Sales Tax, Use Tax and Internet Transactions
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Tax Nexus Electronic commerce implies collecting and paying sales tax. But sales tax laws vary not only from state to state but even among counties, towns, transit districts and other taxing authorities. How does an online merchant comply with this variety of tax responsibility?

Sales tax cannot be assessed in a jurisdiction if the seller does not have substantial physical presence in the jurisdiction. Presence for tax purposes is called tax nexus. If your company has offices in Texas, for example, you have nexus in Texas and are responsible for collecting sales taxes for goods shipped to customers in Texas. This applies whether those goods happen to be physical goods or electronic bits.

If your company has contracted with a sales agent in another state, you are considered to have tax nexus in that other state.

However, the fact that you ship goods via the post office, UPS or FedEx to other states where they have presence does NOT mean that you have nexus in those other states. Simply using a shipping service does not constitute nexus. Similarly, if your Internet Service Provider stores your Web pages on a server that is physically located in another state does NOT mean that you have nexus in that other state. If you send catalogs to another state (i.e., physical paper catalogs), you do NOT have tax nexus in that state, so the availability of an online catalog does NOT establish tax nexus for your company in that other state.

In short, tax laws and nexus for electronic commerce work in pretty much the same way as they would for a mail order business which takes orders over the telephone. One main difference, however, is that when mailing a physical product, the merchant obviously knows the shipping address of the buyer. Not so with electronic products...the merchant only need know and IP address or email address. Of course, the merchant can ask for an address but there isn't the same automatic connection between address and location as with physical goods (in other words, the buyer could lie to avoid paying sales tax.)

 

Use Tax So, you think you have a way to avoid paying (or charging) sales tax--just order from a company that does not have nexus in your state. While this was common a few years ago, it is no longer so. Today most states have use taxes which are the same idea as sales taxes but which do not require nexus. The rates for use tax may be the same or different as sales taxes.

What this boils down to is that if you're selling across the Net, you need a large table of regions and applicable taxes.

 

Which Taxes? If you have tax nexus in a state, what taxes must you pay? Certainly, state sales tax. But there are also counties, towns, transit districts and other taxing authorities that must be considered. And if you don't have nexus, you have to pay use tax for all those same taxing authorities. It has become very complex. A niche software industry has been created simply to track sales and use tax responsibilities of companies selling in the U.S. These packages are primarily indexed by Zip code but in many cases multiple tax authorities imposing different tax burdens cross a single Zip code. The software is typically updated monthly in an effort to keep up with all the sales taxes in all the jurisdictions throughout the United States.

The industry is just beginning to comprehend sales taxes outside the United States. Selling products across national borders often requires the computation of Value Added Taxes (VAT). At the time of this writing (May, 1997) no software exists for the Net which computes VAT but companies have announced its imminent release.

 

Practice The current state of practice of tax computation on the Net varies. The best companies calculate applicable taxes in real time and add it to the customer's bill before he commits to the purchase. Other sites do not calculate taxes in real time but notify customers that appropriate tax will be added to the bill prior to settlement. These companies are generally selling hard goods which need to be shipped making the real time requirement for credit card purchase authorization slightly less critical. A third practice seen on the Net is to not even mention taxes but add it on to the bill prior to settlement. Although not uncommon, it is not recommended--it is misleading.

The reason for this uneven practice of dealing with sales taxes across Web sites is due to complexity and cost. If a company has only one presence, it need only calculate sales taxes for orders from that state and use taxes from everywhere else. But companies that have a chain of retail outlets in addition to their mail and Web order business must calculate sales taxes for orders from all locations in which they have retail outlets and use taxes from other places...which may be quite complex.

Today, sales tax software is expensive...over $20,000. Many merchant companies are reluctant to spend that much on such a small part of their Web site. In addition, if they have an existing mail order business independent of the Web, they may already be paying for similar software, but which does not yet interface to their Web site. Many companies are finding work-arounds until the software is more in line with expected returns from online sales.

©1997, Harry Tennant & Associates

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