A taxing debate

The ongoing debate about Internet taxes has officially been put on hold.

The Internet Tax Freedom Act has been extended by two years, and now doesn’t expire until Nov. 1, 2003.

On face value, that would seem like a major victory for those in favor of limiting government interference with the still fledgling Internet business sector, but in reality it doesn’t do much to limit state and local taxation.

The Act does ban three specific things:

* Taxing Internet access.

* Multiple taxation on the same transaction.

* Discriminatory taxation. A government body cannot impose a higher tax rate for Internet transactions than would be used for non-Internet transactions. A second part of this also bans states from looking at a company’s electronic transaction record to determine if it has a tax obligation in that state.

“The ability of states to tax electronic transactions is not governed by the act,” says Jeff Friedman, partner with KPMG and member of the Advisory Commission on Electronic Commerce. “Internet transactions are governed by the tax regime that was in place before the Internet Tax Freedom Act, and long before the Internet. It’s the old rules of commerce that determine whether an Internet seller collects sales tax.”

The same rules that typically apply to catalog sales also apply to Internet transactions. The determining factor is having a physical presence in the state in question. If the company selling via the Internet is based in Ohio, then it is obligated to collect Ohio sales tax.

“There is a lot of litigation determining what a physical presence actually is,” says Friedman. “There are cases where the question is whether leasing property such as servers is enough to qualify as a physical presence.”

Another gray area is in the area of partnerships. If an online e-tailer has a relationship where a brick-and-mortar store handles its returns, does that qualify as a physical presence for the e-tailer? The courts have many such issues to decide.

The states argue that the Internet has led to more people buying items from merchants that aren’t local, which means the total sales tax collected will be less.

“There’s a debate on what the real impact of Internet sales is,” says Friedman. “You hear conflicting claims, but the majority of states are now working amongst themselves to come up with a more uniform sales tax.”

This doesn’t mean the same rate for everyone, but rather an agreed upon set of definitions of what category a particular item might fall into. If one state calls an item a grocery item, then so would all the others.

“There are significant differences between how states tax different items,” says Friedman. “It drives retailers bonkers.”

The states want to be able to offer a streamlined sales tax proposal by the time the Internet Tax Freedom Act expires.

“This two year extension is in some ways both a blessing and a curse,” says Friedman. “It’s not a long extension, and most didn’t want a long extension. On the curse side, the states have a lot of hard work ahead of them. There is mounting pressure on them as a group to get something in place and simplify the sales tax system. If they are not all the way there in two years, there will be pressure for the Feds to intervene.”

More information on the states’ efforts to assemble a streamlined sales tax can be found at www.streamlinedsalestax.org.