Taxing e-commerce: an abundance of constraints.

• Author: Carey, Nicholas

1. Introduction II. The Internet Tax Freedom Act III. Case Law: Quill and its Offspring IV. Legislative Solution in Sight? V. Tax Policy Effectiveness VI. "Amazon Laws," Colorado's Notification Approach, and the Intermediary Tax: Potential Solutions. VII. Conclusion and Recommendations I. Introduction

   Since the Internet became a staple of modern life just before the turn of the millennium, it has had the power to be a force for economic change. Sales over the Internet in the United States have increased from $56 billion in 2003 to $102.1 billion in 2006. (1) Global electronic commerce ("e-commerce") sales were expected to top $1.25 trillion by 2013. (2) However, many of these transactions escape taxation by state and local governments, costing states billions in potential revenue. (3) The National Conference of State Legislatures estimates that states' losses total $8.9 billion per year. (4) This Note will examine the actions state and local governments, and ultimately, the Federal government, can take to find a permanent solution to the taxation of e-commerce. These governments will have to act in a way that will continue to promote the expansion of electronic commerce while providing revenue to the states that need it. Recently, the U.S. Senate took steps to solve the Internet tax dilemma by passing the Marketplace Fairness Act. (5) The Act would be a major step in the right direction, but it is uncertain that it will ever pass the House, where it has languished since May of 2013. (6) The plurality of stakeholders makes the issue particularly difficult, as well as critical. There are many obstacles facing the taxation of e-commerce. This Note advocates for various solutions to these obstacles that will maximize stakeholder overall welfare by avoiding overly burdensome business regulation, raising revenues for state and local governments, and minimizing the change in consumer behavior.

2. The Internet Tax Freedom Act

   The Internet Tax Freedom Act ("ITFA") was enacted in 1998 at the dawn of the Internet age. (7) The ITFA does not prohibit all taxation of Internet transactions, as its name may suggest, but it forbids "taxes on Internet access" and "multiple or discriminatory taxes on electronic commerce." (8) "Discriminatory taxes" refers to Internet-only taxes such as bit taxes, email taxes, or bandwidth taxes. (9) Additionally, it refers to a higher tax on goods sold over the Internet than on the same goods sold traditionally. (10) The prohibition on both discriminatory taxes and taxes on Internet access clearly reflects Congress' intent to ensure the unhindered growth of the new medium of communication and commerce. However, nine states' Internet tax laws were grandfathered because they existed prior to the ITFA. (11)

   Additionally, the Act intended to clarify ambiguities in taxation of sales transactions. For instance, sometimes the same goods are not taxed when sold over the Internet but are taxed when sold in person. (12) "Multiple" taxes refers to Congress's concern that e-commerce would be unduly fettered if an online retailer was subject to taxation both in the retailer's jurisdiction and the end user's jurisdiction, if different. (13) However, the ITFA does not clarify where jurisdiction does and does not exist. This leaves interpreting complex case law to discover that most interjurisdiction Internet sales remain untaxed and cost states billions in revenue. (14) Because lawmakers fear too many taxes, we may be left with too few.

3. Case Law: Quill and its Offspring

   Even before the Internet age, courts occasionally struggled with the constitutional problems of taxing remote sellers outside of the purchaser's jurisdiction. (15) The Due Process Clause of the Fifth Amendment provides that no state can deprive citizens (of that state or another) of "life, liberty, or property without due process of law." (16) This includes being deprived of tax dollars. (17) Minimum contacts between seller and state, as defined (however indistinctly) by the Supreme Court, are required to satisfy the Fifth Amendment and validate a tax. (18) The Commerce Clause allows Congress "to regulate Commerce ... among the several states." (19) E-commerce falls within the purview of Congress' constitutional authority since Internet sales between states are exceedingly common. (20) Additionally, the Supreme Court has interpreted the Commerce Clause to have a reverse power. (21) Under the Dormant Commerce Clause, the Court can act in the absence of Congress and invalidate a state law that unduly interferes with interstate commerce. (22)

   Mail order catalogues soliciting the business of consumers in states across the country while operating remotely in one jurisdiction were precursors to e-commerce. In National Bellas Hess v. Illinois, the Supreme Court analyzed the Due Process and Commerce Clause issues together, finding them "closely related." (23) National Bellas Hess, Inc. operated a mail order catalogue from Missouri and sold to customers across the country. (24) The Court held Illinois could not compel National Bellas Hess to pay a sales tax since there lacked "some definite link" between the State of Illinois and the business. (25) The Court recognized that the goal of the Commerce Clause was frustrated if states could tax businesses without a substantial nexus in their jurisdiction: "The very purpose of the Commerce Clause was to ensure a national economy free from such unjustifiable local entanglements." (26)

   Prior to National Bellas Hess, however, was the Court's ruling in Scripto, Inc. v. Carson, in 1960, which remains important today. (27) The Supreme Court upheld a Florida court decision compelling sales tax collection on a Georgia seller that owned no property in Florida and had no employees stationed there. (28) The Court believed that enough of a nexus existed in Florida because Scripto, Inc. entered into contracts with Florida brokers who were paid on commission. (29) Scripto is still an important precedent because it is the basis for affiliate taxing "Amazon laws," discussed infra, that have been instituted in New York, North Carolina, and other states.

   In 1977, the Court decided Complete Auto Transit, Inc. v. Brady, which created a test that has since governed the Dormant Commerce Clause analysis of taxes. (30) The four part Complete Auto test upholds a tax if it "[1] is applied to an activity with a substantial nexus with the taxing state, [2] is fairly apportioned, [3] does not discriminate against interstate commerce, and [4] is fairly related to the services provided by the State." (31) The first prong is the most salient for the purposes of our analysis. The significance of Complete Auto is that it shifted the Court's analysis away from a direct/indirect question under previous tax cases and asked whether a state tax "produce[d] a forbidden effect." (32)

   In 1992, the Supreme Court expanded on National Bellas Hess in Quill Corp. v. North Dakota. (33) It distinguished between the National Bellas Hess Court's analysis of a tax's constitutionality under the Commerce Clause and the Due Process Clause, upholding National Bellas Hess's Commerce Clause standard but reformulating its Due Process holding. (34) Rather than concerning itself with "physical presence," (35) the Quill Court preferred the new Due Process inquiry for personal jurisdiction, "whether a defendant's contacts with the forum made it reasonable, in the context of our federal system of Government, to require it to defend the suit in that State." (36) The Commerce Clause still requires a "substantial nexus" between the taxing jurisdiction and the business. (37) But the Quill Court held that Commerce Clause and Due Process analyses are different because they are motivated by different concerns. (38) Due Process deals with fundamental fairness, while the Commerce Clause analysis ensures that states are not unduly burdening interstate commerce. (39) The Court noted that a business may have sufficient "minimum contacts" with a state required by the Due Process Clause to be taxed, but lack a substantial nexus under the Commerce Clause, (40) perhaps if the discriminatory effect of the tax on interstate commerce was disproportional to the amount of sales being made in the jurisdiction.

   It seems undisputed now that a state is allowed under the Due Process Clause to tax or regulate an entity without physical presence within the state. Most use taxes run into trouble under the Dormant Commerce Clause. It has been argued that the current understanding of the Quill decision is mistaken, and that the only burden on interstate commerce that violates the Commerce Clause occurs when the out-of-state seller has increased administrative and tax collecting costs. (41) Therefore, a state can legitimize any sales or use tax simply by reimbursing the out-of-state vendors for the collection costs they incurred. (42) Gamage and Heckman argue that the tax burden on out-of-state sellers and in-state sellers is actually the same; for instance, in New Jersey a 7% tax is imposed, regardless of the origin of the seller. (43) The Quill Court's goal when analyzing the Dormant Commerce Clause could not have been to position out-of-state businesses better than local businesses, because that would be contrary to its Commerce Clause interpretation. (44) Accordingly, Gamage and Heckman argue the burden results from a remote seller operating in many states that all collect taxes. (45) This difficulty can be overcome, they argue, simply by compensating the out-of-state seller for their costs. (46) "[T]he physical presence rule should not apply if states fully and adequately compensate remote vendors for all tax compliance costs such that there is no potential for burdening interstate commerce. Any other Quill interpretation would be incompatible with Complete Auto." (47) However, it is important to remember that there are over 6,000 taxing jurisdictions in the United States, (48) and...