E-Commerce and Telecom Tax Overview Professor Annette Nellen Online class – Bus 223E Summer 2005.

E-Commerce and Telecom Tax Overview

Professor Annette Nellen

Online class – Bus 223E

Summer 2005

Agenda

The Big PictureInternet Business Today – Trends &

StatsLocal Gov’t Concerns & Constraints*Framing the Internet Taxation IssuesActive Proposals & ProjectsConcluding Observations * The lesson focuses on some local issues as this is what is driving some

activities today, such as the Streamlined Sales Tax Project.

The Big Picture

What is e-business?

Why does e-business challenge our tax rules?

E-Business

Not just Amazon.com, but also … Hardware Software Telecommunications infrastructure Transaction facilitation (such as EBay, security,

advertisers, electronic payment) Search engines Web hosting Internet service providers Retailers and wholesalers of tangible and intangible

items Service providers

The E-Commerce Model Can Change Tax Results

Purchase Technique Sales Tax for CA Sales Tax for SJ

a. Buys the book at a bookstore located in San Jose

6% 1%

b. Buys the book at a bookstore in Cupertino

6% 0% (1% goes to Cupertino)

c. Buys the book from San Jose bookstore’s web site; mailed to him.

6% 1%

d. Buys the book over the Internet from a store not physically located in CA

0%(buyer owes 6%

use tax)

0%(buyer owes 1%

use tax)

e. Buys the book in digitized form and it is delivered to him over the Internet

0%(no tax owed on

intangibles)

0%(no tax owed on

intangibles)

Tax challenges of e-business

LocationFewer needed – thus, less taxing pointsSome needed assets are mobileMore custom inventories – thus, less

storage needsLess vertical integration – thus, more

outsourcingMore global purchases and sales


Transaction methodologyPossibility of anonymous transactions –

verification and paper trail issues Increased bartering – tax challengesEasy to reach out to large geographically

dispersed customer baseGreater number of remote salesOccasional sale versus active seller


Nature of productsDigitized (intangible) versus physical

products In CA – reduction in sales tax base

Storage needs greatly reduced – fewer physical locations

P.L. 86-272 nexus rule for income tax doesn’t apply to intangibles


WorkforceMay be scattered across the globe – taxing

points? More business license locations?Taxable presence where employees are?

TechnologyBusinesses track customer purchases

Usable to also calculate and collect sales tax? Improved buying systems for governments?

Has technology outpaced sales and use tax systems?

YES System is dependent on physical location – now

businesses have fewer physical locations The tax applies predominantly to physical goods,

but today services and intangibles are key consumption items

Usually destination-based yet today, physical location of buyer isn’t important for transfers of intangibles and services

Too many sets of rules that would apply if nexus were broadened. Lots of sets of rules worked before because only large companies were subject to them.

Summary of e-commerce and tax concerns

http://www.cob.sjsu.edu/nellen_a/ETraits.pdf

Agenda

The Big Picture

Internet Business Today – Trends & Stats

Local Gov’t Concerns & Constraints Framing the Internet Taxation Issues Active Proposals & Projects Concluding Observations

E-Business Today

E-commerce sales:up 28% from 2003 1.9% of total retail sales

2001 – 93% of e-commerce = B-B

Weekend following Thanksgiving 2003 – more shopped online than inline

E-Business Today

Growth of “multichannel retailers”Customers want to buy online and return at

the store.Leads the online store to create a physical

presence!

E-Business Today

23% growth in micropayment revenue from 2003 – 2009

73% of CA residents have high-speed Internet access available to them; 13 – 17% subscribe to such accessBoost to CA economy expected from

greater broadband deployment

Agenda

The Big Picture Internet Business Today – Trends & Stats

Local Gov’t Concerns & Constraints

Framing the Internet Taxation Issues Active Proposals & Projects Concluding Observations

Local Gov’t Concerns

CA state and local tax revenue loss from e-commerce:Bruce & Fox: $2.1 billion for 2003

up to $33 billion for 2008- Direct Marketing Association (DMA) – about

9x too high- Tax cheating on rise:

- 1999 – 11% say ok to cheat on tax return- 2003 – 13%

Differences in data

Some of the differences between the UT and DMA estimates are due to DMA using a higher tax compliance rate for businesses and recognizing the likely growth of multi-channel, clicks and bricks commerce where consumers want to be able to buy online but return at a physical store which will lead retailers to have nexus in the state for their online operations and be required to collect sales tax (rather than the consumer having to self-report use tax). Another difference is that DMA suggests that billions of dollars of EDI (Electronic Data Interchange) activity among businesses should have been excluded as not being Internet sales.[1]

[1] Dr. Peter A. Johnson, Direct Marketing Association, “A Current Calculation of Uncollected of Uncollected Sales Tax Arising from Internet Growth,” March 2003; available at http://www.the-dma.org/taxation/CurrentCalculationofUncollectedSalesTax.pdf.

Local Gov’t Constraints

Federal nexus restrictions from Due Process and Commerce Clauses

Telecom Act of 1996 Local – no tax on Direct Broadcast Satellite No barrier to entry

Internet Tax Moratorium Bradley-Burns – CA cities must use state sales

tax base Various propositions – 13, 218 – place voting

constraints on tax increases

Agenda

The Big Picture Internet Business Today – Trends & Stats Local Gov’t Concerns & Constraints

Framing the Internet Taxation Issues

Active Proposals & Projects Concluding Observations

Framing the Issues

The Tax Formula

Customer Desires

Telecom

Vocal players and politics

Framing the Issues: The Tax Formula

Tax = Base x Rate

IF

Have authority to tax!!

Framing the Issues: Authority to Tax - Nexus 101

Connection between jdx and entity such that is permissible for gov’t to impose its laws on the entity.

States have rules that help define that connection + … Income tax – see P.L. 86-272 if tangible personal

property is being sold Sales tax – Quill (US S. Ct. 1992) – if have a

physical presence that is more than slightNOT ALWAYS CLEAR!

FREQUENT LITIGATION!

Nexus – not always easy to interpret state statute

Borders and California Nexus In 2003 in the Matter of the Petition for Redetermination under the Sales and Use Tax

Law of Borders Online, Inc. (SC OHA 97-638364), the Board found that because Borders accepted returns of purchases from Borders.com, nexus existed. The statement was found on-line in July 1999, but was removed in August 1999. The Board found such activities to be an integral part of the selling process (people are more likely to buy online if they can return to a store) and that Borders.com had a physical presence in California (through the in-state affiliate). The appeal was heard and decided by the First Appellate District in May 2005 and affirmed.

Borders Online was formed in 2001 as a Delaware corporation, headquartered in Michigan, to be Internet Company for Borders (it is a successor in interest to Borders Online, Inc.). Online and Borders are affiliated corporations owned by the same corporation. Most likely, one of the reasons why Online was set up as a separate corporation was to limit the number of states in which it would have to collect sales tax, based on such precedent as SFA Folio Collections, Inc. v. Bannon, 585 A.2d 666 (Conn. 1991), cert. denied, 501 U.S. 1223 (1991), SFA Folio Collections v. Tracy, 652 N.E.2d 693 (SCt Ohio 1995), and Bloomingdale's v. Dept. of Revenue, 567 A.2d 773 (1989), aff'd without opinion 591 A.2d 1047 (Penn. 1991), cert. denied, 504 U.S. 955 (1992). Online had no employees or property in CA.

In 1998 and 1999, Online sold over $1.5 million of merchandise over the Internet to CA consumers. Its website noted that goods could be returned to any Borders (physical) store. Borders did not charge Online for this service. This note was removed from Online’s website on 8/11/99. Borders also included a notation on its sales receipts to “visit us online at www.borders.com).

Borders Online – cont’d

Issues before the court were (1) whether Border’s activities were “for the purpose of selling” Online’s goods, and (2) whether Online had sufficient presence in the state, through Borders, to justify that it was required to collect sales/use tax.

The court agreed with the SBE that since Borders only handled returns for Online per the terms on Online’s website, it was acting as Online’s authorized agent. A formal arrangement is not needed because an agency relationship can be implied based on conduct and circumstances and no written agreement is needed.

The handling of returns for Online caused Borders to be “selling” for purposes of §6203(c)(2), because it was an integral part of getting customers to buy online. Online argued that it was not allowed to produce evidence that Border’s reason for taking the returns was unrelated to encouraging sales. No evidence was produced when required and the court noted that even if the return policy provided some benefit to Borders (for example, it got a customer into their store), it could have still induce Online customers to buy from Online.

Online noted that unlike the situations in Tyler Pipe Industries v. Dept. of Revenue, 483 U.S. 232 (1987) and Scripto, Inc. v. Carson, 362 U.S. 207 (1960), Borders was not actually making any sales for Online. The court viewed that perspective as too narrow noting that per Tyler Pipe one is to look at whether the activities of the retailer’s in-state people are “significantly associated with [its] ability to establish and maintain a market in [the] state for the sales.”

The court did not find the returns policy here similar to SFA Folio Collection where the store took returns from the catalog operation under its own policy and for its benefit.


Query: Is this holding a proper interpretation under R&T §6203(c)(2)? R&T §6203(a) provides that “every retailer engaged in business in this state and making sales of tangible personal property for storage, use, or other consumption in this state, not exempted … shall …collect the tax from the purchaser.” R&T §6203(c)(2) provides that “retailer engaged in business in this state” includes “any retailer having any representative, agent, salesperson, canvasser, independent contractor, or solicitor operating in this state under the authority of the retailer or its subsidiary for the purpose of selling, delivering, installing, assembling, or the taking of orders for any tangible personal property.” Clearly, Online is a retailer. Also, noting on its website that Borders will handle returns appears to make it an agent or representative, but was Borders “selling” for Online?

The court stated “The Board appears to have thoroughly considered the meaning of the term, and its reasoning that the act of ‘selling’ encompasses offering other inducements to purchase is consistent with at least one later pronouncement. (Board’s Boarder Opn., supra, Cal. Tax Rptr. (CCH) ¶403-191 at p. 29.974; In the Matter of the Petn. For Redetermination Under the Sales and Use Tax Law of Barnes & Noble.Com (Sept. 12, 2002) [2000-2003 Transfer Binder] Cal. Tax Rptr. (CCH) ¶403-325, pp. 30,447, 30,450 [bookstore’s distribution of discount coupon on behalf of affiliated Internet retailer was integral to selling efforts and thus constituted ‘selling’].)”


There was no evidence of whether sales occurred at Online due to the return policy. Is an offer to handle a return the same sales inducement as providing a coupon (which in Barnes & Noble.Com, the Board found to be more than advertising)? Does “selling” mean offering inducements to sales, or actually making sales, as was done in Scripto (independent contractors taking orders) and Scholastic (teachers taking orders and collecting payment for the bookseller)[1]? Of course, those cases were looking at the in-state person’s actions and relationship with the out-of-state retailer to determine if an agency relationship existed, not whether “selling” was involved (because taking orders is unquestionably selling).

Does R&T §6203 need to be modified again to be clearer? Should it say “selling or inducing or promoting sales” rather than just “selling”? Of course, given the 2005 Borders Online decision, there would appear to be no need to clarify it other than to avoid litigation in the future. Such a change would appear to be permissible within the Due Process and Commerce Clause given that §6203 requires the physical presence of an agent or representative in the state. Also, the proposed new language ties to maintaining a market in the state as required by the U.S. Supreme Court (In Tyler Pipe, supra, the Court stated: “The crucial factor governing nexus is whether the activities performed in this state on behalf of the taxpayer are significantly associated with the taxpayer’s ability to establish and maintain a market in this state for the sales.”)

[1] Scholastic Book Clubs, Inc. v. State Board of Equalization, 207 Cal App 3d 734, 255 Cal Rptr 77 (CA Ct App, 1989).

Framing the Issues: The Tax Base

Varies from state to stateIssues often arise wrt telecom and

technology servicesFrequent changes

NOT ALWAYS CLEAR!

FREQUENT LITIGATION!

Framing the Issues: Customer Desires

Why shop online: Save time Shop when stores are closed Better prices Greater selection and easier to find Compare prices easily Have product shipped directly to recipient List doesn’t include – to avoid/evade taxes!

Flexibility – shop online and return to store New things – Ebay, download media, enormous 24/7

bookstore, online education, etc.

Framing the Issues: Telecom and Internet Access Issues

Digital divideVoIP – federal and state activity3% federal excise taxInternet tax moratorium

Digital Divide

SB 1563 (2002; Chapter 674)CPUC to investigate plan to encourage

widespread availability and use of advanced communications so citizens have access to state-of-art technologies

Report was issued in May 2005

Comments to the CPUC

Dominant broadband providers are unregulated cable providers

Infrastructure must be competitively and technologically neutral

Policy must treat all providers alikeNeed “staggering” amounts of capital for

CA’s telecom infrastructureTax incentives can help

VoIP - Federal

Issues: Who should regulate – federal or state?

How much regulation?

Federal moratorium on state and local taxes? Regulated telecom or unregulated information

service? Must providers contribute to universal service

programs? What about privacy, security and law enforcement

considerations?

VoIP - California

CPUC considering the “appropriate regulatory framework” to govern VoIP

Estimate VoIP will be 40% of total intrastate telecom revenues by 2008 in CA leading to significant revenue loss for CPUC programs

CPUC Commissioner Susan P. Kennedy – 3/04

“VoIP changes everything we know about telecommunications today – the technology, the regulations, the economics – even the language.”

Voice is becoming free – bundled with something else, such as cable.

“We have a small window of opportunity, while PSTN is still dominant network platform for voice services, to develop a new regulatory structure. We have no time to waste debating whether VoIP is a telecommunications service or an information service. It is both. It is neither. And it doesn't matter anymore.”

“We need a new way to determine who should bear the responsibility of meeting important public policy objectives like 911 and universal service. “

Need to eliminate regulation that is no longer useful.http://www.cpuc.ca.gov/static/aboutcpuc/commissioners/kennedy/

speeches/040312_voip.htm

NCSL Telecom Resolution

Principle 5 – States must mitigate potential loss of revenue to local gov’t from telecom tax reform.

7 – “States need to simplify, reform and modernize state and local telecom tax systems to encourage economic development, reduce impediments to entry, and ensure access to advanced telecom infrastructure and services through the US.”

3% Federal Excise Tax

IRS considering updating its regs to reflect today’s technology

What is subject to the tax?several courts: tax n/a if charge not based

on both distance and time1 court: tax applies because intent was to

tax all long distance commercial services; but overturned on appeal (11th Circuit)

IRS – tax remains payable

Relevance to UUT

CA Utility User Tax based on federal excise definitionSo, if 3% not owed, UUT not owed either

Expansion of VoIP Less UUT will be collected by citiesLess 911 fees collected

Internet Tax Moratorium

Renewed – now expires 11/1/07Prohibits state and local gov’ts from

taxing Internet access fees

More on moratorium

Provisions include: A provision was added that the term `Internet access service’ “does not

include telecommunications services, except to the extent such services are purchased, used, or sold by a provider of Internet access to provide Internet access.”

This change is due to confusion over whether DSL services are covered by the original moratorium language. Some states tax DSL on the basis that it consists of both Internet access services and telecom services. DSL providers argue that such treatment puts them at competitive disadvantage with cable modem and direct satellite providers.

VoIP –new law adds: “Nothing in this Act shall be construed to affect the imposition of tax on a charge for voice or similar service utilizing Internet Protocol or any successor protocol. This section shall not apply to any services that are incidental to Internet access, such as voice-capable e-mail or instant messaging.”

Requires the GAO to conduct a study due 11/1/05 of the impact of the moratorium on state and local governments and broadband deployment.

Vocal Players and Politics

Efforts exist to Regulate or not regulate telecom and

related activitiesLimit taxation of Internet and related

activitiesStreamline sales tax systemsDefine nexus nationally for business activity

taxes and income taxes

Agenda

The Big Picture Internet Business Today – Trends & Stats Local Gov’t Concerns & Constraints Framing the Internet Taxation Issues

Active Proposals & Projects Concluding Observations

Active Proposals of Note

SSTPNexus legislative proposalsPromoting deployment of technologyInternational activities

Streamlined Sales Tax Project

Started in 2000 42 states + DC participate, incl CA As of 2/05, 21 states have enacted all or part

of the conforming legislation. For more information, see http://www.streamlinedsalestax.org.

At its July 2005 meeting, the project moved forward with an expected start date for the Governing Board of 10/1/05.

Doesn’t require remote vendors to collect use tax

SSTP - 2

Becomes effective once 10 states representing 20% of population of sales tax states adopt

Once each of the 10 states certified to be in compliance – Governing Board will exist to interpret Agreement1 vote per state

SSTP wants Congress to help by reversing Quill

SSTP - 4

California concerns:Governing Board may conflict with role of

CA legislature and BOEAlso, 1 vote per state

Model would require significant changes to current law, including requiring use of destination basis

Must compensate certified service providers and sellers for reporting and collecting

SSTP - 5

Arguments for SSTP:Provides certainty and simplification for

retailersCompensation for vendorsProvides technological solutions to

simplify assessment and collection process

SSTP - 6

Arguments against SSTP: Uncollected use tax not as high as some

people estimate SSTP doesn’t apply to remove vendors anyway

Some states have protectionist laws that impede e-commerce (it is not just SUT)

Isn’t a “one-rate-per-state” solution as originally promised

Destination-based sourcing will be complicated for some vendors (and create winners and losers among local jurisdictions

SSTP - 7

More arguments against the SSTP:Exemptions still allowed if for a specifically

defined categoryThus, continued work for vendors to track

Growth of multichannel e-commerce vendors will decrease number of remote vendors so more SUT will be collected. Is SSTP still needed?

Nexus Legislation - 1

AB 2061 – must have a physical presence to have nexus

Similar to federal H.R. 1956 (109th Cong) Generally, not present until in CA over 21 days

although some activities exempt which will make some days not count towards the 21

Recordkeeping needed to track days Intrusive to audit FTB revenue estimate for 08-09:

($525 million)


AB 2061 – more from FTB: “appears to be changing tax policy from benefiting

in state activity to benefiting out-of-state activity. The policy behind changing the apportionment formula from a single-weighted sales factor to a double-weighted sales factor was to provide a benefit to corporations with significant property and payroll in California. This bill instead provides a benefit to corporations headquartered outside of California, and could provide an incentive to move jobs outside the state.”


MTC – “factor presence nexus standard” – nexus exists if:

A)Organized or commercially domiciled in a state, or

B)Has either (i) $50K of property, (ii) $50K of payroll, (iii) $500K of sales, or (iv) 25% of total property, payroll or sales in the state


MTC ‘s draft affiliate nexus proposal – remote vendor has nexus for use tax collection if:

1. Vendor related to an in-state business maintaining 1 or more locations in the state, and

2. Vendor and in-state business “use an identical or substantially similar name, TN, TM or goodwill to develop, promote, or maintain sales, OR the in-state business and the out-of-state vendor share a common business plan or substantially coordinate their business plans, or the in-state business provides services to, or that inure to the benefit of, the out-of-state business related to developing, promoting, or maintaining the in-state market.”


H.R. 1956 Expands P.L. 86-272

“other business activity taxes” Nexus if:

1. Incorporated or commercially domiciled in state or

2. Physically present– 21 day rule with several exceptions


Arguments for H.R. 19561. Federal definition provides simplicity to

businesses and reduces likelihood of double taxation.

2. Physical presence means tax imposed only if receive benefits and protections from the state.

3. No revenue loss.4. Similar to permanent establishment (PE)

approach used for int’l transactions


Arguments against H.R. 1956

1. Nat’l League of Cities – annual revenue loss to local gov’ts of $60 billion

2. Violates federalism principles

3. Ignores long-standing law of taxing income-producing activities sourced to a state

4. “Market states” do provide benefits to vendors

5. Physical presence not necessarily simple

Promotion of Technology

Broadband Generally means 4x faster than phone + modem Cable modem, DSL, satellite, wireless, and electric

power lines Some debate on whether it needs promotion

More users, more will be created Benefits to economy Cost Will it grow on its own?

Agenda – Last Part!

The Big Picture Internet Business Today – Trends & Stats Local Gov’t Concerns & Constraints Framing the Internet Taxation Issues Active Proposals & Projects

Concluding Observations

Concluding Observations - 1

World is changing: More global activities New types of transactions and ways of doing

business Borders and physical location losing importance

Rethink tax base Ultimately, all taxes are paid by individuals – but

how should we effectively make this happen? Why put energies into shrinking tax bases such as

with SUT and regulated telecom?

Concluding Observations - 2

We need to separate difficult problems from unsolvable ones.

Always consider principles of good tax policy.

Tax Policy Analysis

See separate file posted along with this ppt file

E-Commerce and Telecom Tax Overview Professor Annette Nellen Online class – Bus 223E Summer 2005.

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Transcript of E-Commerce and Telecom Tax Overview Professor Annette Nellen Online class – Bus 223E Summer 2005.