Taxes

Do I need to collect and remit sales and use taxes?

A state tax regulator or other taxing authority may require a business located outside the area to collect sales taxes from its customers and remit them to the taxing authority if the seller has a sufficient “nexus” with the taxing region. Where the seller lacks a sufficient nexus, the buyer could be required to levy a use tax on himself and pay the tax to the government entity. As most buyers are unaware of their use tax obligations, compliance with use tax laws under these circumstances is rare. Where a seller only has electronic contact with a taxing state based on a Web site that is accessible there, the taxing state’s ability to require the ecommerce site to collect sales taxes is limited.

US authorities seeking to tax ecommerce transactions must meet the same requirements under the Constitution that they must meet when taxing any other type of commerce: they may impose taxes on sales within their regions (sales taxes) or they may levy taxes on the use of property located there (use taxes) only if such taxes comply with the Due Process and Commerce clauses of the United States Constitution. Due process analysis depends upon the extent to which the remote seller takes action directed at the residents of the taxing state, in addition to establishing a Web site. Under the US Constitution’s Commerce Clause, the state may impose the tax if the “tax [1] is applied to an activity with a substantial nexus with the taxing State, [2] is fairly apportioned, [3] does not discriminate against interstate commerce, and [4] is fairly related to the services provided by the State.” Forty-five states impose sales and use tax on commercial transactions. Delaware, Montana, New Hampshire, Oregon, and Alaska do not.

While there has been no definitive ruling as to what level of presence or activity constitutes “substantial nexus” for taxing purposes in connection with electronic commerce, in its April, 2000 Report to Congress, the Advisory Commission on Electronic Commerce acknowledged that the substantial nexus requirement of the due process clause prevents states from imposing use tax collection and remittance duties on remote e-commerce retailers. And the Supreme Court has held that “substantial nexus” in the context of sales and use taxes requires that a seller have a physical presence in the taxing jurisdiction before a state may impose a duty to collect taxes. Thus, a retailer whose only contacts with the taxing state are by mail or common carrier—i.e., advertisements, flyers, and catalogues sent through the mail or by common carrier—lacks “substantial nexus” and cannot be required to collect taxes for that state.

But if an online seller maintains some physical presence in or physical contact with the state, it may be required to collect and forward sales tax. Consider these scenarios:

  • A US state may require a seller to collect taxes for in-state sales if the seller has retail stores, outlet stores, or significant property in the state.
  • If the out-of-state seller had wholesalers or salesmen soliciting sales in the state and forwarding resulting orders to the out-of-state seller for shipment, the seller could be required to collect and remit taxes to the state in which the sales are made.
  • The employees do not necessarily need to be permanently located within the taxing state for its authority to apply, and the sales staffers could be independent contractors rather than employees.
  • The presence of an agent or an affiliate of the out-of-state business can also be enough to find that a remote seller has a substantial nexus with a state. For instance, if an insurance company uses a local broker to sell its services, it may be subject to taxation by the state where the agent operates.
  • A company that sends employees to train or assist customers who buy the company’s services online may have “sufficient nexus” with the state in which the customers are located, even if the employees make only a few visits. A Vermont company that sold customized software and services to customers in New York was required to collect New York sales taxes because its employees visited the state to install and maintain the software.
  • A telecommuting employee who lives within a state with which its employer has no other contact could create a physical presence on behalf of the employer for taxing purposes.
  • Under the “affiliation” theory, the taxing nexus of a company can be imputed to parent, subsidiary, or other related entities. If the activities or the out-of-state seller appear to be closely linked to the activities of a separate affiliated entity located in-state, a sufficient nexus could be found to allow the state’s taxing authority to apply.

Will use of local web servers or ISP and ASP presence complicate sales or use tax liability?
Some states have found that a maintenance of local web server can constitute a physical presence within a state for certain e-commerce retailers because (1) a web-hosting service is acting as the agent of the remote seller, (2) the online seller is making use of the phone lines and infrastructure of the state, or (3) web servers constitute a physical presence on behalf of the online seller. Even more potentially troubling, a substantial nexus with the taxing state could exist based on a point of presence (POP) site in a taxing state maintained by an internet service provider (ISP) or internet access provider (IAP). Such POP sites are usually maintained in several states to provide users with local access and may consist of not more than a room filled with modems and phone lines. States might argue that a POP site in their territory gives rise to taxing nexus because maintaining such site is no different than leasing an office for other types of companies. If so, then a state could find a substantial nexus with online retailers based on a theory that their IAPs and/or ISPs are acting as their agents. This would mean that an Internet-based retailer could be required to collect and remit taxes to every state in which its internet service or access provider was located and/or maintained a POP site. Due to these possibilities, the parties’ respective tax liability should be addressed in their web site hosting and ISP agreements.

Has the US Federal Government Implemented Rules for E-Commerce Taxation?
In 1998, reacting to increasing concern over how and to what extent states can tax Internet sales, Congress enacted the Internet Tax Freedom Act (ITFA). This Act placed a three-year moratorium (postponement) on state and local governments imposition of “taxes on Internet access” services as well as any “multiple or discriminatory taxes on electronic commerce.” A grandfather clause was also included in the Act, which allowed some states to continue taxing Internet access as they had prior to enactment of the ITFA. The moratorium was extended by the Internet Tax Nondiscrimination Act through November of 2003, but has now expired and “should not be re-enacted.” In the 108th Congress, several proposals that would extend the moratorium through 2008 or render it permanent were considered, but a decision was not made.

One project proposed by 40 states and the District of Columbia is the Streamlined Sales Tax Project. This effort started due to the multitude of different sales tax rates based on jurisdiction and the type of good being sold. The project’s Streamlined Sales and Use Tax Agreement, which seeks to limit states to one sales tax rate per state, plus one per local jurisdiction, and would mandate that states and their local governments use common tax definitions and eliminate the requirement that businesses file tax returns with local governments, has been adopted by a majority of the states in the US, subject to certain amendments in some jurisdictions. See the information at http://www.streamlinedsalestax.org.

Will I be responsible for other business taxes when I sell goods or services over the web?

An online business will face tax obligations related to its sales, beyond sales taxes. Here is a summary of some of those other taxes.

Federal Income Taxes
E-commerce businesses must always pay federal income taxes . It is immaterial to the Internal Revenue Service whether the income of companies and individuals is earned through traditional brick and mortar stores or through a website. The Internet does not change the federal taxation of income of those subject to the tax powers of the United States.

Tariffs and custom duties
A tariff or custom duty is imposed by the federal government when certain items are imported from overseas. A custom duty is a tax charged by the U.S. government on certain goods imported into the country. A tariff, on the other hand, is a list that specifies the amount of each duty charged for the various commodities subject to such custom duties. Each type of goods tends to have its own custom duty. According to the 19 U.S.C.A. § 1202, the source country of the goods make a difference, as do various international treaties.

Goods that are subject to a duty or tariff when purchased offline, will face that same tax when purchased online. Thus, if a good is subject to a tariff when ordered from overseas by telephone, the same tariff applies when it is ordered from overseas through a website. The medium of delivery, however, can make a difference. For example, off-the-shelf software is subject to a duty when ordered from overseas, but, if the software program is delivered online instead, no tariffs are applicable. According to 19 C.F.R. § 141.1(b), the importer of the goods is required to collect the tariff. The federal government wants to apply existing duties and tariffs to online commerce and thus avoid the implementation of new duties and taxes related to e-commerce.

International Tax Implications of Conducting Business Online

Other kinds of taxes may be applicable to transactions with consumers located outside the United States. In the European Union (“EU”), for example, the “value added tax” (VAT) is the key tax to consider in doing electronic business consumers. The VAT is a tax on consumer spending within the territory of an EU Member State. Non-EU vendors register with a VAT authority in any EU Member State and then will be levied a tax at a rate applicable in the Member State where the customer is a resident. The revenue is then reallocated to that state after the purchase is made. Under the VAT system, non-EU suppliers selling to businesses within the EU pay the VAT under self-assessment arrangements, however, “electronically supplied services” from non-EU providers to private consumers based in the EU are taxed based on the location of the consumer. Electronically supplied services include, but are not limited to, Web site supply and hosting, software supply and updating, database services, and Internet entertainment. The EU tax system is important for US based telecommunications providers and Internet service providers, who may be required to charge VAT to their EU customers.

Excise Taxes
An excise tax is a tax on an activity, event, exercise of property rights, or on a privilege granted to a consumer. The federal and state governments levy an excise tax on certain specified products, such as gasoline, cigarettes, alcohol, or telephone services. Those purchasing or using the goods or services are required to pay the excise taxes. The collection and remittance of the taxes to the government, however, is by the seller of the goods or services subject to the tax. Sometimes these taxes are included within prices advertised to consumers; for example, U.S. gas stations include all applicable excise taxes in the price of a gallon of gasoline. Gas station owners collect and send the tax to state and federal governments.

The excise taxes most commonly implicated by online activity are the taxes US states and the US government charges on telecommunications services under 25 U.S.C.A. § 4251 and various state laws. Sales of goods sold online will normally have the same excise taxes due when sold offline. Thus, a company which sells a bottle of wine to a consumer online where an excise tax is due on that wine if sold offline must collect and remit the tax to the appropriate state.

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