Taxing the Internet
Virtually every type of
commerce in the United States is subject to some form of taxation at the
federal, state, or local level. The Internet industry (made up of Internet
service providers and online service providers along with companies that do
business over the Internet) is no exception. Yet the fast growth of
electronic commerce , and the novel properties of the industry, pose
special problems for tax authorities.
The
federal government worries that the Internet could become a global haven for
money launderers and tax evaders . States and localities worry that
increasing use of the Internet will erode their tax bases as consumers and
businesses shop and do business outside of their taxing jurisdictions. While
they are anxious to develop more sources of revenue and expand their tax bases,
they also realize that unilateral efforts to collect from the industry may
simply drive the easily moved online operations over the state line. Not
surprisingly, the Internet industry opposes any new taxes on its burgeoning
commerce. Major online retailers and service providers, however, recognize that
there is no case for exempting Internet sales and, perhaps, services from the
same tax laws that apply to offline commerce. But they are especially concerned
with developing uniform, consistent, and fair tax treatment by state and local
authorities. Multiple taxation is seen as a particular threat.
Who has responsibility for taxing Internet commerce?
As the Internet grows and changes, how is existing tax law being applied? What
can and should be taxed--goods and services sold over the Internet? Online
services themselves? And by what level(s) of government? These taxing questions
are likely to keep accountants, lawyers, and international-trade consultants in
BMWs for years.
Estimated
revenues from the Internet are not huge--so far. But predictions of where
they're going are very big. According to industry research, subscription and
advertising revenues from Internet and online services were as much as $2.2
billion in 1995 and may top $14 billion by the year 2000. Advertising revenues
alone made up $131 million last year, but not surprisingly, this represented
less than 0.5 percent of the ad money spent on other media.
Online sales of products over the Internet
amounted to approximately $500 million, less than 0.4 percent of all mail-order
sales. Forrester Research predicts this number will reach $6.6 billion by 2000,
but that would still amount to only 5 percent of all predicted mail-order
sales. But as more consumers become familiar with online commerce, they may
very well begin to shop for products over the Internet precisely to avoid
state and local sales taxes .
Taxing
online sales of mailed products is one obvious revenue opportunity under
existing tax law. The easy analogy here is to catalog sales (although these,
too, have posed problems for state and local authorities). If you buy a pair of
boots from L.L. Bean's catalog, the company must charge you sales tax if you
live in Maine (or any other state), where it maintains a place of business. By
the same token, if you decide to use your computer to buy, say, a five-liter
bottle of 1984 Napa Valley cabernet (for $629) from Virtual Vineyard, the same
rule applies. Virtual Vineyard's location (or "nexus" in tax-speak) is Palo
Alto, so, unless you're having the wine sent to a California address, there
will be no sales tax.
But the situation is different in practice (if not
principle) in the case of products delivered over the Internet .
Establishing nexus can be a tricky issue, for example, when it's a case of
content--such as newspapers, magazines, books, videos, music, or computer
software--being downloaded. The seller may have no idea of the buyer's
location, and hence whether sales tax is due (though new software packages
being developed for online commerce may help remedy this). But the location of
the seller may be even tougher to determine.
As noted
above, a seller must collect sales tax from a buyer if the seller has a
significant "physical presence " in the same jurisdiction where the buyer
takes delivery. Suppose, for example, that the content in question is being
sold by an online service such as America Online, the Microsoft Network,
or any of a myriad of smaller services. Where does that service do business?
Most online service providers operate Point-of-Presence (POP) locations that
allow subscribers to log on to the Internet using a local phone number. These
typically consist of a leased room with modems and routing equipment. Already,
some states have argued that POPs constitute sufficient physical presence for
taxing purposes. But the 1992 U.S. Supreme Court case Quill vs. North
Dakota would seem to defeat such an argument. The Quill ruling protects
sellers of tangible personal property from state taxation if their contacts
within the state are limited to mail-order catalogs, telephone, or the
Internet.
And what if the content is being sold by a
separate vendor through an online service? Some states argue that
taxable nexus can be established if a vendor operates over an online or
Internet service with substantial physical presence within the state. This
opens up a whole new basis for taxation opposed by the industry and unlikely to
be upheld by the courts. After all, to return to our catalog analogy, if L.L.
Bean uses UPS to deliver its boots, that doesn't expose the sale to taxation in
every state where UPS operates. And even if states can win the nexus argument
in court, Internet providers are likely to flee to more tax-friendly
jurisdictions, thus forcing (angry) subscribers to incur long-distance phone
charges for online access.
In
addition to sales taxes, 20 states also impose some form of tax on Internet
and online services or activities. These include Pennsylvania, Connecticut,
Massachusetts, Nebraska, Tennessee, Ohio, and Texas. Many cities are doing the
same. Officials in Fort Collins, Colo., decided last year that Internet
providers were subject to a city sales tax on telephone service and that
subscribers would have to pay a 3 percent sales tax on top of their monthly
access fee. The industry argues that it is not comparable to the (heavily
taxed) telecommunications industry, and that such efforts result in double
taxation--since service providers already pay taxes on phone-line usage--as
well as for Internet vendors. Again, as in the case of wine sales, states have
taxing jurisdiction over transactions only if the seller has sufficient
physical presence in the state.
Tax authorities are further threatened by the growing use
of electronic money . E-cash can be used to facilitate a host of illegal
businesses, including drug transactions, thereby eliminating the need for
suitcases full of $100 bills. It could also swell the underground economy, as
people use it to pay for services, facilitating the avoidance of federal income
tax.
Another dicey issue
confronting Treasury Department enforcement officials is Internet
gambling . Although federal law prohibits gambling by wire in the United
States, and most authorities interpret that to mean that Internet gambling is
illegal here, at least one online casino, Casino Royale, looks and feels like a
virtual gambling emporium. (Sen. Jon Kyl, R-Ariz., has just introduced a bill
to ban online gambling.)
Recognizing that the Internet effectively wipes out national borders, and
fearing that the development of new technologies may be impeded by inconsistent
tax policies, the federal government has been studying the issue of
international tariffs on Internet transactions. At this point, no
countries have imposed tariffs or other taxes on online commerce, but at least
a dozen are considering them. This is a big area of concern for the
administration, since the United States exports $40 billion in services
annually, including software, entertainment and information products, and
professional services.
The Clinton administration's position is
that the Internet should be a federal duty-free zone. In releasing a draft
report on the subject, Deputy Treasury Secretary Lawrence Summers said, "We
absolutely reject the idea that the Internet is some sort of golden goose whose
feathers should be taxed. The key message of the report is no Internet taxes."
This does not mean, however, that the federal government supports abolition of
any taxes on Internet commerce, only that it plans no new taxes at this
time. The Treasury report itself stresses that, in principle, the tax code
should treat Internet transactions exactly like other channels of commerce.
On March 13, Sen. Ron Wyden,
D-Ore., and Rep. Christopher Cox, R-Calif., introduced the Internet Tax
Freedom Act . The bill would impose an indefinite moratorium on state and
local taxes on electronic commerce, though it would exempt certain taxes,
including most sales taxes, that are already in place. The bill also calls on
the administration to develop a comprehensive plan to address the issue, and to
seek bilateral and multilateral trade agreements that make all Internet
activity internationally free of taxes, tariffs, and trade barriers.
The administration is
already working with the World Trade Organization and other
international trade groups on uniform rules for taxation of electronic
commerce. Meanwhile, there are tricky aspects to assessing taxes under current
international tax treaties, including: 1) identifying the country or countries
with authority to tax; 2) classifying the type of income arising from the
transaction (e.g., royalties, sales of goods, or services); 3) tracing
transactions handled with electronic money; and 4) identifying parties to
transactions, and verifying records. In addition, some countries impose
quotas on content such as books, movies, music, and software from
abroad, but the origin of that content can be tough to trace in the thin air of
cyberspace.
