Companies Hold Firm To an E-Tax Future

Companies Hold Firm To an E-Tax Future<@VM>The Real Meaning Of Moratorium?

Gov. James Gillmore

By Steve LeSueur, Staff Writer

Companies that see a bright future in helping state and local governments collect sales and use taxes on Internet transactions will not be stopped in their tracks by what a national commission studying the tax issue recommends in its report to Congress in April.

Although a nationwide framework for e-commerce tax transaction processing may be years away, "specialized software companies already are positioning themselves as sales tax calculators, collectors and remitters," Erik Olbeter, a senior analyst for Schwab Capital Markets and Trading Group of the Charles Schwab Corp., San Francisco, said in a recent report.


Indeed, the market for providing tax solutions that calculate and remit taxes could reach $600 million by 2004, according to the Feb. 14 report authored by Olbeter, "Ecommerce Tax Transaction Processing."

In addition, the European Union is preparing to require soon the collection and remittance of value-added taxes on online sales to European residents, and Japan is expected to follow.

"There is definitely a massive market out there," said Shawn Fahey, vice president of business development and co-founder of esalestax.com Inc. of Englewood, Colo. Founded in June 1999, the 12-employee company is building a software system for both e-merchants and government taxing authorities that should be ready by the end of the year, Fahey said.

"We're going to see more competition in this market," said Dan Sullivan, chief executive officer for Taxware International Inc., Salem, Mass. Taxware has been providing tax compliance software to businesses since 1964 and, with estimated revenue of more than $20 million, is regarded as the major player in the online tax collection arena. "It's going to be very attractive," he said.

The Advisory Commission on Electronic Commerce, a group of 19 government and industry leaders, holds final deliberations March 20 and 21 in Dallas on whether to recommend taxing Internet transactions. The commission, which has been deeply divided on the issue from the beginning, is not expected to reach consensus on this central question.


The commission was established by the Internet Tax Freedom Act of 1998, which placed a three-year moratorium on any new taxes while the panel studied the issue of whether and how to tax Internet transactions. It is chaired by Gov. James Gilmore (R) of Virginia. The moratorium ends October 2001.

Under law, a business is not required to collect use taxes on a product if it does not have a significant physical presence, or "nexus," in the state where the purchaser resides. Purchasers still are required to pay those taxes themselves when they file their state income taxes, but relatively few citizens do. Consequently, most mail and telephone catalog purchases are, for practical purposes, tax free.

With the dramatic rise of Internet commerce, state and local leaders are worried about the potential dwindling of tax revenue to pay for police, schools and other public services.


At the same time, brick-and-mortar retailers fear that they are operating at a disadvantage when shoppers can go online and buy products tax free, which amount to discounts of 5 percent or more.


Gilmore, whose state is home to Internet giant America Online Inc., staunchly opposes taxing Internet transactions. Gov. Michael Leavitt (R) of Utah, also a commission member, regards the current policy as unfair to traditional retailers and as potentially damaging to state tax coffers. He is leading a faction that wants to consider ways to collect online taxes.

A recent report by Forrester Research Inc. estimated that U.S. citizens paid only about 20 percent of sales and use taxes owed on Internet purchases of $13 billion in 1999. Of $665 million in taxes owed, only $140 million was paid.

By 2004, online retail sales will reach a projected $184 billion, which means that the sales and use tax liability will be an estimated $8 billion, according to the Cambridge, Mass., research company.

"State governments won't walk away from $8 billion," said Steven Kafka, an analyst in e-business trade for Forrester.

Kafka predicted that, because technology reduces the tax-collection burden on out-of-state businesses, the Supreme Court will reverse its 1992 ruling that limits the responsibility of businesses to collect taxes on Internet, telephone and mail-order purchases.

"Technology changes the equation" on the Supreme Court ruling, not just for Internet sales but also for telephone and mail order sales, Kafka said. "I think the technology is there to support collecting taxes on all remote sales."

While Leavitt and other government leaders also are looking to simplify sales taxes as a step toward collecting online taxes, industry officials said their software systems could handle the jumble of product definitions and tax rates among the approximately 6,000 state, county and city taxing jurisdictions.

"We would like to see them simply the tax codes, but it could be done today with existing technology," said Sullivan. In fact, Taxware already has thousands of business customers for whom it is collecting taxes on Internet transactions, he said.

The Sales Tax Clearinghouse of Wilmington, Del., is another company jumping into the market. Formed in August 1999, the company announced Feb. 15 its solution for collecting and remitting sales and use taxes. The Sales Tax Clearinghouse, which has under 20 employees, already has some business customers, said Clifford Farmer, company president, although he declined to say how many.

Other companies also are expected to enter the market. Schwab's Olbeter listed a half-dozen companies that could take advantage of this market, including American Express Co., New York; First Data Corp., Atlanta; General Electric Capital Corp., Stamford, Conn.; and Vertex Inc., Berwyn, Pa., the market leader in offline tax transaction processing.


Under the business models now under discussion by government and industry officials, the government would pay for the collection and remittance of sales and use taxes so that the taxes would place "zero burden" on businesses. Currently, about half the states allow businesses to retain a small percentage of sales and use taxes for administrative purposes.

The early innovators will have an opportunity to grab a significant portion of a growing market, but some of the smaller companies also might become takeover targets of larger Internet transaction companies, such as CyberSource Corp of San Jose, Calif., or Cybercash Inc. of Reston, Va., Olbeter said. By Steve LeSueur


Extending the moratorium on Internet taxes is probably one thing most members of the Advisory Commission on Electronic Commerce can agree upon. Unless they are asked to define moratorium, that is.


The 19 government and industry commission members tasked with making recommendations about whether and how to tax Internet transactions likely will recommend in April that Congress extend the moratorium as much as five years to permit additional study of the issue, industry and government officials said.


Opponents of Internet taxes hope that an extended moratorium will entrench the concept of a tax-free Internet. After 2006, "the American people will not permit any expansion of taxes on the Internet," Virginia Gov. James Gilmore (R), commission chairman, said in a Feb. 23 statement explaining his reasons for supporting an extension.


Delaying a decision would also suit Utah Gov. Michael Leavitt (R), who would like to find a way to collect online sales and use taxes without burdening businesses. If it cannot be done, then perhaps all taxes should be eliminated, for both Main Street and Internet businesses, he said.


While both Gilmore and Leavitt support an extended moratorium, they do not agree on its definition or scope.


Leavitt wants to extend the existing moratorium, which applies only to new sales and use taxes, but does not prohibit state and local governments from collecting taxes that existed before the Internet Tax Freedom Act was passed.

Gilmore wants to eliminate the grandfathered taxes and make the moratorium apply to all use taxes on remote Internet sales. "The existing moratorium is not much of a moratorium," he said. "I will urge the commission to clear this up."

Such a proposal would be strongly opposed by Leavitt. "I think it's not only imprudent, but also unconstitutional," he said.

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