By G. Bradley Hargrave
Internet Taxation
In the fall of 1998, Congress passed the Internet Tax Freedom Act which imposed a three year moratorium on the creation of new Internet taxes and called for the creation of a commission to develop Internet tax policy recommendations. While the passage of this legislation undoubtedly helped to create an environment conducive to the flourishing of the Internet marketplace, it is only a temporary fix to a very complex problem. Individual states remain free to impose their own sales and use taxes on Internet access, as well as goods bought and sold over the Internet and software downloads. With over 30,000 taxing authorities in the U.S., every business engaged in e-commerce faces some significant uncertainties in the sale of their goods and services over the Internet.
To date, the vast majority of states have decided not to tax Internet access charges. Yet the states are fairly evenly divided as to whether the download of software from the Internet is a taxable event. (Some of the states which do impose a tax on downloaded information distinguish between "canned" or "shrink wrapped" software, which is taxable, and all other downloads of information, which are not). However, virtually every state has determined that the sale of tangible goods over the Internet is no different than any other sale of tangible goods, and thus is subject to sales tax, provided there is "nexus" with the state.
As a general rule, "nexus" exists if the buyer and/or seller is present in the taxing jurisdiction. But traditional rules of presence become muddled when placed in the context of an Internet transaction. Accordingly, confusion reigns among Internet sellers as to what taxes should be paid and where, while local taxing authorities complain that they are losing out on the Internet bonanza (a fact, admittedly, that few of us will lose any sleep over).
This confusion is particularly pronounced in the area of "use" taxes. Whereas a sales tax is levied on the gross sales price of goods sold, and is thereafter collected by the seller, "use" taxes are charged to the buyer of the goods by the state in which he resides. An out-of-state seller, with no nexus to the taxing authority, has no obligation to collect a use tax, yet the buyer has an obligation to pay it, whether he realizes it or not. The end resultóvirtually total non-compliance by Internet purchasers and significant lost revenue to the taxing authorities.
Large states, such as California, have an incentive to forego the imposition and collection of sales and use taxes because of the incredible growth in Internet related businesses in their states and the corresponding wealth which flows to the taxing authorities. But small states, such as Hawaii and South Dakota (both of which tax both Internet access charges and the downloading of all information) have a legitimate reason to fear the loss of tax revenue as their citizens continue to forego local shopping outlets in favor of online shopping.
The commission formed by the Internet Tax Freedom Act has its work cut out for it. If it fails to develop fair tax rules which address both the revenue needs of smaller states, while preserving the relatively wide-open, unregulated environment necessary for further Internet expansion, more states and local taxing authorities may feel compelled to create new, Internet specific taxes once the moratorium is lifted. Such a failure could create an even more complicated tax environment than the one which currently exists.
G. Bradley Hargrave practices business law in Sonoma County, California, with particular emphasis on business formation issues, contracts, and computer law. He was formerly House Counsel for CrossCheck, Inc., and is a graduate of Santa Clara University School of Law.
Copyright © The Green Sheet, Inc., 1999. All rights reserved.
First Published November 1, 1999
