Proposed US Rules For Sourcing Internet Sales Aren't Clear

by Mike Godfrey, Tax-News.com, New York

15 January 2003

31 states endorsed the Streamlined Sales and Use Tax Agreement (SSUTA) in November, and state legislatures have begun considering enabling legislation; when ten have approved the pact it will come into effect in all 31 states.

SSTP, which for four years has been inching its way towards a multi-state platform that would allow major simplification of the United States' 9,000 different sales and use tax regimes, will apply to all sales, whether on the Internet or not, but won't lead to cross-border taxation on the Internet until Congress removes its ban on cross-border sales taxes. In 1992, the US Supreme Court ruled in Quill Corp v. North Dakota that requiring a business without some physical nexus to a state (say, a store or warehouse) to collect that state's taxes puts an unconstitutional burden on interstate commerce.

The SSUTA effectively assumes that Quill will be repealed, and sets out rules for locating a sale on that assumption. As part of a series on www.ecommercetax.com which has been examining different aspects of the SSTP, Professor David Hardesty has critiqued the SSTP's sourcing rules.

SSUTA's General Sourcing Rules are as follows (this single set of general sourcing rules applies to all retail product sales - with some exceptions - but are not used in determining a purchaser’s liability for use tax):

• When a product is received by the purchaser at the business location of the seller (e.g., retail store), the sale is sourced at the seller’s business location.
  
• When a product is not received at the seller’s business location, then it is sourced at the place of receipt by the purchaser (or the purchaser’s donee, as where the purchase is a gift that is delivered directly to the donee).
• If the place of receipt is not known the sale is sourced to the address for the purchaser recorded in the seller’s business records.
• If the place of receipt is not known, and the seller’s records do no contain information on the buyer’s location, the sale is sourced to the location obtained during the sale; which would include, for example, the purchaser’s billing address.
• If a location is not obtained under the first four rules, the location will be determined as follows:
  • tangible personal property is sourced at the address from which it is shipped,
  • an electronically delivered product is sourced at the location from which it is first available for transmission by the seller, and
  • services are sourced at the location from which the services are provided.

Note that in the case of electronically delivered products and services, a location is disregarded if it merely provides the digital transfer of the product sold.

Professor Hardesty points out that the final rule is unclear as it applies to electronic deliveries, and will likely lead to controversies, for instance where multiple, outsourced or mirror servers are involved. The rule is also unclear as it applies to services: it provides that services will be sourced where they are provided, but a particular service may be provided simultaneously from multiple locations.

Professor Hardesty goes on to examine a range of other interpretative issues that will arise with SSUTA when it is applied to Internet sales. Of course, that will not happen until the issue of the Internet tax moratorium has been resolved.

The current moratorium will expire in September this year, and bills have already been introduced to the new Congress that would extend it. But this time, with the states facing a $30bn deficit in 2003 and Internet sales now representing a significant and fast-growing proportion of sales revenue, there is not much chance that the moratorium will be extended again. The US General Accounting Office has estimated states will lose more than $13 billion each year on untaxed Internet transactions, and the figure is expected to more than triple to $45 billion by 2006.

The existence of the SSUTA will go a long way to convincing Congress to repeal Quill and not to extend the moratorium. The existing tangle of different regimes makes design of an Internet sales tax system an impossible nightmare, and is one of the main reasons that Congress extended the national Internet sales tax moratorium for a further two years.

Under the Streamlined Sales Tax Project proposal, states would be required to establish uniform definitions for taxable goods and services, and maintain a single statewide tax rate for each type of product. The project also seeks to simplify tax reporting requirements for online sellers. But while retailers unsurprisingly support the SSTP, businesses in general are lukewarm or hostile to the plan, which they say would impose burdensome new recording and reporting requirements.

Given that the federal government is likely to have to pick up at least some of the tab for the states' deficits if they can't extend their tax base, the administration will probably support congressional action this year, but the fate of such legislation depends, in part, on what position big-business lobbyists take. The Council on State Taxation (COST) wants Congress to accompany any repeal of Quill with an affirmation that the states can't levy other taxes - such as a corporate income or franchise tax - on companies without facilities in a state. Joseph R. Crosby, COST's legislative director, warns that even a business-state deal might not be enough. He says, "The anti-tax wing of the Republican Party will make it a challenge to get the House to approve any plan, even if there is an agreement between the states and business. So despite our best intentions, we may be stymied because of the ideological considerations."

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