Tax time

It may be too late to reap buckets of tax revenue from this year`s holiday shopping season, but the long battle to launch a multi-state program of collecting sales tax on all Internet sales is finally coming to fruition this month. At least 18 states have agreed to begin participating under terms of the Streamlined Sales and Use Tax Agreement, or SST, a plan drawn up with features like free tax-collection software and back-tax amnesty intended to win broad participation from merchants.

In the planning stages for years, the simplified sales tax plan finally kicked off Oct. 1 as a voluntary program for merchants, though state tax officials as well as large multi-channel retailers who already collect sales tax on Internet and catalog transactions are hoping the built-in incentives will lead to broad participation and, eventually, a mandatory national program as early as next year.

Tough issues

Some tough issues remain with significant implications for the competition between small and large retailers, for catalogers, and even for e-commerce pioneer Dell Inc. But proponents say they expect the remaining issues will be worked out and that the SST is off to a good start toward a national, mandatory program after years of preparation under the Streamlined Sales Tax Project, through which more than 40 states have been working to simplify tax laws.

"The October 1, 2005, implementation date will be an important milestone for both the Streamlined Sales Tax Project and the retail industry," says Richard Prem, head of global taxation for Amazon.com Inc., which for now collects sales tax on purchases in Kansas, North Dakota and Washington, the only states where it has a -physical presence. "The SSTP has made a great deal of progress in creating a vision of a sales tax system that is starting to approach uniformity among state and local governments and that is more simplified so as to eliminate many of the burdens currently facing all retailers, both brick-and-mortar and Internet."

Under the SST program`s current guidelines, participating retailers with more than $6 million in sales will collect sales tax on all transactions, including those currently exempted under federal law when a retailer sells into a state where it has no physical presence, or nexus. But small retailers aren`t necessarily off the hook for the long term, because some of SST`s biggest backers--notably Amazon, with its long list of retail partners and competitors--are pushing for inclusion by retailers of all sizes. A truly streamlined system should make tax collection doable by all sizes of -retailers, Prem says.

Making the program simple for retailer participation has been at the crux of state efforts, tax officials say, because, after two failed U.S. Supreme Court battles, state revenue departments realize that this is their best course toward collecting tax on all transactions regardless of a retailer`s nexus status.

States will lose to retail e-commerce and catalog sales this year an estimated $4.41 billion in sales tax revenue, a figure that will grow to $6.84 billion by 2008, according to a study last fall by the University of Tennessee. When factoring in b2b sales, which account for the lion`s share of e-commerce, the lost-tax--revenue figures rise to a range of $18 -billion to $22.81 billion this year and $21.54 billion to $33.68 billion by 2008, the study says. The university`s Center for Business and Economic Research, which conducted the study, used forecasts of e-commerce sales from Jupiter Research Inc. and applied an average combined state and local sales tax rate of 6.5%.

State tax officials note that that they`re not looking to impose new taxes, but to collect already due taxes that have become harder to collect with the rising tide of e-commerce. "Government doesn`t want to collect new taxes, we just want a system to collect taxes already legally imposed," says Scott Peterson, director of the Business Tax Division in South Dakota`s Department of Revenue and co-chair of the Streamlined Sales Tax Project. "But the way people are switching from shopping in downtown stores to shopping on the Internet, in a number of years we won`t have as many sales to tax any more."

State revenue officials and budget officers aren`t the only ones -advocating the Internet sales tax program. The National Retail Federation has long pushed for the tax to make the retail environment more balanced among both multi-channel retailers with brick-and-mortar chains and merchants that operate mostly on the web and through catalogs, with relatively little of the physical infrastructure that requires retailers to collect tax for purchases made from other states.

"This is about making a tax system that`s fair," says Maureen B. Riehl, vice president of the National Retail Federation and its legal counsel for government and industry relations. "Right now some retailers have this tax-collection responsibility and some don`t. But it should be that we either all have it or none of us have it."

The NRF vs. the DMA

That stance puts the National Retail Federation and the Direct Marketing Association at odds with each other, as the DMA, which mostly represents catalogers, has long supported the status quo. The DMA and other opponents of the tax contend that a sales tax on all Internet sales will stifle the development of e-commerce, particularly among new, struggling e-retailers.

The SST, in its most basic terms, is intended to provide an efficient means for states to receive sales tax revenue on transactions that have been exempt from sales tax since 1967, when the U.S. Supreme Court sided with an office supplies cataloger in National Bellas Hess v. the Department of Revenue of the State of Illinois, ruling that sellers are required to collect sales tax only from buyers in states where the seller maintains a physical presence. The Supreme Court found that imposing sales tax collection duties on non-nexus merchants would create "an unconstitutional burden on interstate commerce." The high court upheld that decision in the 1992 case Quill Corp. v. North Dakota, and noted that the U.S. Congress had the ultimate power to resolve the tax collection issue.

When direct merchants sell to buyers in states where the sellers have no nexus, the buyers themselves are supposed to remit a use tax to their own states based on their state`s sales tax rate. "The way the law stands now, you owe a use tax to the state where you made the purchase if the merchant didn`t charge sales tax," says John Logan, a tax expert with CCH Inc., a publisher of tax and legal information and a provider of tax collection software. But the reality is that few if any consumers ever pay their own use or sales tax, leaving the states without a large portion of what the law says they`re due, he adds.

States formed the SSTP after the Supreme Court`s Quill decision as a way to accept the high court`s challenge and prove that a multi-state system could operate efficiently without imposing a burden on interstate commerce. With an eye toward winning over Congress to support a national, mandatory system, the SSTP set out to certify that a group of at least 10 states, representing at least 20% of the population of sales tax states, had streamlined their tax laws before moving ahead with its voluntary program on Oct. 1.

The 18 states began participation under the SST last month (see map, pages 40-41). As this issue went to press, Nevada was also close to joining the group. Other states are expected to follow suit, and among the 45 sales-tax states only Colorado has said it will probably stay out of the program, Peterson says.

But now the trick is to get merchants to participate, because, without a federal law making interstate tax collection mandatory, the SST can operate only on a voluntary basis.

Seeking a federal law

The larger the number of merchants and states that participate, the better chance SST proponents have of winning federal action, officials say. "The end game is when Congress passes a federal law," Riehl says. "It`s an uphill battle, but we hope to have an authorization bill introduced this fall in the U.S. Senate."

But just how widespread participation will become under a voluntary program depends on how many retailers decide that the benefits outweigh whatever problems they expect to have. The toughest choices will have to be made by retailers with borderline nexus issues, Riehl says.

Retailers that regularly sell into only one or two states where they don`t have a physical presence might choose to establish separate agreements with these states on how to collect sales tax outside of the SST, but then this approach would leave these merchants without the benefits the SST offers. "Retailers will do a cost-benefit analysis and can pick and choose the states they want to cooperate with, but they get the benefits of free collection software and amnesty only if they voluntary participate with all states in the streamlined program," Riehl says. The free software will actually be paid for by the states, figuring that they will get a return on their investment by making sales tax collection--and remittance--easier for retailers.

Although there are some difficult issues to be worked out in the SST program, Riehl and others in the retail industry as well as those in state governments say they believe the SST is on the right track to build a more responsible and equitable system of collecting sales taxes on Internet sales without being burdensome to merchants.

But there still are those who disagree. Critics of the SST program contend that it hasn`t really devised a way to effectively make the overall collection of sales tax simpler and that it could actually make it even more difficult for many retailers to figure and collect the proper amount of tax for each transaction. "If anything, it`s made it more complex," says a spokesman for the Direct Marketing Association, noting that there are more than 7,500 taxing districts in the U.S.

But proponents say that the cooperation that states and many merchants have shown so far in working toward a streamlined tax program will continue to work out remaining issues that could only be addressed once the program started. "I`ve been participating in the SSTP for the past five years, and I believe that the major reason that the SSTP has made significant progress compared to prior efforts is that it has reached out to the business community and taken a collaborative approach," Prem says.

One of the biggest remaining issues, officials say, is finalizing the rules on whether merchants collect a sales tax based on the rate of the origin state, where the merchant conducting the transaction is located, or the rate of the destination state, the location of the buyer.

The SST`s guidelines call for merchants to use the destination state tax rate when selling into a state where they have no physical presence, then remit the collected tax to the buyer`s state. But states that use an origin-based system have been slow to transfer to the destination-state tax because many of their local taxing jurisdictions have opposed a system that would upset the sales tax revenue they have been receiving.

Dell`s deal

Of particular note is Texas, and especially the city of Round Rock, the home of Dell Inc., the second--largest online retailer with $3.3 billion in 2004 retail e-commerce sales. In 20 states where Dell has a physical presence with 130 kiosks in shopping malls, it collects at the destination rate on behalf of the buyer`s state. But all other sales, including in-state transactions, go to Round Rock under terms of an agreement that granted Dell reduced property taxes as an incentive to locate its main operations there.

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"Under a mandatory system, when Dell sells to Virginia, where it now has no physical presence, it would collect the Virginia tax and the revenue would go to Virginia," Riehl says. "But that can upset their business model."

Such complications underscore why it`s important for the SST to expeditiously work on such issues to keep the program moving forward, proponents say.

"States like Texas and Washington with an origin-based tax are waiting to see how other states set things up in the governing board," says Warren Townsend, director of sales, use and excise taxes for Wal-Mart Stores Inc.

One way of settling such issues is following the lead of states that forge ahead with solutions, Townsend adds. Virginia and Utah, for example, have been working on systems that assure and spell out how destination tax received from merchants is fairly distributed to all local jurisdictions due tax revenue from a sale.

Retailers are pushing for consistent long-term notices from states on changes to tax rates, avoiding recent occurrences such as when Ohio and North Carolina passed rate changes at the end of their fiscal years in June, effectively creating a rate change overnight. "That`s a problem for retailers," Townsend says, "because our databases have to be updated so we can charge the correct rate." Retailers are hoping for a 30- or 60-day notice policy.

But even that long notice won`t be much help to catalogers, whose books take months to plan and have several more months of shelf life. "As tax rates change, paper catalogs will be out of date," Townsend says.

The big-small divide

The SST as it`s currently designed also leaves some rifts between large and small retailers. Many larger multi-channel retailers have been using their own systems to collect sales tax, some beginning after court decisions in recent years that have forced merchants to pay fines and make good on uncollected sales tax in states where they have nexus.

While the SST is using free tax-collection software to entice -participation by online retailers, many large merchants that already collect tax using their own systems expect similar treatment. "They want to be compensated for the cost of doing collection," says Riehl of the NRF.

A Joint Cost of Collection Study, conducted by consultants PricewaterhouseCoopers and due for completion this fall, is expected to determine the tax collection costs under the SST. The states behind the SST as well as retailers are hoping the results of the study will support federal legislation to mandate a national SST program that would compensate all retailers for tax collection costs, Riehl says.

There is also the issue of whether the SST should force tax collection duties on retailers of all sizes, in effect reversing the exemption for those with less than $6 million a year in sales. "If the system is truly simple, and if the states follow through on their commitments relating to certified service providers and certified automated software that would largely eliminate the costs and burdens of collecting sales taxes, then sellers of all sizes should be able to comply without significant burden or expense," Amazon`s Prem says.

Waiting for the new year

But the political reality is another matter, Riehl says. "Some large retailers think a small-business exemption isn`t necessary, but that may be politically impossible for states," she says, adding that eBay Inc. has taken a leading role in pushing to keep the exemption.

Despite the Oct. 1 kick-off, the SST program isn`t likely to attract many new merchant participants until after the holiday shopping season. "I don`t see any brick-and-mortar or online retailers changing their systems until after Jan. 1," Townsend says.

But that will just give the new SST governing board more time to continue to fine-tune things, such as completing certifications of tax--collection software, proponents say.

"Simplification will be an ongoing effort," Prem says. "After all, it took more than 70 years to create the complexity that exists in the current sales tax system, but the Oct. 1 implementation of the SST is a good first step down the long road of truly simplifying sales taxes."

If the SST program continues to win over more states and merchants, a mandatory federal program will become more assured, experts say. "It`s not certain that Congress will support this, but if more states conform to the SST--and that`s likely--Congress is likely to pass legislation," says Logan of CCH.

With any luck on the part of states, a national sales tax system could be in place for holiday season 2006.

paul@verticalwebmedia.com

Are digital media products or services?

One of the toughest issues to resolve for all retailers in the Streamlined Sales Tax and Use Agreement, or SST, is how to tax digital music and other digital products and services. "It`s a problem we`ve been working on for years, because digital products keep changing, and how do you define a moving target?" says Scott Peterson, director of the Business Tax Division at the South Dakota Department of Revenue and co-chair of the Streamlined Sales Tax Project.

The challenge lies in the fact that digital music, for example, can be considered either a product or a service--and the difference could determine whether or not it`s taxed, Peterson says. If digital music is downloaded for permanent ownership under Apple Computer Inc.`s iTunes model, states may be more likely to define it as a product, but if it`s rented under the subscription model offered by Napster and others, states may be more likely to consider it a service, he adds.

The issue also complicates tax collection in areas where products and services are bundled together, such as when cell phones are purchased with wireless services, says John Logan, a tax expert with CCH Inc.

Some states like South Dakota are more inclined to tax both products and services, while others tax only products, Peterson says. But the goal of the SST is to have a common taxing system for Internet sales to make it easier for retailers to comply with a multi-state system of collecting sales tax, he says.

Delivery charges present less of a challenge, but still one that needs to be worked out, Peterson says. The issue mainly concerns retailers who object to the additional requirement of adding details to customer invoices. Under the SST, retailers are only expected to collect sales tax on delivery fees charged against taxable items, but under current SST terms retailers are expected to detail in invoices the amount of sales tax collected for each item. "Retailers don`t want to do that since the SST project is supposed to be about simplification," Peterson says.

A compromise will probably result in letting retailers avoid detailing tax allocation in invoices, as long as they show how tax was allocated in their accounting records, Peterson says. "We`ll work that out, but we`ll still have to amend the agreement," he says.