The Sales Tax Tug-of-War

The pressure is on: Main Street retailers and the big chains, not usually lovey-dovey, are pushing for the same resolution to the thorny Internet taxation issue. A year ago, they, as well as many state and local tax administrators, were pinning their hopes on the congressionally appointed Advisory Commission on Electronic Commerce to resolve the controversy over Internet taxation. But when that panel dissolved without reaching a consensus on a fair and effective way to apply sales taxes to e-retailers, the pressure began to mount for the advocates of a level playing field to develop their own solution. Congress added more fuel to the fire by moving quickly on legislation to extend the existing Internet taxation moratorium and taking other steps that major bricks-and-mortar retailers say will undermine efforts to apply sales taxes equitably to all sellers.

“If Congress extends the current Internet tax moratorium without approving legislation to achieve a level playing field for all retailers, future resolution of the issue will be seriously jeopardized,” contends Wal-Mart Vice President David Bullington.

His counterpart at Sears, national taxation expert Chip McClure, is concerned that if the states can’t resolve this issue among themselves quickly, public resistance to taxing electronic commerce could grow so strong that a solution may become politically impossible. “I suspect we have only about 24 months to come up with a workable system,” he says. “If it takes longer than that, the cure may come too late.”

Others, including Illinois State Sen. Steven Rauchenberger, suspect the states may have even less time to fashion a solution to the Internet sales tax dilemma. “This issue is going to flash and pass in the next 18 to 24 months,” he warned state tax officials recently. The problem, according to Rauchenberger, is that “Congress doesn’t believe we [the states] can simplify” the present multi-state sales tax structure.

No silver bullet

For their part, congressional leaders see the issue through a different filter. Rather than focusing on the threat facing states and municipalities from untaxed electronic commerce, House Judiciary Subcommittee Chairman George Gekas (R-Pa.) opened recent hearings on the issue by warning that “current multi-state taxing complexities threaten to stymie the full commercial potential of the Internet.” Either way, part of the solution revolves around technology. The good news is that a growing number of software companies are developing powerful new programs that promise to streamline sales tax collection, both on the Internet and from traditional bricks-and-mortar sellers. Some of these systems are already in use by tax authorities in certain parts of the country. Washington state, for one, has developed a Geographic Information System, or GIS, that provides retailers hooked up to the Internet with the ability to determine the exact tax applicable to a street address.

Many uniformity choices

Even more daunting is overcoming the lack of state-to-state uniformity on sales-tax structures. The thorniest problem of all—finding a feasible way to implement a multi-state system for collecting sales taxes from hundreds of tax jurisdictions across the country—can’t begin to be addressed until state and local governments can agree on a way to simplify the sales tax hodgepodge.

Since mid-1998, tax administrators from Idaho, Utah, and Washington state have been working together to inject some uniformity in their respective sales tax codes under the Northwestern States Sales Tax Pilot Project. Based on meetings with business groups and elected officials, the three states plan to press for sales tax uniformity legislation this year.

Meanwhile, the Multistate Tax Commission has been working on a considerably broader Sales Tax Simplification Project to make administering sales taxes among states uniform. To date, more than 25 state subcommittees have been established to address specific in-state sales tax simplification issues. In addition, a Multistate Tax Commission national committee is grappling with such prickly areas as exemption processing, uniform refund claim procedures, and a uniform sales tax situs for taxable tangible personal property and services.

The National Governors Association and the National Conference of State Legislators are promoting the so-called Zero Burden Sales Tax Administration System that Utah Gov. Mike Leavitt championed during his stint on the EC Advisory Commission.

Most of the attention now, however, is focused on the Streamlined Sales Tax Project—launched in late 1999 by 30 states to simplify the “sales and use tax system that eases the burden of state use and tax compliance for all types of retailers, particularly those operating on a multi-state basis.”

Idaho Tax Commissioner R. Michael Southcombe, chairman of the Multistate Tax Commission and a booster of the newly coordinated Streamlined Sales Tax Project, believes that the changes likely to stem from this effort “will bring radical simplification and uniformity to the tax system.”

But, the question is, will they come soon enough?

McClure is hedging his bets. While the Sears tax expert is confident that the states have no more that two years to hammer out a solution, he’s uncertain whether that timetable can be met. Although there’s plenty of sales tax activity in the states, “I have no idea when we can expect to see any solid results from these efforts,” he says.

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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.