Taxation Vexation

With all the hype surrounding the recent passage of the Internet Nondiscrimination Act by the House of Representatives, Internet taxation has become a hot

issue -- at least, as hot as any exceedingly confusing legislative issue ever gets.

How confusing is it?

In a nutshell, the current situation is this: Sales over the Internet are taxed by state and local governments just like sales from catalog retailers. If a business has a physical presence in a state where a purchase is made, it must impose that state's sales tax on the purchase. If there is no physical presence and no sales tax is collected, the customer is supposed to pay a "use tax" to his or her state, which is usually the same percentage as the sales tax.

So good so far, but that's just the beginning. The true depth of the tax law quagmire has only recently been dredged up for discussion, and that happened, most observers agree, only because the high-profile growth of e-commerce has shined a spotlight on the complexities of state and local tax regulations. And how confusing is that?

According to Ryan & Co., a state and local tax consulting firm, there are more than 36,000 state and local taxing jurisdictions in the United States, and about 7,000 of them impose sales and use taxes. These taxes are based on a traditional selling model - a local buyer and seller - and governments are now struggling to apply these laws to the very non-traditional world of e-commerce. Adding to the confusion are the numerous transactions that are exempt from taxation -- states can declare "tax holidays" for a limited period of time, they can declare certain products exempt (such as food or medicine), and they can declare certain customers (such as charities) exempt from certain taxes.

So an e-commerce merchant, in order to be in full compliance with the law, has to track all of the rules and regulations of each state and locality in which each of its customers resides -- that's potentially 7,000 different tax codes, each of which can change on a yearly basis.

One solution to this mess is tax compliance software such as CORPTax, Taxware, and Vertex. Another option is electronic "malls," where the mall operator provides tax compliance and other administrative services.

But a simpler and longer lasting solution would be to standardize the laws.That, at least, was the conclusion of September 1999 report by Ernst & Young.

"Isolated changes in the sales and use tax system to deal with e-commerce retail sales will not be sufficient to reduce the unacceptably high current costs of collecting sales taxes," the report stated. "What is needed is a fundamental restructuring of sales and use taxes to simplify the system, reduce compliance costs on retailers and consumers, and prepare the sales tax for the more competitive, integrative national consumer economy in the 21st century."

State governments are on the case.In April, several states joined together to form the Streamlined Sales Tax Project, whose mission is to overhaul the existing tax system "to better accommodate interstate commerce, especially the changes presented by the growth of electronic commerce...(and to) develop a substantially simplified sales and use tax system."The group is currently holding open meetings to discuss the issue -- the next one is scheduled for July 13-14 in Chicago.

This story, "Taxation Vexation" was originally published by CIO.

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