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Internet Taxation Themes Legal Research, Issues, and Practice Cyberspace Cyrus Daftary & Todd Krieger March 31 st , 2014

Internet Taxation Themes

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Internet Taxation Themes. Legal Research, Issues, and Practice Cyberspace Cyrus Daftary & Todd Krieger March 31 st , 2014. Agenda. Tax Policy ‘Net’ Tax Themes Practical Tips – Ways to Present Arguments Questions & Answers. Taxation on the Internet. - PowerPoint PPT Presentation

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Page 1: Internet Taxation Themes

Internet Taxation Themes

Legal Research, Issues, and Practice Cyberspace

Cyrus Daftary & Todd Krieger

March 31st, 2014

Page 2: Internet Taxation Themes

Agenda

Tax Policy ‘Net’ Tax Themes Practical Tips – Ways to Present Arguments Questions & Answers

Page 3: Internet Taxation Themes

Taxation on the Internet

The taxation rules currently in force do not

take into account the technological progress in the delivery of services and changes that are necessary in order to prevent loss of tax revenue and distortion of competition.

Page 4: Internet Taxation Themes

Tax Policy - in the 18th Century

In the 18th century Adam Smith articulated the following four principles of taxation as follows:

• Equality

• Convenience

• Certainty

• Economy

Page 5: Internet Taxation Themes

Tax Policy – Following the Great Depression

Sales tax was enacted during the Great

Depression to boost state and and local government revenues.

In 2012, it accounted for 33% of all state and local revenues generated – estimated to be valued in excess of $194B.

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Tax Policy – Today Reduce tax burden Simplify compliance National sales tax Flat tax Obama tax reduction / increase

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Taxation and Jurisdiction

In the U.S. there are 7,600 taxing authorities comprised of states, cities, towns, counties, transportation districts and other special local jurisdictions that impose tax for transactions that occur within their boundaries. • States - 46

• Cities - 4,696• Counties - 1,602• Other jurisdictions - 1,113

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Why Do We Have Taxes?

Fund Social Security, highways, healthcare, education, public safety, defense, war, social services (i.e. food stamps, housing), etc.

Should we tax the Internet sales?US e-commerce sales in 2013 were estimated

to be $450B compared to $225B in 2012. Apple’s App Store generated $10B in revenue

in 2013 compared to $9B in 2012.

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Core Tax Concepts

Indirect and Direct Taxation Nexus:

Sufficient connection with a state to allow taxation

Situs:

Location of the transaction

Permanent Establishment:International standard for taxable presence

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Nexus Taxable presence for state taxation embodied within the “Nexus”

concept Definition of Nexus

- Level of activity in a state that must occur before tax can be imposed

- Sufficient activity or “Nexus” is defined by statute and federal and state court decision

• Rules vary from state to state• Level of activity required to assert Nexus varies by the type of tax (e.g. income tax, sales & use)

- Nexus generally exists if: • Income is derived from sources in the state • Property is owned or leased in a state • Personnel are employed in a state • Capital or property is located in the state

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NexusThe 2000 State Tax Survey

Purpose of Nexus is to justify levying a tax. • Problem – No consistent application of meaning

“Substantial Nexus” – Significant physical presence.

“Economic Nexus” – No universal definition.• Concept evolved after Geoffrey case in 1994.• Ambiguities as to meaning.

• Economic connection and/or activities for a period of time as opposed to physical presence.

Page 12: Internet Taxation Themes

Nexus - Basis for Sales Tax

Quill Corp. v. N. D. (U.S. Supreme Court 1992) In an attempt to assert a use tax collection responsibility on mail

order retailers, some states enacted statutes that defined “retailer” or “vendor” to include those who solicit sales in such a manner that a state’s market is systematically or purposefully exploited.

However, the Supreme Court determined in Quill that the Commerce Clause barred North Dakota from requiring an out-of-state mail-order company to collect and pay use tax on goods sold to state residents when the company had no outlets, sales representatives, or other significant property in the state.

Quill thus established a bright-line rule that allows a state to require out-of-state mail-order companies having a physical presence in the state to collect a use tax, but does not require those who communicate with customers in the state by mail or common carrier to collect such tax.

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Quill Summary & Application

Under Quill, a company must have a “substantial physical presence” in a state before that state may require it to collect and remit sales/use tax.

Attribution, Affiliate NexusActivities and presence of an affiliated corporation in a

state can be attributed to a separate legal entity for the purpose of establishing Nexus

“Bricks-and-clicks” In-store advertisements for website, or vice versa Website coupons for in-store sale items, or vice versa Return of items purchased through website to bricks-and-mortar

location

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Situs

Situs of the transaction – question is to identify where a transaction occurs

eCommerce transactions are typically thought of as the most difficult to situs

• Situs rules vary by jurisdiction

eCommerce transactions are generally considered to be services and are typically sourced in one of the following ways:

• State of origin (location where service is performed) • State of destination (location of the customer) • Proration (based on use of service in multiple states) • State of predominate use

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Permanent Establishment Taxable presence in the international tax context refers to

permanent establishment (“PE”) or U.S. trade or business. Tax treaties define PE as the carrying on of the

business of the enterprise through a fixed place of business.

PE generally exists if: Place of management or branch office Factory or mine Activity not remote from the actual realization of profits

In the absence of a treaty, IRC defines taxable presence as “US trade or business” Income effectively connected with a U.S. trade or business subject to

U.S. Tax Level of activity must be considerable, continuous and regular

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Debates over Internet Taxation

Sales and use tax system VAT system Income tax system Collection & enforcement

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Sales and Use Tax Erosion of a state’s tax base for shifts in spending patterns pitted

against states that can benefit from income tax collected from Internet firms.

In NY, Amazon.com is not subject to NY’s 8% sales tax but Barnes and Noble is subject to the sales tax. It effectively discounts Amazon.com’s prices by 8%.

Examples: CT phase out on computer and data processing services S&U tax FL does not tax charges on online services MA repealed sales tax on Internet services NJ does not tax charges on online services OH taxes Internet services as taxable information services TX taxes Internet services as taxable information services or data processing

services

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VAT

VAT is a tax collected at every stage of product. When products cross international boundaries, a complicated set of issues arise: Who collects the tax? Who remits the tax? What country does the ultimate consumer live in?

Destination country or residence of the consumer keep the tax?

Page 19: Internet Taxation Themes

International Taxation

International taxation based on principles of territory or “connection” with a jurisdiction

What creates jurisdiction? Location of server? Deriving income from a jurisdiction? Where is the

customer? Where to book the transaction? Shift profits

freely? What type of income generated? How to determine the transfer price?

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International Tax Advantages for Technology Companies

Technology companies have more intangible assets than brick-and-mortar counterparts

Allows for greater flexibility in setting up company structure

Can defer U.S. tax indefinitely until it is brought back into the country

Apple legally allocates about 70% of its profits overseas

Google pays an effective tax rate of 2.4% overseas

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Compliance & Enforcement

Lack of paper trail Conversion of tangible to intangible Electronic cash technology eliminates identity

and promotes concealment What constitutes books and records?

Page 23: Internet Taxation Themes

Tax Policy on the Internet

Foster growth and innovation yet achieve

fairness.

Some people believe that taxation of Internet transactions will stifle the growth of e- commerce; some feel the Internet continues to threaten brick and mortar companies and many will no longer be around.

Page 24: Internet Taxation Themes

U.S. Fed Tax Policy on the ‘Net’

On July 1, 1997, the White House issued a “White Paper” that declared “the United States believes that no new taxes should be imposed on Internet commerce.”

The White House took the position in the White Paper that “the same broad principles applicable to international taxation … should be applied to sub-federal taxation. No new taxes should be applied to electronic commerce, and states should coordinate their allocation of income derived from electronic commerce.”.

Page 25: Internet Taxation Themes

Internet Tax Freedom ActITFA – Internet Tax Freedom ActNo federal taxes placed on Internet access or E-Commerce for three years while restricting individual states from enacting new taxes on E-Commerce

Three Year Moratorium • Internet Access • Multiple or Discriminatory Taxes

Advisory Commission on Electronic Commerce • 19 members

8 state/local government8 business/consumers3 federal executive branch representatives

Page 26: Internet Taxation Themes

Internet Tax Freedom Act (cont’d)

Two of the fundamental purposes of ITFA were to ensure the continued growth of the Internet and to prevent multiple or discriminatory taxes which could potentially stifle the growth of E-Business.

The highlights of ITFA included:

No federal taxes on Internet access or E-Commerce; Declared that the Internet should be a tariff free zone; Established an advisory commission – the Advisory Commission on Electronic Commerce; Three year moratorium on multiple or discriminatory taxes on E-Business; and Three year moratorium on new taxes on Internet access fees.

Page 27: Internet Taxation Themes

Internet Tax Freedom Act (cont’d)

There were numerous complicated tax issues surrounding E-Business transactions such as selling and distributing software on the Internet that ITFA / ACEC could have helped address. Some of the issues included:

Who is the customer?

Where does the customer live?

Was the transaction a sale of tangible property, services, or intangible property?

Which jurisdiction has the authority to tax the sale?

What on-line activities constitute sales for sales tax purposes?

When may a state impose a sales or use tax on on-line activities?

What constitutes nexus (a taxable level of business activity) within a taxing jurisdiction?

Page 28: Internet Taxation Themes

Extending the Moratorium

President Bush signed into law S. 150 on 12/03/04 – the Internet Tax Non-Discrimination Act which extended the Moratorium until 11/01/07. President Bush signed into law the Internet Tax Act Freedom Amendments Act of 2007 (H.R. 3678) which extended the moratorium seven more years.

Intent was for the U.S. to work aggressively through the EU and WTO to keep electronic commerce free from tariffs and discriminatory taxes – as well as avoid federal taxes.

Page 29: Internet Taxation Themes

What’s Next

Debate as to whether or not to permanently extend the extension on the Moratorium. (Expires 11/1/2014)

With the current economic state, Obama’s economic stimulus – tax dollars are needed.

Are ‘Net’ taxes a good or bad thing? What do you think the impact will be? Who benefits and loses?

Streamlined Sales Tax Project Marketplace Fairness Act of 2013

Page 30: Internet Taxation Themes

Sales Tax Overview In the United States, the primary transaction tax that is

charged on the sale of goods and sometimes services is the sales tax.

Sales taxes are imposed by state and local governments and are charged to the consumer, but they are collected and paid by the vendor.

An exception to this rule exists when the vendor does not have a physical presence in a state.

In this case, the consumer is responsible for the sales tax payment (known as a use tax). Internet sales use tax valued at $3.5B in 2010.

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Sales Tax Overview

The growth in electronic commerce allows companies to make retail sales directly to consumers through the Internet.

Forty five states and the District of Columbia impose a sales tax upon retail sales of tangible personal property and enumerated services.

The obligation to collect, report and remit sales tax falls upon the selling company if it has Nexus with the taxing state.

The average sales tax rate throughout the country is approximately 6%.

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Sales Tax Collection in the US

Page 33: Internet Taxation Themes

Sales Tax Challenges

Business distortions caused by sales taxes Amazon v. B&N

Consumers of companies with a small tax footprint may be able to purchase tangible personal property and enumerated services at a lower total cost.

Accordingly, these companies enjoy a competitive advantage in the marketplace over companies that are required to collect, report and remit sales tax.

Page 34: Internet Taxation Themes

What is SSTP?

A group of representatives from 44 states met to develop a Model Act for a uniform sales and use tax act – went into effect 10/1/05. See (http://www.streamlinedsalestax.org/)

Project started through suggestion of ACEC and National Governors Association

Mission: develop measures to design, test and implement a sales and use tax system that radically simplifies sales and use taxes (uniform tax bases, sourcing rules, rates).

Focus: improving sales and use tax administration systems for both Main Street and remote sellers for all types of commerce.

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Motivation for SSTP

“We can no longer rely on a Depression-era sales tax system in a digital, 21st century economy and we can’t expect Congress or the Supreme Court to bail us out of the mess we’ve created. Cooperative state action to simplify state and local sales taxes may be the only way to save them.” - Illinois Senator Steve Rauschenberger, former co-chair of the NCSL task force.

“Our revenues are not keeping up with economic growth, so we face a budget shortfall while most other states enjoy surpluses. One reason is that the sales tax base just keeps shrinking. Electronic commerce will only make that problem worse.” - Tennessee Representative Matthew Kisber

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States Participating in SSTPParticipating

States (32)AlabamaArkansasIllinoisIndianaIowaKansasKentuckyLouisianaMaineMarylandMichiganMinnesota MississippiMissouriNebraska

New JerseyNevadaNorth CarolinaNorth DakotaOhioOklahomaRhode IslandSouth CarolinaSouth DakotaTennesseeTexasUtahVermontWashingtonWest VirginiaWisconsinWyoming

Observer States (6)

California

Colorado

Connecticut

Georgia

Idaho

Pennsylvania

Page 37: Internet Taxation Themes

Marketplace Fairness Act (“MFA”)

Each state in the US may impose a sales tax on products or services sold in that state.

The Hess and Quill Corp cases concluded retailers, including catalog and online sellers, only need to collect sales and use tax for states where they have a physical presence. Therefore, if an online retailer does not collect sales tax at the time of purchase, the consumer must pay the use tax due directly to the state.

Business compliance with use tax filing is relatively high, consumer compliance is not.

Residents of the 45 states with sales and use tax are required to pay tax for their online purchases.

MFA seeks to increase compliance by shifting the responsibility for payment from consumers to retailers.

Page 38: Internet Taxation Themes

MFA – Background

Goal of MFA is to allow individual states to collect sales and use taxes from retailers with no physical presence in their state.

MFA was re-introduced on February 14, 2013 (a previous version had been introduced in November 9th, 2011).

MFA passed the Senate on May 6, 2013 There is a Small Seller Exception. Essentially a retailer must

have less than $1MM of total remote sales (in the United States) within the preceding calendar year.

See http://www.marketplacefairness.org/ MFS is not law yet – but more than likely will be one day.

Page 39: Internet Taxation Themes

MFA – Background (cont’d)

MFA has a number of supporters and opponents Supporters – MFA is fair as it taxes both bricks and mortars and

online retailers Opponents – Concerned MFA give the federal government too much

power in state and local government tax affairs

MFA will clearly level the playing field between brick and mortar retailers and online retailers Best Buy vs Amazon Create better competition

Forecasted to generate $22B to $24B in annual sales tax revenue

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Conclusion Companies must rely on existing statutes and

case law developed when commerce was dependent on ‘bricks and mortars’.

States are hurting and there is enough evidence showing competitive inequalities.

Internet retailers will be required to collect sales tax in the coming years.

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Ways to Argue

Facts & Meaning Analogies Framing Devices Legislative History Public Policy

Page 42: Internet Taxation Themes

Question & Answer