On Wednesday, March 12, 2014, the House Judiciary Committee held hearings on Exploring Alternative Solutions on the Internet Sales Tax Issue. The Hearings shed new light on the breadth and diversity of the sales tax issues arising from the MFA’s attempt to remedy state tax revenue shortfalls from the retail e-commerce industry. The Hearing most importantly raised the question of whether the States’ revenue concerns about retail e-commerce are a “sales” tax question or are more the result of deficiencies in the States’ enforcement of “use” tax compliance.
In other words, one of the arguments put forth at the hearing is that if states focused on how to better enforce the use tax provisions already on the books, the need for a significant alteration to sales tax nexus laws would be largely unnecessary.
The issue of whether the States’ revenue shortfall concerns is one driven by the States’ inability to assert nexus over “remote sellers” or the States’ ineffective “use” tax compliance efforts was raised by an article featured in one of the Multistate Tax Commission’s publications. As stated on the MTC’s website, the MTC “is an intergovernmental agency working on behalf of states and taxpayers to administer, equitably and efficiently, tax laws that apply to multistate and multinational enterprises.”
The concept of “use” tax noncompliance and the negative effect on state tax revenues was addressed by the MTC Winter 2013 Review. In An Analysis of Business to Consumer Electronic Commerce Sales and Use Tax Compliance on Revenue Collection, the authors shed an important light on what is driving the States’ sales and use tax revenue shortfall regarding retail e-commerce. This post will further explore the detailed findings contained in the Article.
The MFA Provisions and Terms – Concerns For All Businesses
However, in order to more fully appreciate the potential implications posed by the article, as well as the potential onerous sales tax ramifications the adoption of the MFA would pose to all businesses, a brief discussion of the following MFA terms, as defined within the MFA, warrant special attention:
PERSON.-The term “person” means an individual, trust, estate, fiduciary, partnership, corporation, limited liability company, or other legal entity, and a State or local government.
REMOTE SALE.-The term “remote sale” means a sale into a State, as determined under the sourcing rules under paragraph (7), in which the seller would not legally be required to pay, collect, or remit State or local sales and use taxes unless provided by this Act.
REMOTE SELLER.-The term “remote seller” means a person that makes remote sales in the State.
SMALL SELLER EXCEPTION.-A State is authorized to require a remote seller to collect sales and use taxes under this Act only if the remote seller has gross annual receipts in total remote sales in the United States in the preceding calendar year exceeding $1,000,000. For purposes of determining whether the threshold in this subsection is met, the gross annual receipts from remote sales of 2 or more persons shall be aggregated if—
1. such persons are related to the remote seller within the meaning of subsections (b) and (c) of section 267 or section 707(b)(1) of the Internal Revenue Code of 1986; or
2. such persons have 1 or more ownership relationships and such relationships were designed with a principal purpose of avoiding the application of these rules.
First and of foremost concern, The MFA does not limit the term “REMOTE SELLER” to only online retailers. The MFA may be applicable to and expand any business’ sales tax filing responsibilities.
Secondly, pursuant to the MFA, any state satisfying the criteria of Section 2 of the MFA, by either being a Member State of the Streamline Sales and Use Tax Agreement or through satisfaction of the ALTERNATIVE as set forth in Section 2, AUTHORIZATION TO REQUIRE COLLECTION OF SALES AND USE TAXES, of the MFA, may require “all sellers not qualifying for the small seller exception described in subsection (c) to collect and remit sales and use taxes with respect to remote sales sourced to that Member State…”.
This may result in a business being required to comply with the sales tax provisions of one or more MFA authorized states that the business does not presently have sales tax nexus pursuant to Quill. If the MFA were adopted, a business may be forced to file sales tax returns in each of the SSTA member states even though the business does not have any physical presence in any of those states.
Furthermore, the MFA states that it will have no effect on nexus:
NO EFFECT ON NEXUS.-This Act shall not be construed to create any nexus or alter the standards for determining nexus between a person and a State or locality
But if the MFA can force a business to comply with sales tax provisions in one or more states in which the business does not presently have nexus under Quill, how then is the MFA not “affecting” sales tax nexus?
Finally, the MFA does not mention what effect its adoption would have on individuals who may be deemed “responsible persons” and potentially personally liable for sales or use taxes in one or more newly “authorized” states that satisfy the “authorization” provisions of Section 2 of the MFA.
Does The MFA Answer the Wrong Question?
As noted earlier, the concept of “use” tax noncompliance and the negative ramifications on state tax revenues was addressed by one of the articles featured in the MTC Review. In that article, the authors’ discussion provides a detailed analysis of the leading contributing factors to the States’ sales and use tax revenue shortfall regarding e-commerce.
The authors’ analysis of the potential reduction to States’ sales/use tax revenues arising from consumer electronic commerce takes into account several sets of critical assumptions. According to the authors, based on which set of assumptions one wishes to apply, the annual state sales and use tax revenue shortfall arising from consumer electronic commerce ranges from $14 billion to $20 billion annually nationwide.
Although the potential shortfall attributable to retail e-commerce is quite substantial, it should be viewed in relation to the total annual state tax revenue in the United States. According to the US Census Bureau, state tax revenues for 2012 achieved an all time high of $795 billion. Therefore, the potential annual “sales/use” tax shortfall, i.e. $14-$20 billion, that the adoption of the MFA will purportedly remedy, is only about 2% of the total annual state tax revenue collected in the United States.
The authors’ analysis also highlights the relatively low state use tax rate of compliance, especially as compared to the overall state income tax rate of compliance. Most compelling is the following statement on page 10 of the article:
“Under the current condition, we assume average 1% use tax collections among states. This estimate is based on the states whose use taxes are collected in combined report with their income tax returns.”
The authors further state:
“Individuals seldom apply even when they are offered the opportunity to pay through their individual income tax return. We compare the current 1% to the federal income tax compliance for the year 2006. The idea is if the states try to enforce the use tax, then they can reasonably expect the same compliance rate as the federal income tax, which is 83%. From this study, we found thatwith the compliance rate of 83%, the total revenue lost decreased by nearly 80% using method I, and 70% using method II.”
Furthermore, the authors’ final statement is quite noteworthy:
“Overall, states could increase revenues by $8.5 to $9.8 billion if they start to enforce individual use tax compliance and large business sales tax compliance.”
Expressed more directly, the authors of the article conclude that if the states were more effective and successful in enforcing their respective “use” tax provisions, they could significantly reduce the estimated sale/use tax revenue shortfall attributable to retail e-commerce.
Therefore, the authors’ analysis would appear to support the premise that if the States enhanced their use tax compliance efforts to match those of their income tax compliance, they could reduce the potential state tax revenue shortfall attributable to retail e-commerce to less than 1% of the States’ total tax revenues.
The testimony provided at the Hearings is indicative of the diversity of leading experts’ views on how to address this issue. I found the testimony of Stephen P. Kranz, Partner, McDermott Will & Emery, LLP and the testimony of James H. Sutton Jr. Shareholder, Moffa, Gainor, & Sutton, P.A., most interesting, edifying and well worth the read.
A review of all the expert witnesses’ factual and technical discussions provides one with a keen appreciation of how essential these Hearings are to shed light on the numerous and serious constitutional issues presented by the MFA. These Hearings are equally critical in identifying and discussing the diverse solutions to the States’ revenue concerns arising from retail e-commerce.