Difficulties in Taxing E-Commerce

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, October 31, 1999

Copyright 1999 Robert L. Sommers, all rights reserved.

Part 2 of a 3-part series

Difficulties in Taxing E-Commerce

E-commerce involves using the internet for "purchase and sale transactions" (the sale, lease, license, offer or delivery of property, goods, services or information). Because e-commerce involves numerous computers communicating at the speed of light, purchase and sale transactions are both instantaneous and often unidentified.

Since internet protocol does not require disclosure of identity and users often log on with little verification, it is nearly impossible to determine the name and location of the purchaser. Consequently, many transactions are anonymous.

E-commerce differs from mail order and telephone solicitation, the two most traditional forms of business using remote sellers (sellers in another state or country), because those usually involve the delivery of goods by common carrier (UPS, FedEx) to and from a specific physical location. In short, there is an actual delivery of property from an identifiable seller to an identifiable buyer.

Also, because of the speed in which transactions occur and the frequent absence of a traditional paper trail, it will be very difficult, if not impossible, to apply traditional notions of sales tax jurisdiction. This is especially true with intangible property transmitted by computer, such as software, digital music or electronic books and services.

The Commerce Clause Restriction

The Commerce clause of the U.S. Constitution prevents states and their political subdivisions from imposing taxes that unduly burden interstate commerce. The key issue is whether the company that is being taxed has sufficient connection (nexus) with the taxing authority.

The Supreme Court has ruled that under the Commerce clause, a mail-order company without a physical location, employees or sales agents within a state could not be compelled to collect sales tax on its transactions with that state’s residents. Thus, an out-of-state company that merely engages in an e-commerce purchase and sale transaction with an in-state customer does not have sufficient nexus for sales tax purposes.

Distinguishing Features of E-Commerce

E-commerce has some or all of the following features, which make it difficult to tax under traditional concepts:

Lack of a Paper Trail

Unless a tangible product is delivered by common carrier, it is virtually impossible for a taxing jurisdiction to determine that an e-commerce transaction occurred. For instance, if a consumer downloaded a computer game from a computer located in a foreign country for $19.95, paying by credit card, how would a taxing jurisdiction discover that such a transaction occurred?

Also, consider the following: Would the receipt of a computer game in electronic form convert the game into a non-taxable intangible item, whereas the purchase of the same game at a local computer store would be taxable because it is a tangible product?

If a newspaper has an exemption from sales tax (as most do), will a newspaper that is downloaded in electronic form receive the same exemption? If not, would the tax levied on the electronic version of the newspaper be a discriminatory tax in violation of the Commerce clause?

E-cash Issues

Electronic money ("e-cash"), is a type of debit card (similar to a telephone calling card) where the card itself keeps track of the remaining balance, rather than a third-party bank. This could emerge as the preferred medium of exchange for e-commerce. E-cash will have the same anonymity as cash does in the current "underground" economy. Use of e-cash will further frustrate states and local jurisdictions on taxing e-commerce.

Even without e-cash, e-commerce transactions are easily concealed. For example, suppose your uncle living in Nevada (a state with no sales tax) downloads a computer game then sends it to you as an e-mail attachment. The next time you see your uncle, you reimburse him. How will your state or local jurisdiction monitor this transaction?

In short, e-commerce has the potential to stymie tax collections because of the speed and lack of information on buyers and sellers and also because purchase and sale transactions could have the same secrecy as the underground economy.

Next week: The future for E-commerce taxation.


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