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E-Commerce and Telecom Tax Overview. Professor Annette Nellen Online class – Bus 223E Summer 2005. Agenda. The Big Picture Internet Business Today – Trends & Stats Local Gov’t Concerns & Constraints* Framing the Internet Taxation Issues Active Proposals & Projects

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E commerce and telecom tax overview

E-Commerce and Telecom Tax Overview

Professor Annette Nellen

Online class – Bus 223E

Summer 2005


Agenda
Agenda

  • The Big Picture

  • Internet Business Today – Trends & Stats

  • Local Gov’t Concerns & Constraints*

  • Framing the Internet Taxation Issues

  • Active Proposals & Projects

  • Concluding Observations

    * The lesson focuses on some local issues as this is what is driving some activities today, such as the Streamlined Sales Tax Project.


The big picture
The Big Picture

  • What is e-business?

  • Why does e-business challenge our tax rules?


E business
E-Business

Not just Amazon.com, but also …

  • Hardware

  • Software

  • Telecommunications infrastructure

  • Transaction facilitation (such as EBay, security, advertisers, electronic payment)

  • Search engines

  • Web hosting

  • Internet service providers

  • Retailers and wholesalers of tangible and intangible items

  • Service providers



Tax challenges of e business
Tax challenges of e-business

  • Location

    • Fewer needed – thus, less taxing points

    • Some needed assets are mobile

    • More custom inventories – thus, less storage needs

    • Less vertical integration – thus, more outsourcing

    • More global purchases and sales


Tax challenges of e business1
Tax challenges of e-business

  • Transaction methodology

    • Possibility of anonymous transactions – verification and paper trail issues

    • Increased bartering – tax challenges

    • Easy to reach out to large geographically dispersed customer base

      • Greater number of remote sales

      • Occasional sale versus active seller


Tax challenges of e business2
Tax challenges of e-business

  • Nature of products

    • Digitized (intangible) versus physical products

      • In CA – reduction in sales tax base

    • Storage needs greatly reduced – fewer physical locations

    • P.L. 86-272 nexus rule for income tax doesn’t apply to intangibles


Tax challenges of e business3
Tax challenges of e-business

  • Workforce

    • May be scattered across the globe – taxing points? More business license locations?

    • Taxable presence where employees are?

  • Technology

    • Businesses track customer purchases

      • Usable to also calculate and collect sales tax?

    • Improved buying systems for governments?


Has technology outpaced sales and use tax systems
Has technology outpaced sales and use tax systems?

  • YES

    • System is dependent on physical location – now businesses have fewer physical locations

    • The tax applies predominantly to physical goods, but today services and intangibles are key consumption items

    • Usually destination-based yet today, physical location of buyer isn’t important for transfers of intangibles and services

    • Too many sets of rules that would apply if nexus were broadened. Lots of sets of rules worked before because only large companies were subject to them.


Summary of e commerce and tax concerns
Summary of e-commerce and tax concerns

http://www.cob.sjsu.edu/nellen_a/ETraits.pdf


Agenda1
Agenda

  • The Big Picture

  • Internet Business Today – Trends & Stats

  • Local Gov’t Concerns & Constraints

  • Framing the Internet Taxation Issues

  • Active Proposals & Projects

  • Concluding Observations


E business today
E-Business Today

  • E-commerce sales:

    • up 28% from 2003

    • 1.9% of total retail sales

  • 2001 – 93% of e-commerce = B-B

  • Weekend following Thanksgiving 2003 – more shopped online than inline


E business today1
E-Business Today

  • Growth of “multichannel retailers”

    • Customers want to buy online and return at the store.

      • Leads the online store to create a physical presence!


E business today2
E-Business Today

  • 23% growth in micropayment revenue from 2003 – 2009

  • 73% of CA residents have high-speed Internet access available to them; 13 – 17% subscribe to such access

    • Boost to CA economy expected from greater broadband deployment


Agenda2
Agenda

  • The Big Picture

  • Internet Business Today – Trends & Stats

  • Local Gov’t Concerns & Constraints

  • Framing the Internet Taxation Issues

  • Active Proposals & Projects

  • Concluding Observations


Local gov t concerns
Local Gov’t Concerns

  • CA state and local tax revenue loss from e-commerce:

    • Bruce & Fox: $2.1 billion for 2003

      up to $33 billion for 2008

    • Direct Marketing Association (DMA) – about 9x too high

  • Tax cheating on rise:

    • 1999 – 11% say ok to cheat on tax return

    • 2003 – 13%


Differences in data
Differences in data

  • Some of the differences between the UT and DMA estimates are due to DMA using a higher tax compliance rate for businesses and recognizing the likely growth of multi-channel, clicks and bricks commerce where consumers want to be able to buy online but return at a physical store which will lead retailers to have nexus in the state for their online operations and be required to collect sales tax (rather than the consumer having to self-report use tax). Another difference is that DMA suggests that billions of dollars of EDI (Electronic Data Interchange) activity among businesses should have been excluded as not being Internet sales.[1]

  • [1] Dr. Peter A. Johnson, Direct Marketing Association, “A Current Calculation of Uncollected of Uncollected Sales Tax Arising from Internet Growth,” March 2003; available at http://www.the-dma.org/taxation/CurrentCalculationofUncollectedSalesTax.pdf.


Local gov t constraints
Local Gov’t Constraints

  • Federal nexus restrictions from Due Process and Commerce Clauses

  • Telecom Act of 1996

    • Local – no tax on Direct Broadcast Satellite

    • No barrier to entry

  • Internet Tax Moratorium

  • Bradley-Burns – CA cities must use state sales tax base

  • Various propositions – 13, 218 – place voting constraints on tax increases


Agenda3
Agenda

  • The Big Picture

  • Internet Business Today – Trends & Stats

  • Local Gov’t Concerns & Constraints

  • Framing the Internet Taxation Issues

  • Active Proposals & Projects

  • Concluding Observations


Framing the issues
Framing the Issues

The Tax Formula

Customer Desires

Telecom

Vocal players and politics


Framing the issues the tax formula
Framing the Issues: The Tax Formula

Tax = Base x Rate

IF

Have authority to tax!!


Framing the issues authority to tax nexus 101
Framing the Issues: Authority to Tax - Nexus 101

  • Connection between jdx and entity such that is permissible for gov’t to impose its laws on the entity.

  • States have rules that help define that connection + …

    • Income tax – see P.L. 86-272 if tangible personal property is being sold

    • Sales tax – Quill (US S. Ct. 1992) – if have a physical presence that is more than slight

      NOT ALWAYS CLEAR!

      FREQUENT LITIGATION!


Nexus not always easy to interpret state statute
Nexus – not always easy to interpret state statute

Borders and California Nexus

  • In 2003in the Matter of the Petition for Redetermination under the Sales and Use Tax Law of Borders Online, Inc. (SC OHA 97-638364), the Board found that because Borders accepted returns of purchases from Borders.com, nexus existed. The statement was found on-line in July 1999, but was removed in August 1999. The Board found such activities to be an integral part of the selling process (people are more likely to buy online if they can return to a store) and that Borders.com had a physical presence in California (through the in-state affiliate). The appeal was heard and decided by the First Appellate District in May 2005 and affirmed.

  • Borders Online was formed in 2001 as a Delaware corporation, headquartered in Michigan, to be Internet Company for Borders (it is a successor in interest to Borders Online, Inc.). Online and Borders are affiliated corporations owned by the same corporation. Most likely, one of the reasons why Online was set up as a separate corporation was to limit the number of states in which it would have to collect sales tax, based on such precedent as SFA Folio Collections, Inc. v. Bannon, 585 A.2d 666 (Conn. 1991), cert. denied, 501 U.S. 1223 (1991), SFA Folio Collections v. Tracy, 652 N.E.2d 693 (SCt Ohio 1995), and Bloomingdale's v. Dept. of Revenue, 567 A.2d 773 (1989), aff'd without opinion 591 A.2d 1047 (Penn. 1991), cert. denied, 504 U.S. 955 (1992). Online had no employees or property in CA.

  • In 1998 and 1999, Online sold over $1.5 million of merchandise over the Internet to CA consumers. Its website noted that goods could be returned to any Borders (physical) store. Borders did not charge Online for this service. This note was removed from Online’s website on 8/11/99. Borders also included a notation on its sales receipts to “visit us online at www.borders.com).


Borders online cont d
Borders Online – cont’d

  • Issues before the court were (1) whether Border’s activities were “for the purpose of selling” Online’s goods, and (2) whether Online had sufficient presence in the state, through Borders, to justify that it was required to collect sales/use tax.

  • The court agreed with the SBE that since Borders only handled returns for Online per the terms on Online’s website, it was acting as Online’s authorized agent. A formal arrangement is not needed because an agency relationship can be implied based on conduct and circumstances and no written agreement is needed.

  • The handling of returns for Online caused Borders to be “selling” for purposes of §6203(c)(2), because it was an integral part of getting customers to buy online. Online argued that it was not allowed to produce evidence that Border’s reason for taking the returns was unrelated to encouraging sales. No evidence was produced when required and the court noted that even if the return policy provided some benefit to Borders (for example, it got a customer into their store), it could have still induce Online customers to buy from Online.

  • Online noted that unlike the situations in Tyler Pipe Industries v. Dept. of Revenue, 483 U.S. 232 (1987) and Scripto, Inc. v. Carson, 362 U.S. 207 (1960), Borders was not actually making any sales for Online. The court viewed that perspective as too narrow noting that per Tyler Pipe one is to look at whether the activities of the retailer’s in-state people are “significantly associated with [its] ability to establish and maintain a market in [the] state for the sales.”

  • The court did not find the returns policy here similar to SFA Folio Collection where the store took returns from the catalog operation under its own policy and for its benefit.


Borders online cont d1
Borders Online – cont’d

  • Query: Is this holding a proper interpretation under R&T §6203(c)(2)? R&T §6203(a) provides that “every retailer engaged in business in this state and making sales of tangible personal property for storage, use, or other consumption in this state, not exempted … shall …collect the tax from the purchaser.” R&T §6203(c)(2) provides that “retailer engaged in business in this state” includes “any retailer having any representative, agent, salesperson, canvasser, independent contractor, or solicitor operating in this state under the authority of the retailer or its subsidiary for the purpose of selling, delivering, installing, assembling, or the taking of orders for any tangible personal property.” Clearly, Online is a retailer. Also, noting on its website that Borders will handle returns appears to make it an agent or representative, but was Borders “selling” for Online?

  • The court stated “The Board appears to have thoroughly considered the meaning of the term, and its reasoning that the act of ‘selling’ encompasses offering other inducements to purchase is consistent with at least one later pronouncement. (Board’s Boarder Opn., supra, Cal. Tax Rptr. (CCH) ¶403-191 at p. 29.974; In the Matter of the Petn. For Redetermination Under the Sales and Use Tax Law of Barnes & Noble.Com (Sept. 12, 2002) [2000-2003 Transfer Binder] Cal. Tax Rptr. (CCH) ¶403-325, pp. 30,447, 30,450 [bookstore’s distribution of discount coupon on behalf of affiliated Internet retailer was integral to selling efforts and thus constituted ‘selling’].)”


Borders online cont d2
Borders Online – cont’d

  • There was no evidence of whether sales occurred at Online due to the return policy. Is an offer to handle a return the same sales inducement as providing a coupon (which in Barnes & Noble.Com, the Board found to be more than advertising)? Does “selling” mean offering inducements to sales, or actually making sales, as was done in Scripto (independent contractors taking orders) and Scholastic (teachers taking orders and collecting payment for the bookseller)[1]? Of course, those cases were looking at the in-state person’s actions and relationship with the out-of-state retailer to determine if an agency relationship existed, not whether “selling” was involved (because taking orders is unquestionably selling).

  • Does R&T §6203 need to be modified again to be clearer? Should it say “selling or inducing or promoting sales” rather than just “selling”? Of course, given the 2005 Borders Online decision, there would appear to be no need to clarify it other than to avoid litigation in the future. Such a change would appear to be permissible within the Due Process and Commerce Clause given that §6203 requires the physical presence of an agent or representative in the state. Also, the proposed new language ties to maintaining a market in the state as required by the U.S. Supreme Court (In Tyler Pipe, supra, the Court stated: “The crucial factor governing nexus is whether the activities performed in this state on behalf of the taxpayer are significantly associated with the taxpayer’s ability to establish and maintain a market in this state for the sales.”)

  • [1]Scholastic Book Clubs, Inc. v. State Board of Equalization, 207 Cal App 3d 734, 255 Cal Rptr 77 (CA Ct App, 1989).


Framing the issues the tax base
Framing the Issues: The Tax Base

  • Varies from state to state

  • Issues often arise wrt telecom and technology services

  • Frequent changes

    NOT ALWAYS CLEAR!

    FREQUENT LITIGATION!


Framing the issues customer desires
Framing the Issues: Customer Desires

  • Why shop online:

    • Save time

    • Shop when stores are closed

    • Better prices

    • Greater selection and easier to find

    • Compare prices easily

    • Have product shipped directly to recipient

    • List doesn’t include – to avoid/evade taxes!

  • Flexibility – shop online and return to store

  • New things – Ebay, download media, enormous 24/7 bookstore, online education, etc.


Framing the issues telecom and internet access issues
Framing the Issues: Telecom and Internet Access Issues

  • Digital divide

  • VoIP – federal and state activity

  • 3% federal excise tax

  • Internet tax moratorium


Digital divide
Digital Divide

  • SB 1563 (2002; Chapter 674)

    • CPUC to investigate plan to encourage widespread availability and use of advanced communications so citizens have access to state-of-art technologies

    • Report was issued in May 2005


Comments to the cpuc
Comments to the CPUC

  • Dominant broadband providers are unregulated cable providers

  • Infrastructure must be competitively and technologically neutral

  • Policy must treat all providers alike

  • Need “staggering” amounts of capital for CA’s telecom infrastructure

  • Tax incentives can help


Voip federal
VoIP - Federal

  • Issues:

    • Who should regulate – federal or state?

      • How much regulation?

    • Federal moratorium on state and local taxes?

    • Regulated telecom or unregulated information service?

    • Must providers contribute to universal service programs?

    • What about privacy, security and law enforcement considerations?


Voip california
VoIP - California

  • CPUC considering the “appropriate regulatory framework” to govern VoIP

  • Estimate VoIP will be 40% of total intrastate telecom revenues by 2008 in CA leading to significant revenue loss for CPUC programs


Cpuc commissioner susan p kennedy 3 04
CPUC Commissioner Susan P. Kennedy – 3/04

  • “VoIP changes everything we know about telecommunications today – the technology, the regulations, the economics – even the language.”

  • Voice is becoming free – bundled with something else, such as cable.

  • “We have a small window of opportunity, while PSTN is still dominant network platform for voice services, to develop a new regulatory structure. We have no time to waste debating whether VoIP is a telecommunications service or an information service. It is both. It is neither. And it doesn't matter anymore.”

  • “We need a new way to determine who should bear the responsibility of meeting important public policy objectives like 911 and universal service. “

  • Need to eliminate regulation that is no longer useful.

    http://www.cpuc.ca.gov/static/aboutcpuc/commissioners/kennedy/speeches/040312_voip.htm


Ncsl telecom resolution
NCSL Telecom Resolution

  • Principle 5 – States must mitigate potential loss of revenue to local gov’t from telecom tax reform.

  • 7 – “States need to simplify, reform and modernize state and local telecom tax systems to encourage economic development, reduce impediments to entry, and ensure access to advanced telecom infrastructure and services through the US.”


3 federal excise tax
3% Federal Excise Tax

  • IRS considering updating its regs to reflect today’s technology

  • What is subject to the tax?

    • several courts: tax n/a if charge not based on both distance and time

    • 1 court: tax applies because intent was to tax all long distance commercial services; but overturned on appeal (11th Circuit)

    • IRS – tax remains payable


Relevance to uut
Relevance to UUT

  • CA Utility User Tax based on federal excise definition

    • So, if 3% not owed, UUT not owed either

  • Expansion of VoIP

    • Less UUT will be collected by cities

    • Less 911 fees collected


Internet tax moratorium
Internet Tax Moratorium

  • Renewed – now expires 11/1/07

  • Prohibits state and local gov’ts from taxing Internet access fees


More on moratorium
More on moratorium

Provisions include:

  • A provision was added that the term `Internet access service’ “does not include telecommunications services, except to the extent such services are purchased, used, or sold by a provider of Internet access to provide Internet access.”

    • This change is due to confusion over whether DSL services are covered by the original moratorium language. Some states tax DSL on the basis that it consists of both Internet access services and telecom services. DSL providers argue that such treatment puts them at competitive disadvantage with cable modem and direct satellite providers.

  • VoIP –new law adds: “Nothing in this Act shall be construed to affect the imposition of tax on a charge for voice or similar service utilizing Internet Protocol or any successor protocol. This section shall not apply to any services that are incidental to Internet access, such as voice-capable e-mail or instant messaging.”

  • Requires the GAO to conduct a study due 11/1/05 of the impact of the moratorium on state and local governments and broadband deployment.


Vocal players and politics
Vocal Players and Politics

  • Efforts exist to

    • Regulate or not regulate telecom and related activities

    • Limit taxation of Internet and related activities

    • Streamline sales tax systems

    • Define nexus nationally for business activity taxes and income taxes


Agenda4
Agenda

  • The Big Picture

  • Internet Business Today – Trends & Stats

  • Local Gov’t Concerns & Constraints

  • Framing the Internet Taxation Issues

  • Active Proposals & Projects

  • Concluding Observations


Active proposals of note
Active Proposals of Note

  • SSTP

  • Nexus legislative proposals

  • Promoting deployment of technology

  • International activities


Streamlined sales tax project
Streamlined Sales Tax Project

  • Started in 2000

  • 42 states + DC participate, incl CA

  • As of 2/05, 21 states have enacted all or part of the conforming legislation. For more information, see http://www.streamlinedsalestax.org.

  • At its July 2005 meeting, the project moved forward with an expected start date for the Governing Board of 10/1/05.

  • Doesn’t require remote vendors to collect use tax


Sstp 2
SSTP - 2

  • Becomes effective once 10 states representing 20% of population of sales tax states adopt

  • Once each of the 10 states certified to be in compliance – Governing Board will exist to interpret Agreement

    • 1 vote per state

  • SSTP wants Congress to help by reversing Quill


Sstp 4
SSTP - 4

  • California concerns:

    • Governing Board may conflict with role of CA legislature and BOE

      • Also, 1 vote per state

    • Model would require significant changes to current law, including requiring use of destination basis

    • Must compensate certified service providers and sellers for reporting and collecting


Sstp 5
SSTP - 5

Arguments for SSTP:

  • Provides certainty and simplification for retailers

  • Compensation for vendors

  • Provides technological solutions to simplify assessment and collection process


Sstp 6
SSTP - 6

Arguments against SSTP:

  • Uncollected use tax not as high as some people estimate

    • SSTP doesn’t apply to remove vendors anyway

  • Some states have protectionist laws that impede e-commerce (it is not just SUT)

  • Isn’t a “one-rate-per-state” solution as originally promised

  • Destination-based sourcing will be complicated for some vendors (and create winners and losers among local jurisdictions


Sstp 7
SSTP - 7

  • More arguments against the SSTP:

    • Exemptions still allowed if for a specifically defined category

      • Thus, continued work for vendors to track

    • Growth of multichannel e-commerce vendors will decrease number of remote vendors so more SUT will be collected. Is SSTP still needed?


Nexus legislation 1
Nexus Legislation - 1

  • AB 2061 – must have a physical presence to have nexus

    • Similar to federal H.R. 1956 (109th Cong)

    • Generally, not present until in CA over 21 days although some activities exempt which will make some days not count towards the 21

    • Recordkeeping needed to track days

    • Intrusive to audit

    • FTB revenue estimate for 08-09:

      • ($525 million)


Nexus legislation 2
Nexus Legislation - 2

  • AB 2061 – more from FTB:

    • “appears to be changing tax policy from benefiting in state activity to benefiting out-of-state activity. The policy behind changing the apportionment formula from a single-weighted sales factor to a double-weighted sales factor was to provide a benefit to corporations with significant property and payroll in California. This bill instead provides a benefit to corporations headquartered outside of California, and could provide an incentive to move jobs outside the state.”


Nexus legislation 3
Nexus Legislation - 3

  • MTC – “factor presence nexus standard” – nexus exists if:

    • Organized or commercially domiciled in a state, or

    • Has either (i) $50K of property, (ii) $50K of payroll, (iii) $500K of sales, or (iv) 25% of total property, payroll or sales in the state


Nexus legislation 4
Nexus Legislation - 4

MTC ‘s draft affiliate nexus proposal – remote vendor has nexus for use tax collection if:

  • Vendor related to an in-state business maintaining 1 or more locations in the state, and

  • Vendor and in-state business “use an identical or substantially similar name, TN, TM or goodwill to develop, promote, or maintain sales, OR the in-state business and the out-of-state vendor share a common business plan or substantially coordinate their business plans, or the in-state business provides services to, or that inure to the benefit of, the out-of-state business related to developing, promoting, or maintaining the in-state market.”


Nexus legislation 5
Nexus Legislation - 5

H.R. 1956

  • Expands P.L. 86-272

    • “other business activity taxes”

  • Nexus if:

    • Incorporated or commercially domiciled in state or

    • Physically present

      • 21 day rule with several exceptions


Nexus legislation 6
Nexus Legislation - 6

Arguments for H.R. 1956

  • Federal definition provides simplicity to businesses and reduces likelihood of double taxation.

  • Physical presence means tax imposed only if receive benefits and protections from the state.

  • No revenue loss.

  • Similar to permanent establishment (PE) approach used for int’l transactions


Nexus legislation 7
Nexus Legislation - 7

Arguments against H.R. 1956

  • Nat’l League of Cities – annual revenue loss to local gov’ts of $60 billion

  • Violates federalism principles

  • Ignores long-standing law of taxing income-producing activities sourced to a state

  • “Market states” do provide benefits to vendors

  • Physical presence not necessarily simple


Promotion of technology
Promotion of Technology

  • Broadband

    • Generally means 4x faster than phone + modem

    • Cable modem, DSL, satellite, wireless, and electric power lines

    • Some debate on whether it needs promotion

      • More users, more will be created

      • Benefits to economy

      • Cost

      • Will it grow on its own?


Agenda last part
Agenda – Last Part!

  • The Big Picture

  • Internet Business Today – Trends & Stats

  • Local Gov’t Concerns & Constraints

  • Framing the Internet Taxation Issues

  • Active Proposals & Projects

  • Concluding Observations


Concluding observations 1
Concluding Observations - 1

  • World is changing:

    • More global activities

    • New types of transactions and ways of doing business

    • Borders and physical location losing importance

  • Rethink tax base

    • Ultimately, all taxes are paid by individuals – but how should we effectively make this happen?

    • Why put energies into shrinking tax bases such as with SUT and regulated telecom?


Concluding observations 2

Concluding Observations - 2

We need to separate difficult problems from unsolvable ones.

Always consider principles of good tax policy.


Tax policy analysis
Tax Policy Analysis

  • See separate file posted along with this ppt file