(Republished with permission of the Bar Association of Metropolitan St. Louis and the St. Louis Bar Journal.)
Estimates indicate that electronic retail sales in 2010 within the United States were approximately 8% of all equivalent retail sales, or a total of $134.9 billion. This amount is nearly triple the amount of electronic retail sales made in the year 2000. Further, electronic retail sales are expected to grow at five times the rate of sales from conventional brick-and-mortar retail stores for the period from 2010 to 2020. Resulting from this increase in electronic retail sales is the complex issue of how to impose and collect sales tax revenue on these electronic transactions.
Experts believe that if every state imposed and collected a tax on all online sales, including electronic retail sales and electronic business to business sales, the states would cumulatively receive an additional $10 billion in revenues each year. This could potentially reduce the average state’s budget deficit by 17%. Other estimates show that annual national losses of state and local sales tax on electronic retail sales could reach $11.4 billion by 2012.
Because of the recent depressed state of the economy, states are looking for alternative ways to boost revenue and decrease annual operating deficits. One such method that states are considering is the increased collection of sales and use tax. States are trying to eliminate the inability to collect sales or use tax on electronic retail sales from out-of-state retailers. States are contemplating, and some states have enacted, new legislation which broadens the definition of who is subject to collection and remittance of tax under applicable laws so as to allow states to increase collection of sales tax on electronic retail sales.
This article will generally review the existing laws governing collection of sales and use tax revenue including any constitutional limitations on the states’ ability to do so. The article will also discuss new and proposed laws affecting sales tax on electronic retail sales and concludes that the taxability of electronic retail sales needs to be addressed by federal legislation.
Application and Collection of Sales Tax and Constitutional Limitations on Out-of-State Sellers
Generally, a sales or use tax is imposed on all sales of tangible personal property. For example, in Missouri “Every vendor making a sale of tangible personal property for the purpose of storage, use or consumption in this state shall collect from the purchaser an amount equal to the percentage on the sale price imposed by the sales tax law in section 144.020 and give the purchaser a receipt therefor.” Other states have a sales or use tax similar to the state of Missouri, but with varying definitions of the goods taxable and the rate at which they are taxed. Some states, such as Alaska, Delaware, Montana, New Hampshire and Oregon, have no sales tax.
Thus, the individual states are generally free to impose a sales or use tax on the sale, lease or rental of goods and some services. The Supreme Court, however, has provided that certain constitutional limitations prohibit states from requiring out-of-state retailers to collect and remit sales tax on sales to in-state residents. Quill Corp. v. North Dakota addressed whether a Delaware corporation, which engaged solely in sales of office supplies by mail-order, must collect and remit use tax on property purchased for use in North Dakota. The North Dakota law in question had been specifically amended to address the taxability of out-of-state mail-order suppliers and provided that any retailer who solicited the North Dakota consumer market by means of three or more advertisements within a 12-month period was required to collect and remit use tax because it was considered to be maintaining a place of business in the state.
The Court in Quill held that while North Dakota had authority to tax out-of-state mail-order suppliers because its use tax statutes were consistent with the Due Process Clause, under the Commerce Clause the imposition of tax was an unconstitutional burden on interstate commerce. The Court found that North Dakota could not require out-of-state mail-order sellers who had no other physical presence in the state to collect and remit sales or use tax. Quill affirmed the principal that there is a clear distinction between mail-order sellers, like the one in Quill, who communicate with customers in the state by mail, and those who have a physical presence in the taxing state.
According to the Court, a tax such as the one in Quill will only be sustained under the Commerce Clause if the “tax (1) is applied to an activity with a substantial nexus with the taxing State (2) it is fairly apportioned, (3) it does not discriminate against interstate commerce, and (4) it is fairly related to the services provided by the State.” A retailer lacks the “substantial nexus” required by the Commerce Clause and fails the first part of the four-part test set forth above where its only contact with a state is by mail or common carrier.
Similar to a mail-order vender, internet sellers generally lack a “substantial nexus” with a taxing state unless the seller maintains an office or other physical presence in the state. For instance, the nation’s largest internet retailer, Amazon.com, LLC (“Amazon”), collects tax in only the five states in which it has offices – Kansas, Kentucky, New York, North Dakota, and Washington. While Amazon has warehouses in six additional states, it avoids creating a “substantial nexus” in those states by owning the warehouses in a subsidiary and by creating an arms-length arrangement between Amazon and the warehouse/shipper subsidiary. Further, Amazon is seeking specific legislation in South Carolina and Tennessee, two states in which it desires to build warehouses, which would statutorily exempt it from the collection of sales or use tax.
Other cases demonstrate that a physical presence within a taxing state is necessary to establish a sufficient nexus with the state. In Scripto Inc. v. Carson, the seller had no offices or regular employees in the taxing state, but it employed independent contractors to solicit sales of its products. The Court upheld a use tax on the out-of-state retailer ultimately disregarding the fact that the salesmen on behalf of the seller were not employees. Similarly, the use of only one sales representative, although an independent contractor, is sufficient to establish a physical presence and substantial nexus under the Commerce Clause so as to subject the retailer to collection of out-of-state tax.