Shopping the Internet tax-free may soon be a luxury of the past.
This story first appeared in the June 20, 2011 issue of WWD. Subscribe Today.
A string of states is pushing legislation to require online sellers to collect sales taxes, while the U.S. Congress also may enter the fray as soon as this month with a bill to do the same. The controversy surrounding the issue pits Internet-only retailers, and other so-called “remote sellers” like catalogue companies, against traditional brick-and-mortar storefronts, including those with e-commerce sites that typically are required to collect sales taxes in states in which they have stores.
The controversy often is misidentified as being focused on small Main Street retailers struggling against e-commerce behemoths. However, large multistate stores are on the side of small retailers in complaining that they are at a competitive disadvantage when consumers calculate the added cost of sales tax before shopping with tax-free, Internet-only Web sites.
“It’s a very unfair advantage that online sellers have — an 8 to 10 percent cost benefit right up front,” said a chief executive officer of a major chain, who requested anonymity. “It hurts employment in states where there is an investment in shopping malls and brick and mortar and will continue to erode the tax bases of every state in America who are now losing sales tax to online sellers who don’t have any stores.…Congress needs to wake up to this issue. The world has changed. There has to be a level playing field.”
By some estimates, uncollected taxes from all online sales could total more than $10 billion a year nationwide.
A 2009 University of Tennessee study concluded that next year state and local governments are projected to miss out on $11.4 billion to $12.65 billion in sales taxes uncollected from e-commerce sales.
U.S. e-commerce sales among all retailers in 2012 are forecast to be $217.5 billion, up from this year’s projected $197.3 billion and an increase from $176.2 billion in 2010, according to Forrester Research. In contrast, in 1998 Internet sales were $5.5 billion, the first year the research firm has data. Additionally, as online sales have grown, so has their share of retail spending, which in 1998 was only 0.47 percent. This year, the Internet’s retail share is expected to be 9 percent and by 2015 increase to 11.1 percent, according to Forrester.
But some retailers even see a larger issue stemming from the tax question. Because online retailers can beat the sales tax, they can run bigger sales. “All the brands online are on sale,” said one senior official at a specialty chain. “It’s killing other businesses. This is a much larger issue than just the sales tax.”
Even Wal-Mart, which has a vibrant e-tailing operation, is siding with those seeking to tax online purchases. “Online-only retailers have long held a very unfair tax advantage over brick-and-mortar businesses, but the loophole has been closed and Arkansas businesses can now compete on a fair and level playing field,” said Steve Nave, senior vice president, walmart.com, after Arkansas passed sales tax legislation.
States struggling to balance their budgets are seeking additional revenue sources and are pushing legislation to require online sellers to collect sales taxes where they have a physical presence, or a “nexus,” such as a warehouse, call center or headquarters, or where an affiliate has one. It’s a reversal from a decade ago when states were loath to impose taxes on Internet companies fearing that would impede the sites’ growth.
“It’s not surprising that states are trying to figure out how to generate additional tax revenue. You have to recognize that they have serious challenges in balancing their budgets. But it really pays to tread lightly here,” said Paul Hurley, ceo of Ideeli. “It’s supercomplicated. One of the dangers with legislating technical progress is it’s very easy to stifle businesses that depend on technology and the Internet. For want of a little bit of tax revenue, you could stifle a whole industry.…Interstate commerce is generally legislated by the federal government, and the right place to legislate this issue is at the federal level and even there, it’s going to be complicated.”
Added Overstock.com ceo Patrick M. Byrne, in comments published on the company’s Web site after a Connecticut law was enacted: “It is unconstitutional for a state to pass a law making out-of-state retailers collect sales tax simply for having business relations with marketing affiliates in those states.”
Congress is poised to consider legislation, although previous attempts haven’t progressed much in more than a decade. Assistant U.S. Senate Majority Leader Dick Durbin (D., Ill.), is expected to introduce a measure as early as this month that would give states the authority to require all retailers to collect sales taxes in the 45 states and District of Columbia where the tariffs exist, according to a spokeswoman for the lawmaker.
While giving states the authority to require universal retail sales tax collection, the Durbin bill also aims to simplify state and local sales tax systems. Retailers support simplification also as a means to lower their out-of-pocket costs to collect and remit. There is now myriad thousands of state sales tax schemes with which to comply.
Durbin proposes that before being allowed to collect sales taxes, states would have to belong to the Streamlined Sales Tax Project, started in 1999 as a joint state and business effort. The Durbin bill would also provide a way to compensate retailers for the cost of collecting and remitting sales taxes to states, according to an outline of the bill.
“Federal legislation is the only way to fix this,” said Frank Julian, vice president-tax counsel with Macy’s Inc., which like other traditional retailers with e-commerce sites, collects sales tax in states where stores are located.
Key to effective legislation, Julian said, is having truly simplified state sales tax systems, which he said hasn’t happened with the Streamlined Sales Tax Project. Although two dozen states have been certified by the project, Julian said complexities still persist. For example, he cited varying treatment among states of how apparel — and which kind — is taxed.
“Unfortunately, a lot of time and effort has been put into the process both in the government and business side,” Julian said of the streamlining effort. “The goal hasn’t been achieved.”
And there are lots of legal hurdles to overcome, both at the national and state levels. In Texas, for example, a bill aimed at compelling Amazon to collect taxes was vetoed by Gov. Rick Perry, who said he would prefer to first do a thorough investigation involving consumers, retailers, online companies and technology experts to determine policy regarding the sales tax.
California has a bill in play compelling online retailers with a physical presence, or with an affiliate with a physical presence, to collect sales taxes. And New York State passed a bill in 2008, while Connecticut OK’d one last month. There are legal challenges to tax statutes in New York, Colorado and Illinois.
Legal challenges being raised involve Congress’ constitutional power to regulate interstate commerce as well as setting a standard for when retail businesses have enough of a physical presence in states to be forced to collect sales taxes.
The last word nationally on state sales tax collection was a 1992 U.S. Supreme Court decision, Quill Corp. v. North Dakota. It’s a case involving a Delaware office supply company that at the time had $1 million in annual sales in the state, where its customers used software to track product availability and each year received 24 tons of catalogues and flyers in the mail. State officials ruled Quill had to collect sales taxes because it regularly solicited business in the state.
However, the Supreme Court ruled that in order for sales tax collection to be required, a company had to have a physical presence. Furthermore, the court noted that Congress has the purview to define physical presence for states and otherwise set state sales-tax collection requirements.
Lacking a national standard, states have sought to define physical presence — aside from the location of stores — to include distribution centers, showrooms, subsidiaries, independent sales representatives, advertising flyers and computer databases, as well as marketing affiliates.
While state bills have worked to raise the awareness of the issue, congressional action is sorely needed to bring uniformity and end the piecemeal debate, said Maureen Riehl, vice president and government relations counsel with the National Retail Federation.
The NRF is focusing on garnering Capitol Hill support for a Durbin sales-tax bill as a vehicle for change. “He’s got a big job,” Riehl said, of the expected debate and difficulty of passage with a presidential election year approaching.