INTERNET TAXATION - State Taxation of Electronic Commerce


Walter Hellerstein
Professor of Law, University of Georgia
Partner, Sutherland, Asbill & Brennan


A. The Growth of Electronic Commerce Electronic commerce is growing at exponential rates, and it is predicted that these growth rates will continue. For 1997, there was $20 billion of commerce over the Internet, with approximately $19 billion of business-to-business transactions and $1 billion business-to-consumer transactions. For 1998, total Internet commerce is projected to reach $50 billion. Estimates for the year 2000 (assuming computer programs allow us to enter the next millenium) range from $100 to $500 billion, with some estimates as high as $600 billion. Approximately 85 percent of the commerce is expected to involve business-to- business transactions.

B. State Sales and Use Taxes

1. Fiscal Significance State sales and use taxes are the single largest source of state revenue. They account for roughly one-third of the state tax base and in some states (e.g., Texas and Florida, they account for more than half the state tax base).

2. The Existing Tax Structure The retail tax is in principle a single-stage levy on consumer expenditures, i.e., it applies only to the final sale for personal use and consumption. In fact, the American retail sales tax includes a substantial amount of "business consumption" (which may be an oxymoron to tax economists, but not to state legislators), with estimates of such consumption in the 40% range. In addition, largely for historical reasons (as distinguished from reasons of tax or economic policy), state sales taxes have been largely confined to sales of tangible personal property. Although most states tax some services, the states (with a handful of exceptions) do not tax services generally.

3. Taxpayer Concerns Taxpayers are concerned that state taxation of electronic commerce will inhibit the growth of economic activity associated with the Internet (i.e., it will kill the goose that lays the golden egg). They are also concerned with the burdensome compliance obligations that taxation of electronic commerce imposes or could impose on industry.

4. State Concerns States are concerned that, with the movement of more and more commerce on to the Internet, they will lose their tax base if such commerce is not taxed. In other words, they view cyberspace as the "black hole" of sales tax revenues


A. State Level Responses Some states have applied their existing taxes on telecommunications, data processing, and information services to Internet access, online services, and other activities related to electronic commerce. Other states have backed away from initial positions of state tax administrators that such activities were taxable. Still other states (probably the majority) have done nothing.

B. Proposed Congressional Legislation: The Internet Tax Freedom Act IFTA is designed to place a moratorium on specific state taxes on Internet access, online services, and electronic commerce while a congressionally- authorized consultative group studies the issues raised by state, federal, and international taxation of Internet-related activity and recommends legislation to address the problems identified.

C. The National Tax Association Communications and Electronic Commerce Tax Project Under the auspices of the National Tax Association (NTA), the Communications and Electronic Commerce Tax Project has undertaken the task of addressing the problems raised by state taxation of electronic commerce. The NTA project's Steering Committee reflects a broad spectrum of government, industry, and independent organizations, along with academic experts. The Project's Drafting Committee has issued an initial report. There are currently six subcommittees that are charged with addressing specific issues arising out of the Project's discussions including the scope of the problem, tax base issues, situsing and sourcing issues, tax rate issues, and simplification issues.


A. Scope of the Solution: Not Limited to Electronic Commerce Whatever solution Congress (or any other group) proposes for state taxation of electronic commerce cannot be strictly limited to electronic commerce. It must also (at a minimum) include consideration of other remote vendors in order not to create competitive inequalities between those engaging in remote transactions through the Internet and those engaging in remote transactions by more traditional means (e.g., the mail).

B. Nexus: Vendor Collection With De Minimis Rules A rational solution to the problem of taxing remote commerce would require the vendor to collect the sales or use tax and remit it to the purchaser's state when the vendor can identify the purchaser's state at reasonable administrative costs, whether or not the vendor has physical presence in the purchaser's state. At the same time, small vendors should not be required to comply with the tax laws of 50 states.

C. Sourcing and Situsing The sales tax is essentially a consumption tax and therefore the tax base should be assigned to the state of destination (i.e., the purchaser's state). Consequently, a sales tax should assign the sale to the state of the actual destination of the goods or services or, if the actual destination cannot be identified, perhaps to the billing address of the purchaser or some other reasonable proxy for the destination of the sale. It may be appropriate to enlist the assistance of financial intermediaries in providing information to assist vendors in identifying the purchaser's state. There should be some "default" rule for assigning the tax base in circumstances when the destination of the purchaser is unknown or unknowable (e.g., a "throwback" rule assigning the sale back to the state of origin or a "throwaround" rule distributing the sale among the states in which known sales occur).

D. Uniformity in Definitions There should be uniformity in the states' sales tax bases. The states can retain sovereignty over whether to tax and what to tax, but once they decide to tax a particular good or service, they should be required to adopt definitions consistent with other states' definitions of similar goods or services. Otherwise business faces overwhelming burdens in complying with the inconsistent tax laws of 50 states. In addition, there needs to a be single administrative or judicial body that would have authority to interpret these uniform definitions, otherwise one could have inconsistent rules in different states.

E. Simplified Administration There should be simplification in state administration of the sales tax including simplification in taxpayer registration, tax returns and remittances, taxpayer audits, and exemption certificates.

F. One Rate Per State Any national solution to the problem of state sales taxation of electronic (and other remote) commerce will require one rate per state. The present situation with differing local rates in local jurisdictions, whose boundaries are often difficult to ascertain, puts an unacceptable compliance burden on remote sellers.

G. Necessity for Congressional Legislation Congressional legislation will be necessary to implement any broad-based solution to the problem of taxing electronic commerce. On the one hand, it will be necessary to modify the rule of Quill, which forbids the imposition of a use tax collection obligation on a non-physically present vendor. On the other hand, it will be necessary to preclude the states from taxing electronic commerce unless they comply with rules that make tax compliance administratively tolerable for remote sellers (e.g., uniform base and one rate per state). Congress has ample authority to enact such legislation under the Commerce Clause, and any Due Process objections to the application of a congressionally-sanctioned regime are likely to be inconsequential, assuming arguendo that Congress lacks the power to override due process limitations on state taxing power.


We have an historic opportunity for capitalizing on the intense interest in electronic commerce as a vehicle for making salutary changes in the structure and administration of the state sales tax.