December 26, 2000, 9:55 AM

The Sales Tax Tug-of-War

(Page 2 of 2)

Others see different problems that could doom these state-focused tax simplification efforts. Arguing that most state sales tax codes are “rife with questionable exemptions that favor certain kinds of business and distort the proper functions of the market,” California State Sen. Ray Haynes warned Congress that it is “unrealistic … to expect that states can get together and settle this matter on their own.”

There’s evidence that political pressures may ultimately overpower the push for tax simplification by state officials. Among the 15 states that adopted the NCSL streamlined sales tax model since January, at least 150 bills have been introduced this year to carve new tax exemptions for everything from gum balls to bee-keeping equipment, and from nicotine patches to car wax.

Ultimately, the issue may hinge on whether state politicians are able to resist their natural urge to tinker with sales tax policy. Without the assurance of a uniform nationwide approach, even the most sophisticated technological solution to the Internet tax problem could collapse. Either way, the outcome will have long-term consequences for U.S. retailing, and for the American system of government itself.

“This may be the most important issue that states have faced in a generation,” says William Pound, executive director of the National Conference of State Legislatures. “How Congress and the states resolve it will influence the balance of power between the federal government and the states for decades to come.”

Ken Rankin is a Washington, D.C.-based writer.

Tax Loophole or Bottomless Liability Pit?

Uncertainty over Internet sales tax collection rules has created a dicey dilemma for large bricks-and-clicks retail chains. Most are eager to carve out their share of the online market, but with hundreds of traditional stores across dozens of states, these chains have clear-cut nexus problems. Even so, some have managed to sidestep the obligation to collect sales taxes in states where they have a strong physical presence by incorporating their online marketing activities as separate businesses from their traditional retail operations.

The nation’s largest retailer, Wal-Mart, has already taken this step, and as a result, web surfers can buy Wal-Mart products online without paying sales tax, even if they live next door to one of its stores. Other chains, including booksellers like Barns & Noble, have adopted a similar strategy to level the playing field in their marketshare battle with pure-play e-marketer Amazon.com.

Although the International Mass Retail Association-the Washington, D.C. lobby group that represents Wal-Mart and scores of other major chains-has not surveyed its members on their tax collection policies, IMRA Director of Tax and Financial Issues Lisa Wolski says that “as of right now, most of them seem to be collecting sales taxes on their Internet sales. But they’re watching what happens with Wal-Mart very closely.”

At this time, at least, the law seems to be on the side of Wal-Mart and others who have sidestepped nexus concerns by separate incorporation strategies. The Supreme Courts in both Connecticut and Pennsylvania have upheld this practice, and state tax officials have not yet found a way to successfully challenge this approach.

But since the Federal courts have not yet addressed this issue, chains that rely on separate incorporation as a basis for not collecting state taxes could find themselves facing a huge downstream liability, Wolski acknowledges.

“I’m sure Wal-Mart is concerned about this possibility, and has set aside large reserves to cover potential penalties and interest charges in the event of a legal reversal,” she says.

Even under the current interpretation of the law there are troublesome gray areas for retailers who incorporate separately from their cyber operations. Handling product returns or honoring warranties could conceivably create instant tax liabilities at these chains, for example. If Wal-Mart sells a TV set online, but allows consumers to return defective items to its retail stores, states could argue that the separate incorporation process was just a sham to escape tax collection obligations.

As if to acknowledge these potential problems, officials at Wal-Mart have made it clear that they restructured their online businesses as separate subsidiaries with considerable reluctance. “Congress should not force businesses to alter their corporate structure simply to remain price competitive,” Wal-Mart Vice President David Bullington said in recent congressional testimony.

Clicks-and-mortar retailers who are continuing to collect sales taxes are even more eager for a legislative solution from Washington. Staples, which operates stores in 44 states and has a robust online business, told Congress that the current situation leaves the chain at a “severe competitive disadvantage” compared to “pure-play Internet retailers” who sell office supplies.

Testifying before the House Subcommittee on Commercial and Administrative Law, Staples CEO Tom Stemberg said the existing moratorium and the extension bill approved recently by the House unfairly reward e-retailers with no physical presence in a state, while penalizing those with facilities and a work force in that state.

If Congress approves final legislation this year to extend the I-tax moratorium, “the only fair and equitable solution in the short-term is to expand the moratorium to include all existing sales and use taxes on Internet transactions so that the original Internet Tax Freedom Act truly lives up to its name,” he said.

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