Academic journal article Brigham Young University Law Review

Electronic Commerce and the State and Federal Tax Bases

Academic journal article Brigham Young University Law Review

Electronic Commerce and the State and Federal Tax Bases

Article excerpt

Although the papers in this Symposium focus primarily on the challenges posed to the state and local tax bases by electronic commerce,l it is important to note that electronic commerce also threatens to erode the U.S. federal income tax base. And while a few countries, like the Cayman Islands,2 can afford to be oblivious to this matter because they do not rely significantly on a tax system to fund government operations, the vast majority of countries that tax income or consumption or both, must treat the issues addressed in this Symposium as serious problems indeed.

At the federal level, the taxation of electronic commerce can be thought of as a case of Back to the Future because it begins almost sixty years ago with an early form of electronic commerce in Piedras Negress Broadcasting Co. v. Commissioner.3 That case involved a Mexican corporation operating a commercial radio station on the Mexican side of the Rio Grande River. About ninety-five percent of the corporation's income came from U.S. advertising, and approximately ninety percent of listener responses to the advertising came from within the United States.4 In short, the case involved a foreign corporation, located hard by the U.S. border, beaming its service into the United States and collecting virtually all of its revenue from U.S. customers. Thus, at an intuitive level, it is easy to feel considerable sympathy for the Internal Revenue Service's assertion that the station's profits earned from U.S. advertisers were subject to the U.S. income tax. Nevertheless, the Mexican corporation objected, pursued its day in court, and obtained a decision that its advertising profits were outside the income taking jurisdiction of the United States Government.5

With that precedent on the books, it became very easy for the U.S. Treasury to conclude that the profits on pure mail order sales emanating from foreign countries to customers inside the United States were also beyond the jurisdiction of the United States with respect to the federal income tax.6

At the state and local level, matters relating to pure mail order sales proceeded on an independent track and in a somewhat later time period. By decisions in 19677 and 1992,8 the U.S. Supreme Court held that constitutional constraints prevent state and local governments from imposing any kind of consumption tax regime (a retail sales tax or compensating use tax)9 on pure mail order sales" from outside the taxing jurisdiction to customers inside the taxing jurisdiction unless the tax is levied on the in-state customer, rather than on the seller.ll Collection of such a consumption tax is no problem where the purchased property requires a license in the purchaser's state of residence (automobiles, trucks, etc.) so that the purchase is revealed to state authorities in the licensing process. A consumption tax cannot, however, be practically collected from the consumers of goods that are the subject of most mail order transactions, as consumer compliance is effectively voluntary. Not surprisingly, voluntary compliance is quite low, and the consequence of the Supreme Court's decisions has been to leave state and local governments without any practical means to tax mail order sales emanating from outside the state where the consumer resides.12

As explained above, the federal income tax does not apply to profits generated from pure mail order sales originating from outside the United States, and state and local consumption taxes are effectively inapplicable to pure mail order sales originating from outside the taxing jurisdiction. These conclusions seem fully applicable to federal taxation of income from sales that are initially solicited through Internet advertising and then transacted over the Internet between a customer in the United States and an out-of country seller's out-of country website.l3 Similar conclusions are also, arguably, applicable in the case of state and local consumption taxes.14

Extension of the mail order tax exemption to Internet sales has been a cause of concern among taxing officials worldwide. …

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