Bottom Line: Moving to Zero-Burden Tax Regime

Posted: 08/2000

Moving to Zero-Burden Tax Regime
By George Abi-Esber

Telecom services are generally subject to a multitude of transactional taxes as well as complex and burdensome sales and use tax administration systems. In addition to the 45 states (and the District of Columbia), more than 7,500 local jurisdictions impose sales and use taxes. That number jumps to more than 20,000 when jurisdictions imposing specific telecom transaction taxes, such as emergency 911 charges, are included.

Most of these jurisdictions apply nonuniform laws and regulations regarding the imposition of these taxes. Burdensome compliance requirements for multistate retailers formed the underlying rationale for the nexus rule that the U.S. Supreme Court adopted in the National Bellas Hess, Inc. v. Department of Revenue and Quill Corp. v. North Dakota decisions. The nexus rule protects remote sellers and service providers from the duty to collect sales and use taxes in states where they do not have physical presence, such as offices or sales representatives, in those states.

Now, the advance of the Internet and electronic commerce–of which telecom transactions are the largest part–are prompting a wholesale evaluation of
the complexity of the sales tax system and momentum toward simplification.

Shifting Tax Base

States and local government fear that their sales tax revenue bases, which form the largest percentage of their overall tax revenue, will be seriously compromised by electronic commerce. Consumers are increasingly shifting their buying from brick-and-mortar retailers that are required to collect sales taxes to Internet merchants that generally are not. Businesses, on the other hand, fear that states might adopt new taxes specific to the Internet that would unduly impede the growth of the Internet.

These fears led to the formation of the Advisory Commission on Electronic Commerce
(www.ecommercecommission.org), which Congress appointed in October 1998 to study the taxation of Internet activities.

As soon as the Advisory Commission embarked on its mission, it realized that the taxation of Internet activities could not be addressed without considering the separate sales and use tax systems in the United States in their totality.

For that reason, the commission considered many models for reforming and simplifying the state and local sales tax systems. A proposal by the National Governors’ Association (www.nga.org) for “The Streamlined Sales Tax System for the 21st Century,” also known as the zero-burden tax system, was one of the simplification models that the commission considered.

The Advisory Commission, however, reached the end of its term without garnering the required supermajority agreement to send its recommendations to Congress. The zero-burden system, however, took on a life of its own, becoming the focal point of the state and local government simplification efforts.

Simplification Proposal

The NGA proposal set out the general blueprints of the zero-burden tax system. Essentially, the proposal attempted to minimize the costs and burden of sales tax compliance for sellers to as close as possible to zero through the combination of the following:

* Employing technology to shift sales tax administration to a trusted third party (TTP) that takes on the responsibility for calculating, collecting, reporting and paying the tax;

* Simplifying the sales and use tax laws and administrative procedures in key areas; and

* States assuming responsibility for the cost of creating the technology-based system and the costs of integrating the TTP’s system to the accounting systems of sellers.

The key feature of the simplified system is that sellers have the choice of whether or not to participate in the technology-model part of the system. The key player in the system would be the
TTP, which would employ a cluster of processes and services that would include a certified tax engine and financial payment services.

Illustration: A Technology Model for Simplifying Sales Taxation

A merchant that would use a TTP would channel each sale inquiry or each completed transaction to the TTP who would use the tax engine component of its system to determine, inter alia, the applicable jurisdiction(s), taxes, tax rates, exemptions, and special maximum tax rules, if any. Then, the TTP would send the tax information output back to the seller for price display or invoicing purposes.

If the sale or transaction was completed, the TTP would use its financial payment processes to extract the tax owed at the time of the transaction from the customer’s available fund accounts (e.g., the customer’s credit card account). In the case of a cash transaction over the counter, the merchant would have to establish a fund account that the TTP would debit when tax is calculated on such transactions. Subsequently, the TTP would deposit the money in a trustee account for future remittance or would remit the collected tax directly to the state. The TTP would have to maintain records of all completed transactions with their relevant tax information for future transmittal to the state (see “A Technology Model for Simplifying Sales Taxation” diagram, page 98).

Under the NGA proposal, if the retailer uses a TTP, then the retailer would be removed from all audit responsibilities, except for periodic “system checks” sufficient to ensure that the seller is sending the appropriate information to the TTP. The proposal expects multiple TTPs to be certified by the states.

The NGA proposal also envisioned a set of strategic administrative simplifications that would assist not only the TTPs in executing their tax administration functions, but also sellers and service providers who choose to continue to fulfill their tax administration obligations following current practices.

Some of the simplification aims of the proposal include:

* Uniform product and service classifications and definitions;

* Uniform sourcing rules for multijurisdictional transactions; and

* Uniform procedures for the administration of exempt certificates.

Streamlined Sales Tax Project

The National Conference of State Legislatures (www.ncsl.org) succeeded the NGA in championing the Streamlined Sales Tax System. In January, the NCSL drafted model legislation for adoption by the states that authorized departments of revenue to:

* Enter into discussions with states regarding the development of a multistate, voluntary, streamlined system for sales and use tax administration; and

* Participate in a sales tax pilot project with other states and selected businesses to test means for simplifying sales and use tax administration.

Nineteen states have adopted the NCSL model either by legislative or executive action, and more states are expected to join them. Out of these legislative actions, the Streamlined Sales Tax Project
(www.streamlinedsalestax.org) was formed. The project’s mission and goals trace the general guidelines of the NGA proposal for a simplified tax administration system that integrates technology solutions with key procedural and administrative simplifications. The project already has met three times and approved the formation and implementation of a voluntary pilot project to test the TTP model, also referred to as the Certified Service Provider model.

Kansas, Michigan, North Carolina and Wisconsin are the first states to test the TTP Model. On June 16, North Carolina issued a Request For Proposals (RFP) (see IPS Bids at
www.state.nc.us/PandC/) to all parties interested in performing the functions of the
TTP. More than one entity may be awarded contracts to become TTPs under the RFP. The first live test of the concept is expected to take place in October 2000.

The results of the pilot project, which will run through October 2001, will be used to refine features of a national streamlined system. A RFP for the national system is expected to be issued in about nine to 12 months after the start of the pilot.

Strategic Aims

After more than four decades of complex sales and use tax systems, state and local governments are acting very swiftly to find nationwide simplification solutions to these systems. The reason for this swift action is the increasing interest and efforts of Congress, in the last three years, to curb the states’ power to tax aspects of Internet activities. The stated grounds behind these congressional efforts have been to protect the growth of electronic commerce from the undue burdens of the complex state and local sales tax systems.

The congressional efforts have culminated in a number of bills, such as The Internet Tax Reform and Reduction Act of 2000 (H.R. 4267), which would enact restrictions on the states’ power to tax Internet access services, digital goods and their nondigital counterparts for the next six years and would create new nexus havens for remote sellers.

States are fearful that the increased congressional involvement in this area would seriously undercut their ability to raise tax revenue and will undermine their sovereignty. Forty governors signed a letter to Congress stating that the states will lose more than $30 billion a year if the bill exempting digital goods and their digital counterparts is passed.

Thus, with the Streamlined Sales Tax Project, they are trying to evidence to Congress that they are more serious than ever about simplifying their tax systems and that Congress’ action would be unnecessarily harmful to their interests.

In the long run, the states are hoping that if they reach a sufficient level of uniformity and simplification, they would have a better chance of overturning the Hess-Quill line of decisions and of replacing the physical presence rule with an economic presence rule. Under the economic presence rule, remote sellers and providers would be required to collect sales and use taxes only if the total amount of their annual sales into a state is above a certain threshold.

In the next two years, states’ efforts to simplify the sales tax administration will intensify. During that period, Congress is expected to be slow in imposing any major limitations on the states’ power to tax existing goods and services. In the meantime, the Streamlined Sales Tax Project will have ample time to advance key concrete simplification proposals and the ability to test the workability of the TTP model of the zero-burden tax system.

George
Abi-Esber, Esq., is the manager of tax research at TAXWARE International Inc. (www.taxware.com). Abi-Esber’s course,
“E-commerce: Special Taxation Issues,” sponsored by the Center of Professional Education, is being taught around the United States. He can be reached at
georgea@taxware.com.