net.wars: Tax returns (to haunt you, to fill in, to the government, to the state of origin...)

by Wendy M Grossman | posted on 04 March 2011

In 1994, when Jeff Bezos was looking for a place to put the online bookseller he intended to grow into the giant, multi-faceted online presence it is today, he began with a set of criteria that included, high up on the list, avoiding liability for sales tax as much as possible. That meant choosing a small state, so that the vast majority of the new site's customers would be elsewhere.

Wendy M Grossman

Bezos could make this choice because of the 1992 Supreme Court decision in Quill Corp v. North Dakota, blocking states from compelling distance sellers to collect sales tax from customers unless the seller had a substantial physical operation (a "nexus") in the customer's state. Why, the reasoning went, should a company be required to pay taxes in a state where it receives no benefit in the form of public services? The decision helped fuel the growth of first mail-order sales and then ecommerce.

And so throughout the growth of electronic commerce Americans have gone along taking advantage of the relief from sales tax afforded by online sales. This is true despite the fact that many states have laws requiring their residents to declare and pay the sales tax on purchases over a certain amount. Until the current online tax disputes blew up, few knew about these laws – I only learned of them from a reader email some years ago – and as far as I'm aware it isn't enforced. Doing so would require comprehensive surveillance of ecommerce sites.

But this is the thing when something is new: those setting up businesses can take advantage of loopholes created for very different markets and conditions. A similar situation applies in the UK with respect to DVD and CD sales. Fulfilled by subsidiaries or partners based in the Channel Islands, the DVD and CD sales of major retailers such as Amazon, Tesco, and others take advantage of tax relief rules intended to speed shipments of agricultural products. Basically, any package valued under £18 is exempt from VAT. For consumers, this represents substantial savings; for local shops, it represents a tough challenge.

Even before that, in the early 1990s, CompuServe and AOL, as US-based Internet service providers, were able to avoid charging VAT in the UK based on a rule making services taxable based on their point of origin. That gave those two companies a significant – 17.5 percent – advantage over native ISPs like Demon and Pipex. There were many objections to this situation, and eventually the loophole was closed and both CompuServe and AOL began charging VAT.

You can't really blame companies for taking advantage of the structures that are there. No one wants to pay more tax – or pay for more administration – than is required by law, and anyone running those companies would make the same decisions. But as the recession continues to bite and state, federal, and central governments are all scrambling to replace lost revenues from a tax base that's been , the calls to level the playing field by closing off these tax-advantage workarounds are getting louder.

This type of argument is as old as mail order. But in the beginning there was a general view – implemented also in the US as a moratorium on taxing Internet services that was renewed as recently as 2007 – that exempting the Internet from as many taxes as possible would help the new medium take root and flourish. There was definitely some truth to the idea that this type of encouragement helped; an early FCC proposal to surcharge users for transmitting data was dropped after 10,000 users sent letters of complaint. Nonetheless, the FCC had to continue issuing denials for years as the dropped proposal continued to make the rounds as the "modem tax" hoax spam.

The arguments for requiring out-of-state sellers to collect and remit sales taxes (or VAT) are fairly obvious. Local retailers, especially small independents, are operating at a price disadvantage (even though customers must pay shipping and delivery charges when they buy online). Governments are losing one of their options for raising revenues to pay for public services. In addition, people buy online for many more reasons than saving money. Online shopping is convenient and offers greater choice. It is also true, though infrequently remembered, that the demographics of online shopping skew toward the wealthier members of our society - that is, the people who best afford to pay the tax.

The arguments against largely boil down to the fact that collecting taxes in many jurisdictions is administratively burdensome. There are some 8,000 different tax rates across the US's 50 states, and although there are many fewer VAT rates across Europe, once your business in a country has reached a certain threshold the rules and regulations governing each one can be byzantine and inconsistent. Creating a single, simple, and consistent tax rule to apply across the board to distance selling would answer these.

No one likes paying taxes (least of all us). But the fact that Amazon would apparently rather jettison the associates program that helped advertise and build its business than allow a state to claim those associates constitute a nexus exposing it to sales tax liability says volumes about how far we've come. And, therefore, how little the Net's biggest businesses now need the help.

Wendy M. Grossman’s Web site has an extensive archive of her books, articles, and music, and an archive of all the earlier columns in this series. Readers are welcome to post here, at net.wars home, follow on Twitter or send email to netwars(at) skeptic.demon.co.uk (but please turn off HTML).