The Faux Battle Over Online Sales Taxes

So now the battle is joined.

The Senate has passed, sending to The House, a bill that would impose a requirement that online merchants submit to state tax collection in states where they have no physical presence.

To try to make this more palatable they are exempting businesses with less than $1 million in annual sales, but this doesn't matter when you get down to brass tacks.

Amazon, WalMart and other large retailers with online presence are supporting this move. This sounds insane, but it in fact is not -- it is yet another attempt to destroy their competition using the jackboot of government rather than through free and open competition.

In the 1990s when I ran MCSNet we wanted to open an office in Wisconsin to serve Milwaukee business and residential customers. There was an easy way to handle residential dial-in customers through what amounted to a "virtual POP" but doing so for business users was far more difficult as at the time the technology to do so at a reasonable cost was not "fully baked." If we wanted to implement our Cheapernet T1 service, for example, we needed equipment in leased physical space in-state. This meant that we had our name on space and our own hardware present in the location, which under long-standing law created nexus.

Nexus is the principle of "ties" or "activity" in a given location; for a business it is important as it triggers the requirement to comply with state and local tax requirements. In short, it brings you under the jurisdiction of that state. During the 1990s we had received several "demand letters" from both New York and California insisting that we "give" their sales tax authorities data dumps of everything we had sold to entities in both states. We had responded with "Bite Me!" to these demands several times; at one point I actually photocopied my butt-cheeks and sent that back in one of their demand letter reply envelopes. Both states were on fishing expeditions; as a Chicago-area ISP we did not do a material amount of business with people in either state, and only physical sales of property would have been taxable anyway. Nonetheless they were actually trying to audit us! It was a pure harassment tactic but lacking jurisdiction there was nothing either state could do to force us to comply.

Wisconsin was a different matter since we wanted to conduct business there. I investigated setting up a separate corporation to run that location and then engage in a business transaction with this "captive entity" such that the Wisconsin-registered corporation would show no net profit. The idea here was to evade the "nexus" that would otherwise attach to MCSNet in Wisconsin, thereby evading the requirement to register in the state and expose ourselves to the Wisconsin tax authorities.

Before you start screaming "you dirty tax evader!" please realize something -- MCSNet's primary business was the sale of services that were not subject to sales tax. We sold very few tangible goods; as a percentage of sales you couldn't find them. The only reason we stocked and sold such goods was that it was convenient for customers, especially high-speed dedicated line business customers, to be able to order up service and get the hardware (along with warranty repairs or swap capability) from us.

The issue from my perspective was the pain in the ass factor from the sales tax auditors. They were real jackasses, and showed up every couple of years to harass us. I understand the reason for their audits, as once you register and start collecting tax you also have an exemption certificate; the goods you buy for resale are not taxed when you buy them -- you collect the tax when you sell them to the customer and remit it. This provides a tremendous incentive to cheat by abusing your tax certificate to buy things without paying the sales tax that you intend to, and do, consume internally. The audits are performed for the purpose of catching this and nailing the violators, of which there are many.

But the fact remains these guys would show up and consume what often amounted to a full day of time and sometimes multiple days from some of my critical employees. Being a relatively small business of about three dozen employees to have one of my key people tied up "at whim" by these guys who wanted to riffle though our purchase orders to and invoices from suppliers, pointing at a random shipped item (say, a router) and demanding to know exactly where Serial #302052 went (and proof that the tax was paid if it wasn't sitting in our inventory, whether we paid it when we put it to use internally or we billed, collected and remitted the tax if we sold it to a customer) was a royal pain in the ass.

We never cheated on our state tax obligations and despite these audits not once were we tagged for a deficiency. But I was going to be damned to Hell if I was going to intentionally expose ourselves to this crap coming from another state if I could legally avoid it.

The advice I got from our counsel was that I could try a scheme like I described where a "captive corporation" rented the space and owned the gear, then engaged in what amounted to a zero-profit transaction with us, but if I did so I was risking at best a civil suit from the tax authorities in Wisconsin and if someone up there got aggressive I might even get indicted.

I passed as the cost of getting sued would grossly exceed the cost of compliance, never mind the (small but present) risk of a criminal indictment, and just set the thing up. As it turned out Wisconsin was more-reasonable than Illinois in regard to deciding to show up and harass us -- they didn't during the remainder of the time I ran the place. We did our paperwork and remitted what we owed, and that was that.

Amazon, for its part, has engaged in this sort of screwball deal with its distribution centers in various states, arguing that this doesn't give them nexus and thus they don't need to collect tax. When threatened they reply with the threat to close the center and fire the employees (who are residents of the subject state) or sue, which effectively stalls the clock. This set of tactics has "worked", because Amazon (and similar firms) are huge corporations with internal legal staffing that can fight these things and, at worst, delay the outcome driving up the costs for the states and there is virtually no chance that the company or its officers will be indicted by the states in question for tax evasion, as is the case for a small business. The problem is that as these cases have gone on over the years it has become increasingly apparent that Amazon and these other retailers will eventually lose and be forced to both pay and collect the taxes and might be exposed to penalties, interest and retroactive tax billing for willful evasive activity.

So what Amazon appears to have decided to do is play screw the other guy by forcing them into having a "virtual" nexus that otherwise would not exist! This is then sold to people as "fairness."

It is nothing of the sort.

Amazon could choose to have distribution centers only in no-sales-tax states. It could then tell the rest of the states to "pound sand." There is a long-standing US Supreme Court decision ("Quill") that they can stand behind if they take this approach and are without question in the clear in doing so. But by doing so Amazon would have a serious problem because transit time and cost become a big problem, and since everyone wants everything right now, shipping cost is a huge expense and getting larger, and Amazon sees both cutting that cost and increasing speed of delivery as a competitive advantage (it is) they want to open distribution centers close to the people who shop.

But that leaves them with a problem because to do that they create nexus, and with nexus comes compliance costs. Since they've become increasingly unable to avoid this and meet their business goals they now seek to use the jackboot of government to shove it down their competitors' throats!

That's what this is about folks -- audit and compliance costs. It is not about "sales tax" per-se. Those audit and compliance costs are a big problem and an open-ended channel of abuse from virtually every state. Further, simply figuring out your liability accurately is a problem all on its own because there are not only state sales taxes in many states there are county and local overrides, leading to the need to accurately track and bill tax based on thousands of jurisdictions with rates that change on a pretty-frequent basis. The business selling on the Internet could easily find itself not only subject to something like 46 State audits but also audits by counties and cities that impose "override" taxes, as many states allow. This runs the number of potential audits into the hundreds or worse, all independent of one another, and forces said businesses to buy a service of some sort that can handle accurately tracking and computing the various rates in force in different places.

If you think these folks at the state sales tax audit departments won't use this law to harass small businesses you're dead wrong. They will. California and New York, in particular, are virtually certain to do so immediately -- hell, they tried to force MCSNet to comply with their crap while we had no presence, no office, and sold essentially nothing into those states. If they could have compelled MCSNet to show up in their state with our records for an audit they would have done exactly that.

This bill, if it passes into law, will impose that sort of crap on any business that both sells online and has more than $1m in revenue, which is in fact a pretty small number. MCSNet passed that revenue number when we could still count our employees on my fingers.

Were I running MCSNet today and this bill were to pass I'd shut it down the next morning.

It's simply not worth it.

This isn't about taxation -- it's about Amazon, WalMart and a handful of other large online retailers forcing others to bear compliance costs that they voluntarily assumed as a consequence of their business model and which these other firms have legally avoided through their business model.

Source: The Market Ticker

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