ECommerce and Telecom Tax Overview

1
E-Commerce and Telecom Tax Overview

• Professor Annette Nellen
• Online class Bus 223E
• Summer 2005

2
Agenda

• The Big Picture
• Internet Business Today Trends Stats
• Local Govt Concerns Constraints
• Framing the Internet Taxation Issues
• Active Proposals Projects
• Concluding Observations
• The lesson focuses on some local issues as this
  is what is driving some activities today, such as
  the Streamlined Sales Tax Project.

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The Big Picture

• What is e-business?
• Why does e-business challenge our tax rules?

4
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

5
The E-Commerce Model Can Change Tax Results
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Tax challenges of e-business

• Location
• Fewer needed thus, less taxing points
• Some needed assets are mobile
• More custom inventories thus, less storage
  needs
• Less vertical integration thus, more
  outsourcing
• More global purchases and sales

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Tax challenges of e-business

• Transaction methodology
• Possibility of anonymous transactions
  verification and paper trail issues
• Increased bartering tax challenges
• Easy to reach out to large geographically
  dispersed customer base
• Greater number of remote sales
• Occasional sale versus active seller

8
Tax challenges of e-business

• Nature of products
• Digitized (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 doesnt
  apply to intangibles

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Tax challenges of e-business

• Workforce
• May be scattered across the globe taxing
  points? More business license locations?
• Taxable presence where employees are?
• Technology
• Businesses track customer purchases
• Usable to also calculate and collect sales tax?
• Improved buying systems for governments?

10
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 isnt 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.

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Summary of e-commerce and tax concerns

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

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Agenda

• The Big Picture
• Internet Business Today Trends Stats
• Local Govt Concerns Constraints
• Framing the Internet Taxation Issues
• Active Proposals Projects
• Concluding Observations

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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

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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!

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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 access
• Boost to CA economy expected from greater
  broadband deployment

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Agenda

• The Big Picture
• Internet Business Today Trends Stats
• Local Govt Concerns Constraints
• Framing the Internet Taxation Issues
• Active Proposals Projects
• Concluding Observations

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Local Govt 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

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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/CurrentCalculation
  ofUncollectedSalesTax.pdf.

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Local Govt 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

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Agenda

• The Big Picture
• Internet Business Today Trends Stats
• Local Govt Concerns Constraints
• Framing the Internet Taxation Issues
• Active Proposals Projects
• Concluding Observations

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Framing the Issues

• The Tax Formula
• Customer Desires
• Telecom
• Vocal players and politics

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Framing the Issues The Tax Formula

• Tax Base x Rate
• IF
• Have authority to tax!!

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Framing the Issues Authority to Tax -
Nexus 101

• Connection between jdx and entity such that is
  permissible for govt 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 slight
• NOT ALWAYS CLEAR!
• FREQUENT LITIGATION!

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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 Onlines website on 8/11/99. Borders
  also included a notation on its sales receipts to
  visit us online at www.borders.com).

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Borders Online contd

• Issues before the court were (1) whether Borders
  activities were for the purpose of selling
  Onlines 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
  Onlines website, it was acting as Onlines
  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 Borders
  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 retailers
  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.
  
  
  
  
  
  
  
  
  
  
  
  
  

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Borders Online contd

• Query Is this holding a proper interpretation
  under RT 6203(c)(2)? RT 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. RT 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. (Boards 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
  bookstores distribution of discount coupon on
  behalf of affiliated Internet retailer was
  integral to selling efforts and thus constituted
  selling.)

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Borders Online contd

• 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
  persons 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 RT 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 taxpayers 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).
• 
  
  
  
  
  
  
  
  

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Framing the Issues The Tax Base

• Varies from state to state
• Issues often arise wrt telecom and technology
  services
• Frequent changes
• NOT ALWAYS CLEAR!
• FREQUENT LITIGATION!

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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 doesnt include to avoid/evade taxes!
• Flexibility shop online and return to store
• New things Ebay, download media, enormous 24/7
  bookstore, online education, etc.

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Framing the Issues Telecom and Internet Access
Issues

• Digital divide
• VoIP federal and state activity
• 3 federal excise tax
• Internet tax moratorium

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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

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Comments to the CPUC

• Dominant broadband providers are unregulated
  cable providers
• Infrastructure must be competitively and
  technologically neutral
• Policy must treat all providers alike
• Need staggering amounts of capital for CAs
  telecom infrastructure
• Tax incentives can help

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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?

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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

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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/commission
  ers/kennedy/speeches/040312_voip.htm

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NCSL Telecom Resolution

• Principle 5 States must mitigate potential loss
  of revenue to local govt 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.

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3 Federal Excise Tax

• IRS considering updating its regs to reflect
  todays technology
• What is subject to the tax?
• several courts tax n/a if charge not based on
  both distance and time
• 1 court tax applies because intent was to tax
  all long distance commercial services but
  overturned on appeal (11th Circuit)
• IRS tax remains payable

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Relevance to UUT

• CA Utility User Tax based on federal excise
  definition
• So, if 3 not owed, UUT not owed either
• Expansion of VoIP
• Less UUT will be collected by cities
• Less 911 fees collected

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Internet Tax Moratorium

• Renewed now expires 11/1/07
• Prohibits state and local govts from taxing
  Internet access fees

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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.

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Vocal Players and Politics

• Efforts exist to
• Regulate or not regulate telecom and related
  activities
• Limit taxation of Internet and related activities
• Streamline sales tax systems
• Define nexus nationally for business activity
  taxes and income taxes

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Agenda

• The Big Picture
• Internet Business Today Trends Stats
• Local Govt Concerns Constraints
• Framing the Internet Taxation Issues
• Active Proposals Projects
• Concluding Observations

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Active Proposals of Note

• SSTP
• Nexus legislative proposals
• Promoting deployment of technology
• International activities

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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.
• Doesnt require remote vendors to collect use tax

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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 Agreement
• 1 vote per state
• SSTP wants Congress to help by reversing Quill

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SSTP - 4

• California concerns
• Governing Board may conflict with role of CA
  legislature and BOE
• Also, 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

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SSTP - 5

• Arguments for SSTP
• Provides certainty and simplification for
  retailers
• Compensation for vendors
• Provides technological solutions to simplify
  assessment and collection process

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SSTP - 6

• Arguments against SSTP
• Uncollected use tax not as high as some people
  estimate
• SSTP doesnt apply to remove vendors anyway
• Some states have protectionist laws that impede
  e-commerce (it is not just SUT)
• Isnt 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

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SSTP - 7

• More arguments against the SSTP
• Exemptions still allowed if for a specifically
  defined category
• Thus, 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?

50
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)

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Nexus Legislation - 2

• 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.

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Nexus Legislation - 3

• MTC factor presence nexus standard nexus
  exists if
• Organized or commercially domiciled in a state,
  or
• 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

53
Nexus Legislation - 4

• MTC s draft affiliate nexus proposal remote
  vendor has nexus for use tax collection if
• Vendor related to an in-state business
  maintaining 1 or more locations in the state, and
• 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.

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Nexus Legislation - 5

• H.R. 1956
• Expands P.L. 86-272
• other business activity taxes
• Nexus if
• Incorporated or commercially domiciled in state
  or
• Physically present
• 21 day rule with several exceptions

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Nexus Legislation - 6

• Arguments for H.R. 1956
• Federal definition provides simplicity to
  businesses and reduces likelihood of double
  taxation.
• Physical presence means tax imposed only if
  receive benefits and protections from the state.
• No revenue loss.
• Similar to permanent establishment (PE) approach
  used for intl transactions

56
Nexus Legislation - 7

• Arguments against H.R. 1956
• Natl League of Cities annual revenue loss to
  local govts of 60 billion
• Violates federalism principles
• Ignores long-standing law of taxing
  income-producing activities sourced to a state
• Market states do provide benefits to vendors
• Physical presence not necessarily simple

57
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?

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Agenda Last Part!

• The Big Picture
• Internet Business Today Trends Stats
• Local Govt Concerns Constraints
• Framing the Internet Taxation Issues
• Active Proposals Projects
• Concluding Observations

59
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?

60
Concluding Observations - 2

• We need to separate difficult problems from
  unsolvable ones.

Always consider principles of good tax policy.
61
Tax Policy Analysis

• See separate file posted along with this ppt file