What's Next for Internet Taxes? Quill Decision May Finally Get Revisited

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DALLAS - The commission created to advise Congress on Internet sales taxes is expected to present a report that recommends providing all remote sellers even broader nexus protection than what exists today. However, the commission, which met for the last time here this week, failed to gain the votes needed to present a formal recommendation on how remote sales should be taxed.

The 19-member Advisory Commission on Electronic Commerce - which consists of leaders from industry and consumer groups and representatives from state, local and federal government - was appointed in 1998 as part of the Internet Freedom Act to study federal, state, local and international taxation and tariffs using the Internet and Internet access. It must present its recommendations to Congress by April 21. Currently, there is a three-year moratorium on new, special and discriminatory taxes, which means that no new taxes can be imposed on sales over the Internet until October 2001.

The commission voted 11-1 last week in favor of a compromise proposal submitted by a bloc of business members recommending that Congress:

• Make permanent the ban on Internet access taxes.

• Eliminate the 3 percent federal excise tax on telecommunications.

• Establish standards to simplify state tax systems.

• Define nexus standards for a company's physical presence and provide specific examples for out-of-state taxation.

• Establish a new advisory commission to oversee states' tax simplification efforts.

• Extend the current moratorium for another five years.

The compromise also prohibits the taxation of digitized goods and products - downloadable computer software, electronic books or musical recordings and "tangible" equivalents such as books, CDs and movies - during the moratorium.

More specifically to direct marketers, the proposal asks Congress to adopt legislation expanding a 1992 decision by the U.S. Supreme Court - known as the Quill decision - prohibiting states from taxing mail-order sales unless the seller has a physical presence in the state. Currently, both catalog and Internet sellers collect sales taxes from customers on behalf of a state if their companies have a physical presence there. The business bloc's proposal, however, indicates that physical presence doesn't include such things as an Internet service provider or an Internet home page and that a seller doesn't have nexus if it has a contractual obligation with another party in a state that it uses simply for product returns or to repair goods.

"If Congress approves these nexus provisions, it would be good news for direct marketers," said Stanley Sokul, a Washington-based lawyer and member of the commission representing the Association for Interactive Media. "They would clarify and, in some cases, offer even broader nexus protection than they have now."

Sokul said the report may influence Congress to amend the Quill decision. While Congress usually doesn't have decision-making authority over the Supreme Court - since the Quill case was decided under the commerce clause of the Constitution, "Congress has the ultimate authority to regulate interstate commerce," he said.

The business members on the commission are C. Michael Armstrong, chairman/CEO of AT&T; Richard Parsons, president of Time Warner Inc.; Robert Pittman, president/CEO of America Online Inc.; David Pottruck, president/co-CEO of Charles Schwab Corp.; John Sidgmore, vice chairman of MCI WorldCom and chairman of UUNET; and Ted Waitt, chairman of Gateway Inc. Virginia Gov. James Gilmore, chairman of the commission, also supported the proposal.

Seven members abstained, including three members from the Clinton administration, Utah Gov. Michael Leavitt and Washington Gov. Gary Locke. Dallas Mayor Ron Kirk cast the lone dissenting vote.

The nexus issue was a sticking point and a key reason the proposal didn't get the necessary two-thirds majority. Representatives from state and local municipalities were reluctant to agree to its call for federal law to clearly define what constitutes a company having a physical presence in a sales-tax jurisdiction.

Some commission members, for example, thought some of the nexus proposals would give computer companies such as Gateway the ability to set up subsidiary "stores within stores" and contract for repair services while avoiding sales-tax collection. Leavitt mentioned several times during the negotiations that he has always wanted Quill to be overturned - thereby allowing states to require retailers anywhere in the United States to collect sales taxes.

The rift in the commission came as no surprise, since it has been bitterly and philosophically divided into two camps since its formation: those who advocate banning all Internet-related taxes and those who worry that making the Internet a tax-free zone would jeopardize the $150 billion in annual sales tax collected nationwide and force states to cut services or raise other taxes.

As a result of the vote, the proposal cannot be made as a formal recommendation to Congress. Members expect, however, to have a teleconference March 30 to continue their talks. The proposal will be outlined to Congress and include the fact that the vote was 11-1. Members also will be able to submit their personal views on e-commerce taxation issues.

The ultimate decision on Internet taxation is not up to the commission, noted attendee George Isaacson, legal counsel for the Direct Marketing Association, adding, "Congress really makes the final decision."

Indeed, lawmakers already are taking action. On his first full day back from the presidential campaign trail, Sen. John McCain, R-AZ, chairman of the Senate Commerce Committee, introduced a bill last week that would extend the tax moratorium until 2006.

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