October 2, 2005

No Web Tax Yet

By Evan Schuman, Ziff Davis Internet

Opinion: A widely misunderstood Oct. 1 deadline set by a group of states calling themselves the Streamlined Sales And Use Tax Project is making some e-commerce players worried. But the move actually has little to do with the Web and a lot to do with Halloween.

Like a Java version of the sword of Damocles, the threat of a Web tax has loomed over e-Commerce players since the Web was formed a little more than a decade ago.

But fitting for an October deadline, this sword is more of the tissue-paper and cardboard type, one that looks scary only from a distance. Upon closer examination, e-commerce shops are discovering it's a twist on the Halloween tradition called Threat Or Treat.

But first, there's some background we need to get out of the way.

Both sides in this debate point to a pivotal U.S. Supreme Court decision in 1992, which essentially said that states cannot force businesses to collect sales tax from customers unless that business has a "physical presence" in the state where that customer is based.

Note that the high court's decision was in 1992, a full two years before the commercial Web existed.

For you purists out there, Tim Berners-Lee is credited with inventing the World Wide Web in 1989, but there wasn't an initial functional system deployed until 1990—while Berners-Lee was still working at CERN, the European Organization for Nuclear Research.

The first graphical browser—NCSA Mosaic—didn't launch until late '93 when the classic NCSA What's New pages were launched. It was 1994 before businesses started to truly use the system.

Here's a great piece of trivia: The NCSA What's New page was shut down in '96, which was an official acknowledgement that there were far too many Web sites to list them all or to even list the important ones.

The preceding Web history recap was merely meant to stress that the Supreme Court decision was by no means intended as a Web tax decision, as it's unlikely any of the Justices even knew of the impending Web at that point.

That decision certainly didn't prohibit e-commerce players from collecting those sales taxes. It merely said that a state couldn't force the site to do so. It's voluntary and has always been voluntary, which is important when assessing the significance of recent efforts by some 18 states in supporting a movement called the Streamlined Sales And Use Tax Project (SSUTA).

The 1992 Supreme Court decision was more concerned with mail catalogs and other telephone order facilities that might have stores in one state but would ship products to many other states.

The problem with "physical presence" is the corporate relationship with Web and non-Web companies. Barnes & Noble recently argued to a California court that it's online and brick-and-mortar companies were distinct and that—they argued—meant the location of brick-and-mortar locations had no bearing on the Web operation.

The state shot that argument full of holes using Barnes & Noble's own policies of accepting returns from the Web site at its physical locations. That, the court agreed, showed a special relationship.

Personally, I don't think the court even needed to go there. The judge could have limited questioning to "Mr. E-Commerce exec, who owns you? And who owns your physical stores? Same company? Next case!"

As e-commerce sites do what they must do and become more intertwined with their physical operations—leveraging the strengths of each, as some marketer out there is saying—the shell game of presence has to stop.

This would mean that any e-commerce players with a lot of physical stores (Walmart.com, for example) must pay tax where their corporate parent has any people, whether it's a warehouse, a store, a call center or anything else.

This would give pure-play e-commerce players (Amazon.com being the largest example) a definite advantage.

This would mean that a small e-commerce site out there somewhere would not only be able to charge less because of reduced overhead, fewer channel conflicts and even the tendency to disregard manufacturer-recommended pricing from time to time, but it could get out of charging sales tax where its multi-channel rivals couldn't.

This is a crucial distinction, especially as price comparison sites get more sophisticated and start noting which sites are likely to charge sales tax and an estimate of shipping charges. This way, an Amazon deal to waive shipping charges can be compared apples-to-apples with a site that charges slightly less but that will charge shipping.

When the choices for the identical product are getting that close, the difference of one site charging sales tax and another not charging sales tax might easily make the difference between making or not making a sale.

Legally, consumers who purchase from online sites are supposed to pay those sales tax debts themselves. They're also supposed to report racetrack winnings along with any coins they find on the street. All of the above are equally likely.

The states argue that it's legally easier for them to go after the Web sites. And therein lies the implicit threat and the only stick the states hold: They are making a not-so-subtle threat to start suing e-commerce sites unless they start collecting state sales tax.

The SSUTA group set Oct. 1 as a target date for states to start enforcing—OK, threatening.

The legal standing that the states would have to force e-commerce sites to comply is weak at best, but it's the classic lawsuit threat: "We may lose, but you'll be forced to spend tons of money for lawyers and appearing in courtrooms and giving depositions. And, heck, there's always a chance that we'll win, so you might as well do what we want now and not take any chances."

The threat that pure-play e-commerce sites will be forced to pay is unrealistic. The legal action is focused more on multi-channel sites whose corporate parents probably have something somewhere in most states and, if they don't, they're probably only one acquisition away from doing so. The simple act of moving a call center or hiring a different call center outsourcing company could suddenly give a company a presence—legally "nexus"—in an additional state.

Consider Lands' End. It was fine, but it was then purchased by Sears (which then merged with Kmart). All of a sudden, where doesn't the Lands' End family have some physical location?

The SSUTA's threats will only work on larger companies that arguably have some kind of presence in most states and would therefore concede to having to charge sales tax.

For them, SSUTA is offering an amnesty program. That program pretty much says that if the site starts charging sales tax right away, the state will agree to not sue them for back payments. If not, everything stays on the table in the "imminent threat" category.

"They really don't have the leverage to threaten the online retailers unless (the retailers) are benefiting from the road systems, the police, etc.," said Dick Eppleman, the director of government markets for Vertex, a tax software vendor. "I don't think there's an incentive to collect" unless the company has that physical presence in that state.

Eppleman points out that SSUTA is doing some good work on cleaning up ambiguous and conflicting issues with at-time-contradictory state sales tax rules.

One frequently cited example is candy versus food. Many states will not charge sales tax on food but will for candy. Wisconsin officials were involved in a compromise that dictated that anything with flour in it is food, not candy. (Question: How many hours will it take Hershey's to start adding in microscopic dots of starch to chocolate bars to avoid the tax?)

The 13 states that are now working with SSUTA are Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, New Jersey, North Carolina, North Dakota, Oklahoma, South Dakota and West Virginia. Six that will be added in the next few years are Arkansas, Nevada, Ohio, Tennessee, Utah and Wyoming.

In short, the Web has little impact on any of this. The only retailers who should consider the amnesty program are ones who honestly believe they have operations in that state. And if they do, they should have been charging sales tax for years. For those who don't, there's no need to make any changes.

There is a true threat hanging over their e-commerce heads, though. Some states have been lobbying Congress to change the law to force e-commerce sites to charge the same sales tax as everyone else.

That's a very interesting situation. Congress would be able to deliver literally billions of dollars in additional revenue to the states, which the states could use to pay for various federally mandated programs. It's unusual for Congress to be able to help states get money directly, so this would be a nice twist.

Should they do it? My only concern is fairness. If it's universal and it hits all e-commerce sites at the same time and in the same way, it wouldn't hurt any one site more than any other. And I can't imagine consumers and businesses cutting back online purchases because of a universal single-digit percentage increase.

But such a move would take quite some time to push through, assuming the votes can be found at all.

Until then, though, e-commerce sites can greet those 18 states ringing their doorbells with a friendly, "Sorry, kids, but I won't collect your taxes for today. But before you start toilet-papering my site, I have bags of 20 percent off coupons good for today only. And if you register right now, I'll give you all a brand new cookie."