Shopping Anyone? The Online Sales Tax Debate

By Amanda Stein

If you’ve ever shopped online, you have probably noticed that you can often avoid paying sales tax. So, why should one pay sales tax when purchasing a book in a store, but not when that same purchase is made online? The United States Supreme Court says this result is required to protect interstate commerce.

In Quill v. North Dakota, 504 U.S. 298 (1992), the US Supreme Court struck down North Dakota’s attempt to collect use tax from out-of-state retailers as violation of the “dormant” Commerce Clause. A use tax is a corollary to a sales tax: the sales tax is levied on in-state sales of goods while the use tax is levied on out-of-state sales. The Quill court held that a retailer must be physically present in the taxing state in order for that state to require the retailer to collect use taxes from in-state consumers. Consequently, when consumers’ only contact with online retailers is over the Internet and the online retailer has no physical presence in the taxing state, the state cannot require the online retailer to collect use tax.

The result is that states must rely on individual taxpayers to self-report their use tax liability for goods purchased out of state. Unsurprisingly, compliance is low and it is practically difficult for states to enforce against individuals. Given the significant (and growing) volume of online retail sales, this constitutes a large portion of consumer spending that states’ sales and use taxes are unable to reach.

Despite the seeming clarity of the bright line rule laid down in Quill, courts (including the US Supreme Court) have done a fair job of muddying these waters. In the Quill opinion itself, the Court noted that physical presence means more than a “slight presence” and therefore the presence of “a few floppy diskettes” would not constitute physical presence. Quill, 504 U.S. at 315, fn. 8.

State courts have come to varying conclusions over the degree of physical presence required, especially with regard to in-state visits by the employees of out-of-state companies. In Florida, for example, the temporary presence of an out-of-state company’s executives at various seminars was not sufficient to establish a physical presence of that company in Florida. Florida Dep’t of Revenue v. Share Int’l, 676 So.2d 1362 (Fla. 1996), cert. denied, 519 U.S. 1056 (1997). In contrast, 30 in-state deliveries to Illinois customers over about 2 years was sufficient presence to give Illinois power to tax an out-of-state furniture merchant. Town Crier, Inc. v. Department of Revenue, 315 Ill.App.3d 286, 248 Ill.Dec. 105, 733 N.E.2d 780, 782 (1st Dist. 2000).

Many states have turned to their legislatures to deal with these issues. There is an ongoing legislative battle across the country as states consider bills, which attempt to statutorily define physical presence. The following is a (non-exhaustive) list of states with recently passed or currently pending bills that target online retailers:

• Arizona (HB 2551)

• Arkansas (SB 738) – passed April 1, 2011

• California (SB 234)

• Connecticut (HB 6624)

• Hawaii (SB 1355)

• Illinois (HB 3659) – passed March 10, 2011

• Massachusetts (H01731)

• Minnesota (SF0458)

• Missouri (HB 970)

• New Mexico (HB 102)

• Rhode Island (HB 5115)

• Tennessee (SB 1489)

• Texas (SB 1798)

• Vermont (HB 143)
One common approach is to target out-of-state retailers that use in-state affiliates to generate sales. Several bills would require retailers with in-state affiliates that refer at least $10,000 in sales from in-state purchasers to collect and remit sales tax. Other bills take a more aggressive approach. For example, the California legislature is currently considering Senate Bill 234, which would expand the coverage of California’s sales and use tax statute to the maximum allowable under the federal constitution.

The Stakes

Some argue that these bills are simply a money grab by states. To some extent that is true: every time a government seeks to increase the reach of a tax, the result will be more revenues. However, if the purpose of the sales and use tax is to tax consumption, then there is no theoretical reason why internet sales should be excluded. Whether one buys the book online or in the store, it is still consumption of a book. The current system is unfair because it forces in-state retailers to bear all the burden of sales and use taxes and allows online retailers to escape them completely.

Moreover, it is unclear that this inconsistency is truly protective of our national economy. Quill’s physical presence test is rooted in the dormant commerce clause rationale that states should not burden interstate commerce by protectionist measures. However, the physical presence rule goes beyond protection from local favoritism and gives a huge competitive advantage to online retailers at the expense of in-state retailers. This is the kind of policy decision that Congress should make in its affirmative power to regulate commerce, rather than as an unintended consequence of outdated judicial doctrine.

Some argue that if the online retailer does not have a physical presence in the taxing state, then the state is not providing any services to the retailer, and therefore the state has done nothing to “earn” those sales taxes. This argument misses the mark. The sales and use tax is not a tax on the online retailer; rather, it is a tax on the consumer resident that is located in the taxing jurisdiction. Consumers should not be able to escape paying sales taxes, simply by making their purchases online. The law needs to change in order to accommodate the reality of online commerce. Online retailers should be treated like all other retailers and should not benefit from tax evasion.

Both sides of this debate argue that their preferred rule would better protect business. Clearly, this depends on the type of business and where it is “located.” On the one hand, businesses with physical stores compete with online retailers. Forcing online retailers to collect taxes would level the playing field between them. In this instance then, forcing online retailers to collect use taxes would seem to help some businesses.

On the other hand, forcing online retailers to collect sales and use taxes might be a barrier for some companies to expand their businesses online. Since there are literally thousands of state and local government entities that levy sales taxes across the nation, many argue that it would be prohibitively expensive for small businesses to track the tax rates of these governments and to link them to the proper consumers. However, there are already companies that offer tax compliance services. Many online businesses already use the services like PayPal to complete online transactions. While the cost of sales tax compliance services might be high now, one could fairly expect the price of such services to decrease if the law changed. Moreover, many of the proposed state laws protect small businesses from these administrative burdens by setting thresholds that do not trigger use tax collection obligations until the retailer has sold a certain amount of goods in the state.

Regardless of whether one is in favor of the so-called “internet sales tax” or not, it is clear that Congress should end this bickering in our state courts and legislatures. A clear and cohesive policy would certainly be more beneficial for our national economy.

Google settles Buzz brouhaha, other privacy suits pending

By Joseph A. Nicholson

The world’s dominant online search company appears to also be one of the world’s biggest violators of consumer privacy rights. On March 30, 2011 the Federal Trade Commission announced a settlement of charges against Google, Inc. that it used deceptive practices when it rolled out its Buzz social network in 2010. As part of the settlement, Google agreed to implement a comprehensive privacy program to protect consumer data, and will submit to independent privacy audits for the next 20 years. Public comments can still be posted here.

According to the FTC complaint, the Buzz rollout consisted of a message from Google allowing gmail users to either enroll in the program or opt-out. One deceptive practice, alleged the FTC, was that even those users who clicked to opt-out were enrolled anyway. But, additionally, even those who agreed to participate in Google Buzz were never adequately informed that a list of the people they emailed most would be made public as part of the network’s default settings.

The rollout of Google Buzz also prompted a class action lawsuit brought by users who claimed publication of their email lists violated their privacy. The lawsuit alleged violations of the Stored Communications Act, Wiretap Act, and Computer Fraud and Abuse Act. In October, a San Jose federal district judge tentatively approved a proposed settlement agreement in the class action in which Google would create an $8.5 million fund, approximately 13 cents per 32 million class members. If approved, the settlement would require about $6 million of the fund be distributed to internet privacy organizations like the Electronic Frontier Foundation and the Berkeley Center for Law and Technology. Attorneys for the class would receive more than $2 million collectively, while Buzz users would receive no direct compensation. In agreeing to the settlement, Google admits no wrongdoing, but has publicly apologized for mistakes made with Buzz.

Other consumer privacy lawsuits still pending against Google include at least two class actions alleging wiretap violations for contextual ads sent to gmail users. Meanwhile, Google is still defending against several class actions alleging that roving Google Street View cars captured private data from wi-fi networks, and was recently fined 100,000 euros for similar activity in France.