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Online Tax-Free Shopping May Soon Be Obsolete

January 13, 2009 12:53 PM
by findingDulcinea Staff
With tax revenue dwindling along with the recession, states are considering taxing online purchases to cover the shortfall. But Web-based merchants are rallying against the move.

New York State Leads Movement to Tax Online Sales

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If online retailers collected sales taxes on purchases, they could harness some $3 billion in revenue for financially struggling governments, estimates Sucharita Mulpuru, an analyst for Forrester Research.

States are facing an $89 billion shortfall this fiscal year. So it’s clear why governments are considering new legislation to tap into e-commerce’s potential wellspring of new revenue.

The Streamlined Sales Tax Governing Board, a coalition of 22 states and more than 1,100 brick-and-mortar stores, is pushing to have Congress draft and pass legislation to implement uniform measures for taxing online purchases.

“For example, one state might now consider a T-shirt clothing and tax it as such,” writes the AP, “while another might consider it a sporting good and tax it differently.”

A 1992 Supreme Court ruling determined that states cannot have out-of-state businesses collect sales taxes unless they have a “physical presence” in the state. Thus, anyone’s purchase from, say, BN.com being shipped to a state that has brick-and-mortar Barnes & Noble bookstores would have to pay sales tax, while that same purchase shipped to a state with no Barnes & Noble stores would be tax-free.

In the forefront of taxation of online purchases is New York state, which passed a law last April that requires all online purchases being shipped to New York state residents be taxed.

The “Amazon tax,” as it is informally called, was signed into law by Gov. David Patterson last year, but analysts correctly predicted backlash, including challenges from Web businesses like Internet shopping giant Amazon.com, who oppose the measure.

But advocates for local retailers say the bill “level[s] the playing field” for New York’s brick-and-mortar stores. James Sherin, the president of the Retail Council of New York State, wrote in The Buffalo News that, despite Amazon.com’s criticism of the plan as bad for the consumer, “We think it is the right track toward shattering the legal stasis that for years has given all out-of-state merchants an unfairly large and unintended competitive advantage over New York’s brick-and-mortar merchants.”

Other groups representing New York retailers had argued for years that the exemption from sales tax gave out-of-state online retailers “an unfair competitive advantage,” writes Internet News.

Stores in nearby parts of New Jersey, which does not tax clothing purchases, have enjoyed a similar advantage for years. Former New York Mayor Rudy Giuliani hosted “tax-free” shopping weeks in the city in the late 1990s that, he claimed, did a world of good for local retailers.

Last spring New York state estimated the new online tax requirement would generate about $50 million in revenue during this fiscal year. But in a Jan. 12 Associated Press article, Matt Anderson, spokesman for the state’s Division of the Budget, said that the new online sales tax will pull in closer to $23 million over the year.
Any new tax on online purchases could face legal challenges similar to efforts to stop the “Amazon tax”. Both the Direct Marketing Association and the National Retail Federation are trying to determine the constitutionality of the bill, which they believe may go against the 1992 Quill v. North Dakota decision that “effectively determined that out-of-state retailers cannot be required to collect sales tax on purchases sent to states where they did not have a physical presence,” writes DMNews.

Amazon and online retailer Overstock.com are both suing New York state over the new sales tax law. Overstock is not collecting taxes from New York state residents at this time because it cancelled some 3,400 online affiliate programs in the state. The retailer is part of an advocacy group called NetChoice, which is supporting tax simplification plans. Overstock CEO Steve DelBianco has said that “online retailers should have to collect taxes only in states where they have a physical presence,” the AP writes.

On the federal taxation front, some are calling for activities with no physical presence at all to be taxed. Tax advocate Nina Olson wrote a report, cited by Ars Technica, suggesting the Internal Revenue Service develop rules on how to determine and itemize real income earned from “virtual worlds” such as World of Warcraft and Second Life.

“Economic activities associated with virtual worlds may present an emerging area of noncompliance, in part, because the IRS has not issued guidance about whether and how taxpayers should report such activities,” Olson wrote. “IRS guidance could improve taxpayer compliance even if it simply clarified that in-world transactions are not taxable.”

Related Topic: Tax-free shopping in New York City

New York City has experimented with tax-free brick-and-mortar shopping in the past. During tax-free shopping weeks specific to clothing in 1998 instituted by then-Mayor Rudy Giuliani, many New York retailers said their sales doubled on everything from underwear to hiking boots, reported The New York Times. The tax breaks were meant not only to appease shoppers but also local retailers, who said they were losing business to New Jersey because of New York’s 8.25 percent sales taxes.

Giuliani said that the New York State sales tax of 8.25 percent made shopping difficult for some New Yorkers and tax-free shopping gave them a reprieve. “This tax is the most regressive, most damaging tax to people who have limited incomes of any, because it doesn’t respect the level of income that you have,” he said.

Opinion & Analysis: ‘Amazon tax’ pros and cons

The bill, Michael Santo, editor of Real Tech News, wrote in April, closes an important loophole: “Normally sales tax has depended on the retailer having a physical presence in a state. Of course, this would exclude Amazon.com, and be a real attraction to people who live in high sales tax states like New York (and California). Naturally states see this as a negative.”

But the new tax will likely “level the playing field” for local stores, wrote James R. Sherin, Chief Executive Officer of the Retail Council of New York State, last spring. “Every New Yorker who longs for the day when independent book stores, music sellers and clothing stores dotted our Main Streets knows the importance and value that these merchants contribute to our state. Not just competition, selection and employment—but contributions to schools and communities that aren’t replaced by a faceless dot-com enterprise. And now we have a plan that helps to keep that fair competition a reality,” he was quoted as saying in the Buffalo News.

Stephen J. Dubner, co-author of the bestselling book “Freakonomics,” writes that there are many arguments about why online merchants should not have to collect sales tax, but most are not very compelling: “Imagine how hard it is to be a brick-and-mortar shoe store, for instance, when your online competitors not only don’t have the brick-and-mortar costs to contend with but also don’t have to collect sales tax from customers," he wrote.
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