Wyden, D-Ore., is taking the lead on the Senate debate. “A lot of stakeholders are involved, and there is a lot of money involved. Its a hard one to get to the end of the road on.”
So the issue presses on. Congress and the states have renewed their nearly 4-year-old effort to find out whether — and how — states should get tax revenue from online sales. And while the current exemption on new domestic Internet taxes expires in October, a more imminent tax threat for the Internet and e-commerce looms in Europe.
There, it is not an issue of whether governments should do it — the Europeans clearly want to subject e-commerce to taxation — but rather how it will be done. And that “how” could soon impact any company that conducts trans-Atlantic business in the digital world.
Crossing National Borders
For nearly three years, the Organization for Economic Cooperation and Development has been studying the issue of how to apply different countries and regions taxing schemes internationally to e-commerce. Key questions are how to apply consumption taxes, how to tax business profits and how to classify products delivered electronically for tax purposes.
Consumption taxes have emerged as the most pressing issue for governments and industry, because the European Union is pushing hard to find ways to require foreign companies to collect value-added taxes (VAT) from EU customers for products delivered electronically, such as music and software.
EU governments already collect the VAT for physical goods ordered online and digital products delivered electronically to business customers within the EU. But governments and businesses are still struggling to develop an acceptable approach to collecting the VAT from consumers on sales of electronically delivered products.
“Governments are concerned of revenue leakage,” says Richard Hammer, international tax counsel at the U.S. Council for International Business. “Were concerned they will overtax it.”
EU officials, however, argue that their proposal is aimed more at fixing a competitive disadvantage facing European companies than capturing lost revenue. European companies are now required to collect the VAT on digital sales, even from customers outside the EU. Foreign companies, however, are not required to collect the VAT from their EU customers — yet.
And the EU is working hard to change that. For the past year, it has been struggling to hammer out an agreement among its 15 member states for imposing the VAT on all companies that do business within its borders. EU member states initially disagreed on whether foreign companies would have to register in each EU state and remit tax revenue to each of them. The latest plans would allow companies to register in one member state, but they would still have to collect the VAT rate of each nation in which their customers live.
“They have a justifiable concern about the distortion of the playing field by virtue of their tax system,” says Peter Lichtenbaum, a partner specializing in international trade and e-commerce at Steptoe & Johnson in Washington, D.C. “The debate is over whether they are proposing to fix it in a way that helps.”
Foreign companies say there is no accurate way to determine which country a customer comes from, making it difficult to apply the appropriate VAT rate. Companies based in low-VAT-rate countries would have an advantage over U.S. companies because they can apply their home countrys VAT rate on sales to any EU resident, they say.
Businesses “want it to be fair and not impede e-commerce,” says Lisa Tate, vice president and director of tax policy at the Coalition of Service Industries.
One suggestion, which has received a cool response from industry, would be to enlist credit-card companies to help verify a customers location. But Tate and others argue that while credit-card companies do need a postal address for billing their customers, this is not always an accurate reflection of where the consumer resides.
U.S. government and industry officials have urged the EU to wait to implement its proposal until the OECD finishes its work on the issue.
“The key thing is, really, you want an international integrated approach,” says James R. Fisher, vice president and senior tax counsel at Universal Music Group, a unit of Vivendi Universal.
Others say it also is important that the EU not rush into an unworkable plan, because other countries that also impose a VAT will likely follow.
“One can assume that non-EU countries with some kind of a VAT system, which is a majority, are monitoring the EU decision-making and will probably adopt the decisions or part of it,” says Frank Steimel, director for international taxation at Siemens and a member of two of the OECDs tax advisory groups.
But the OECD is struggling with the same questions as the EU.
“How do you enforce tax collection from people not in your jurisdiction? That has always been the difficult sticking point,” says David Holmes, who heads the e-commerce division within the OECDs fiscal affairs unit.
States vs. Feds
Back in the U.S., the e-commerce tax debate remains at a much more basic level — not how, but whether to tax online sales across state lines.
That debate has dogged states and catalog merchants for decades. Now its also been arbitrarily yoked to the passage by Congress of another moratorium against new or discriminatory Internet taxes, including access taxes. Lawmakers passed the first moratorium nearly three years ago; it will expire in October. Some powerful partisans, such as the National Retail Federation and some organizations representing state and local governments, are saying they will not endorse a new moratorium unless Congress handles the extraordinarily complex dilemma of whether or not states will reap online tax bonanzas.
The issue is not should e-commerce be subject to taxation. Generally, it already is. The question is should states have the right to force out-of-state merchants to collect taxes for them.
If, for example, the state of Maryland cannot force Amazon.com to collect sales taxes when a Maryland resident buys a book from the Washington state online retailer, then Maryland will likely never see the tax that it is, technically, owed from the sale. Because of a pair of Supreme Court decisions — in 1967 and 1992 — the burden of tax remittance during “remote sales” like those performed through the Internet is upon the consumer. The last court case, however, opened the door for taxation by concluding that the decision about whether states should have this power lies with Congress.
Now the matter is out of the courts and is being batted around on Capitol Hill. For more than 18 months, Dorgan and Wyden, who champion different approaches to the issue, have been engaging in high-stakes negotiations over language that might offer middle ground.
The senators have been close several times to a compromise, Piatt says. Holding them up, for example, are two key issues: whether states should be limited to a single sales tax rate, and the number of states that must sign off on tax simplification regulations before any federal law comes into effect.
At the same time, different associations of state officials have been toiling to fashion a legislative template for state legislatures to vote upon that would make the daunting tangle of sales tax regimes throughout the country more uniform. Getting states to sign on to a simplification plan is key for any congressional action on the subject. And its an issue that has divided states since mail-order taxes became an issue in the 1960s.
The differences among the organizations involved “need to be ironed out,” says Charles McDonald, president of the Alabama Retail Association. “There is too much at stake.”
From McDonalds point of view, a tax-free Internet harms local businesses and local communities.
Most prominent among the stabs at simplification is the Streamlined Sales Tax Project, which is run by state tax administrators who aim, among other things, to make uniform definitions for taxable items to simplify rates, and to adopt single audit methods. For example, if the states voted that cheese was a food, then cheese would always be a food in every state and never a “snack” or anything else, which affects whether the item is taxed or not.
Alternative Proposal
After the streamlined project advanced its model legislation, the National Conference of State Legislatures concluded that it was too rigorous to be palatable for many states and offered a more dressed-down version.
“The original [Streamlined] recommendation was the states should try to do everything at once,” says Neal Osten, director for commerce and communications at the NCSL. “Most of our members knew that was not feasible.”
The National Governors Association is also involved in the debate at the state level. The group backs Dorgans controversial proposal that each state decide upon a single tax rate for e-commerce, which may or may not be different from the existing state sales tax rate, and which would not be affected by local sales taxes. Both the NCSL and the Streamlined project oppose the “one-rate-per-state” requirement.
“The governors have to sign the bill, but the fight isnt going to be in the executive office; its going to be in the legislatures,” Osten says, remarking that debate over adopting one rate per state would be incendiary in state legislatures, where local lawmakers would be reluctant to forbid their towns and cities from establishing their own sales taxes.
Osten predicts that it will take two or three years for states to be able to show they are serious about change. Given that, the NCSL endorses the idea of passing another temporary moratorium and then shooting for congressional action again in a few years, when the states have made concrete progress.
Other partisans demand that Congress deal with the issue now, while the complicated issue is fresh in lawmakers minds.
But the issue is bigger than the Internet. Most of the pro-tax proposals floating around would transform entire state sales tax systems, and they would tip the taxing balance of power in interstate commerce toward governments and away from businesses.
“This boils down to something we all learned in third grade — the war whoop at the Boston Tea Party,” says Bartlett Cleland, director of the conservative Institute for Policy Innovations Center for Technology Freedom. “It stuns me that the National Governors Association and the rest of them dont acknowledge that this is really a big deal. They treat it so casually, as if it should be granted without much review, which I think is so inappropriate for the level of what they are asking for.”