Taxing (or Not Taxing) Services is Wrong Focus - How to Improve Sales Tax

The sales tax, used by almost all states, is a consumption tax. Generally, consumption is what the final consumer does.  For example, a company manufactures paper, a greeting card company purchases some of that paper to make greeting cards and sells them to the final consumer or to a distributor who sells them to the final consumer. As the paper or cards move through this supply chain, a sales tax exemption for items purchased for resale prevents sales tax from being charged. The final consumer is the only one who pays sales tax when the card is purchased (reaches the end of the supply chain).

Supply chains and tax systems are not always this "simple" though because not everything a business buys is directly for resale.  A recent case in Kansas found that electricity purchased by Southwestern Bell Telephone, Co. LLC (No. 120,167 (2020)) to help in the delivery of telecommunications services was exempt from sales tax because it was used in this production. A lot of time and effort though went into the determination of whether Southwestern Bell owed sales tax.

A simpler approach is possible and is really part of a proper sales tax system. This approach is that businesses should not pay sales tax on any of their purchases; only the final consumer should pay sales tax.

The Kansas case is just one of many decided every year in addition to ones settled on audit and dealt with by sellers in determining if they should be charging sales tax to a customer. This is a lot of wasted time given that the sales tax should be just on the final consumer. This required element of a sales tax avoids "pyramiding" in the system which occurs when a business pays sales tax and factors that into the price it charges customers leading to tax charged on tax.

There are annual discussions in many state legislatures and by taxpayers and industry associations about not imposing sales tax on services. I think the better focus is on changing the law to tax a broad base of consumption (including services except perhaps for some medical services) and only charging the tax to the final consumer.

This is how a value-added tax (VAT) works. In a pure VAT system (one without lots of exemptions or special rates), everyone pays VAT on all purchases. If that buyer is a business, they get their VAT back. This helps ensure collection by collecting the tax throughout the supply chain. It also prevents the need for a seller to accept an exemption certification from a business buyer and then be liable for the sales tax if it turns out the certificate is invalid.

Will this system work? In theory. In reality, states rely on sales tax paid by businesses so it is hard to replace. But I think a gradual shift to broaden the base, such as to include digital goods that are equivalent of taxable tangible goods (such as iTunes and digital books), entertainment, and personal services will help. Also, not including business purchases in the expansion of the sales tax base. AND, it is important to lower the rate so this is not a tax increase but a tax system improvement effort to make it function better today and in the future. It will also avoid the eroding sales tax base that affects many states today, such as technology allows us to buy non-taxable digital versions of what was previously a taxable tangible purchase (books is a good example).

So, let's eliminate time spent arguing for sales tax exemptions for businesses and expanding tax bases to include more services and instead pursue:

• Prohibiting any sales tax base expansion from applying to items purchased by business (so as not to make the existing pyramiding problem worse).
• Expanding the sales tax base to cover all final consumption with very few exemptions, while lowering the rate. 

What do you think?

California, the CDTFA and the Wayfair Decision

On October 24, 2018, the California Department of Tax and Fee Administration (CDTFA) held an information session on the Wayfair decision's application in California. California's statute says we interpret the commerce clause as is done at the federal level. So that interpretation changed with the US Supreme Court's decision on June 21, 2018 when they found that the longstanding physical presence nexus rule of Quill (1992) is incorrect and unsound.

I attended the hearing.  It was short and the CDTFA provided some helpful information about the application of Wayfair to district taxes in California, and more. They also took questions and comments. I offered a few. The CDTFA was also taking written comments.  Following is what I suggested to the CDTFA in my written comments. My key concern is that if California follows the South Dakota standard, hundreds of thousands (possibly even over 1 million, and all over the world) of remote vendors are going to meet the 200 or more transactions per year due to the 39 million possible customers in California (SD has a population under 1 million in contrast). Thus, the transaction threshold should be skipped and we aim for a sales and use tax system that balances realistic enforcement activity by the CDTFA and the continued need to have California buyers self-assess and pay use tax (which will apply in fewer transactions due to larger vendors meeting the $100K per calendar year threshold).

What do you think (please read on)?

“Retailer engaged in business in this state” as meaning “any retailer that has substantial nexus with this state for purposes of the commerce clause of the United States Constitution” (R&T §6203(c)) must now be interpreted in light of the U.S. Supreme Court’s new commerce clause interpretation as spelled out in South Dakota v. Wayfair, 138 S.Ct. 2080 (6/21/18). This is not an easy task, but a necessary one as the statute needs to be followed.

Key elements of the Wayfair decision:

• The “physical presence rule of Quill [Corp. v. North Dakota, 502 U.S. 808 (1992)] is unsound and incorrect.”
• The physical presence standard should not be the standard for the “substantial nexus,” first part of the four-part test of Complete Auto Transit (430 U.S. 274, 279 (1977)).
• Physical presence is an “arbitrary, formalistic” measure.
• South Dakota’s sales tax collection requirement protects interstate commerce by ensuring “sufficient nexus” based on both “economic and virtual contacts” sellers have with the state. Three features of South Dakota law (S. 106 (2016)) support this:

a.     Safe harbor for limited business activity: South Dakota law only requires remote sellers who annually have over $100,000 of sales of goods or services into the state or 200 or more transactions.

b.     No retroactive application: There is no obligation to remit sales tax for years preceding the effective date of the state’s remote sales law.

c.      A system to reduce administrative and compliance costs: South Dakota follows the Streamlined Sales and Use Tax Agreement (“SSUTA”). The SSUTA requires uniform definitions, state level tax administration, and the provision of compliance software to sellers with audit protection to those who use it.

d. The Court did not find that all remote sellers can be subject to a state’s taxes.

The first two of the three features of South Dakota law are relatively easy to implement. However, the third feature is not so simple and it is not clear how important each feature of the SSUTA is. For example, is it the availability of free, audit protected software to remote sellers? Or are other compliance features possible substitutes?

Another factor to consider is that California with a population of 39.5 million, relative to South Dakota’s population of 870,000, presents an entirely different administrative challenge for the CDTFA. That is, far more remote vendors will meet the 200 or more transactions in a year in California than in South Dakota. These sellers are not only located in the U.S. but outside of California, but also outside of the United States. For example, Amazon’s Fulfillment by Amazon (FBA) program, Shopify and eBay serve sellers from outside of the U.S. It would be very easy for a vendor selling socks, books, holiday decorations, or other tangible items to have 200 customers in a year in California. In addition, other sales sites including crowdfunding sites where emerging businesses provide tangible goods to funders, can easily become “retailers engaged in business” in California under the limited business activity thresholds of South Dakota law that were reviewed by the Court.

The significant number of vendors that would be subject to sales tax collection in California under the South Dakota thresholds raises at least two challenges:

1)     Possible litigation under the commerce clause that the burden of compliance with California and other state tax laws is an undue burden on interstate commerce. While the Court did uphold the South Dakota law, the retailers involved in the litigation all had annual revenues exceeding $1 billion. The Court did not consider that the 200-transaction threshold could apply to vendors with far less than $100,000 annual sales in a state. In its amicus brief, Etsy states that in 2017, 1.9 million businesses using its site generated $3.25 billion of gross sales. This averages $1,711 per seller. Many of these sellers though, could easily have 200 or more transactions in states with large populations such as California. This litigation possibility is not unique to California but could arise in any state.

Application of the 200-transaction threshold without the SSUTA features or SSUTA-type features might also lead to litigation on the basis that the state’s broadened nexus reach violates the commerce clause and is not in line with the Supreme Court’s new nexus interpretation.

2)     Can the CDTFA effectively administer sales tax administration for hundreds of thousands of remote vendors that would meet the 200-or-more-transaction threshold and treat such “retailers engaged in business in this state” similar to retailers physically present in the state? Also, is this significant task an appropriate use of resources considering the ability to continue to collect use tax from in-state buyers who are not charged sales tax by a seller? The Wayfair decision does not eliminate the need to continue to enforce use tax laws against in-state buyers as not all sellers will meet sales tax collection requirements under the South Dakota thresholds.

New sales tax collection obligations for vendors requires vendors to make possibly significant changes to be ready to calculate, collect and remit the sales tax. Software is likely needed that needs to be integrated into existing recordkeeping and sales software. Vendors may need to seek assistance from tax advisers which requires time in finding an adviser and ensuring everything is properly in place so that collection and remittance can be performed correctly and efficiently. Thus, when the CDTFA announces a date for when its interpretation of Revenue and Taxation §6203(c) in light of the Wayfair decision is effective, there should be sufficient lead time (likely 90 days minimum) before any vendor is required to start collecting and remitting. Vendors need time to review sales of the past calendar year and current calendar year to see if they even meet the specified thresholds.

Similarly, going forward once a vendor crosses the collection thresholds, they should be given 60 to 90 days before they must start collecting, for the reasons noted earlier.

Also, changes in the responsibility of in-state vendors to start collecting district taxes in districts where the vendor meets the CDTFA threshold requires lead time to review past records and get a recordkeeping system in place to track where and when a vendor has new district tax obligations.

Finally, consumers may think that the Wayfair decision and the announcement of how the CDTFA will modify the interpretation of R&T §6203(c) in light of that decision, means that use tax is no longer required. Thus, it will be important to clarify this for both individual and business buyers so they know they still have use tax reporting and payment obligations when they are not charged sales tax on taxable items.

Additional Information:

• National Conference of State Legislators (NCSL).“Principles of State Implementation after South Dakota v. Wayfair” (6/29/18).
• Nellen, “A Wayfair Whirlwind of Stakeholder Considerations – Part 1,” State Tax Notes, 10/15/18; and Part 2, forthcoming.
• “Is There a Fair Way Forward after Wayfair?  Assessing the Effect in California of the United States Supreme Court’s Recent Decision,” Joint Informational Hearing of the Assembly Committee on Revenue and Taxation and Senate Committee Governance and Finance, 10/15/18; outline of Nellen testimony.
• Nellen, 21^st Century Taxation blog, “State Reactions to Wayfair Decision”.

Are California taxes high?

California State Sales Tax Rate Breakdown. Most cities also have sales tax making the total rate higher,
such as 9.25% in San Jose.

Are California's taxes high? I was asked this question recently by a reporter with Politifact California. Assemblymember Travis Allen who is running for governor had stated that California had the highest taxes. His website says that California has the highest personal income tax and state sales tax rates. [Chris Nichols article of 7/11/17]

If just looking at the rate structure, those are correct statements. The Federation of Tax Administrators posts helpful and current tables of the PIT and sales tax rates among the states.

So far as the California personal income tax though, less than 5% of individuals are at the highest rate of 13.3%. Many Californians owe little or no state income tax because the exemptions in California are fairly high.

But, everyone pays the sales tax, directly and indirectly.

When a state has high tax rates, it is due to two possible reasons (and perhaps both at the same time):

1. A narrow tax base
2. Lots of spending

A narrow tax base is certainly the reason for California's high sales tax rate. We only tax tangible personal property and then not even all of that. We tax almost no personal services, entertainment or digital goods. This also makes the tax system inequitable, non-neutral and inefficient because the exempt consumption tends to be that of higher income individuals.

What do you think?

Top Ten Items of Tax Policy Interest for 2015 - #3

 

Continuing with my list of ten news items and activities from 2015 that I think have particular tax policy relevance.  Today, for my third item is Justice Kennedy's concurring opinion in Direct Marketing Association v Brohl, Exec Dir, Colorado Dept of Revenue, No. 13-1032 (3/3/15). In this opinion, Justice Kennedy posits that perhaps given “changes in technology and consumer sophistication,” it is time to revisit the Court’s 1992 decision in Quill, 504 U.S. 298! He also noted that Quill was a case “questionable even when decided, [that] now harms States to a degree far greater than could have been anticipated earlier.”  This is a major item for 2015. It is really an invitation to any and all states with a sales tax to send a bill to a remote (non-present) vendor and hope that the vendor will challenge the assessment all the way up the administrative and judicial review process to land on the US Supreme Court's agenda.

This is what North Dakota did a long time ago when it challenged the Bellas Hess decision of 1967 arguing that physical presence as a sales tax nexus standard was out of date. While North Dakota lost, the Court did clarify that for Due Process purposes (14th Amendment), a physical presence was not required, just a purpose to establish a market in the state ("if a foreign corporation purposefully avails itself of the benefits of an economic market in the forum State, it may subject itself to the State's in personam jurisdiction even if it has no physical presence in the State"). But, the Court said for commerce clause purposes, a physical presence was required before a state could impose sales/use tax collection obligations on a remote vendor. The Court also noted that since Congress controls the commerce clause, it could provide a different result it it wanted to. States have been hopeful for over 20 years since but without any enacted legislation, will certainly take up Justice Kennedy's call to action and pursue a repeat of the steps that led to Quill, although the states are hoping the Court will cut back on the physical presence standard in some way.

At least one state so far has accepted Justice Kennedy's invitation. Alabama has new regulations that go into effect for sales on or after 1/1/16 requiring vendors with a substantial economic nexus in the state to collect sales/use tax from customers. One of the requirements for substantial economic nexus is "retail sales of tangible personal property sold into the state exceed $250,000 per year based on the previous calendar year’s sales."

Let's see what happens and what other states follow Alabama's lead.

What do you think? 

My list so far of news and activities of 2015 with tax policy relevance (no ranking involved):

1. Congress can alter out tax system via a lot of non-tax bills - here
2. IRS funding challenges - here

Sales Tax as a Penalty?

A proposed California initiative may surprise you.  It calls for a 1000% sales tax on "political advertisements."  This certainly sounds like a penalty. It raises constitutional issues (free speech, for example).  See more at post below originally posted at SalesTaxSupport.com.

In California, it is not uncommon for tax proposals to appear on voter ballots through the initiative process. In fact, voters in California have even voted on whether income should be apportioned using three factors or a single sales factor (single sales factor won - Prop 39 of 11/6/12). An "active measure" posted the the California Secretary of State's Office that caught my attention calls for a 1000% sales tax on "political advertisements" (15-0106). More specifically, it says it is imposed on the "privilege of influencing public elections and political issues." While the proposal provides that exemptions are only as federally required, there is an exemption specified for the first $1 million of spending in a calendar year. In measuring this threshold and what the tax applies to, both cash and bartering transactions are considered. The proceeds of the tax are earmarked for public education.

So, why a 1000% tax? It certainly sounds like the purpose is to limit such advertisements. If the purpose were solely to get more funds for education, then the normal sales tax could apply, but the funds earmarked for public education (not a good idea). What is the normal sales tax for political ads? Per California Sales Tax Reg 1541(b)(1), "The production of printed matter for a consumer is a sale of tangible personal property whether the materials incorporated into the printed matter are furnished by the consumer or the printer." Thus, they are subject to sales tax. But the services of an advertising agency in designing ads is generally a tax-exempt service. But issues can come up if the end product is transferred in tangible rather than digital form or there is bundling (Reg. 1540(b)(1)).

It is not clear if the proposition intends to expand the current sales tax to include the development of political advertisements, or just change the applicable tax, such as for printed ads, from the normal (roughly 9%) to 1000%.

The California Legislative Analyst's Office analysis (10/28/15) notes in its short analysis of the proposal that there are "many legal uncertainties" as the proposal would limit forms of political communication and that the fiscal effect is "uncertain."

Beyond just determining if the intent is to broaden the base of the sales tax for political ads or just tax printed ads at 1000%, there is a constitutional issue as to whether this proposal impedes free speech under the First Amendment of the U.S. Constitution? There are a few cases on this. For example, one that dealt with a situation involving a newspaper (freedom of the press), is Minneaplis Star v. Minnesota Comm'r, 460 U.S. 575 (1983), where newspapers had to pay a use tax on ink and paper where other businesses were exempt. Per the Court's syllabus, "Minnesota's ink and paper tax violates the First Amendment not only because it singles out the press, but also because it targets a small group of newspapers. The effect of the $100,000 exemption is that only a handful of publishers in the State pay any tax at all, and even fewer pay any significant amount of tax. To recognize a power in the State not only to single out the press, but also to tailor the tax so that it singles out a few members of the press, presents such a potential for abuse that no interest suggested by Minnesota can justify the scheme."

It seems likely that a similar result would be found where one type of printed message is singled out for a punative tax that, in effect, limits the form of speech.

We'll see what happens to the proposal.

What do you think?

Designing sales tax exemptions - what is necessary?

Several sales tax exemptions fall under the "necessity of life" category - or at least that is typically how a state might describe them. For example, see page 1 of California Board of Equalization Pub 61 which lists food, health and housing under this category. One that caught my attention recently is Idaho's addition of  “eyeglasses and eyeglass component parts” as a sales tax exemption effective July 1, 2015.

While the lens are health related, the frames are often fashion related. Frames range in price from $50 including the lens (!) to over $250 for just the frames. If I'd been asked, I would have suggested that Idaho just exempt the cost of the lens and the cost of a basic frame (perhaps $20). The rest should be subject to sales tax. That helps the system be more equitable as expensive frames are not a necessity of life and more likely to be purchased by individuals who can afford the more expensive frame AND the sales tax.

For a bit more and the links, see a short post originally posted to Sales Tax Support.

Idaho recently amended its list of sales tax exemptions to include "eyeglasses and eyeglass component parts" (HB 75, 3/24/15, effective 7/1/15).  There were already exemptions for drugs, hemodialysis supplies, braces and orthopedic appliances, dental prostheses and other medical related items. While eyeglasses seem to fit the list, there is a significant difference between eyeglasses and most medical supplies and devices. Eyeglasses are also a designer item where the cost can be quite high due to the choice of frame. Also, for most medical items, the doctor prescribes the item and the patient has no choice of style or manufacturer. In contrast, patients have a lot of choice in eyeglass frame.

So, the exemption helps any one in need of corrective lenses, but provides a bonus to individuals who want the $300 (or higher) frame rather than a $40 frame. This could be alleviated by only providing the sales tax exemption for the glass and then only the first $50 of the cost of the frame. It would not be difficult to compute. It also sends the message to consumers that the exemption is only for the medical aspect of the purchase, not the designer element of it.

What do you think?

Logical sales tax ruling on a web-based business

Since the start of e-commerce and web-based businesses, uncertainties have existed about how sales tax applies to their operations. Often, the state eventually issued guidance for many types of transactions, particularly those involving software. Where there was no specific guidance, you just need to read the statute, understand the technical and legal nature of the business operations and what it provides to customers, and derive an answer. Some companies have also sought rulings from state agencies.

I think a recent ruling from the New York Department of Taxation and Finance reaches a logical conclusion. TSB-A-14(27)S (8/20/14) involves a business (B) that operates a website where people can place an order with a restaurant and pay. B’s website lists about 5,000 restaurants in 27 cities. Website visitors search for a restaurant, see the menu, place an order and pay. B generates money by charging various services to the restaurants: one-time activation fee, menu update fee, and a marketing services fee. The latter fee is charged for every order. When a customer pays for their order, B charges the customer including sales tax and remits those funds to the restaurant less the marketing services fee. Restaurants are responsible for handling sales tax compliance, food returns and complaints. B provides customers with a receipt for their order.

NY imposes sales tax on food and drink sold in or by restaurants and similar establishments if consumption is on the premises or where the vendor serves food off the premises.

The Commissioner ruled that B was not liable for sales tax as it did not operate a restaurant or provide catering services. B’s business is “Internet advertising services and fulfillment services to the restaurants.” The ruling notes that if B does not remit the sales tax it collects to the restaurant, “the Commissioner reserves the right to collect those funds from [B] under the doctrine of money had and received.” Finally, B’s services are not subject to sales tax.

Seems logical. Too bad the law wasn't crystal clear enough to avoid the time for the taxpayer and state of issuing the Advisory Opinion.  It looks like there is no fee charged for obtaining one, but certainly, costs of the research and drafting by the taxpayer and their tax advisers and the state in issuing the ruling.  [Click here for the form to request an opinion and here for the instructions if you want to see what is involved in getting an opinion.]

Note - the result might not be the same for all states. B is only potentially liable for sales tax in a state if they have a physical presence there and if they are selling something subject to sales tax. Most states do not tax many services, but B needs to check. B also needs to see if its connection with a restaurant in a state causes B to be considered physically present in the state.  Fun stuff!

What do you think would make sales tax life easier for B?

Sales tax complexity example

Colorado map from the USGS

Many local governments have sales tax in addition to the state's sales tax. Tax rates likely vary among local entities. Thus, it is necessary to define that local jurisdiction.  We might assume that should be easy because it would be based on the name of the city or the zip code - something easily known. But, that is not true, there are many areas where zip codes do not tie to the local sales tax rate.

Thanks to Karen Davis of T.M. Byxbee Company, P.C. in Connecticut for pointing out to me an example of the complexity that can exist in trying to determine the proper sales tax rate to charge.  The Colorado Department of Revenue has a web tool where you can determine the local sales tax.  For some of the jurisdictions though, you'll also need a map to determine the rate. For example, here is the description provided for the city of Aurora (emphasis added). Also note that unlike other states, such as California, there might be separate filing obligations for the cities (rather than reporting everything on one sales tax return).

"AURORA:
The city sales tax rate is 3.75%. Please note that this is a Home Rule City. The Colorado Department of Revenue does NOT collect sales tax for home rule cities. Aurora is located in three counties: Arapahoe, Adams and Douglas.

ADAMS COUNTY:
The county sales tax rate is 0.75%. The Regional Transportation District sales and use tax of 1.0% applies in Adams County West of Box Elder Creek. The Scientific and Cultural Facilities District sales and use tax of .1% applies to all of Adams County.

ARAPAHOE COUNTY:
The county sales tax rate is .25%. The Regional Transportation District sales and use tax of 1.0% applies to that portion of Arapahoe county which is south of Interstate 70 and west of Picadilly Road to Jewell, and west of Gun Club Road to Quincy, and generally west of Monaghan Road, including Arapahoe Park and Aurora Reservoir.  The Scientific and Cultural Facilities District sales and use tax of 0.1% applies to all of Arapahoe County.

DOUGLAS COUNTY:
The county sales tax rate is 1.0%. The Lincoln Station Local Improvement District near Interstate 25 on Park Meadows Drive has a sales tax of .5%. The northeast portion of Douglas County, Highlands Ranch, the Park Meadows Mall area, Lone Tree, Acres Green, and Lincoln Station LID are located in the Regional Transportation District, which has a sales and use tax of 1.0%.  The Scientific and Cultural Facilities District sales and use tax of .1% applies to all of Douglas County except in the towns of Castle Rock and Larkspur."

To see others, go to the Department's website and click on "View Local Sales Tax Rates."

Can it be easier?  YES.  One easy approach would be to have just one rate per state with some portion of that going to cities. That might not be politically easy as each local jurisdiction might have varying needs for sales tax revenues depending on other sources of revenues and spending their needs. I think though, that cities and counties would be well-served by working to get to one-rate-per-state because it would then be easier for vendors to collect and remit sales tax. And perhaps Congress would be more willing to enact the Marketplace Fairness Act if sales tax collection were easier. There would still be a need to identify the location of the buyer to get the sales tax to the correct place, unless there is reliable data on spending among local jurisdictions so that the total local portion could be apportioned among local jurisdictions using that data.

What do you think?

Odd ways to generate revenue

Just in the past few months, I have heard stories or been interviewed about state and local government practices to generate revenue in unusual ways.  For example, some California cities are willing to enter agreements with vendors to locate a sales office in their borders and receive a return of some of the sales tax generated (see 5/19/12 Los Angeles Times article). I think the opportunities for doing this will increase when/if the Marketplace Fairness Act passes. With the MFA, more vendors will be required to collect California sales tax despite the lack of a physical presence in the state. So, why not locate some small office in a city that is willing to rebate some of the tax collected for the city to the vendor?

Another instance is a government hiring a third party to help it collect taxes owed. While that might seem innocent enough - outsourcing, it raises a variety of issues.  There is a nice write-up of many of these issues in a Action News Alameda article I was interviewed for a few weeks ago -  “City of Alameda Moves Forward With Contingency FeeBusiness Tax Audit Effort,” David Howard, 7/30/13. 

The tax sharing is problematic as this is not what we pay taxes for. Taxes are to help fund government operations. When people learn that part of their taxes go into the coffers of a vendor, they will think that the government doesn't really need the revenue so why not lower rates and will be puzzled about what the purpose of tax is.  This is also a race to the bottom as local governments reduce their hard to generate tax revenues and compete against each other for tax dollars.

The outside auditor situation is also problematic, such as because the third parties, typically paid on a commission basis, are not trying to determine if the proper amount of tax was paid, but if too little tax was paid. There are also privacy issues. The solution - hire more auditors that work for the government.

What do you think about these approaches?

Minnesota Governor's Tax Plan

 

http://www.salestaxsupport.com/

I have a post at SalesTaxSupport.com on Governor Dayton's tax reform plan that includes broadening the sales tax base and lowering the rate. While that is a great way to modernize the tax system, he needs to avoid expanding the base for business purchases.  For more, please take a look - here.

What do you think?

Vermont Study on its Sales Tax

In July, I blogged about the formation of a Study Committee in Vermont on the Sales and Use Tax (7/3/12 post). Well, I had the opportunity to testify before the committee (by phone) on October 15, 2012. This committee will look at a few aspects of sales tax issues. The October 15 hearing focused on e-commerce issues. I was asked to testify on State Solutions to Collecting from Remote Vendors.

A few of my comments:

"In framing the issue it is important to consider the parameters states face in reaching the goal of collecting sales and use tax in the e-commerce environment. The state sales tax is an existing significant tax. In Vermont it represents about 24% of the total tax base. It would be good to collect this tax that's already on the books rather than raise or create other taxes.  The challenge is the nexus requirement for sales tax which provides that vendors need only collect sales tax from customers, if the vendor has a physical presence in the state, and that presence is more than a slightest presence and per the 1987 Tyler Pipe case, "whether the activities performed in [the] state on behalf of the taxpayer are significantly associated with the taxpayer's ability to establish and maintain a market in this state for the sales.""

Physical presence is not an entirely clear standard as evidenced by conflicting decisions among state courts and sometimes even between a higher and lower court within the same state. As noted by the District Court in the Direct Marketing Association v Colorado case of 2012, the Quill decision puts states in a "difficult position." Quill and e-commerce leave states with limited options to collect all of their sales tax.

I have created a map that shows various actions taken by some states which I'll get into shortly.  But it is important to note that whether the action was joining the Streamlined Sales and Use Tax Project or enacting so-called "Amazon" laws or affiliate nexus laws, no state is collecting all of the sales and use tax it is entitled to. 

Looking at state actions to collect sales and use tax, we should consider both legislative actions and administrative actions. States should also consider sales and use tax in the context of both sellers and buyers and the costs of compliance and competitive issues regarding whether vendors have to collect. We also need to consider the reality that any federal solution will most likely exempt small sellers, so consumers will still need to understand their use tax obligations."

I noted that legislative measures in some states, such as the so-called "Amazon laws" were not effective because they do not apply to all vendors, are easy for vendors to avoid (such as by canceling their affiliate contracts), and might not meet the constitutional requirements of Quill and Tyler Pipe. I noted, as I've been stressing for years, that adminstrative efforts should be pursued including finding vendors who do have a physical presence in the state and better educating consumers about their use tax obligations.

I'll post more later on some of my recommendations.

What state action would you recommend to improve sales/use tax collection on e-commerce sales?

Sales Tax Oddities - Food

A recent ruling in Florida is a reminder of the lack of logic and transparency in some of the special rules and exemptions common in sales tax laws. The question asked of the Florida Department of Revenue was when salad bar items and baked goods would and would not be subject to sales tax.

In Florida, as well as several states, if the food item is prepared for consumption on the premises (such as at a restaurant), sales tax applies. So, what about when your grocery store has a salad bar? Does it matter if a customer eats it in store, in the parking lot, at home?  Not really. It depends on whether the person could eat it in the store, such as because there are tables and chairs by the salad bar. Does it matter if the store also gives you a fork?

Well, if you could eat your salad at the store, sales tax must be charged. Per the ruling:

"Taxpayer’s sales of salad bar items are taxable at the two stores that have tables and chairs because these items are prepared foods sold for immediate consumption. Sales of salad bar items at the store that does not have tables and chairs are exempt when packaged without eating utensils."

And here are the rulings regarding deli items prepared on the premises as well as baked goods:

"Deli Salads. Taxpayer’s sale of deli salads (i.e., chicken, tuna, egg, and potato) is taxable because the salads are not prepared off the premises and sold in the original sealed container. The exception for prepared food sliced into smaller portions provided in s. 212.08(1)(c)9., F.S., does not apply because the repackaging of the deli salads by store employees does not involve slicing."

"Bakery Products. Taxpayer’s sales of the bakery products are exempt, since they are packaged in a manner consistent with an intention by the customer to consume the products off the seller’s premises."

It would be much easier and more transparent* to either tax all food or none of it. When there are exceptions and special rules, then the tax agency needs to define the exemptions, issue rulings and publications, and confirm compliance via audits. And, taxpayers are confused because it seems that the end result is the same whether or not there are tables, chairs or a packaged fork - they get to consume the salad.

* transparency - when taxes apply and how they apply should be clear. No hidden taxes.

For the ruling, see FL Technical Assistance Advisement – TAA 12A-021 (9/13/12).

What do you think?

Sales and Use Tax Collection Issues

A recent article (9/1/12) in a Tennessee paper - "Politicians among online tax scofflaws - Amazon shoppers supposed to voluntarily pay use tax," by Josh Brown, notes that some politicians had not paid their use tax. Namely, some campaigns, although the article notes that it has since been paid.

I am not surprised.  I am surprised though about states allowing state agencies to make purchases from vendors who do not collect sales tax.  These agencies might not have systems in place to be sure the use tax is paid. How do they identify which invoices did not have sales tax included? What about employee reimbursements?

I've got a few pieces on the Scholastic Book Clubs case (see here and here). Schools need money, consumers do a poor job of self-assessing and paying use tax, most cities have bookstores or Internet vendors who collect sales tax, so, why do the schools allow the teachers to hand out the Scholastic order forms during work hours? Could the legislator pass a law saying the schools may only do it if they collect the use tax on the orders?  This is likely just one example.  

Query - how much do states and their agencies and local governments spend on purchases from vendors who do not collect sales tax?  For such sales, for what percentage is the use tax paid?

What do you think?

A bit of nexus history - 1967 versus 1991 versus 2012 technology

In preparing for a presentation on the Quill case (which is today (!) at 3 pm Eastern), I had the opportunity and need to reread the lower court decisions. For a quick review, here are the citations and progression that led to the 1992 US Supreme Court decision which we hear so much about (and which has its 20th anniversary this year).

N.D. v. Quill Corp., Dkt. 41677, 5/15/90	Per Bellas Hess, Quill not required to collect Title passes in Illinois (despite 90 day guarantee) “should have been presenting facts … showing that North Dakota spends funds for the protection and benefit of” Quill
N.D v. Quill Corp., 470 NW2d 203 (ND SCt 1991)	Quill must collect World has changed since Bellas Hess
Quill Corp. v. North Dakota, 504 US 298 (1992)	Quill not required to collect Bellas Hess modified Due Process – met due to purposeful direction Commerce Clause – need physical presence (although Congress can provide otherwise) Differences exist between DP and CC

 
The North Dakota Supreme Court said that technology and communications had advanced so much from the 1967 Bellas Hess ruling to 1991, that Bellas Hess should be changed (other reasons were also provided for why ND thought Bellas Hess should be overruled). The court stated: 

“The burgeoning technological advances of the 1970's and 1980's have created revolutionary communications abilities and marketing methods which were undreamed of in 1967.”  Also, "technological advances have made physical presence within the jurisdiction meaningless in modern commerce." And, the "almost universal usage of automated accounting systems, and corresponding advancements in computer technology, have greatly alleviated the administrative burdens created by such a collection duty." Also, North Dakota offered vendor compensation. 

The court noted the lesser burdens placed on sellers by a use tax thus justifying a lesser nexus standard. Interestingly enough, this argument has been reversed today to justify economic nexus for income tax purposes rather than using the physical presence sales tax standard. For example, in A&F Trademark, Inc. v. Tolson, 605 SE2d 187 (NC Ct. App, 12/07/04), it was noted that under a sales tax, a taxpayer becomes state’s tax collector.  “[A] state income tax is usually paid only once a year, to one taxing jurisdiction and at one rate, [but] a sales and use tax can be due periodically to more than one taxing jurisdiction within a state and at varying rates.” Id., at 13." (additional reasons for a different nexus standard for sales and income taxes were also provided in the A&F case).

I was surprised to read that 1991 language again. Even 21 years later, while the technology exists to allow for any vendor to collect sales tax in all state and local jurisdictions, it is expensive and still needs human assistance. And the variations among jurisdictions and constant change pose challenges.

What do you think?  Has technology advanced enough since 1967 or even 1991 to remove the physical presence nexus standard for sales tax? Is technology even the appropriate vantage point for answering this question (let's not forget about the Due Process and Commerce Clauses)?

California's Troubled, Outdated Tax System

Three tax initiatives/propositions will appear on the November 2012 California ballot. This is a poor way to change the tax law.  Voters have to take the proposal as it with no opportunity for improvement. Fortunately, the two tax rate increase ones are temporary. The three initiaves are:

1. Temporary Taxes to Fund Education. Guaranteed Local Public Safety Funding. Initiative Constitutional Amendment (No. 1578) - Governor Brown's initiative to help balance the budget.
2. Tax for Education and Early Childhood Programs. Initiative Statute. (No. 1574) - Molly Munger's proposal to get more funding for schools.
3. Tax Treatment for Multistate Businesses. Clean Energy and Energy Efficiency Funding. Initiative Statute (No. 1550) - proposes to only allow the single sales factor apportionment formula and use the revenue generated for clean energy projects.

I will have more on these proposals later including suggestions for how to analyze them and their pros and cons.

What I want to note here is a statement in The Economist of 6/16/12 in an article "Not quite Greek, but still weak."

California's budget problems begin with a tax system that is out of date. For most of the last century, sales taxes, which are relatively stable, were the state's main source of revenue, whole more volatile income taxes were less important. But that was when California's economy was still based on making things. Today it is a service economy, and services are exempt from sales tax."

The Economist has it right.  The tax system is out of date. Elected officials and voters tend to make the problems worse by raising the tax rate rather than fixing the base (what is subject to tax) for the income and sales taxes. As I note in my paper on California's Tax Problems:

Most of the specific tax problems in California’s existing tax structure described below can be solved by fixing the tax base - they cannot be solved with a rate increase. A rate increase would make most of these problems worse."

For more details on many of these problems, please see my papers and op eds here.

What do you think about California's tax system and current proposals for the ballot?

Amazon collecting more sales tax - Relevance to Congress?

There have been recent news stories about Amazon starting to collect sales tax in some states.

• Texas on July 1, 2012 as part of an agreement to expand in Texas (see Statesman.com of 7/29/12)
• Nevada in 2014 (see Las Vegas Sun of 4/23/12)

And, per legislation enacted in 2011 in California (AB 155), Amazon is to start collecting sales tax on  September 15, 2012 (January 2013 should the feds enact legislation "authorizing the states to require a seller to collect taxes on sales of goods to in-state purchasers without regard to the location of the seller").
AB 155 also provides: "The Director of Finance shall, on or before August 15, 2012, certify in writing to the Governor, the Senate Committee on Rules, the Speaker of the Assembly, and the State Board of Equalization whether or not federal law has been enacted on or before July 31, 2012, authorizing the states to require a seller to collect taxes on sales of goods or services to in-state purchasers without regard to the location of the seller."

I assume the above is a formality and on the "to do" list for the Department of Finance.  Given it is election year and Congress has many things on its plate, it seems unlikely they will enact any of the current versions of the Main Street Fairness legislation (for details on the proposals, click here.)

Also note that the California Board of Equalization is working on revising Reg 1684 to address AB 155 changes to R&T Section 6203.

So, what is the effect on Congress' interest in enacting legislation to, in effect, overturn the Quill decision and let states that have satisfied certain simplification requirements to collect sales tax from non-present vendors?  One of the Main Street Fairness proposals (H.R. 3179) has such a high de minimis threshold ($1 million) that it will allow the majority of internet vendors who do not already have nexus in particular states to continue to be exempt from collecting sales tax. Thus, it seems that the bill is really after the larger vendors, such as Amazon.

What do you think?  Do you think Congress will pass on a Mainstreet Fairness Act proposal if it sees that Amazon is collecting tax in more states?   What about if states are also making better efforts to collect use tax?

What about simplification to make collection of all sales and use tax a no brainer? (such as having the customer's credit card or Paypal account charged by the state for the sales tax at time of purchase?)

Vermont Sales Tax Committee to be Formed

Vermont H.782 enacted in April 2012 made several changes including creating a 7-member Study Committee to "examine the sustainability of the sales and use tax in the context of Vermont’s changing economy." The committee seems to have come about due to controversy over taxation of cloud computing (see BloombergBusinessweek article of 4/2/12).

Per the legislation: "The committee shall study how to make the Vermont’s sales and use tax more sustainable and equitable in light of Vermont’s changing economy. Specifically, the committee shall consider:
  (A) the taxation of software, platform, and infrastructure as services accessed remotely;
  (B) the taxation and sourcing of sales of tangible personal property made via the internet; and
  (C) the feasibility of taxing services more broadly than under current law."

The report is due to the legislature by 1/15/13.

Observations:

• A study of any state's sales tax base is generally a good idea because of our changed ways of living and doing business. Personal consumption today consists of a lot more than tangible personal property. It includes services, intangibles and items purchased over the Internet (rather than at the local store). While not specifically mentioned, the committee should also consider digital goods.
• The committee should also look at how it can stop applying sales tax to business purchases to avoid pyramiding of the tax.
• Services to be taxed should not include ones used by businesses. Time should be given to implementing any new tax on personal services so that the affected business and the state tax agency have time to get procedures and processes in place. A few years ago, Michigan enacted legislation to start taxing specified services in two months. The legislation was then repealed on the first day. Many view that as evidence that sales taxes on services are doomed to fail. What is doomed to fail is legislation that is not allowing for an effective implementation process.  I'd also suggest providing a refundable income tax credit for some portion of the costs the service businesses incur in getting ready to collect the sales tax.  I have more on this here.
• The committee should take some steps to ensure that its work will be of use. Too often, tax commissions diligently study the tax system and its problems, get public input, develop recommendations and issue a report. The report then sits on a shelf. For details on some suggestions, click here.
• Broaden the base AND lower the rate.

What do you think?

Sales Tax Issues for Remote Sellers

Rich Prem, VP Indirect Taxes and Tax Reporting for Amazon, shared a Top 10 list of issues remote sellers face. He shared it with BloombergBNA (6/22/12) and the Federation of Tax Administrators.  

Rich's list:

1. Shipping and handling

2. Taxability of gift sales or send sale

3. Product returns

4. Origin versus destination sourcing

5. Restocking fees

7. Time zones

8. Using multiple systems to calculate tax

9. Exemptions

10. Other types of taxes and fees

I encourage you to take a look at the list and its brief explanations for each item. Most of the items stem from differences among the states, such as which tax both handling and shipping, which tax neither and which tax one but not the other (such as California taxes handling but not shipping).

Rich points out that states should be considering these issues before any federal legislation is enacted that may cause a large increase in the number of sellers registering in a state and collecting sales tax.

There will be other issues as well, such as:

• Registering correctly and knowing what rate is required when a state has varying rates among local jurisdictions.
• Whether states should create some type of vendor reimbursement. Most online sales are via credit card and when sales tax is added to the bill, the seller has to pay a higher fee to the credit card company (as do Main Street retailers). So, a portion of the sales tax collected does end up paid by the seller to cover the fee. Plus there are additional administrative costs of collecting and remitting sales tax in several states, rather than in just one or a few states.

Some of the issues could be addressed by states providing very clear (Plain English) instructions for remote vendors on the state's website.  Also, if reporting can be consolidated onto one form, that should help. For example, Rich's last item notes that some states may have additional fees to be collected, such as for electronic waste.  Allowing sellers to report on fewer forms should be helpful.

What do you think? What should be added to Rich's list?  How might states address some of these issues?

20 years after Quill decision - still waiting for a solution

I'm honored to be a guest blogger on Forbes today compliments of fellow blogger Peter Reilly who is always finding interesting aspects of tax decisions and sharing his insights with taxpayers and tax practitioners.  My post is on the reality that it has been 20 years since the US Supreme Court reminded states and taxpayers that any solution to the challenge of collecting sales tax in a cross-border marketplace was with Congress.  That is - it is the 20th anniversary of the Quill decision. Check it out, along with Peter's always interesting posts - here.

fyi - there are links to the case and some current activity in the post.  You can hear the oral argument and opinion announcement for the Quill case here. The 1992 opinion was written by Justice Stevens, pictured here.

Justice John Paul Stevens, retired 2010