IP: ISA State Taxation Task Force statement

[Dave Farber <farber () cis upenn edu>]

http://www.isa.net/about/releases/taxexsum.html


     ISA State Taxation Task Force 


Logging On to Cyberspace Tax Policy (*1)
Executive Summary




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I. Introduction 


This is to summarize the contents of a white paper (hereinafter the White
Paper) prepared on behalf of and in conjunction with a Task Force of
Interactive Services Association (ISA) member companies by Ernst & Young
LLP (*2). The purpose of the White Paper, entitled Logging On to Cyberspace
Tax Policy, is to initiate discussions with the nation's tax policymakers
about the state and local transaction tax issues affecting the Internet and
online services industry (the Industry). 


The Industry is important to the nation's economic growth and to individual
states' economic development in that it promises to grow dramatically in
the near future. Utilization of the Internet and proprietary subscriber
networks (*3) will provide increasingly significant consumer benefits
including improved access to information, lower prices and increased
business efficiency.


Much uncertainty exists as to the manner in which state and local taxes
should be applied to the Internet and online services industry. The
uncertainty results from a lack of understanding of: a) Internet and online
service technology; b) the nature of the various types of businesses
providing Internet and/or online services; c) the nature of the various
types of transactions that take place over the Internet and proprietary
subscriber networks; d) the applicability, if any, of current state tax
laws to this new and rapidly evolving Internet and online Industry; e)
whether and how such laws can be implemented in the Internet and online
services environment; and f) what state tax approach would best serve the
interests of the states and the Industry.


The White Paper seeks to educate policymakers about the technology upon
which the Industry is based and about the unique nature of the Industry, as
well as to present practical and equitable recommendations which can serve
as a basis for construction of a uniform, consistent and fair tax scheme.
The recommendations are summarized in Section V. below. 






II. Industry Background


A. Internet and Online Activities               
Generally, members of the Industry are engaged in the sale of access
services and/or content.


1. Access services are those services that enable a customer to get onto
the Internet and/or proprietary subscriber networks easily, for example, by
simply dialing a phone number. 


a. According to Industry vernacular, generally:
1) An Internet Service Provider (ISP) is a business providing access to the
Internet.
2) An Online Service Provider (OSP) is a business providing access to a
proprietary subscriber network. Many OSPs also provide their customers the
ability to access the Internet.
b. ISPs and OSPs generally provide their services in return for the payment
of subscription and/or usage fees. 
 
2. Content consists of information and services delivered electronically
via the Internet or proprietary subscriber networks to the public. 


a. Content is made available to the public by OSPs, by some ISPs, and via
the World Wide Web sites of third-party Content Providers.
b. The cost of most content provided by OSPs and ISPs is included in their
subscription and/or usage fees.
c. A limited number of Web site operators provide content for a fee which
they bill directly to the consumer. 
d. Some sales of content would be treated as taxable sales of tangible
personal property if delivered other than electronically, e.g. downloaded
videos, music, books. This market is extremely limited at the moment.


B. Mail Order Sellers


Retailers selling tangible personal property over the Internet and
proprietary subscriber networks are essentially mail order sellers who
deliver their goods to an identifiable address. The White Paper assumes
that mail order sellers:


1. Are simply major users of the Internet and proprietary subscriber
networks in marketing their wares over those electronic facilities;


2. Are protected by traditional constitutional restraints upon the states;
        
3. Are subjected to traditional state use tax collection requirements; and 


4. Bill their customers directly for their sales.




C. Nexus (Taxing Jurisdiction) Considerations


The United States Supreme Court has ruled that states have taxing
jurisdiction over only those out-of-state sellers of tangible personal
property who have nexus (sufficient physical contact) with the state. When
a transaction involves a sale that is delivered electronically, the sellers
lack of any physical contact whatsoever with the state should insulate it
from the states taxing jurisdiction. (*4)




D. Relationship to Telecommunications Carriers


Generally, customers of ISPs and OSPs purchase telecommunications capacity
from telecommunications carriers in order to gain access to the Internet
and online services. ISPs and OSPs also purchase underlying transmission
capacity from telecommunications carriers to operate their businesses. All
of those parties pay taxes on such telecommunications services provided by
the telecommunications carriers.




E. Locating Sales


Internet and online services, by their nature, are not designed with
geographical boundaries in mind. This severely limits the Industrys ability
to comply with tax administration requirements based upon locating either
the source or the destination of electronic transactions. When a sale is
delivered electronically, the ISP, OSP or Content Provider often cannot
determine the physical location of the sales destination. This can be true
even if the Provider itself happens to be subject to the taxing
jurisdiction of the state of the user.






III. Economic Significance of the Industry


A. Economic Benefits


1. Potential


Internet and online services hold enormous potential for reducing customer
costs, improving business productivity, and expanding access to
information, for consumers, businesses and students.  The growth of
Internet and online services will generate significant benefits to business
and household users as well as employment opportunities in individual
states and localities.


2. Recent Employment Experience


For example, Internet and online services-related employment in five of the
seven Task Force member companies grew from approximately 3,500 in 1993 to
approximately 9,500 in 1995, an annual growth rate of more than 60 percent.




B. Sizing the Internet and Online Service Market


Internet and online services are experiencing rapid growth, but it is
important to recognize that the industry is still relatively young.  The
Internet and online service marketplace has enormous potential, but the
current level of revenues is quite small both in absolute dollars and
relative to non-electronic sales of communication and information services. 


1. Estimated revenues from Internet access and consumer online services
ranged between $1.6 billion and $2.2 billion in 1995, according to two
industry research firms. Despite all the attention the Internet and online
services have received, they still represent a very small proportion (less
than 0.8%) of total communication services revenue (including telephone,
television and radio broadcasting, and cable and other pay television
services). 


2. Revenues for Internet access services in 1995 totaled approximately $250
million in 1995, according to SIMBA Information, Inc. and Jupiter
Communications.


3. Revenue estimates for consumer online services in 1995 ranged from $1.2
billion (SIMBA Information, Inc.) to $1.8 billion for online content
packaging (Jupiter Communication). Most consumers use online services
principally for electronic mail and accessing information.


4. Content, which traditionally was supported by subscription revenues from
online services, is increasingly being supported by advertising revenues as
more content moves to the World Wide Web. Ad spending on the World Wide Web
and online services totaled $131 million during 1995 (SIMBA Information,
Inc.), or less than 0.5 percent of spending on television, network radio,
and magazine advertising. 


5. The Internet and online equivalent of mail order sales of tangible
personal property in 1995 totaled approximately $500 million (SIMBA
Information, Inc. and Forrester Research), or less than 0.4 percent of
consumer mail order sales.




C. Growth Potential


Internet and online services are projected to grow rapidly during the next
five years, assuming that those services can continue to develop in the
unimpeded manner that they have over the past few years.


1. By 2000, revenues from subscriptions and advertising for Internet access
and consumer online services are projected to grow between $7 billion
(SIMBA Information, Inc.) and $14 billion (Jupiter Communications).
Projections also differ on the mix of subscription and advertising revenues.


2. By 2000, the Internet and online equivalent of mail order sales of
tangible property is projected to reach $6.6 billion by Forrester Research.
This would represent less than five percent of mail order sales.


3. The growth of Internet and online services will generate new sources of
tax revenues for states from expanded employment, increased profitability
from business productivity improvements, and expanded use of
telecommunication services.     






IV. Industry Observations


A. Distinctions Between Telecommunications Services and the Industrys Services


1. The essence of the Industrys services is not telecommunications services.
        
2. While telecommunications-like services may be a component of Internet
and online services, it is a minor one. Other components, such as file
transfers, information access and retrieval, and protocol conversions which
allow communication with a variety of users, are the true essence of
Internet and online services.


3. Underlying transmission services provided by telecommunications carriers
are already subjected to specific taxes by many states.


4. Internet and online services fall within the Federal Communications
Commissions definition of enhanced services, rather than within that of
basic telecommunications services. 




B. Irrelevance of Location


The states will often be unable to determine the locations of sellers over
the Internet and proprietary subscriber networks. In fact, the nature of
the Internet and online technology makes the physical location of the
seller irrelevant to the sellers business operations. Such a seller may be
able to operate in a states market effectively from far beyond the states
borders, where it may be immune to the states taxing jurisdiction. Any
government seeking to require tax collection by such a seller faces a
formidable challenge. 




C. Industrys Potential Role


Only through close cooperation between the Industry and the policymakers
can there be hope of designing and implementing an effective tax system
that takes into account the unique nature of the Industry.




D. Looking Before Leaping


The Industry is concerned that, if the states move too quickly, they will
risk creating, rather than resolving, major problems. Since relatively
small amounts of tax are currently at stake, there is time in which to work
together to develop a fair and efficient tax system. Such a system should
ensure uniform application and consistent administration of any tax while
protecting the development and expansion of the Industry. A deliberate and
cooperative approach will avoid the dangers that lurk in precipitate and
uninformed action on the part of the states, dangers that could hinder the
development of the Industry. 




E. Tax Elements


The Industry believes that the only type of tax that can be applied
effectively to Internet and online transactions will be a transaction tax
that is imposed upon the purchaser, not upon the Industry; that, in the
absence of better information as to the location of the purchaser, a seller
should be allowed to rely upon the billing address to identify the state
whose tax will apply; and that the billed charges should be used to
determine the amount of the end users tax liability. New developments, such
as the increasing use of electronic cash to pay billed charges, can be
expected to produce new tax collection and allocation challenges. The
Industry stands ready to work with the states in a cooperative effort to
meet those challenges.




F. Consistent Definitions


Inconsistency among the states in defining and applying terms defeats the
possibility of achieving uniform, fair and efficient administration of any
tax.  Cooperative efforts must, therefore, concentrate on creating one set
of definitions for states to adopt; and those definitions must be
interpreted consistently from state to state.




G. Uniform Rate in Each State


The greatest threat to the type of tax system contemplated here is any
requirement that a remote seller have to account for a multiplicity of
taxes at lower levels of government.  Relieving the Industry of such a
requirement is the key to obtaining the Industrys cooperation to produce an
effective tax administration capability for the states with respect to
electronic sales. Such relief is a vital prerequisite to achieving the
purposes set forth herein. 






V. Recommendations


State tax rules should be uniform, fair, certain, and administratively
simple. They should not discriminate against electronic commerce or
Internet-based transactions, and they should not hinder economic growth.
The development of tax rules applicable to the Industry should be pursued
with deliberation to ensure the achievement of these goals. Specifically,
it is the position of the ISA White Paper Task Force that, if the states
adopt a tax system applicable to the Industry, that system should call for:


A. Adoption of uniform definitions among the states;


B. Establishment of a uniform rate, within each state, of any applicable tax; 


C. Recognition of the fact that the only type of tax that can be applied
effectively to purchases made over the Internet or proprietary subscriber
networks will be a tax on the purchaser with respect to the purchase
transaction itself; and


D. Attribution, to the extent possible, of any applicable tax to the state
into which the sales are billed.


The subject of nexus needs rethinking insofar as it pertains to the complex
environment that characterizes the Internet and Internet-based transactions.






VI. Conclusion


The above recommendations are intended to address the concerns of tax
policymakers, on the one hand, and the Industry, on the other. Their
implementation, however, can be accomplished only through close cooperation
between the Industry and the policymakers. Time is of the essence. The line
is open.




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Endnotes


(*1) This Executive Summary of that white paper is copyrighted by the
Interactive Services Association and its state online taxation white paper
task force. With proper attribution, it may be quoted or reprinted.


(*2) Companies having representatives on the Task Force include: America
Online, Inc., AT&T, CompuServe Inc., GE Information Services, Inc., IBM,
Microsoft Corporation, and NETCOM On-Line Communication Services, Inc.


(*3) For purposes of this paper, the term proprietary subscriber network
refers to networks that are proprietarily or corporately owned but which
make their services available to the public for fees. Private or
intracompany networks, sometimes called intranets, are outside the scope of
the White Paper.


(*4) The White Paper explores the question of whether a Point of Presence
(POP) in the form of readily movable equipment (e.g., a computer, modem or
router) subjects a remote ISP or OSP to the taxing jurisdiction of a state
for transaction tax purposes. The White Paper does not address the question
of whether a POP subjects a remote ISP or OSP to the taxing jurisdiction of
a state for income tax purposes or of a local taxing jurisdiction for
property tax purposes.










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