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E-Commerce: The Taxman Cometh?
Connecticut grapples with leveling the playing field for sales and use taxes on online transactions
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Business New Haven
9/18/2000
By: Michael C. Bingham
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In October 1999, the federal Internet Tax Freedom Act (ITFA) became law. This imposed a three-year moratorium on the ability of state and local governments to impose taxes on Internet commerce.
The law will expire next year, and already powerful forces are at work to determine not if the Internet should be taxed, but how it should be taxed.
It's an issue with historic ramifications. Certainly, few computer users would favor paying a tax for every e-mail, online sale or minute spent online. But many of the lawmakers sitting on the federal Advisory Commission on Electronic Commerce - which advises members of Congress on the issue - are strongly in favor of some form of Internet taxation.
No one doubts that the e-commerce explosion has played a powerful role in the U.S. economic boom, and many agree with California Gov. Gray Davis, who says, “I do not favor the application of the sales tax for the Internet because I certainly don't want to kill the golden goose that is laying the egg.”
Therein lies the rub. In the aggregate, sales taxes account for roughly 40 percent of state budget revenues. And as sales of items from automobiles to xylophones migrate from Main Street to the Internet, state governments must seek new ways to extract their pound of flesh on each transaction - or to make up revenue shortfalls by devising new or raising existing other taxes.
Nevertheless, the concept of a tax-free Internet has many supporters, including Massachusetts Gov. Paul Cellucci and U.S. Sen. John McCain (R-Ariz.). However, it seems likely that states soon will find ways to cooperate in managing the taxation of interstate e-commerce.
At the nexus of the issue is the fact that states are presently restricted by law from compelling vendors to collect sales taxes on “remote” online sales - those crossing state lines. And states of course have different rates of sales taxation, with some U.S. states (e.g., New Hampshire) levying none.
In states such as Connecticut, such “remote” transactions are supposed to be subject to “use” taxes - that is, on the buyer's end of the sale. This mechanism is in effect voluntary, however, and the Nutmeg state relies on in-state purchasers of out-of-state goods and services online to report such sales on their state income-tax documents - and to pay the six-percent levy on eligible items and services.
According to Gene Gavin, commissioner of the state's Department of Revenue Services (DRS), the issue of sales-tax collection on out-of-state purchases is not a new one, dating back to the birth of sales and use taxes in Connecticut in the 1930s. It is only since about the mid-1990s, with the explosion of commerce over the Web, Gavin says, that the issue has become more prominent - and more pressing.
“Without a doubt, taxation of remote sales is the first major challenge of the Millennium to framers of state tax policy,” Gavin says. “This is so even though it is not a new issue, nor is the sales-tax obligation on these remote purchases a new tax.”
Under current law, it is the obligation of the purchaser of goods or services from out of state - not the seller - to pay a sales or use tax on the transaction. Says Gavin: “The sales tax is not a tax on the seller or the business itself. It is a tax that the purchaser pays for the privilege of acquiring and having the use of a tangible personal property in a particular jurisdiction.”
In the electronic commerce arena, Gavin frames the issue as a matter of fairness. “Exempting electronic-commerce transactions from sales and use taxes is discriminatory to those Main Street businesses that are the mainstay of our communities,” he says.
He points to a study by Moody's Investors Service that calculated that if traditional U.S. retailers lose only seven percent of all sales to the Internet, their profitability could decline by as a much as half. In even a moderate recession, Gavin says, that could spur business closings and job losses that would reduce property-tax revenues to municipalities and business-tax revenues to the state.
“There should be no difference whether you buy a computer from a store on Chapel Street in New Haven or from a vendor in California that has no store here,” Gavin asserts. “There should be no difference in what taxes the buyer pays. Otherwise, you're giving an advantage to that out-of-state seller.”
To redress the imbalance, Gavin prefers that the issue be returned to the states following ITFA's expiration next year and that states agree on a protocol for reporting and/or collecting sales tax on the seller's end. The technology, he notes, is already in place.
“If e-tailers know where to ship the goods, then they should know what tax rate to apply,” Gavin says. “It is almost ironic that these leaders of technology almost ignore the fact that the technology exists to collect the tax on a sale. Many large e-tailers already have the wherewithal to collect the tax and have been doing so for many, many years.”
Barring that, Gavin says, it may be left to Congress to mandate that any company, anywhere, carrying on business with residents of a state be required to collect and remit sales tax on taxable transactions to that state.
Gavin characterizes Connecticut businesses as “model citizens” when it comes to reporting out-of-state purchases - electronic or otherwise - and paying taxes on them. It is private citizens, he says, who have been less scrupulous - or simply ignorant of the law.
“The problem is not with businesses,” Gavin says. He suggests that the threat of a DRS audit has been sufficient to enforce compliance on business-owners. Nevertheless, he estimates that Connecticut is losing about $75 million a year is use taxes - mainly from individual buyers.
He also refutes the characterization of Connecticut as hostile to e-commerce generally.
“Since 1996, Connecticut has been pointed out as a state that has not supported the growth of electronic commerce,” says Gavin. “That is incorrect. In 1996, we started to phase out our taxes on computer and data-processing services [at a rate of one percent annually]. Today, [measured against] our normal sales tax rate of six percent, for computer and data-processing services is currently two-percent, and charges on Internet access will be one percent next year and be eliminated the year after that.”
Gavin also points out that, “We were the first state to have a truly taxpayer-friendly Web site [www.drs.state.ct.us], developed to be educational for ordinary taxpayers, not just accountants and attorneys.”
Among its innovations, says Gavin, is its listing of Connecticut's “Top 1000 Tax Delinquents, begun in January 1997. Gavin credits what he calls the “public stockade of the information superhighway” with generating $52 million in collection of delinquent taxes since the lists inception.
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