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<P align=center>Copyright � 1998 by Eric J. Sinrod and Jeffrey W. Reyna
<STRONG></STRONG></P>
<P align=center><STRONG>SWEET LAND OF E-LIBERTY: THE INTERNET TAX FREEDOM
ACT</STRONG></P>
<P align=center>Eric J. Sinrod<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_1_"><SUP>(1)</SUP></A>
& Jeffrey W. Reyna<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_2_"><SUP>(2)</SUP></A></P>
<P>Internet<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_3_"><SUP>(3)</SUP></A>
commerce is growing exponentially.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_4_"><SUP>(4)</SUP></A>
Practically 2.5 million small business owners have signed on to the Internet so
far.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_5_"><SUP>(5)</SUP></A> In
addition to numerous individual consumer purchases over the Internet, millions
of Americans purchase monthly Internet access from Internet Service Providers
("ISPs").<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_6_"><SUP>(6)</SUP></A> </P>
<P>The nation's 30,000 local, state and federal taxing authorities<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_7_"><SUP>(7)</SUP></A> are
quite aware of the revenue potential of the Internet. Each one of these
jurisdictions potentially could levy taxes on monthly Internet access fees, the
sale of goods and services over the Internet, "bits"<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_8_"><SUP>(8)</SUP></A> of
digital information, and information "packets"<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_9_"><SUP>(9)</SUP></A> sent
over the Internet. Eight states so far have enacted laws imposing a taxes on
Internet access or Internet commerce.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_10_"><SUP>(10)</SUP></A>
The potential for multiple and differential taxation of Internet transactions is
obvious. </P>
<P>With this potential taxation quagmire in mind, Congress earlier this year
approved the Internet Tax Freedom Act ("ITFA")<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_11_"><SUP>(11)</SUP></A> as
part of the 1998 Omnibus Consolidated Appropriations bill. President Clinton
signed the Appropriations bill, including the ITFA, on October 21,1998.</P>
<P><STRONG>ITFA OVERVIEW</STRONG></P>
<P>The Act has four main provisions. First, beginning October 1, 1998, the Act
imposes a three-year moratorium on "taxes on Internet access"<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_12_"><SUP>(12)</SUP></A>
and "multiple or discriminatory taxes on electronic commerce."<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_13_"><SUP>(13)</SUP></A>
</P>
<P>Second, the Act establishes an 19-member Advisory Commission on Electronic
Commerce (the "Commission"), composed of members from the federal government,<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_14_"><SUP>(14)</SUP></A>
local and state governments,<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_15_"><SUP>(15)</SUP></A>
and appointed representatives of the electronic commerce industry who are
selected by the majority and minority leaders in the House and Senate.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_16_"><SUP>(16)</SUP></A>
The Commission's principal directive is to undertake a "thorough study of
Federal, State and local, and international taxation and tariff treatment of
transactions using the Internet and Internet access and other comparable
intrastate, interstate or international sales activities."<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_17_"><SUP>(17)</SUP></A>
Perhaps the Commission's most important directive is to submit a report
outlining its findings-including legislative recommendations on Internet
taxation-no later than 18 months after the enactment of the Act, or April 21,
2000.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_18_"><SUP>(18)</SUP></A>
</P>
<P>Third, the Act states that it is the "sense" of Congress that no federal
taxes on the Internet and Internet access should be enacted during the
three-year moratorium.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_19_"><SUP>(19)</SUP></A> In
other words, the federal government should not tax the Internet at the same time
that it is prohibiting state and local jurisdictions from doing so. </P>
<P>Finally, the Act urges the President to seek to enter into trade agreements
that "remove barriers to global electronic commerce."<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_20_"><SUP>(20)</SUP></A></P>
<P><STRONG>PASSAGE OF THE ACT</STRONG></P>
<P>Passage of the Act was not without controversy. Most vocal among the Act's
opponents was the National Governors' Association, which claimed that the Act
would pose a serious challenge to state sovereignty.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_21_"><SUP>(21)</SUP></A>
State and local officials had expressed concern that the Act would lead to an
erosion of sales tax revenues akin to what they claimed had been occurring with
respect to mail-order catalog sales.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_22_"><SUP>(22)</SUP></A>
This concern stems primarily from the Supreme Court decision in <EM>Quill Corp.
v. North Dakota</EM>, 504 U.S. 298 (1992). The Court in <EM>Quill</EM> struck
down as an unconstitutional violation of the Commerce Clause, a North Dakota law
that imposed sales taxes on mail-order catalog purchases made by North Dakota
residents. Relying on a familiar "substantial nexus" analysis, the Court held
that such a tax was unconstitutional if the seller of goods did not have a
physical presence in the state where the customer placed the order.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_23_"><SUP>(23)</SUP></A>
The Court further ruled that mere use of a common carrier within the state, such
as UPS or FedEx, failed to establish a nexus that satisfied the Commerce
Clause.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_24_"><SUP>(24)</SUP></A></P>
<P>Proponents of the ITFA pointed to taxation schemes analogous to the North
Dakota statute, among others, that have attempted to tax Internet commerce or
access, as a means of highlighting the potential for burdensome and multiple
taxation by thousands of jurisdictions.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_25_"><SUP>(25)</SUP></A> In
the Internet commerce arena, complicating any possible analogy to the mail-order
catalog example, stands the fact that Internet sales are often begun and
completed entirely on-line. The purchase of software over the Internet provides
an appropriate example.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_26_"><SUP>(26)</SUP></A> An
on-line software retailer often bypasses the traditional reliance on FedEx or
UPS for product delivery, instead downloading the product directly to a
customer's computer over the Internet. Such transactions seem to pose even more
difficult challenges to the achievement of the "substantial nexus" necessary for
state or local taxation within the limits of the Commerce Clause.</P>
<P>State and local taxation of Internet access and ISPs has fueled further
support for an Internet tax moratorium. One example of taxation of ISPs involves
the City of San Bernardino's attempt to tax large ISPs under the City's Utility
User Tax by classifying ISPs as "teletypewriter exchange services."<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_27_"><SUP>(27)</SUP></A> In
yet another example, Wisconsin taxed Internet access as a "telecommunications"
service.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_28_"><SUP>(28)</SUP></A>
Taxing Internet access is seen by some proponents of the ITFA as "double
taxation," with taxes on the phone service individuals use to access their ISPs,
and taxes levied again on the actual service of the ISPs.</P>
<P>The ITFA is a substantial first step in addressing, and hopefully resolving,
taxation and Commerce Clause issues affecting e-commerce and the Internet. </P>
<P><STRONG>TAX MORATORIUM</STRONG></P>
<P>The two key provisions of the ITFA are the moratorium on local, state, and
federal taxation of Internet commerce and Internet access, and the creation of
the Advisory Commission on Electronic Commerce. The moratorium will have the
most immediate economic impact by allowing Internet businesses to continue their
unprecedented growth without the specter of multiple and burdensome taxation
schemes. </P>
<P>The moratorium prohibits any state or local political subdivision from
imposing "(1) taxes on Internet access, unless such tax was generally imposed
and actually enforced prior to October 1, 1998; and (2) multiple or
discriminatory taxes on electronic commerce."<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_29_"><SUP>(29)</SUP></A> As
with all legislation, the devil is in the details. The Act carefully defines
"multiple tax"<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_30_"><SUP>(30)</SUP></A>
and "discriminatory tax"<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_31_"><SUP>(31)</SUP></A>
and provides several exceptions to the application of the tax moratorium. At the
same time, and as part of a legislative compromise, the Act states that any
entity that provides any material that is "harmful to minors," without
adequately restricting access to minors, will be exempt from the Act's
moratorium and will be subject to taxation that would otherwise violate the
Act.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_32_"><SUP>(32)</SUP></A></P>
<P>The Act defines "multiple taxation" to encompass a tax imposed by a local or
state jurisdiction that could be imposed by another local or state jurisdiction
for "essentially the same electronic commerce."<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_33_"><SUP>(33)</SUP></A>
This definition explicitly excludes the imposition of a sales tax on "electronic
commerce or a tax on persons engaged in electronic commerce which also may have
been subject to a sales or use tax."<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_34_"><SUP>(34)</SUP></A> Of
course, in order to escape under this latter provision, the tax also likely must
pass the constitutional test outlined by the Supreme Court in <EM>Quill</EM>.
This difficult burden effectively precludes local and state jurisdictions from
imposing a sales tax on Internet transactions where there is an insufficient
"nexus" to the taxing jurisdiction. The Internet industry probably would contend
that this provision, when combined with the current framework of the law
regarding state and local taxes on interstate transactions, would protect it
from the burdensome myriad of taxation schemes that threaten to stifle
e-commerce.</P>
<P>By comparison, the Act defines a "discriminatory tax" as any tax imposed by a
state or local jurisdiction that singles out Internet transactions or Internet
services for special taxation.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_35_"><SUP>(35)</SUP></A>
This includes taxing an Internet transaction that would not otherwise be
taxable, or taxation on the Internet transaction of a person or entity that
would not otherwise be taxed if the transaction were conducted by other means,
or the taxation of ISPs at a rate higher than the tax rate imposed on services
that provide "similar information services" through other means.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_36_"><SUP>(36)</SUP></A>
With respect to the taxation of Internet access alone, the Act provides that a
tax is "discriminatory" if the ISP is deemed to be the agent of the seller of
goods merely because the ISP hosts the seller's Web "content" or processes
orders through an out-of-state computer server.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_37_"><SUP>(37)</SUP></A>
This final provision seems to imply that a state would not run afoul of the
moratorium if it based its taxing jurisdiction on a server's presence in the
state. However, only time will tell whether this apparent exception will provide
a window for state taxation.</P>
<P>In any event, the ITFA provisions outlined above provide a far-reaching
moratorium on Internet taxation that is likely to prevent state and local
jurisdictions from imposing anything but the most narrow and carefully tailored
of tax schemes that avoid the pitfalls of multiple or discriminatory
taxation.</P>
<P><STRONG>ADVISORY COMMISSION ON ELECTRONIC COMMERCE</STRONG></P>
<P>In the long-run, the Act's impact likely will be measured by the findings and
recommendations of the Advisory Commission, which probably will play a central
role in the development of model state legislation for Internet taxation.<A
href="http://www.hrblaw.com/artdocs/article_21.htm#N_38_"><SUP>(38)</SUP></A>
The work of the Commission hopefully will lead to a resolution of any potential
Internet tax quagmire through the adoption of a sensible, uniform, and
non-discriminatory approach to taxing Internet commerce and Internet access.
After undertaking a study of the ramifications on electronic commerce created by
local, state, federal, and international taxation, the Commission should be able
to formulate a sensible approach to Internet commerce that will foster
continuing economic growth in this sector. </P>
<P>Notes</P>
<P><A name=N_1_>1. </A>Eric J. Sinrod, a partner in the San Francisco office of
Hancock Rothert & Bunshoft LLP, practices commercial litigation and
Internet, information and communications law, and can be reached at
[email protected] or [email protected].
<P><A name=N_2_>2. </A>Jeffrey W. Reyna, an associate in the San Francisco
office of Hancock Rothert & Bunshoft LLP, practices commericial litigation
and Internet law, and can be reached at [email protected].
<P><A name=N_3_>3. </A>For purposes of this Article, the Internet is defined by
the Internet Tax Freedom Act as "collectively the myriad of computer and
telecommunications facilities, including equipment and operating software, which
comprise the interconnected world-wide network of networks that employ the
Transmission Control Protocol/Internet Protocol, or any predecessor or successor
to such protocol, to communicate information of all kinds by wire or radio."
Internet Tax Freedom Act � 1101(e)(3)(C), enacted as part of the 1998 Omnibus
Consolidated Appropriations Bill.
<P><A name=N_4_>4. </A>Internet-based commerce is expected to reach a volume of
anywhere from $37 billion to $350 billion by the year 2002. <EM>See</EM> <EM>A
Taxing Situation</EM>, WIRED NEWS, Aug. 31, 1998, available at <<A
href="http://www.hrblaw.com/artdocs/<http://www.wired.com/news/politics/story/14731.html?wnpg=all>;">http://www.wired.com/news/politics/story/14731.html?wnpg=all>;
Gov. Michael O. Leavitt, <EM>Support the Internet Tax Freedom Act</EM>,
Computerworld, Apr. 13, 1998, available at
<http://www.house.gov/chriscox/nettax/leavitt.html>.</A>
<P><A name=N_5_>5. </A>This figure accounts for 35% of all small businesses in
the United States (excluding home-based businesses). Of these, 900,000 small
businesses have launched web sites, and nearly half of these are conducting
Internet commerce. <EM>See</EM> Mel Duvall, <EM>Report finds small biz leading
e-commerce change</EM>, ZDNet, Feb. 11, 1998, available at <<A
href="http://www.hrblaw.com/artdocs/<http://www5.zdnet.com/zdnn/content/inwo/0211/284199.html>.">http://www.hrblaw.com/artdocs/<http://www5.zdnet.com/zdnn/content/inwo/0211/284199.html>.</A>
<P><A name=N_6_>6. </A>An Internet Service Provider, or ISP, provides
individuals and/or businesses with connection to the Internet over conventional
phone lines or cable connections, usually for a monthly fee. Direct, and
therefore faster, connection to the Internet is often provided to educational
institutions or larger businesses. ISPs range from large national companies with
millions of customers such as AOL, to small, local companies with only dozens or
hundreds of customers.
<P><A name=N_7_>7. </A><EM>See</EM> <EM>A Taxing Situation</EM>, <EM>supra</EM>
note 4.
<P><A name=N_8_>8. </A>A "bit" refers to the smallest unit of data stored in a
computer. Bits have values of either "0" or "1." These collections of 0's and
1's generally store data or execute instructions, often when grouped into
"bytes." Bytes are usually made up of eight bits, while half a byte (four bits)
is affectionately called a "nibble." <EM>See</EM> <<A
href="http://www.hrblaw.com/artdocs/<http://www.whatis.com>">http://www.hrblaw.com/artdocs/<http://www.whatis.com></A>
(containing definitions of common Internet and high-tech terminology). </P>
<P>The ITFA defines a "bit tax" as "any tax on electronic commerce expressly
imposed on or measured by the volume of digital information transmitted
electronically, or the volume of digital information per unit of time
transmitted electronically." ITFA � 1104(1). </P>
<P><A name=N_9_>9. </A>A "packet" is a "unit of data that is routed between an
origin and a destination on the Internet or any other packet-switched network.
When any file . . . is sent from one place to another on the Internet," the
information is divided into manageable "packets" of information for efficient
routing and delivery to its ultimate destination. Each of these individual
packets contains the address information for its ultimate destination. "The
individual packets for a given file may travel different routes through the
Internet," and therefore through multiple tax jurisdictions, before the packets
are "reassembled into the original file" at their ultimate destination.
<EM>See</EM> <<A
href="http://www.hrblaw.com/artdocs/<http://www.whatis.com>">http://www.hrblaw.com/artdocs/<http://www.whatis.com></A>
(containing definitions of common Internet and high-tech terminology).
<P><A name=N_10_>10. </A><EM>See</EM> David Hardesty, <EM>House Passes Internet
Tax Freedom Act-Senate Next</EM>, Electronic Commerce Tax Services, June 27,
1998, available at <http:// <A
href="http://www.hrblaw.com/artdocs/www.mshb.com/EC/062798.htm>.">http://www.hrblaw.com/artdocs/www.mshb.com/EC/062798.htm>.</A>
<P><A name=N_11_>11. </A>The Internet Tax Freedom Act is codified in Titles XI
and XII of the 1998 Omnibus Consolidated Appropriations bill.
<P><A name=N_12_>12. </A>Section 1101(a)(1).
<P><A name=N_13_>13. </A>Section 1101(a)(2).
<P><A name=N_14_>14. </A>Section 1102(b)(1)(A).
<P><A name=N_15_>15. </A>Section 1102(b)(1)(B).
<P><A name=N_16_>16. </A>Sections 1102(b)(1)(C)(i) - (iv).
<P><A name=N_17_>17. </A>Section 1102(g)(1).
<P><A name=N_18_>18. </A>Section 1103.
<P><A name=N_19_>19. </A>Section 1201.
<P><A name=N_20_>20. </A>Section 1203(a).
<P><A name=N_21_>21. </A><EM>See</EM> Rebecca Vaseley, <EM>Govs, Mayors Issue
New Warning on Net Tax Bill</EM>, WIRED NEWS, Oct. 17, 1997, available at:
<http://<A
href="http://www.hrblaw.com/artdocs/www.wired.com/news/politics/story/7781.html?.wnpg=all">http://www.hrblaw.com/artdocs/www.wired.com/news/politics/story/7781.html?.wnpg=all</A><BR><BR>
<P><A name=N_22_>22. </A><EM>Id.</EM>
<P><A name=N_23_>23. </A>The North Dakota statute at issue in <EM>Quill</EM>
required, among other things, that every "retailer maintaining a place of
business in" the state had to collect a sales tax on sales of goods and remit
them to the state. N.D. Cent. Code. � 57-40.2-07 (Supp. 1991). The definition of
"retailer" included "every person who engages in regular or systematic
solicitation of a consumer market in the state." N.D. Cent. Code. �
57-40.2-01(6). As a result, the law reached mail-order retailers who did not own
or maintain any property in North Dakota. </P>
<P>Advocates of the ITFA also have relied on examples such as <EM>Quill</EM>,
arguing that a moratorium on taxation of e-commerce by state and local
authorities would avoid a burdensome patchwork of multiple taxation that would
otherwise stifle the burgeoning commerce on the Internet.</P>
<P>In the end, the Supreme Court left the final resolution of the issue of state
taxation of interstate commerce to Congress. In adopting a "bright line" rule
requiring a substantial nexus to the taxing state (such as ownership or
management of property), the <EM>Quill</EM> Court ultimately stated that
resolution was "made easier by the fact that the underlying issue is not only
one that Congress may be better qualified to resolve, but also one that Congress
has the ultimate power to resolve." <EM>Id.</EM> at 318.
<P><A name=N_24_>24. </A><EM>Id.</EM>.
<P><A name=N_25_>25. </A><EM>See e.g.</EM> Dean F. Andal, <EM>State and Local
Taxation of Electronic Commerce: Read My E-mail, No New Taxes</EM>, Symposium:
Multi-Jurisdictional Taxation of Electronic Commerce, International Tax Program
and the Society for Law and Tax Policy, Harvard School of Law, April 5, 1997.
Mr. Andal is the Chairman of the California State Board of Equalization. He was
one of five people appointed by House Speaker Newt Gingrich to the Advisory
Commission on Internet Commerce. Speaker Gingrich also appointed David Pottruck,
President and co-CEO of Charles Schwab & Co., Governor James Gilmore of
Virginia, Grover Norquist of Americans for Tax Reform, and Richard D. Parsons,
President of Time Warner, Inc.
<P><A name=N_26_>26. </A><EM>See</EM> Wendy R. Leibowitz, <EM>Taxman Has
Interest In Internet Biz: States At Odds With Clinton Over Moratorium
Proposal</EM>, Law Journal Extra, March 16, 1998, available at <<A
href="http://www.hrblaw.com/artdocs/<http://www.ljx.com/internet.0316taxman.html>.">http://www.hrblaw.com/artdocs/<http://www.ljx.com/internet.0316taxman.html>.</A>
<P><A name=N_27_>27. </A><EM>Id.</EM> at 3.
<P><A name=N_28_>28. </A>Wisc. Stat. ��77.51(21m) & 77.52(2)(a)5.
<P><A name=N_29_>29. </A>Section 1101(a)(1)-(2).
<P><A name=N_30_>30. </A>Section 1104(6).
<P><A name=N_31_>31. </A>Section 1104(2).
<P><A name=N_32_>32. </A>Section 1101(e) et seq.
<P><A name=N_33_>33. </A>Section 1104(6)(A). As part of the definition of
"multiple tax," the Act provides that taxation schemes that provide a credit for
taxes imposed by other jurisdictions, "for example, a resale exemption
certificate," would not be considered in violation of the moratorium.
<EM>Id.</EM>
<P><A name=N_34_>34. </A>Section 1104(6)(B).
<P><A name=N_35_>35. </A>Section 1104(2) et seq.
<P><A name=N_36_>36. </A>Section 1103(2)(A)(i)-(iv).
<P><A name=N_37_>37. </A>Section 1104(2)(B)(i)-(ii).
<P><A name=N_38_>38. </A>One of the duties of the Commission is to undertake an
"examination of model state legislation" on Internet commerce and Internet
access taxation. Section 1102(g)(2)(D). </P></BODY></HTML>