Marketplace Fairness Act will replace ineffective use taxes

Use taxes

Use taxes

Marketplace Fairness Act Header

On May 7, 2014 U.S. Senator and Assistant Majority Leader Dick Durbin (D – Ill.) called on the House of Representatives to pass the Marketplace Fairness Act. The bill passed the Senate with overwhelming bipartisan support last year, but has stalled in the House since that time.

In his comments, Sen. Durbin noted that current law only allows states to enforce sales tax on Internet sales through use taxes. Use taxes are imposed on consumers and has notoriously low compliance and enforcement. For example, Durbin notes that Illinois has a 5% compliance rate. The lack of enforceability results from the relatively low amount of tax owed per person and the difficulty of enforcing the law through audits of all state citizens. As a result, most state residents do not report or pay use taxes, and are unlikely to face an audit from the state. For this reason, state use taxes are not an effective mechanism for enforcing the sales tax.

Constitutional law prohibits states from requiring out-of-state vendors to collect the tax at the time of the sale. The Marketplace Fairness Act aims to resolve this problem by creating a congressionally sanctioned requirement for out-of-state vendors to collect tax. Durbin emphasized the need to push the legislation through, calling it the only “reasonable means of achieving fair and adequate enforcement of state sales tax laws”.

Durbin urges rapid passage of the law to reduce state tax revenue deficits as quickly as possible. You can view the full Senate colloquy on a C-Span video.

Chris Saddock

Chris Saddock

Supreme Court supports click through nexus rule

click through nexus rule

click through nexus rule

U.S. Supreme CourtThe Supreme Court has recently bolstered state efforts requiring remote vendors to collect sales tax. In a recent ruling, the court declined to review a case challenging New York State’s click through nexus rule. The New York law finds that a remote or Internet seller establishes physical presence when in-state retailers refer clients to the site through advertisements. This technique is called “click-through” or attributional nexus. Nexus is established because the in-state vendor’s presence is attributed to the remote vendor. For example, if a New York based company advertises a product and allows completion of the purchase via a link with Amazon, Amazon must collect sales tax on the purchase.

The denial of certiorari is at odds with previous opinions from the Supreme Court. Historically, the court has found that states lack the power to require vendors to collect tax unless the vendor has a “physical presence” in the state. Moreover, the court has narrowly interpreted the “physical presence” requirement, usually requiring a building or in-state personnel. The court’s interpretation was strict enough that Illinois the Supreme Court found that “click-through” nexus was unconstitutional. The Illinois court’s ruling focused on the lack of physical connection through a web link.

As a result, the court’s refusal to overturn New York’s law creates the opportunity for states to expand their collection efforts over at least some remote vendors. The New York win aids states in collecting tax from remote Internet vendors at a time when Internet sales are at an all time high. Without comprehensive legislation detailing the limits of state taxing powers, vendors may be subject to unpredicted tax collection requirements. Retailers may face increased tax risks as states increase enforcement efforts related to attributional nexus.

Chris Saddock

Chris Saddock

Puerto Rico makes changes to sales tax and beefed up tax enforcement

tax enforcement

In order to preserve the status of its only investment grade bond and reduce its outstanding debt, Puerto Rico has increased its sales tax rate and stepped up tax enforcement. Tax is a logical place to begin repairing the territory’s credit status because taxes can reduce Puerto Rico’s ratio of debt to revenue. Additionally, sales tax is a key to bond sales in Puerto Rico. The only Puerto Rican bond to retain an investment grade rating is the Cofina bond, whose revenue is backed by sales tax.

Recent legislation attempts to fight these problems by increasin

Puerto Rico sales tax increase

Puerto Rico just raised its sales tax to 7 percent.

g the sales tax to 6 percent and stepping up tax enforcement. Effective as of February 1, 2014, a new sales tax limits the authority of municipalities to tax food and food ingredients. The new law keeps the previous overall rate of 7 percent, but imposes a mandatory 1 percent tax on food and food ingredients. Municipal sales and use taxes are reduced from 1.5 percent to 1 percent, effectively reallocating these funds to the territory level. The reallocation is also part of an effort to create a uniform municipal sales tax. This uniformity is intended to ease Puerto Rico’s efforts to tax remote Internet vendors who sell to consumers in the territory.

In addition to increasing the rate, Puerto Rico is also increasing enforcement. Currently, Puerto Rico’s underground economy makes up 27 to 28 percent of gross domestic product. This is significantly higher than the continental United States, which has an underground economy estimated at 19 percent of GDP. In fact, Puerto Rico only collects 56 cents for every dollar of tax due.

Additional enforcement could result in an additional $391 million in tax revenue, which could significantly reduce Puerto Rico’s outstanding debt and thus increase its credit rating. In order to fight sales tax evasion, Puerto Rico has added a new $20,000 fine for each instance of sales tax evasion, and hired an additional 200 tax enforcement investigators. Further, the territory has introduced legislation to require all businesses engaged in sales to certify sales tax payment systems with the Treasury. Such registrations will provide accountability and reduce the financial incentive for business to evade the sales tax.

The changes to Puerto Rico’s sales tax appear centered on increasing enforcement and creating a uniform tax. Businesses operating in Puerto Rico should be aware of the increased focus on tax collection and the potential for additional efforts to tax remote vendors.

Chris Saddock

Chris Saddock

Marketplace Fairness Act Update

Marketplace Fairness Act Update

Marketplace Fairness Act Update

Marketplace-Fairness-Act 

Marketplace Fairness Act Update: On March 12, the House Judiciary Committee held a hearing to consider alternative proposals to the Marketplace Fairness Act (MFA), which passed the Senate with overwhelming support in May of 2013. The House hearing entitled “Exploring Alternative Solutions on the Internet Sales Tax Issue” focused on potential alternatives the Senate bill. A panel of six sales and use tax experts were questioned about five alternative solutions.

Andrew Moylan, senior fellow at the R Street Institute, proposed an “origin sourcing” model for taxing remote sales. Under this method sales tax is determined by the location of the seller, as opposed to the predominant system where tax is determined by the consumer’s location. The committee examined the flaws of this proposal, finding that origin sourcing was  a drastic change to current tax collection methods and surely would  have unknown pitfalls. It was argued that origin sourcing would likely encourage states to “race to the bottom” for the lowest tax rate.

Finally, origin sourcing was found to risk taxation without representation because it would impose state sales tax laws on out-of-state consumers. As a result, Rep.  Jason Chafetz concluded that the proposal was “dead on arrival.”

Next, the panel considered increasing consumer information reporting and enforcing the use tax more efficiently. Essentially, this solution would shift the burden away from vendors to the consumer via a 1099 style report. States would collect tax by enforcing the individual requirement to track and remit the use tax owed when purchasing from a remote vendor. However, the panel criticized the proposal for its potential to violate consumer’s privacy rights and placing an unnecessary burden on the consumer.

William Moschella, a shareholder at the law firm of Brownstein Hyatt Farber, provided a somewhat radical alternative, suggesting that Congress could use its Commerce Clause power to prohibit the shipment of goods that violate the sales tax laws of the state to which the goods are shipped. This method was later identified as dangerous to commerce and analogized with allowing states to erect fences to protect their taxing power. The proposal received little attention from the committee.

Finally, Joe Crosby, a principal at MultiState Associates, Inc. suggested that the Marketplace Fairness Act was an appealing solution. The software proposed by the MFA would integrate with most software systems, could file all returns, and provided immunity from audits. Further, the software is robust enough to handle differences in state taxing methods. As a result, implementing the MFA is likely to allow continued diversity while limiting the liabilities and burdens of the current system.

In conclusion, Stephen Kranz, partner at McDermott Will & Emery suggested that the only real alternative to the current system is simplification and uniformity through technology. Accordingly, he urged the panel not to focus on alternatives to the MFA, but rather on how to modify the MFA to address concerns about simplify, state sovereignty and software integration with existing systems.

Chris Saddock

Chris Saddock