Internet Taxation Solutions for Amazon, Inc.

Guy D. Hugaert
October 9, 2011
IS 535
Professor Amita Suhrid-Cherewick

Internet Taxation and Legislation One of the hottest political issues regarding taxation is how to tax revenue generated on the internet. Before the internet, stores were required to collect the appropriate sales tax rate in the state where the store was located. The store then forwarded the collected tax to the state tax collector. This system was working fine and was quite simple until the invention of the internet. The system has not changed for the traditional ‘brick and mortar’ store but things are much different for the ‘online’ store. This is where it gets interesting, how do we ensure that the sales taxes are paid or who is responsible for collecting the tax and what rate is paid and what state gets the taxes? For example, where should any sales tax is paid for candy ordered via the Internet from an Ohio vendor by a California resident while traveling in Georgia that is sent to a relative in Michigan (Nellen, 1999)? When the internet went commercial in 1995 it was free of regulation and taxes from the US government at all levels until 1996 when several US states saw the Internet as a great source of revenue for their states. Ten states (Hawaii, New Hampshire, New Mexico, North Dakota, Ohio, South Dakota, Tennessee, Texas, Washington & Wisconsin) started charging ISP’s an Internet access tax. This lead to the authoring of the 1998 Internet Tax Freedom Act by Representative Christopher Cox, R-CA and Senator Ron Wyden, D-OR and signed into law by President Bill Clinton on October 21, 1998(legacy.gseis.ucla.edu, 1998). This bill was drafted and passed to preserve the future potential of the internet. This bill was grandfathered in the ten states listed above and was designed to halt the possible taxation by thousands of taxing jurisdictions in the US. The various types of taxes it outlawed are Internet access taxes, Telecommunications taxes, Franchise Taxes, Bit taxes, Bandwidth taxes and Email taxes. One type of tax that is not prevented by this Act is the taxation of the sale of goods through the Internet. A state is allowed to collect a sales tax only if it has ‘nexus’ with the transaction in order to be able to collect. This has been interpreted as the company must have a physical ‘location’ in that state, such as a store or office. Many states (New York, Arkansas, Colorado, Illinois, Rhode Island, North Carolina and California) are starting to challenge that interpretation and of ‘location’ and are expanding the tax collection requirements to companies that have a marketing firm, a subsidiary inside their state to collect the taxes. The companies cite a 1992 Supreme Court decision that states could only require companies that had a physical presence within the state to act as tax collector (Quill Corp. v North Dakota, 1992). In California a major battle is going on with the largest online retailer Amazon, Inc. and the State’s Governor Jerry Brown.

Amazon, Inc. Amazon is widely known as the world’s largest online retailer. Headquartered in Seattle, WA it was established in 1994 and went online in 1995. It starts as an online bookstore but quickly expanded its product offerings to include CD’s, DVD’s, computer games, software and later included household goods including electronics and furniture among other things. They also entered the business of Cloud Computing in 2006 with its Amazon S3 pay-as-you-go month-to-month storage solution. Amazon also sells its products through Third-party sellers which now derives about forty percent of its sales. These ‘associates’ receive a commission for referring customers to Amazon through links on their website. Amazon collects sales taxes from only five states. They also refuse to collect from 40 of the 45 states that have a statewide sales tax. Of these 40 states are at least twelve states where Amazon has a physical presence such as a distribution center or wholly owned subsidiary (American Independent Business Alliance, June 2011). Many large ‘brick and mortar’ retailers are claiming Amazon and other online retailers have an unfair advantage by not collecting sales taxes. Customers are required to remit sales taxes directly to the state, but few, if any, actually pay these taxes. Amazon claims to support a National Sales tax but many think they simply are trying to avoid collecting any taxes and support this by the millions of dollars they spend to fight any enforcement legislation.

Current Issues

This brings us to the year 2011 and the state of California. On June 28th Governor Jerry Brown signed a bill that would require out-of-state retailers to collect sales taxes on purchases from California residents effective July 3, 2011. This new bill re-defines the ‘presence’ in California to include affiliates who collect a commission and also when the seller has a related company operating in California (LA Times, 6/30/2011). This new law is expected to raise an additional $317 million dollars to the state. Amazon immediately terminated its relationship with its approximately 10,000 affiliates in California because Amazon has no intention of complying with the new law. Amazon then immediately spent $5 million dollars to collect the needed 500,000 signatures needed to put a referendum on the ballot in California to repeal the law. Amazon was not real confident in their ability to convince California voters not make Amazon collect the sales tax and they feared being perceived as acting in their own selfish interest. This lead to an agreement that California would defer the enforcement until September 2012 and Amazon would agree to withdraw the referendum. Amazon did retain the right to challenge the law on Constitutional grounds.

Amazon claims it wants a national sales tax that is a flat rate and would be much easier to implement. Many retailers doubt the sincerity of these statements. They claim Amazon is simply refusing to collect the taxes and buying time to fight the issue on Constitutional grounds or simply moving its affiliates out of California(Galkin, 9/22/2011). Many of the competitors belong to the California Retailers Association who support the new law because they feel Amazon and other online retailers do not collect the tax and therefore have an unfair price advantage since most if not all purchasers do not voluntarily pay the state sales tax.

Recommendations

Online sales surpassed store sales for the first time during the 2010 Christmas shopping season. This trend is likely to continue as using computers and the websites themselves will be easier to use and with the increased use of smart phones to order products. Even though much of California’s budget is wasteful spending there is still a need for the state to be able to collect sales tax revenue. This was not a severe problem in years past but with the increase in Internet sales and the decrease in revenue due to our current recession has caused states to scramble to make up lost revenue. The online retailers have argued that the customer has to wait for its product and that enough consumers will want to get the item instantly that the ‘brick and mortar’ stores will still get their customers. ‘Brick and mortar’ retailers complain that people are simply ‘looking’ at their stores and then proceed to purchase the item online at a discounted price due to no sales tax. This leads us to what are some actual solutions to this problem: 1. Leave things as they are. Do not force companies to collect the sales tax unless they have a physical presence in that state because they get no value from the taxes collected in the form of services. Leave it the responsibility of the resident taxpayer to pay the taxes voluntarily. 2. Pass a national sales tax for sales over the internet. These taxes would be sent to the state of the purchaser of the item. This will take some time to pass since some states are already collecting the tax and it will be difficult to get an agreement on the rate and method of collection. 3. Let the states who wish to collect be able to do so. Some companies will not wish to do any business in that state and the state itself will have to evaluate whether the increase in sales tax revenue is worth a chance that businesses could pull out of the state altogether.

Proposed Solution

With internet sales surpassing retail stores in 2010 show that times are changing and the collection of state sales taxes must change also. States have three main methods of collecting revenue: sales taxes, property taxes and income taxes. In bad economic times like we are currently in revenue in most states is decreasing due to lower property values, lower personal incomes and internet sales taking market share from traditional retailers. Customers are used to paying a sales tax if it is included in the final price of an item, even with online purchases. To think someone will voluntarily pay sales tax on an internet purchase is wishful thinking at best. It is also an unfair advantage for the online retailer to not have to collect as compared to a standard retailer that is forced to collect. My proposed solution to this is both simple and logical and easily explained.

Part of the solution to the problem is who gets to collect the sales tax on an item that is purchased while on vacation and shipped to another state to a friend. Simply put, the payer’s home state collects the sales tax. It is the same in the case of a traditional store in your home state. He who pays for the item pays the sales tax to his home state. Since you can go online anywhere in the world there needs to be a constant. The constant will be the address on the billing section will determine which state collects the sales tax for that transaction. To prevent fraud when a person enters their credit card info the state is determined by the home address of that consumer automatically the same way we determine if it a MasterCard or Visa card. Maybe an additional state code could be entered to ensure the correct state rate is applied. This can be incorporated into any online shopping cart service. The tax rate is automatically calculated the same way shipping costs are calculated on most sites.

Are there possible ways to get around these taxes? Yes. People could get out of state accounts or credit cards of a state that does not have any sales tax. But most people would simply pay the tax. Amazon would then simply collect the tax and pay their affiliates. I think they are just delaying the inevitable. Internet sales taxation will be a standard method of tax revenue by states and with the growth of Internet sales Amazon will survive. There are many things online retailers could do in the meantime to delay implementation of sales tax collection. For example, a large disclaimer stating that it is a violation of law to not pay the sales tax and have an option on the website shopping cart for the ‘honest’ consumer to pay the tax voluntarily or to have a link to the state Franchise Tax Board on the website so a customer could pay the tax voluntarily. These types of responses by retailers could delay the advent of forced collection of state taxes at least until the economy improves or a better solution is discovered. The idea of sales taxes is to get revenue from the residents’ consumer spending along with tourist spending. There would always be a need for revisions and adjustments. One that comes to mind is hotel sales taxes paid for over the internet. Hotels websites shopping carts would need to be modified due to the state where the hotel is located would need to collect the taxes on that transaction, not the address of the purchaser. There are no doubt many other exceptions to the home address of the purchaser but these websites can be easily modified to collect for the different state depending on the industry. Taxation in any form is always going to be hotly debated. There are those who say no taxes and those that want their fair share of any transaction. But we live in a society where we all depend on each other for many basic services including defense, roads, schools, etc. These services have to be paid for in an equitable way and I think my solution would please most anyone!

References

Annette Nellen, CPA, Esq. “Federal Internet Tax Freedom Act-The Myths and the Realities”. Feb 1999.

H.R. 4328 “The Internet Tax Freedom Act”. legacy.gseis.ucla.edu. Nov 1998.

Quill Corp v. North Dakota, 504 U.S. 298 (1992).

American Independent Business Alliance. “Amazon’s Physical Presence in US States”. Http//:www.amiba.net.resources/news-archive/amazon. June 2011.

Marc Lifsher. “California tells online retailers to start collecting sales taxes from customers”. LA Times. June 30, 2011.

William S. Galkin, Esq. “Amazon Mysteriously Postpones Offensive Against California Sales Tax”. http//:seekingalpha.com. September 22,2011.