A Moratorium on Internet Taxes

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, October 17, 1999

Copyright 1999 Robert L. Sommers, all rights reserved.

A Moratorium on Internet Taxes

This is part one of a three-part series on E-commerce taxation. Next column: Tax issues posed by E-commerce.

Because of complicated issues surrounding electronic commerce (E-commerce) taxation, Congress passed the Internet Taxation Freedom Act (ITFA) in 1998. This act imposes a three-year moratorium on federal and state taxation of internet transactions. The moratorium began October 21, 1998, and remains in effect until October 21, 2001.

Congress realized that because the internet involves many computers, routing transactions throughout the country and even the world, potentially dozens of jurisdictions could attempt to tax a single transaction.

Internet Access

ITFA applies to taxes on internet access that were not generally imposed or enforced prior to October 21, 1998. The ban also prevents states and political subdivisions from imposing new taxes on internet access. Internet access means, in general, any computer, telephone communication facility, equipment or operating software which comprises the internet (the interconnected world-wide network using Transmission Control Protocol/Internet Protocol known as TCP/IP).

Example: ITFA bars a tax on monthly ISP (internet service provider) services provided by AOL, Compuserve or a company like Earthlink, but taxes on telephone services used to connect to your ISP are not prohibited.

ITFA applies to E-commerce, defined as any transaction conducted over the internet or through internet access, comprising the sale, lease, license, offer or delivery of property, goods, services or information, whether or not for consideration.

IFTA bars states and political subdivisions from imposing "multiple or discriminatory" taxes on transactions involving E-commerce, including income and franchise taxes, property, sales and use taxes, as well as eliminating a seller's obligation to collect and remit such taxes.

Discriminatory Taxes

If an E-commerce transaction is subject to a tax that is any different from a tax imposed on similar property, goods or services through other means, then the tax is discriminatory.

Example: If purchasing a book through the internet is taxed differently or at a higher rate than in a bookstore, the tax is discriminatory.

Out-of-state vendors ("remote sellers") engaged in E-commerce have no obligation to collect sales taxes if traditional remote sellers (mail-order and telephone solicitation vendors) do not collect sales taxes. Sales tax cannot be levied on a transaction simply because the purchaser uses E-commerce to access the seller's computer (or web site) to acquire property, goods or services. Also, states cannot use an "agency nexus" theory to claim that a purchaser's or seller’s ISP is an in-state agent for the seller.

Example: If a purchaser in California uses his computer to connect with a bookseller's computer located in Nevada (a non-sales tax state), neither California nor any political subdivision may levy a sales tax, even if the purchaser used a Californian ISP to connect to the internet.

Example: If a Nevada-based bookseller hosts his website on a California computer and a Californian resident purchases a book, California cannot claim there is an agency nexus to tax the transaction.

Note: If a vendor has sufficient nexus (connection) within a taxing jurisdiction (usually a physical presence through a location or sales people), the vendor may be required to collect and remit sales taxes.

In addition, if a remote seller in one state, uses a computer in another state for internet access or online services, there is no agency relationship between the remote seller and the company providing the access or online services.

Example: Where a New Hampshire company, with no physical presence in California, hosts its website with a Californian ISP, California cannot impose a sales tax on purchase and sale transactions just because a Californian ISP is involved.

If books, magazines or newspapers in physical form are not subject to sales tax, then internet downloads of that same information cannot be taxed.

Multiple taxes on the same transaction or service, either in the same taxing jurisdiction or two or more taxing jurisdictions, are also prohibited.

Exceptions to ITFA

Vendors who knowingly conduct E-commerce involving obscene materials that are otherwise harmful to minors cannot enjoy ITFA protection, unless procedures are implemented to insure the vendor deals with persons over age 17.

ITFA protections apply to internet information and search services such as Yahoo, Lycos, Alta Vista and ISPs that host such websites, as well as telecommunication companies that transmit information via the internet.

Also, bundled software that includes E-commerce or internet applications are protected under ITFA, but only to the extent E-commerce or internet applications are contained within the bundled software. For example, if an ISP bundles software that includes a telephone application, such as voice mail, this portion is excluded from ITFA protection and, thus, subject to tax.


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