State Sales & Use Tax on Internet Transactions

Federal Communications Law Journal, Dec, 1998 by Sandi Owen

I. INTRODUCTION

With the explosive growth of electronic commerce, the way people do business is dramatically changing. More and more transactions are being conducted electronically, and the geographic boundaries that once played such a significant role in commerce are rapidly disappearing. With this growth and globalization of electronic commerce, state and local taxing authorities have become concerned that the information superhighway bypasses state and local taxation. Since sales and use taxes on transactions are major sources of revenue for state and local governments, erosion of this tax base has serious repercussions for their ability to support local infrastructures. Industry interests, however, express concern that taxation of Internet transactions, both from a financial and administrative perspective, would discourage innovation and investment in the information superhighway and impede its growth.

This Note argues that the existing structure for taxation of physical commerce does not fit the developing reality of an electronic commerce-based economy. The traditional means of taxing the sale of goods and services is based on concepts of physical assets, geographic locations, and face-to-face encounters. Commerce on the Internet is based on technology where there is no locality, no physical presence, and no geographic boundaries. Since Internet transactions do not fit into the traditional physical commerce tax structure, new standards for defining when and how a taxing jurisdiction may tax an Internet transaction must be developed.

Internet transactions have virtually eliminated the geographic boundaries between states and localities that formerly provided the framework for sales and use taxation. As a result, a national tax policy must be developed either through uniform state laws or federal legislation. Any federal legislation or uniform state laws developed to regulate interstate electronic commerce must balance the needs and concerns of state and local taxing authorities with the needs of businesses and consumers. This balance must occur within the framework of basic tax principles of fairness and equality and minimization of administrative and compliance burdens.

Although the taxation of electronic commerce raises issues in several tax areas, including international taxes, federal income taxes, and state and local property taxes, the focus of this Note is on state and local sales and use taxes. The Internet transactions that are discussed are the sale of goods and services over the Internet, with either physical or on-line delivery to the purchaser from the vendor. This Note does not discuss sales and use tax issues relating to other Internet transactions, such as the sale of Internet access services, Web space, or Web page advertising.

Part II of this Note provides an overview of the traditional sales and use tax structure and discusses why modern electronic commerce does not fit into this traditional structure. Part III discusses some of the challenges of taxation of electronic commerce and the concerns of state and local taxing authorities versus those of businesses and consumers. Part IV provides a review of what guidance is currently available and the constitutional considerations in the taxation of Internet transactions. Part V proposes a national approach, through federal legislation or uniform state laws, to the sales taxation of Internet transactions and offers recommendations, such as a shift of focus from the seller's to the buyer's location, for addressing the taxing challenges of doing business in cyberspace.

II. OVERVIEW

A. Traditional Sales and Use Tax Structure

The typical sales tax structure of a state involves a retail sales tax imposed on tangible personal property purchased in the state.(1) A state may also impose a use tax on its residents for tangible personal property acquired in another state but used in their resident state.(2) Sales and use taxes are typically imposed on purchases by the final consumer, and transactions between businesses are exempt.(3) The sales tax has been referred to as a "tax on the freedom of purchase[,]" whereas the use tax is a "tax on the enjoyment of that which was purchased."(4)

Three factors determine whether sales or use tax liability in a particular state exists for a transaction: (1) the type of good being sold, (2) situs, or the location where the transaction takes place, and (3) nexus.(5) Traditionally, sales tax has been imposed on tangible goods, not on intangible goods or most services, and is assessed and collected at the location where the good is transferred from the seller to the buyer (the situs).(6) The concept of nexus concerns whether the taxing jurisdiction has sufficient connection to have the authority to impose taxes on the transaction and collection responsibility on the vendor.(7) Each of these factors will be explored within the context of the Internet, as opposed to traditional physical, retail transactions.

B. Shift to Electronic Commerce