Taxation and the Internet - U.s. E-tax Policies: Legal And Constitutional Dimensions

U.S. E-TAX POLICIES: LEGAL AND CONSTITUTIONAL DIMENSIONS

The Constitution's Commerce Clause grants Congress the power "to regulate commerce. . .among the several states." However, the formulation of state and local tax policy has traditionally been left to those jurisdictions. If the federal government preempts the states' ability to set their own tax policies, some argue it would violate the principles of federalism. Congress can regulate activities that "substantially affect" interstate commerce, but it cannot order states to enforce federal regulatory programs, since that infringes upon state sovereignty. A state's authority to regulate commerce within its borders is limited by the Due Process Clause of the 14th Amendment and the Commerce Clause. The latter gives states the jurisdiction to tax commercial sales only when sufficient contact between the buyer and seller exists within the state.

Generally, sales of intangible property are not taxed in the U.S. But technology now permits the conversion of many tangible goods, such as books and recordings, to digitized content that can be delivered entirely online. The taxable status of such content remains uncertain.

The Supreme Court established two important legal precedents for the e-taxation debate. In 1967, it ruled in National Bellas Hess v. Illinois that a state could only tax commercial transactions when the seller maintained a physical presence, or "nexus"—an office, a warehouse, of a sales agent—in that state. Requiring out-of-state vendors to cope with the complexity of various state and local sales tax systems constituted a barrier to interstate commerce. In 1992, the Court reinforced this decision in Quill Corp. v. North Dakota, which involved state sales taxation and out-of-state mail-order vendors. It reiterated the nexus requirement, but noted that Congress could pass laws requiring remote vendors to charge state sales taxes on all sales, if Congress provided national guidelines to simplify state sales tax collection.

This constitutional and legal framework affects e-commerce taxation in several ways. Since consumers can purchase goods and services online from evendors located anywhere in the U.S., questions of whether the federal or state government is the appropriate authority to generate tax regulations come to the forefront. The parallels between catalog sales and e-commerce transactions led officials to apply the Bellas Hess and Quill rulings to online sales taxation. However, the Internet's lack of geographical borders and the difficulty of defining what constitutes a "physical presence" or "substantial nexus" between e-buyer and e-vendor complicate this practice.

To gain time to generate comprehensive e-taxation policies and to allow unfettered growth of e-commerce, Congress passed the Internet Tax Freedom Act (ITFA) in 1998. ITFA placed a three-year moratorium on the creation of "discriminatory and multiple" e-commerce taxes by states and localities. It also banned federal sales taxes of Internet transactions, promoted tax-free international e-commerce, and established an Advisory Commission on Electronic Commerce to develop national guidelines for e-taxation. But the Advisory Commission failed to offer any official recommendations to Congress and the matter remained inconclusive.

The federal government levies excise taxes on Internet service transactions such as airline ticket sales and on telecommunications. Internet access is taxed in nine states and downloaded information and software in 29. Most states levy corporate income taxes on profits generated from providing Internet access and from the online sale of goods and services. States usually "source" income from e-commerce sales of tangible property to the customer's state of residence, and income from the sale of intangible digital content to the vendor's home state. The federal government taxes income earned through e-commerce in the same manner as income earned via traditional channels.

Numerous e-commerce taxation schemes have been proposed, many as legislative bills submitted to Congress. Possible solutions include:

• permitting state and local e-sales taxes if states simplified and standardized their tax systems
• banning all e-commerce taxation
• instituting a national e-commerce sales tax
• creating a centralized, third-party collection system for state sales taxes, to be used by all online vendors
• establishing a national value-added tax (VAT) levied on all household consumption of goods and service, regardless of how they are sold.