By Deidra Darsa

New streamlined regulations and special software are being combined to simplify the maze of retail tax codes in the U.S.

Sometimes, nothing can be more complex than attempting to eliminate complexity. A perfect example of this conundrum can be seen in the current attempts by states to simplify their retail tax codes to accommodate Internet sales.

Of the 50 states, 45 have sales and use taxes that require consumers to pay a tax to their state when they purchase items in another state, either offline or through the Internet. Combined, these taxes generate more than $150 billion per year and, on average, account for roughly one-third of state government revenues used to pay for education and safety services, according to the National Governors' Association. While that is a substantial sum, studies by Forrester Research found that of the $13 billion in taxable retail goods sold online in 1999, only 20 percent of the taxes on those transactions was collected. By year's end, Internet sales had pulled $525 million in 1999 sales taxes away from state and local government coffers as consumers shopped online instead of on Main Street, where taxes are customarily collected at the point of purchase.

States Respond to the Advisory Commission on Electronic Commerce The Advisory Commission on Electronic Commerce was created by The Internet Tax Freedom Act of October 1998 to consider issues associated with the taxation of retail sales on the Internet.   Sales and Use Tax: What is it and Who Collects it? Even though the sales and use taxes are on the consumer, the merchant is typically responsible for collecting the tax and sending it to the consumer's state.

Considering 47.9 percent of state revenue comes from sales taxes that fund schools, police, fire and transportation services, according to the U.S. Census Bureau, a substantial sales and use tax revenue loss could affect the quality of life in many communities. It is because of this that state leaders, and state and retail organizations are working together to develop ways to streamline sales tax and level the playing field for brick-and-mortar and online retailers.

Simpler Is Better

"Governors have commenced the streamlining process," notes Frank Shafroth, director of state and federal relations, the National Governors' Association (NGA), Washington, D.C. "They have held a large number of meetings to radically simplify and streamline sales tax systems."

NGA's policy calls for congressional action to require all merchants to collect use taxes, regardless of whether they have a physical presence in the state. In exchange, states would have to simplify their sales and use tax systems by adopting changes such as a single rate per state for remote sales or using software-based systems to facilitate tax-collection responsibilities.

The Streamlined Sales Tax Project, begun in March 2000, is the result of the states' desire to simplify the onerous retail sales and use tax system. Elements that will be part of the first phase of the Project include a set of uniform definitions, uniform rules for sourcing, rounding and bad debts, modernized exemption administration and other simplification features. There are over 30 states involved in the project, all hoping to design, develop and implement a system that will reduce the tax collection burden to retailers, which in turn will increase retail tax revenues to the states.

"Our intent is to streamline and simplify," says a spokeswoman close to the project. "Because each state has its own set of rules, businesses have been screaming for a long time that the current sales tax system is very complicated and the administrative burden of companies that conduct interstate transactions is beginning to be too great. Even states complain that the compliance burden on them is getting too complex and burdensome. So the interest is on both the side of the businesses and state to streamline the process."

Fewer Systems, Fewer Rates

In December 2000, the Streamline Project drafted and unveiled model state legislation that would provide specifics for one sales or use tax system to be used by all 45 states that collect a sales or use tax. The following January 2001, state legislatures began considering model legislation that would allow them to participate with other states in a reformed sales and use tax system.

Under this new system, tax rates will remain the same but each state's tax base (items that are taxable) will be adjusted so as to be consistent from state to state. For instance, if marshmallows are taxable under Illinois law, then they will be taxable under every state's law. Project members are also looking into ways to reduce the number of tax rates per state, and, if successful, this would cut internal compliance costs significantly.

The other big element in this is technology. The current sales tax collection system is almost entirely paper based. Under the new system nearly all filings and returns will be done electronically. "Toys-R-Us said they actually rent a warehouse in Georgia to store their sales and use tax paper files. They measure that amount of paper in cubic yards," says this spokeswoman. If the Streamline process goes into effect, that will go away. "We're virtually eliminating the administrative burden on business," she says.

Diane Hardt, co-chair of the Streamline Sales Tax Project (SSTP), is on staff of Wisconsin's Department of Revenue's tax administration. "We know that for e-commerce businesses to come forward we have to simplify the [sales and use tax] process," she says. "We're working to simplify sales tax and make them more uniform across the 45 states that have sales tax. We're developing some new technology models that will be used to process sales tax returns and payments."

A Pilot Software Program

In September 2000, Project participants approved a pilot program to test software specifically designed by Pitney Bowes, Taxware International, Hewlett-Packard, and esalestax.com that will assume complete responsibility for determining, collecting, and remitting the use tax owed on a transaction. The pilot was launched in Kansas, Michigan, North Carolina and Wisconsin.

Participation is voluntary, but those states that take part are asked to adopt authorizing legislation and enact certain simplification measures including adopting uniform product codes and sourcing rules, developing uniform definitions of state tax laws, creating a central, one-stop registration system, and limit the frequency that local governments can change their tax rates.

"The pilot serves two purposes: one, to test the technology and, two, to show that states can work together to simplify the process," says Hardt. Additionally, the pilot, which is testing with current law, is testing technology links between third parties and the revenue department that is participating in this pilot.

Those businesses that choose to join-in will find the benefits exceptional. The National Governors' Association notes four benefits: 1) Small- and medium-size businesses could choose to participate by using state-certified software that would assume the complete responsibility for determining, collecting, and remitting the use tax owed on a transaction. In this case, the retailer would be exempt from any audit—except for deliberate fraud—or costs; 2) Small- and medium-size businesses could use software that would perform only the tax calculation function; 3) Large, interstate retailers, like Sears and Wal-Mart, could ask states to certify their existing tax software and thereby reduce their audit exposure; and 4) Retailers could choose not to participate or use state-certified software. They would receive no incentives, but would benefit from simplified, more uniform state and local sales and use tax laws.

"It's difficult to comply with the law when there's so many different laws," notes Hardt. "There's plenty of room for simplification."

On the National Level

In the last Congress, others were working with Congressional leaders to pass legislation, H.R. 4462, the "Fair and Equitable Interstate Tax Compact Simplification Act of 2000," and S. 2775, the "Internet Tax Moratorium and Equity Act," that would have leveled the sales and use tax playing field by authorizing states to develop and enter into an Interstate Sales and Use Tax Compact (new bills will be introduced in the current Congress). Those states joining the Compact would be required to adopt a simplified sales tax system. This requirement has caused concern among some state leaders.

"The feeling among states is that they need to control their own destiny and simplify the process," notes Hardt.

"[S. 2775] went further than to say simplify," says Neal Osten, senior committee director, National Conference of State Legislators. "It told states how to do it. We always get nervous when Congress begins to tell states what laws should look like."

The "Internet Tax Moratorium and Equity Act" forces a mandatory one-rate tax rate for all commerce, according to Osten. "Under [S. 2775] states would have had to come up with one rate for the entire state. That was a deal killer for us."

Osten explains, "As written, New York would have to lower the tax rate for New York City, yet raise it in upstate New York."

While the National Conference of State Legislatures (NCSL) opposed parts of S. 2775, it is hopeful that a successful Streamlined Sales Tax Project pilot will curtail any mandatory legislation by Congress. "We're hoping to show Congress progress by 2001," says Osten. "By the end of sessions in 2002, we are hoping to have the majority of states collecting sales tax pass legislation."

On January 27, 2001 the NCSL's task force on State and Local Taxation of Telecommunications and Electronic Commerce unanimously endorsed the Uniform Sales and Use Tax Administration Act and the Streamlined Sales Tax Agreement that had been put together by the SSTP. They did, however, include a number of amendments that made changes in the governance, base and rates, definitions, bad debt and vendor compensation sections.

E-Fairness

As the debate continues on the states' tax rates, everyone agrees on one thing: level the playing field between brick-and-mortar retailers and online retailers. And, the E-Fairness Coalition is working to do that. Representing over 1.5 million brick-and-mortar and online retailers, retail corporations and associations, shopping centers, outlet centers and independently owned Main Street shops, the Coalition is working with state and national governments and organizations in pursuit of a fair retail tax system.

"We've been able to bring a focus onto the issue and been able to push all sides to moving towards a solution," says Peter Lowy, E-Fairness Coalition founding chairman and CEO of Westfield America, Inc. "One of the major accomplishments of E-Fairness is that it has been able to help shape the debate of sales taxes over the Internet and the implications of that."

The E-Fairness Coalition supports the "Internet Simplification and Equity Act" introduced by Senator Dorgan (D-ND) and, contrary to the National Conference of State Legislators, insists that this bill does not require the states to do anything. Instead, the legislation puts valid conditions on a grant of authority.

"The simplification process in this bill is similar to the guidelines that the states are working on," says Lowy. "We believe the debate now is how can the states make it work so the retailers can collect these sales taxes in a non-intrusive fashion. From an E-Fairness point of view, we think that the most politically palatable solution is a blended tax right across the states."