Internet Taxes Pit States Against Industry

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Internet Taxes Pit States Against Industry

By Neil Munro
Staff Writer

"Any tax scheme compensating states for losses caused by out-of-state online commerce would cost more to collect than it would be worth."

- Bill Melton
CyberCash Inc.
The raging battle over Internet taxes is likely to end up in court regardless of whether U.S. lawmakers approve a controversial bill that would curb taxes on Internet companies, say congressional, industry and state officials.

If members of Congress pass the Internet Tax Freedom bill, sponsored by Rep. Chris Cox, R-Calif., and Sen. Ron Wyden, D-Ore., industry and states will meet in federal courts to dispute how many Internet-related taxes would be curbed or barred altogether, said Neal Osten, committee director for commerce and communications at the Washington-based National Conference of State Legislators.

States will eventually face the Supreme Court in a rerun of the 1992 Quill Corp. vs. North Dakota Supreme Court decision, said executives and government officials. That decision declared that the Constitution's interstate commerce clause freed out-of-state mail-order merchants from any legal requirement to collect a state's sales taxes when selling items to a resident of that state. Only when there is "nexus" -meaning the merchant has a store or an office in a particular state - can a state force the company to collect sales taxes, according to the decision.

But state officials fear that online merchants won't have nexus with any state, except the state they locate their headquarters in, denying the states billions of dollars in annual tax revenues.

"The rules of nexus need to be examined and modified to deal with electronic commerce. ... That ought to be a voluntary effort between states and industry, and not subject to federal legislation," said Harley Duncan, director of the Washington-based Federation of Tax Administrators.

Also, anonymous online purchases of digital goods, such as music, information or software, will hinder states from claiming sales taxes, even when the merchant is based in the state. And if states, cities and counties can levy taxes on online sales, they will face increasing pressure from Internet companies to cut the tax rates.

Already, governors from California, Massachusetts and New York say they will bar state-level online taxes in an effort to attract infotech businesses to their states. Many states have also amended their property tax rules to exclude intellectual property, including custom-built software and the master copy of popular software programs, such as the Windows 95 software owned by Redmond, Wash.-based Microsoft Corp.


Steve Case, president of America
Online Inc.
By 2000, electronic commerce revenues should reach $160 billion, including $7 billion from sales of music, tickets and other consumer items, $22.5 billion in financial services, $33 billion in access charges, $32.4 billion in content sales and $65 billion in business-to-business deals, according to a report by Forrester Research Inc., Cambridge, Mass.

In the tax debate, business leaders have played hardball, saying they need the U.S. Congress to enact a permanent moratorium on state-level taxation of Internet companies, and that they only want equal treatment with other industries, including the mail-order industry.

Because of opposition from the states, congressional staffers have narrowed the Internet Tax Freedom bill to bar a smaller range of taxes than originally included, and have put a five-year limit on the moratorium on new taxes.

Although some state lobbyists fear the bill may win Senate approval, some industry officials say it has been derailed. "It was only a symbolic bill anyway," intended to deter the states from levying new taxes and to force them to negotiate a nationwide tax deal with industry, said Harris Miller, president of the Arlington, Va.-based Information Technology Association of America.


Harris Miller, president of the Information Technology Association of America
But any agreement on taxes between industry and the states seems unlikely, partly because industry officials are loath to pay the taxes, arguing that any tax losses caused by online commerce will be offset by increased taxes from greater economic activity caused by the online industry.

Any tax scheme designed to compensate states for any losses caused by out-of-state online commerce "would probably cost a lot more to collect than it would be worth," said Bill Melton, president of CyberCash Inc., based in Reston, Va., which is developing electronic cash for online commerce.

Steve Case, president of America Online Inc., Dulles, Va., declined to discuss the issue, saying that electronic commerce is still in its infancy. But according to an AOL press release dated July 1, "electronic commerce is going to penetrate every aspect of our lives." The press release also added that AOL helped its 7 million subscribers buy $2.6 million worth of flowers on Mother's Day, up 50 percent from the 1996 total.

"If a problem occurs eventually, let's deal with it then," said Eric Schmidt, chief executive officer of Novell Inc., a networking software company based in Provo, Utah.

And lobbyists working on behalf of the states fear the industry is just trying to evade taxes. Industry is complaining about burdensome state taxes, even though no states impose an Internet-unique tax, said a Senate staff member working with state lobbyists. Industry's complaint "is a Trojan horse ... for a tax break. That's what they are really after," not an agreement, he said.

However, if industry and local governments can't agree, then the White House will step in to forge a settlement, said Ira Magaziner, chief architect of the White House's new policy on electronic commerce.


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