There’s been noise in the news lately about how the State and Federal government is looking towards imposing sales tax on internet or e-commerce businesses for the first time.  This will mean a lot of changes in the way business is done online, and it’s worth examining the issues piece by piece.

1. What is a Sales Tax, really?  There’s a great article over at eHow about Sales Tax you should take a look at if you’re really interested in this, but in a nutshell, a sales tax is essentially a tax added onto, and often calculated into, the price of goods and services, that a Seller is obligated to collect and give to a State although the Buyer is essentially the one paying the tax.  It’s a tax on consumption, and it’s usually made up of money that goes to State, County, and local authorities.

2. Why haven’t internet based businesses been required to collect State sales tax to date?

For a long period of time now, sales on the internet or e-commerce have been largely tax free.  If you buy something from a business located in another State, they have not charged you a local sales tax for their area, because you don’t live there.  They haven’t paid a sales tax to your State, either, under the grounds that they don’t really have a business there, even though, technically, you probably are liable for local sales taxes for things brought into the State, but as a practical matter, most States don’t enforce this sort of thing, because it’s been impractical to track these sorts of transactions.

For those of us that live at the border of two States, this occasionally becomes an issue, at least for large items.  I live just over the border in Pennsylvania from Delaware, and I do a portion of my shopping there, partially because Delaware has no sales tax, and partially because it’s just plain closer than the same stores in Pennsylvania.  However, for bigger price items, such as appliances and computers, Pennsylvania is following up with merchants and sending out tax bills representing uncollected sales tax.    In fact, starting in 2012, Pennsylvania has established a Use Tax, that you have to pay for things you order over the internet where the 6% sales tax has not been paid.  There’s even a special line in the tax return where you can estimate this, if you don’t keep careful track of the purchases themselves (and I am not sure who does.)

As you can imagine, tracking things like sales or use tax owed by individuals when things were purchased out of State is difficult to track or enforce, hence Pennsylvania’s catch-all solution of a Use Tax and adding a line for it on the State Tax return.  More practically, for small businesses located all over the Country or globe, it’s been impractical to ask them to do all the paperwork necessary to establish a business license or permit in every single State, and then pay each State whatever amount may or may not be owed- the amount of cost to comply probably far outstrips the amount of tax that should be paid, so it was ignored.  On top of this, e-commerce was seen as a fledgling market, and there were thoughts about the waiver of sales tax being part of encouraging the growth of these businesses.

E-commerce, however, is no longer a trivial part of the economy.  And States, as well as the Federal government, are hurting for tax revenue and are looking for any additional possible revenue streams they can find.  Sales tax payment and collection, especially from large internet companies like Amazon, are going to become a reality sooner than later.

3. OK, I get it.  People are buying stuff online, not only in Stores, and States are feeling a pinch and want their share.  But how is this going to effect things?

We already know people are smart when it comes to saving money, and smartphones have made being a smart consumer even easier.  It’s become simple to go to a store, check out an item, and compare prices for it across the web, at other stores- you name it- on your phone or tablet.  As a result, consumers sometimes have ended up using bricks and mortar stores as “show rooms” for merchandise they will instead purchase online, if the price is better or they save sales tax.  This practice of show rooming has gotten to be pervasive enough that one business in Australia is now charging a “Just Looking Fee” of $5, which it will refund if you make a purchase, to discourage people from this practice.

For other businesses, like a high-end kitchen store I know of in Wilmington, Pro Kitchen Gear, e-commerce has meant that it can have a virtual presence anywhere in cyber-space by becoming a seller on, which keeps the business viable beyond its simple bricks and mortar location.  I asked the owner if this essentially made his bricks and mortar business a “front” for his e-commerce business, he said no, but it meant that he could do much more volume and make more money each year than he could ever hope for, even with his store in a desirable location in the community.  By blending bricks and mortar and e-commerce, his business has a much greater chance of success than if he was limited to one shop in one location only.

For a business like Pro-Kitchen Gear, a simple website with offerings of what he had in stock would not work as well as the Amazon option.  With Amazon acting as the middle man, he pays a small percentage of the sale- a “finder’s fee,” so to speak, to Amazon, in exchange for Amazon hooking the buyer and seller up.  Some items Pro Gear ships from their store, and other items are essentially in a locker at an Amazon warehouse, and they fulfill orders from there.

In terms of the Sales Tax issue, since Amazon already has the means to collect money for shipping and sales tax in each and every jurisdiction, and enough volume to set up payments to each State for these sales, it’s going to be easier and more convenient for almost every small retailer to expand their business through this sort of e-commerce relationship rather than try to comply one by one with each State’s individual sales tax requirements and business license issues.  (You might even say this tax will end up helping rather than hurting sales through Amazon and other retail sales aggregators online.)

4.  Why should I have to collect a sales tax for a State I don’t live in or do business in except for mailing a package?  Why should I have to pay tax on something I got in the mail versus in person?

The purpose of taxation in the first place is based on the notion that the Government needs money to operate, and each of us benefits from what the Government provides, in direct and indirect ways.  We benefit at least around the place where we live, or where our businesses are located, from the upkeep on roads, having a police force, having had electrical and sewer lines installed, and more- you name it.  Paying taxes that collectively support governmental functions, even those we may not personally benefit from, are seen as generally part of the social contract we have with each other and our government- whether we’re talking municipal, County, State or Federal taxes.

Now, when you sell a good or service over State lines, it’s clear the Seller benefits from the governmental services where he lives, but not where the Buyer lives.  The benefits and burdens of doing business in a State where the business is not physically located, and whether or not tax needs to be paid has been going on for years in this Country, long before the Internet.

It all started out with a case that got to the Supreme Court called  International Shoe vs. Washington.  In this case, a shoe sales company’s only presence in Washington State was its travelling salesmen.  These salesmen would go door to door, or rent out a hotel room, and display sample merchandise (a portable showroom, so to speak) and take orders that were transmitted to the home office for acceptance or rejection and then would be fulfilled and sent out from headquarters, located in St. Louis.  While the shoe sales people lived in the State, the question came up whether the “home office” had to pay into the State unemployment compensation fund for these folks, even if the company itself was not located in the State, and the actual closing of the business transaction also happened out of State as well.  The Supreme Court said that Washington first had to show it had jurisdiction over the company and salespeople, and this would require that a company had “sufficient minimum contacts” within the State that made it reasonable for them to be sued there.  The Court came up with a test for reasonableness that included the following factors: (1) the defendant must have sufficient minimum contacts with the forum state; (2) the suit against the defendant must arise out of those contacts; and (3) the exercise of jurisdiction must be reasonable.  The amount of business being transacted by International Shoe in Washington State and its activities added up to the Court holding that it was reasonable for International Shoe to be sued in Washington State Court, and to pay Unemployment Compensation payments within that State, because it was benefitting from the laws and protections of the State while doing business within its borders .( There’s a great law journal article about this in the Journal of High Technology Law, discussing how minimum contacts work in the age of Cyberspace).  The Court’s wording here becomes important as we look into internet sales tax as highlighted below:

“But to the extent that a corporation exercises the privilege of conducting activities within a state, it enjoys the benefits and protection of the laws of that state. The exercise of that privilege may give rise to obligations, and, so far as those obligations arise out of or are connected with the activities within the state, a procedure which requires the corporation to respond to a suit brought to enforce them can, in most instances, hardly be said to be undue.”   

“It is evident that these operations establish sufficient contacts or ties with the state of the forum to make it reasonable and just, according to our traditional conception of fair play and substantial justice, to permit the state to enforce the obligations which appellant has incurred there.”

So we know from International Shoe, when a Company is doing substantial business within a State, even if it does not have a physical presence there, it benefits from its laws and protections and it is reasonable to expect the company to comply with local State laws.  In the bill currently being debated in Washington, internet sales tax would have to be collected by businesses doing at least one million in remote sales annually, and there are arguments as to whether this figure is too low, causing an undue burden to many mom & pop retailers.  Amazon, eBay and other online retailers are trying to help craft a bill that’s fair, knowing the amount of business they transact means they really can’t avoid sales tax collection any longer.  However, for small businesses like Pro Kitchen Gear, their ability to comply with sales tax collection issues may largely become dependent on whether they can afford the software that will enable this to happen automatically on their own website.  If not, will they be forced to join a service like Amazon, almost like indentured servants, to have their tax and other legal obligations taken care of by this giant aggregator, while paying a percentage of sales for the privilege?  Only time will tell for sure.

The Fallout- Predictions

It will be interesting to see how this internet sales tax issue plays out.  Everyone hopes this will level the playing field between bricks and mortar shops and online only retailers, perhaps preserving or even encouraging people to shop locally rather than online and preserve local jobs in the process.  However, I will bet it will cause more and more local shops to try to augment their businesses with online options, and to do so through “business aggregators” like eBay or Amazon.  Whether these giants also end up with anti-trust issues as they corner the market will largely depend on how reasonable the ‘overhead’ fees are.

As software becomes cheaper and data easier to manage, more and more retailers of all sizes will be expected to comply with individual State laws.  I would bet it’s only a matter of time until the Federal Government is forced to come up with a scheme of “Federal Business License” that allows businesses to have a virtual presence and permission to do business in all 50 States, since the piecemeal system works to everyone’s detriment currently.  The question will then become whether the threshold cost of a Federal Business license would be reasonable enough to encourage more interstate commerce, or prohibitively expensive, discouraging businesses from expanding literally or physically beyond their home borders.

In the meantime, States, in their usual fashion, may begin to craft their own State laws to encourage more and more businesses to set up within their boundaries.  For example, will States like Delaware and New Hampshire, that do not charge a sales tax, end up with beneficial business climates that improve their economy, while States with higher local sales taxes end up paying the price accordingly?  (Is it any surprise that one of the highest performing malls in the Country is Christiana Mall in Delaware where people come from surrounding States to make purchases?)  Will folks move to States like New Hampshire and Delaware to avoid sales tax if these taxes become prohibitive elsewhere?  Will these States be able to become home for internet commerce, relying on buyers, not sellers, to pay taxes in their Use Tax or other scheme, while avoiding responsibility themselves for these taxes?

The jury is out, of course.  One thing is clear, however- the “tax holiday” for the internet is about to end.  eCommerce is now a more mature industry, and it will have to step up to the plate just like everyone else.   It means that developers who find ways to simplify compliance with these taxes will make a small to large fortune.  And it means that even folks who consider themselves small business people will be required to become much more sophisticated about conducting interstate commerce than ever before.  Whether this encourages more business by opening up new markets and opportunities or makes going into business much more difficult for the average joe waits to be seen.

The internet is growing up, and this is just one of the many growing pains we’re having along the way.  Get ready for a bumpy ride.

See also: Internet Sales Tax fairness- NY