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Internet Law and Practice1 Chapter 5 -- Taxation Internet Law and Practice1 Chapter 5 -- Taxation § 5.1 Scope Numerous excellent treatises and other reference sources already exist to inform serious students about the general rules of taxation. This chapter will not attempt to add to that existing body of literature. Rather, it will assume that the reader is either an experienced tax professional, that he is advised by one, or that he has access to a “regular” tax library. The first portion of this chapter will provide the historical background to help the reader understand the development of the tax law that is unique to electronic commerce, and to place that history into its proper political context. Of necessity, the authors’ perspective will affect the history, since we were all involved representing our business-sector clients, either on the NTA Tax Project’s Steering Committee, or in some other way, in lobbying for and interpreting the Internet Tax Freedom Act. The remaining portions of the chapter, primarily aimed at corporate tax directors and the lawyers and accountants who advise them, will address the tax issues unique to electronic commerce businesses. As tax rules and tax planning ideas affecting electronic commerce are developed, implemented, audited and litigated, our objective is to report them. It is intended that this chapter will be updated periodically, as both technology and the law develop. 1 Portions of this chapter are based on articles by Ken Silverberg and Mark Foster that appeared in the Journal of Multistate Taxation and Incentives, titled “The Internet Tax Freedom Act: Will It Be a Success or a Failure?,” 9 JMT 4 (July 1999); and “ACEC’s Report to Congress on Electronic Commerce – Mission Accomplished?,” 10 JMT 6 (August 2000), published by Warren, Gorham & Lamont, a division of RIA, copyright (c) 1999 and 2000, respectively, RIA. Used with permission. - - 2 - - § 5.2 Historical Context -- The 1996 Boston Conference Most observers agree that the first time U.S. tax professionals demonstrated serious awareness that the advent of electronic commerce would challenge their traditional paradigm was the so-called “Boston Conference” in November 1996. The Conference on Taxation of Telecommunications and Electronic Commerce was sponsored jointly by the Federation of Tax Administrators, the Multistate Tax Commission, the National Conference of State Legislatures, and the National Tax Association. Unlike many such continuing education conferences, there were probably more experts in the stated subject matter seated in the audience than there were on the various panels. Most of the scheduled speakers were from the world of academia, or were involved in the governmental side of tax administration, and these individuals had the charge of framing the issues, most of which had recently been “discovered” by a handful of legislators and tax administrators. The audience, however, was dominated by corporate tax directors, attorneys, accountants, and others who were employed by companies already engaged in electronic commerce. These individuals had already encountered the need to adapt traditional tax compliance rules to their evolving businesses, and many were well aware of the issues. Their management and shareholders had already inspired them to progress to the next step of the process – tax planning. The business participants in the Boston Conference represented several telecommunications service providers, Internet service providers, financial institutions, traditional retailers, publishers, recording studios, the print and broadcast media, and others whose employers were already generating electronic commerce revenue. Their companies were concerned that they not be surprised by either of two types of tax liabilities. First, they were unsure whether electronic presence in a jurisdiction would make them subject to income or franchise taxes (herein, “business activity taxes”) to which they had not previously been exposed. The traditional tax paradigm required some income tax nexus, which was usually conferred by the physical presence of employees, agents or property, in a remote state or a foreign country, before businesses would be subjected to income or franchise taxes. Now, these businesses had an electronic presence which enabled them to earn revenue from the - - 3 - - residents of those remote states and foreign countries. Applying the traditional tax nexus paradigm to their activities, they found they could generate this revenue without being subject to the tax regimes of these remote jurisdictions. Their objective was to participate in the electronic commerce debate and help preserve the exemptions from these business activity taxes. The second concern was the potential duty to collect sales, use or value-added taxes (herein, “transaction taxes”) from their customers, and remit these taxes to the remote state or foreign country. Again, the traditional paradigm required the jurisdiction to prove that the remote business entity had tax nexus before it could impose a duty to collect transaction tax. The businesses already participating in electronic commerce were generally exempt from this duty, and wanted to maintain that status. However, there was great concern that the governments that impose transaction taxes might attempt to change the paradigm retroactively, by means of audits, assessments and litigation, and thereby make the business and its shareholders subject to the transaction tax, which should rightfully have been the burden of the customer, if collected contemporaneously. Further, these businesses were aware of the administrative burden involved with transaction tax collection in multiple jurisdictions, and their representatives were there to prevent that burden from being multiplied, making them subject to the sales tax collection rules of potentially thousands of states and localities. Another group of businesses was represented in the audience that day in Boston – the direct mail, or catalog sales, industry. Even though electronic commerce was still in its infancy in 1996, some of the most active participants in that industry got there by migrating from the world of catalog retail sales. After all, how much different was it for a customer to place his order by calling the toll-free telephone number printed in his catalog, as opposed to logging on to the Internet from his desktop computer? Even though the human interface was missing from the electronic commerce version of the transaction, the tax paradigm was the same. Remote vendors who did not maintain a physical presence in a state or a country did not have nexus for either business activity taxes or for the duty to collect transaction taxes, and they wanted to preserve the status quo. The direct mail industry had been fighting and winning the tax nexus battle for years. These businesses did not want their successes to be undermined by some new paradigm invented - - 4 - - to deal with electronic commerce. If any new paradigm was to be invented, the direct mail industry representatives wanted to be at the table as it happened. By the end of the Boston Conference, an unprecedented cooperative spirit seemed to emerge from the business, government and academic sector participants. The explicit consensus was that electronic commerce presented new issues that could not adequately be addressed by the existing paradigm, and that the tax professionals from these three worlds were the most qualified to address the issues and resolve them. Informal pledges of cooperation were the order of the day. As it developed, the National Tax Association would soon assemble these informal pledges of cooperation into one of the most extraordinary tax study venues ever created. § 5.3 -- The National Tax Association Communications and Electronic Commerce Tax Project (“NTA Tax Project”) During the months following the 1996 Boston Conference, much follow-up discussion took place, culminating in the organization in September 1997, of the NTA Tax Project. The National Tax Association served as the neutral convener of a Steering Committee composed of sixteen representatives of the business community, sixteen representatives of state and local government, and seven “other” representatives of academia, professional organizations, and the federal government. The NTA Tax Project embarked on the daunting task of framing the issues raised by the clash of the existing tax paradigm with electronic commerce. It had as its principal purpose to consider alternative policies that could be implemented to deal fairly and sensibly with those issues. The work of the NTA Tax Project centered on transaction tax issues, and its participants immediately turned to identifying a practical method of enabling remote sellers to collect transaction taxes for all states and localities to which their products were delivered. The Steering Committee intended its September 1999 final report to provide a blueprint for reform of the transaction tax systems of state and local government. Although the recommendations contained in the NTA Tax Project’s final report have not to date become a part of any federal legislation, most of these substantive recommendations are - - 5 - - embodied in the report of the Advisory Commission on Electronic Commerce and included in the Simplified Sales Tax Project, both discussed infra. This is consistent with the strong preference of the state and local government representatives on the Steering Committee. Many of them had first-hand experience with the fairly recent federal pre-emption of one tax that had previously
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