One of the most common misconceptions for ecommerce retailers is that sales taxes are not due on Internet transactions. Nothing could be further from the truth. Ecommerce retailers, in fact, are responsible for sales taxes and are subject to penalties and fines for the failure to pay them.
Quill case is important
The misconception originates from a 1992 Supreme Court ruling known as the Quill case. The Quill case was decided in the pre-Internet arena, but it has subsequently become applied to online transactions, too. In Quill, the Supreme Court stated that it will not enforce sales tax laws because, in part, of the undue burden that retailers face when dealing with potentially thousands of sales tax jurisdictions. That is, the Court stated that tax systems are so complex, and there are so many jurisdictions, it would be an undue burden to require retailers to be familiar with and comply with each and every jurisdiction. For ecommerce retailers, this is certainly the case since virtually all of them sell to nationwide customers who live in various cities, counties and states, all of which levy sales taxes on retail transactions. Each of these jurisdictions could have different sets of rules. Requiring retailers to know and be familiar with each set of these is just not feasible. Nonetheless, in Quill, the Court was very explicit to say that sales taxes still apply to these retail sales even though it chose not to enforce the collection of them.
Because of this lack of enforcement, retailers have traditionally failed to calculate, collect and pay sales taxes owing on Internet transactions. Many confused this lack of collection with the Tax Moratorium Act that Congress enacted in 1998, thinking that Act applied to the collection of all taxes on Internet transactions. In fact, the Moratorium Act has nothing to do with sales taxes. It merely stated that no new taxes, such as a hypothetical “Internet access tax” or “bit rate tax,” can be created on Internet transactions. It has no effect upon existing taxes such as sales taxes. The states, meanwhile, did not enforce the collection of their own sales taxes for much more practical reasons: There simply was not much sales activity on the Internet and the foregone sales tax dollars were therefore relatively small.
Growth of Internet
In the last two years, both of these variables have dramatically changed. There is now much sales activity on the Internet. And, following from that, studies show that there will be nearly $20 billion of unpaid sales taxes in 2005 from these online transactions. (This $20 billion is expected to double within a few short years.) Since many state governments are running fiscal deficits, these governments are looking for new sources of revenue and the $20 billion of unpaid sales taxes is looming large.
To address these circumstances and respond to the Quill ruling, a group of states jointly drafted and signed the Streamlined Sales Tax Project (“SSTP”). Under the SSTP, emphasis is placed upon achieving rule uniformity and compliance simplicity. The states hope that with this process in place, Congress will pass legislation to expand the jurisdiction capabilities of the Courts who, the states hope, will enforce the collection of the various Internet-related sales taxes. The SSTP became effective on October 1, 2005, when a dozen states formally ratified the rules required under the SSTP, with another six states being in partial compliance. Nearly all other states have signed the SSTP contract, but it will take them some time until they fully implement the rules.
The agencies behind the SSTP took the concept of ‘simplification’ to the next logical step by appointing private firms to develop technology to automate the process of calculating sales taxes, filing sales tax returns and paying the tax proceeds on behalf of the retailer. These private firms are called Certified Service Providers, or CSPs. To date, seven CSP candidates have passed the initial phase, but of them, the SSTP has stated that only two, Exactor and Taxware, have systems in place that have been tested and qualify for certification in the near future. Other companies are expected to receive this certification in time.
But compliance with current sales tax laws does not rest on the SSTP and the hiring of a CSP. Many states are becoming aggressive in enforcing existing sales tax laws and not waiting for SSTP to come into effect. In fact, large, online retailers such as Barnes & Noble, Borders and Office Depot found this out the hard way via back taxes, interest and fines imposed upon them due to their failure to pay sales taxes. Thousands of consumers nationwide were recently invoiced for taxes they did not pay when purchasing cigarettes online. Under Internet Sales Tax Fairness rules, companies are finding that they need to register and pay sales taxes if they want to sell to state governments. Small companies, with revenue in the low millions, are being hit with audits and penalties of tens of thousands of dollars for failure to collect taxes.
The bottom line is that sales tax compliance is a real issue, independent of the SSTP. Retailers need to be aware of this. Retailers cannot beg forgiveness after the fact – they will still owe penalties and fines for failure to comply on a timely basis. Fortunately, CSP-like technology providers can offer solutions that help you address this issue by providing a simple, reliable and accurate solution that operates in a completely automated manner, regardless of which state you are located in or which state you are selling to.