The imposition of sales and use taxes on e-commerce: a taxing dilemma for states and remote sellers.

• Author: Swartz, Ryan J.

1. INTRODUCTION

   The Internet has greatly influenced business enterprise and the landscape of the economy. (1) Not only may a burgeoning company establish a physical storefront, but it may also enter the realm of cyberspace, conducting business through virtual transactions. (2) Consumers purchase items from the comfort of their homes, buying everything from books and airline tickets to clothing and computers. (3) This new form of electronic commerce (e-commerce) has become a staple in both the domestic and international economies. (4) Consequently, businesses and consumers will spend approximately one hundred billion dollars through e-commerce in 2003. (5)

   The treatment of sales and use taxes in online transactions is an important issue in e-commerce law. (6) A seller of goods in an intrastate transaction must collect a sales tax from the buyer and remit the tax to the government. (7) When a buyer purchases a good from an out-of-state seller (remote seller), whether through mail-order catalogue or e-commerce, the buyer's state imposes a use tax. (8) The remote seller must collect and remit the tax provided that it has a substantial nexus, or physical presence, within the buyer's state. (9)

   A seller on e-commerce (e-retailer) acts as a remote seller by generating sales from buyers outside of its state of incorporation and principal place of business. (10) Thus, an e-retailer may conduct business in fifty states but lack physical presence in forty-nine states, and will therefore be exempt from collecting use taxes from out-of-state buyers. (11) With thousands of e-retailers generating billions of dollars in sales, the amount of uncollected use taxes is staggering. (12) States are eager to recover these lost revenues. (13)

   This Note will explore the issue of sales and use taxes on e-commerce. Part II will define sales and use taxes and explain why states aim to require e-retailers to collect use taxes. (14) Part III will analyze the relevant constitutional issues, specifically, Quill Corp. v. North Dakota (15) and its substantial nexus requirement. (16) Part IV will discuss of the role of Congress in e-commerce taxation. (17) Part V will present the arguments of consumers, Main Street retailers, remote sellers, and the states. (18) Finally, Part VI will present an argument as to why states should not require remote sellers to collect and remit use taxes until states simplify the current sales and use tax system. (19)

2. SALES AND USE TAXES: WHY STATES NEED REMOTE SELLERS

   Certain state and local governments impose sales taxes on sales or leases of tangible personal property and certain services. (20) The primary function of the sales tax is to generate revenue for the taxing jurisdiction. (21) Sales taxes became widely utilized in response to the Great Depression, and Mississippi's legislature was the first to impose a sales tax in 1932. (22) Today, there are over 7,600 state and local governments out of approximately 30,000 jurisdictions that impose sales taxes. (23) Each taxing jurisdiction has its own tax code, containing varying tax rates, definitions and classifications of taxable and exempt items, and tax compliance procedures, all of which may change throughout the year. (24) Unlike the remittance of income taxes, individuals and entities are not responsible for remitting sales taxes to the government. (25) Rather, the seller bears the administrative burden of calculating, collecting, and recording the sales tax on each transaction and remitting such taxes to the appropriate government entity on a periodic basis. (26)

   When a buyer purchases goods from a remote seller, the buyer's state or locality imposes a use tax. (27) States and localities impose use taxes to discourage purchases that are not subject to the sales tax. (28) These government entities require remote sellers to collect and remit the use tax, provided that the remote seller maintains a physical presence within the taxing authority's jurisdiction. (29) When the remote seller lacks physical presence and the government entity cannot require the remote seller to collect and remit the use tax, purchasing from a remote seller is not without tax consequences. (30) The buyer is required to self-impose and forward the tax to the appropriate government entity. (31) Thus, when a buyer purchases goods from a remote e-retailer, he must pay a use tax, regardless of whether the e-retailer maintains physical presence in the buyer's state. (32)

   The crux of the e-commerce taxation problem, however, is that buyers rarely comply with use tax laws. (33) Compliance is low because most buyers are unaware of their use tax obligations and pay only on a voluntary basis. (34) States rarely enforce the use tax against buyers because they lack the financial and administrative means. (35) Taxing authorities have difficulty identifying the online purchasing activity of buyers, making enforcement of the use tax administratively impossible. (36) Moreover, a reliable and efficient auditing system simply would not be cost effective. (37)

   Thus, state and local governments rely almost exclusively on remote e-retailers to collect the use taxes generated by online transactions. (38) With consumer compliance and enforcement low, taxing authorities consider collecting use taxes from remote sellers to be the most effective use tax collection mechanism. (39) Taxing authorities, however, can require a remote seller to collect use taxes only when it has a physical presence in the buyer's state. (40) Most e-retailers have a physical presence in only one state, yet the nature of cyberspace allows them to sell goods to buyers in all states. (41) Therefore, most online sales remain untaxed and states lose billions of dollars in revenue because they cannot require remote sellers lacking physical presence to collect and remit use taxes. (42) The states may blame the Supreme Court case of Quill Corp. v. North Dakota. (43)

3. QUILL CORP'S PHYSICAL PRESENCE STANDARD

   The Remote Seller's Constitutional Shield

   The roots of Quill Corp. originated in the 1967 Supreme Court case of Nat'l Bellas Hess, Inc. v. Dep't of Revenue of Ill. (44) National Bellas Hess (National) was incorporated in Delaware with its principal place of business in Missouri. (45) The company biannually mailed catalogues to its Illinois customers, but otherwise had no contact with the state. (46) The Illinois Department of Revenue obtained a judgment providing that Illinois statutory law required National to collect and remit use taxes. (47) National challenged the judgment on constitutional grounds, arguing that the statute violated the Fourteenth Amendment's Due Process Clause and unduly burdened interstate commerce. (48)

   The Supreme Court acknowledged that in certain circumstances a state may require a remote seller to collect a use tax. (49) The Court noted, however, that it had never held a state could impose use tax obligations on a seller whose only connection with the state is by common carrier or United States mail. (50) Referring to National's Due Process and Commerce Clause claims as "closely related," (51) the Court enunciated that the Constitution requires a definite link or minimum connection between a state and the entity it attempts to tax. (52) The Court reversed the Illinois judgment, refusing to disregard the "sharp distinctions" between situations in which a remote seller maintains a physical presence in the buyer's state and when it does not. (53) The Court further stressed that the impediments on interstate commerce resulting from the imposition of use taxes supported the reversal of the Illinois judgment. (54)

   Twenty-five years later in Quill Corp., the Supreme Court revisited the physical presence issue. (55) Quill Corporation (Quill) sold one million dollars worth of merchandise to various clients in North Dakota, but lacked physical presence in the state. (56) North Dakota imposed use tax obligations on every person who regularly or systematically solicited consumers in the state. (57) North Dakota's Tax Commissioner filed an action to require Quill to pay use taxes, which the North Dakota Supreme Court upheld as constitutional. (58) Ignoring the precedent set in Nat'l Bellas Hess, the court reasoned that changes in the economy warranted the departure of the physical-presence nexus requirement. (59) The court instead focused on Quill's economic presence in North Dakota, holding that such presence constituted a sufficient nexus to justify imposing use tax responsibilities on Quill. (60)

   The United States Supreme Court reversed the judgment of the North Dakota Supreme Court. (61) Deviating from Nat'l Bellas Hess, the Court created separate tests under the analytically distinct Due Process Clause and Commerce Clause. (62) Under the Due Process Clause, states may impose use tax duties on businesses that continuously and broadly solicit business within a state, regardless of physical presence. (63) The Due Process Clause did not prohibit the state from imposing use tax obligations because Quill directed its attention to North Dakota residents. (64)

   The imposition of use tax obligations, however, must also satisfy the Commerce Clause and its substantial nexus requirement. (65) The Court stressed that the minimum contacts requirement of the Due Process Clause is not identical to the substantial nexus requirement of the Commerce Clause, as each clause is fundamentally different in its purpose. (66) The function of the Commerce Clause's substantial nexus requirement is to limit state burdens on interstate commerce. (67) The Court explained that the substantial nexus requirement encompassed Nat'l Bellas Hess and its articulation of the physical presence requirement. (68) The substantial nexus requirement thereby creates a safe harbor for remote sellers with no connection to the buyer's state. (69) Thus, a remote seller such as Quill lacking physical presence in the buyer's state is exempt from...