This article can be found in the May/June 1995 issue of Electronic Retailing Magazine.
Sales taxes. They hang like a dark cloud over almost every sales transaction. Nobody really wants to pay them or collect them. Many consumers and electronic retailers avoid the sales tax issue under the impression (often mistaken) that interstate transactions are exempt from these tedious and costly rules. In fact, many direct-response marketers have taken advantage of this perception to promote interstate sales at the expense of “Main Street” vendors. Consequently, federal and state lawmakers and regulators are cracking down on marketers and consumers alike. The Federal Trade Commission, responding to pressure from Congress and state governors, recently brought a series of enforcement actions against deceptive advertisements concerning sales tax obligations. Meanwhile, states have begun cracking down on consumers who fail to pay taxes on their out-of-state purchases. And Congress threatens to pass legislation that would significantly curtail “tax-free” marketing by allowing states to collect sales tax directly from out-of-state marketers.
Division and Confusion Among Marketers, Consumers and Regulators
Electronic marketers and consumers are often puzzled by their obligations under state sales and use tax laws. This confusion has helped foster division among members of the electronic retailing community. HSN and QVC, for example, collect sales tax from residents of every state, while most infomercial producers try to limit their obligations to as few states as possible.
As the federal government cuts spending, state governments are forced to look elsewhere for new sources of revenue. Some states have begun to target their residents for unpaid taxes on out-of-state purchases, but most states complain that it is extremely difficult to enforce consumers’ use tax obligations. Elected state officials would rather require out-of-state marketers, instead of voting constituents, to remit state sales taxes. Traditional retailers would also like states to collect more taxes from out-of-state marketers. In their view, the perceived difference in sales tax obligations creates an unfair price advantage for out-of- state marketers. Requiring all marketers to collect and remit sales tax would level the playing field. On the other hand, direct marketers complain that collecting state, county and local sales taxes would be an administrative nightmare. According to one estimate, mail order companies would have to file more than 400 tax forms each month and more than 5,000 forms each year.
Finally, most consumers would rather not pay any taxes at all. They have become quite accustomed to “tax-free” shopping and would not appreciate a change of the perceived status quo.
Sales and Use Tax Obligations
So what are the rules? Briefly stated, a marketer that has a sufficient “nexus” to a particular state is generally required to collect and remit state sales taxes. A number of different elements can establish a taxpayer’s nexus to the taxing state. A marketer may be subject to a state’s sales tax requirements if it owns (directly or indirectly) a retail outlet, a warehouse, an office, or other place of business or property in that jurisdiction. The nexus can also be established through the use of employees, independent contractors, agents or other representatives to solicit business within a state. If a California company uses telemarketers in Nebraska and a fulfillment house in Pennsylvania, it may have to collect and remit sales tax for products sold to Nebraska and Pennsylvania residents.
An electronic marketer’s media buys may also subject it to a state’s taxing power. If the marketer solicits business within a state through regular or continuous advertising, and the advertisements are transmitted or distributed from a location within the state, the marketer may have a sufficient physical presence to subject it to the state’s taxing jurisdiction. Companies that advertise and sell products in more than one state, and contract services which are carried out in more than one state, may be subject to the sales tax laws of several jurisdiction
The consumer’s obligation, although more straight-forward, is often misunderstood or ignored. Consumers are generally unaware that most states require their residents to remit a “use tax” (the functional equivalent of a sales tax) for out-of-state purchases used or consumed in their home state. According to the Federation of Tax Administrators, 45 states and the District of Columbia impose a sales tax or use tax on the purchase of tangible property. However, because states cannot require companies lacking a physical presence to collect sales tax, they must rely on consumers to fulfill their use tax obligations.
Federal Trade Commission Enforcement
States and other organizations have pressured the Federal Trade Commission to investigate advertising claims by direct marketers that out-of-state residents are not obligated to pay taxes on their out-of-state purchases. Electronic marketers promoting sales by advertising, “No sales taxes apply to out-of-state residents,” may find themselves at the wrong end of an enforcement action.
Last fall, Senator Dale Bumpers (D-Ark) and five other Democratic senators sent a letter to FTC Chairman Janet Steiger, requesting the Commission to “initiate an immediate investigation” of mail-order firms and catalog companies which advertise that no taxes apply to goods shipped to out-of-state customers. They argued that such advertising was deceptive and should be stopped, given that most states required their residents to remit use taxes for mail-order goods. The National League of Cities, United States Conference of Mayors, National Association of Counties, National Conference of State Legislatures, National Governors’ Association, and the Government Finance Officers Association have joined Senator Bumpers in calling for more aggressive FTC action on these issues.
On the heels of the Bumpers letter, the Multistate Tax Commission urged the FTC to require direct marketers to disclose that consumers may be obligated to remit a use tax on their out-of-state purchases. The MTC advised the Commission that “the obligation to pay use tax is widely misunderstood by consumers,” adding that “the source of this misinformation increasingly is the limited and selective information concerning use taxes included in catalogs and other direct marketing literature.” No specific determination has been made yet, however, with regard to the issues raised by Bumpers and the MTC.
Recent State Actions
The Florida Department of Revenue also urged the FTC to investigate direct mail order marketers that fail to tell their customers of their obligation to pay use taxes on out-of-state purchases. Last year, Florida began experimenting with an advertising campaign to increase collection of use taxes and direct targeting of 1000 physicians, dentists, engineers, attorneys and other professionals in the state. Spurred by a 225% increase in use tax collections, the Florida agency plans to expand the project to include all 30,000 doctors and dentists in the state, and to target an additional 10,000 state residents known to have made big ticket purchases from mail order companies.
States are also seeking federal legislation that would allow them to collect use taxes directly from out-of- state marketers. The National Governors’ Association approved a resolution urging Congress to pass federal legislation “to restore fairness to competition between community and out-of-state mail transactions” and to provide a means for states to collect taxes that are owed to them.
Last year, Senator Bumpers introduced a bill called “The Tax Fairness for Main Street Business Act of 1994.” Co-sponsored by 10 Democrats and 2 Republicans, the measure would have allowed states to require mail order companies to collect and remit state use taxes. It would have applied only to companies with more than $3 million in annual gross receipts, or $100,000 in annual receipts in a given state. The legislation died as a result of strong opposition by then-Senate Majority Leader, George Mitchell (D-Me), who was concerned about the impact it would have had on Maine businesses, including catalog-giant L.L. Bean. Bumpers has already reintroduced identical measures twice this year, threatening to continue to do so until legislation is passed.
The Direct Marketing Association has spearheaded industry opposition to congressional attempts to give states more taxing authority. DMA has successfully argued thus far that Bumpers’ proposals would create an administrative nightmare for direct marketers, forcing them to hire a separate work force just to keep track of their local, county and state sales tax obligations for every jurisdiction in which a sale is made. Some marketers have even claimed that the cost of compliance would exceed the revenues that would be collected by local, county and state governments.
So what does this mean to electronic marketers? First, the FTC has started what may become a broad- based investigation of deceptive advertising of sales and use tax obligations. Electronic marketers should carefully review their advertising and marketing materials to ensure that no false or misleading statements are made concerning customers’ sales tax obligations. Second, marketers operating or advertising in multiple jurisdictions should consult legal counsel to make sure they are in compliance with state sales tax collection, reporting and remission laws. Finally, out-of-state marketers relying on their competitive tax advantage over in-state retailers should keep close track of congressional efforts to “level the playing field.” Passage of legislation similar to that proposed by Senator Bumpers could have a significant impact on the bottom line of many electronic retailers.