State Sales and Use Taxation of Intangible Goods and Services
Purchased via the Internet

Brad Graham


I. Introduction   .  .  .  .  .  .  .  .  .  .  .  .  .  1
II. Sales and Use Taxes  .  .  .  .  .  .  .  .  .  .  .  4
III. The Advent of the Internet .  .  .  .  .  .  .  .  . 11
A. The World Wide Web and Electronic Commerce   .  .  . 13
B. Taxation of Internet Transactions   .  .  .  .  .  . 15
IV. State Jurisdiction to Tax Internet Transactions .  . 18
V. Current Legislation  .  .  .  .  .  .  .  .  .  .  . 22
VI. Proposed Solutions   .  .  .  .  .  .  .  .  .  .  . 27
A. Consumption Tax   .  .  .  .  .  .  .  .  .  .  .  . 27
B. Destination Based Sales Tax   .  .  .  .  .  .  .  . 30
C. Seller-State Option  .  .  .  .  .  .  .  .  .  .  . 33
VII. Suggested Approach   .  .  .  .  .  .  .  .  .  .  . 37
VIII.Conclusion  .  .  .  .  .  .  .  .  .  .  .  .  .  . 40

I. Introduction

 Alice lives in Des Moines, Iowa, but is currently on vacation in northern California staying at the house of her aunt Anne.  Anne, a computer enthusiast, shows Alice how to "window shop" and buy goods over the Internet.  Alice eventually decided to purchase a new laptop computer via the Internet using Anne's computer.  Alice has the computer shipped to an address in Aspen, Colorado where she will be spending a few days toward the end of her vacation.  While she is still connected to the Internet from Anne's computer, Alice decides to purchase some software that she downloads to Anne's computer and copies to a floppy disk.  Finally, Alice purchases a book to send to her brother, Tom, whose birthday is only a couple of weeks away.  She purchases the latest Tom Clancy novel from an Internet vendor and sets the delivery address to Tom's home in Florida.
 What are the sales tax consequences of these transactions?  Or, more accurately, what should be the sales tax consequences of these transactions?  Should each transaction be taxed in California?  In Iowa?  In the state of the vendor?  Or, given the facts above, do Colorado or Florida have a claim?  Some other state?  A combination?  None of the above?  Such questions are prompting new state and federal tax legislation.
 Internet commerce is exploding. A study conducted by Forrester Research, Inc. projects "that electronic commerce will reach about $350 billion by 2002, from an estimated $22 billion this year."1  IntelliQuest reports that in 1999, "more than 79.4 million adults are online."2  That is more than double the number online in 1996.3  An additional 18.8 million people are planning to go online in the next year, a total of over 100 million by the year 2000.4  As significant, "60% of Internet users shop online and nearly 20% purchase online."5  Those shoppers have plenty of stores to choose from.  More than 400,000 companies have an Internet site.6
 As Internet commerce becomes an increasing factor in our nation's economy state and local governments reach for their share of sales taxes.  Currently, the 1998 Internet Tax Freedom Act (ITFA) imposes a three-year moratorium on all Internet taxes.  How federal, state, and local governments attempt to tax electronic transactions after the ITFA moratorium expires will have a major impact on the future of the Internet a well as national and global tax policy.
 This paper will focus mainly on state sales and use taxes as they relate to transactions conducted over the Internet.  The paper will discuss where the power of states to impose taxes originated, traditional analysis of a state's jurisdiction to tax, and the current methods used by states to impose sales and use taxes.  Next, the paper will address the advent of the Internet, current case law regarding a state's ability to obtain jurisdiction over Internet users, and current legislation controlling Internet taxation.  Finally, existing proposed solutions to the Internet sales and use tax dilemma will be outlined and new solutions will be proposed.

II. Sales and Use Taxes

State sales and use taxes were first introduced in the 1930's.7  A sales tax is a tax on the retail sale of specified property or service and is a percentage of the cost of the property or service.8  The purchaser of the good pays the sales tax to the vendor, who collects and remits the tax to the states. Traditionally, sales taxes are imposed only on tangible goods and services.
A use tax is a "tax on the use, consumption, or storage of tangible property, usually at the same rates as the sales tax, and levied for the purpose of preventing tax avoidance by the purchase of articles in a state or taxing jurisdiction which does not levy sales taxes or has a lower rate."9  Purchasers of goods from out-of-state vendors are usually responsible for determining the amount of tax owed on the transaction and remitting it to the state.  The amount of the tax is the difference between the tax paid to the state of purchase and the amount of tax that would have been imposed if the transaction had occurred in the consumer's state.
 Because many customers living in use tax states are totally unaware of the tax they don't pay it.  Retrieving these uncollected taxes is virtually impossible because of the large number of consumers who buy goods from out-of-state vendors.  Therefore, many states want to be able to utilize a system similar to what they use for sales taxes.  However, states cannot impose such a burden on foreign vendors until they obtain jurisdiction over them.

1. State Jurisdiction over Foreign Vendors
 Jurisdiction over foreign vendors can be obtained by states if it can be shown that certain Constitutional requirements are met.  The Due Process and Commerce clauses restrict a state's power to tax transactions of out-of-state retailers.  The Due Process Clause is concerned with "the fundamental fairness of governmental activity."10  The Commerce Clause, which limits regulation of interstate commerce to Congress, on the other hand, is concerned about "the effects of state regulation on the national economy."11  The Supreme Court has decided a number of cases addressing the state's ability to tax.  It has developed standards that must be met under the Due Process and Commerce Clauses in order for a state to impose its taxes on a person or transaction.
 The first important Supreme Court case on this issue was National Bellas Hess, Inc. v. Department of Revenue of Illinois.12  National Bellas Hess, Inc. (Bellas Hess) was a mail order house with its principal place of business in Missouri.13  It owned no tangible property in Illinois, had no sales outlets, representatives, telephone listings, or solicitors in Illinois. It did not advertise there by radio, television, billboards, or newspapers.14  Bellas Hess mailed catalogues twice a year to customers throughout the United States, including Illinois, supplemented by occasional "flyers."15  Orders for merchandise were mailed to Bellas Hess's Missouri plant, and goods were sent to customers by mail or common carrier.16  The Illinois Department of Revenue obtained a judgment from the Illinois Supreme Court requiring Bellas Hess to collect and pay to the State the use tax imposed by Illinois upon consumers who purchase out-of-state goods for use within the State.17
 Bellas Hess appealed the decision to the United States Supreme Court.  It challenged the Illinois use tax statute on Due Process and Commerce Clause grounds.18  The Court first considered the Commerce Clause challenge.  The Court said the Commerce Clause requires a minimum connection between the state and the entity it seeks to tax.19  In order to meet the Due Process requirements, the Court said, the state must demonstrate the seller obtained benefits from the state for which the taxation is payment.20  The Court ultimately reversed the Illinois court's decision. It held that if catalogs and other mailings into a state are the seller's only contacts with it, the state does not have the jurisdiction to tax the seller.21  In order to meet the Due Process and Commerce Clause standards, the Court said, the physical presence of the seller in the taxing state is required.22
In another decision, Complete Auto Transit, Inc. v. Brady,23 the Supreme Court proposed the following test: whether (1) "the activity [was] sufficiently connected to the State to justify the tax;"24 (2) "the tax [was] fairly related to the benefits provided the taxpayer;"25 (3) "the tax discriminated against interstate commerce;"26 and (4) "the tax [was] fairly apportioned."27  In the Brady case the Court held that a tax on the privilege of doing interstate business would be unconstitutional.28  However, a tax on the benefits that the seller received from the taxing state would be constitutional.29
In Quill Corporation v. North Dakota30 the Supreme Court again addressed the physical presence requirement.  In this case North Dakota attempted to impose the burden of collecting and remitting use taxes on goods bought for use in North Dakota onto an out-of-state mail-order company who sold the goods.31  Again, as in Bellas Hess, the only contact that the mail-order company had to the taxing state was by common carrier or United States mail.32  In this case the Court drastically changed its Due Process standard.  The Court expressly overruled the notion that physical presence was required for a state to impose a duty to collect taxes on an out-of-state vendor under the Due Process Clause.33  "We have abandoned more formalistic tests that focussed on a defendant's "presence" within a State in favor of a more flexible inquiry into whether a defendant's contacts with the forum made it reasonable to require it to defend the suit in that State," says the Court.34
Utilizing the new, more flexible inquiry into a defendant's contacts with the forum, the Supreme Court stated that if a commercial actor purposefully directs its efforts toward the residents of another state, then an absence of physical presence would not defeat personal jurisdiction in that state.35  Finally, the Court states that mail-order businesses that are engaged in continuous and widespread solicitation within a state may be subject to its jurisdiction.36
Though the Court departed drastically from the Due Process analysis of Bellas Hess, it did not change the Commerce Clause test.  The Court reaffirmed the bright-line test of Bellas Hess that exempted foreign merchants from the burden of collecting and remitting use taxes to the forum state where the merchant's only contact with the state was by common carrier or mail.37
After Quill the sufficient nexus standard is unclear.  Mail-order businesses that only contact states through mailings will be free of use taxes.  How many more contacts with the forum state are necessary before use taxes are imposed?  How does the Internet fit in to all of this?  Before that question is answered, a background of the Internet is necessary.

III. The Advent of the Internet

The Internet is a "giant network which interconnects innumerable smaller groups of linked computer networks."38  Governmental institutions, corporations, individuals, non-profit organizations, and public institutions own the computers on the Internet.39  These interconnected computers together form what is known as "cyberspace," an international medium of communications.40  Communications in cyberspace can occur virtually instantly between individuals or groups of people around the world.41
 The Internet was originally designed for military purposes.  In 1969 the Advanced Research Project Agency (ARPA) created an experimental network of computers, called ARPANET.  It allowed the military, defense contractors and university laboratories researching defense issues to communicate more easily.42  "The network was designed to be a decentralized, self-maintaining series of redundant links between computers and computer networks, capable of rapidly transmitting communications without direct human involvement or control, and with the automatic ability to re-route communications if one or more individual links were damaged or otherwise unavailable."43  With this configuration, if any portion of the network were damaged, in a war for instance, important communications and research could continue.44
To further this goal, each computer was to be linked to many other computers.45  Then, each message could take a number of different paths to its final destination depending on the status of the routes at that time.46  If a route were damaged then the message would find another route that was free of obstructions and follow it.47  All of this routing and re-routing would occur without human aid or knowledge.48
Each message is broken into smaller pieces called "packets."49  When a message is traveling through cyberspace all of its packets can travel along the same path to its destination or the packets may follow completely different paths.50  When the packets are sent along different paths it is called "packet switching" and the destination computer will reassemble the packets into the original message when all the packets arrive.51
The Internet is comprised of the ARPANET and a number of other independent networks such as USENET, BITNET, and CSNET.52  These networks all found that it would be useful to link to each other so to improve communications between groups and to increase the amount of information available to each group.53  No one person, group or government entity controls the Internet.  There is not control center or primary storage location.54  It is comprised of millions of individual computers that communicate using the same protocols and exist around the world.55  It would not be feasible or wise to have only one entity controlling all of the information on the Internet.56

A. The World Wide Web and Electronic Commerce
One way that the Internet can be used to exchange information is through the "World Wide Web."  The web uses the hypertext markup language as its standard communications protocol.57  The information on the Web can be viewed using a software program called a "browser."  Text, sound, video, and graphics can all be viewed with a browser.  In addition, each Web page can contain hyperlinks to other pages anywhere on the Web.  To access the linked page all one must do is click on the link using their mouse.
Originally created for scientific and academic uses, the Web is now used by individuals, non-profit organizations and the business community.  The Web provides a very inexpensive and effective way for individuals and businesses to exchange information.  Thus, businesses began marketing and then selling their products via the Web.  With only a valid customer credit card number, businesses will sell and ship their products anywhere the customer would like or, if possible, will download the product straight to the customer's computer.
The Web acts as a "cyber-showroom" where consumers can view a company's products and prices and then order the products they want without ever speaking with a representative of the company.  This is a very attractive scenario for businesses.  The use of the Web to sell its products saves the company money and allows the business to reach before unreachable customers.58  A company with a Web page does not need any physical structure, other than a small amount of storage space on a server, or any sales people to complete a transaction over the Web.  One Business Week estimate states, "doing business via the Net results in a cost savings of about 5% to 10% of sales."59  Hence, many companies are eager to begin or increase the amount of Web transactions they conduct.
Electronic commerce has already made an impact in a number of areas.  Large numbers of consumers are purchasing their airline tickets, computers, software, books, entertainment, and are even trading stocks online.60  The reach of the Internet and electronic commerce appear to be limitless.

B. Taxation of Internet Transactions
With the number of users and retailers on the Internet growing at such an incredible rate and with the projected growth of electronic commerce, states have begun demanding their share of the revenues in the form of sales and use taxes.  Problems arise, however, when states attempt to implement sales and use taxes on Internet transactions.  Traditional sales and use taxes, as discussed supra, were imposed by the state in which a good was delivered or a service was performed.  The mail-order industry is a good example.  When a consumer orders a product over the telephone lines from an out-of-state company to be shipped to the consumer's home address, the sales and use tax rates of the consumer's state are levied against the product.
 This method of taxation would be adequate for taxing the Internet but for one problem.  The problem is that some goods and services can be delivered to the consumer electronically.  Goods that are not delivered to the customer electronically but are delivered to the customer's door are called "tangible" goods.  Tangible goods include such things as clothing, books, computers, hammers or any other good that is in a physical, discernable form when it is delivered to the customer.  Goods that are transferred to the customer through electronic means are called "intangible."  Examples of intangible goods are software that is downloaded directly to a customer's computer from a Web site, the contents of a book, magazine or newspaper that a customer reads online and music that the consumer can download.
 The major problem with taxing intangible goods is that there is no way that the vendor can tell where the customer is at any given time and where the goods are being sent.61  The point of delivery may be different than any other point in the transaction.62  Thus, traditional tax strategies are not suitable for imposition on intangible goods.
 The situation at the outset of this paper demonstrates the difficulties that lawmakers face in attempting to tax electronic commerce.  The first purchase made by Alice is a laptop computer that is to be delivered to her in Aspen, Colorado while she is vacationing there.  What state's sales and use taxes should be imposed on that transaction?  Alice purchased the computer online while she was in California, so is California the place to tax her?  The computer is to be delivered to her in Colorado.  Should the transaction be taxed in Colorado?  Finally, Alice is a resident of Iowa; maybe she should be taxed in that state.
 The other transactions raise similar questions.  Should the downloaded software be taxed in California, Iowa or not at all?  Should the book Alice bought for her brother be taxed under the laws of Florida or some other state?  Many proposals exist to address these questions and they will be examined later in this paper.  First, it must be determined if states have the jurisdiction to tax electronic commerce.

IV. State Jurisdiction to Tax Internet Transactions

Since the Internet is relatively young case law is not nearly as abundant as it is in the mail-order industry.  However, a number of cases have been decided that relate to the Internet and specifically Internet jurisdiction.  The Supreme Court has not yet faced the issue of Internet personal jurisdiction thus the pertinent cases have been decided by district and appellate courts.
The first case of interest is Bensusan Restaurant Corp. v. King.63  In this case a New York corporation sued a Missouri man over a trademark infringement.64  The New York corporation owned a famous New York City Jazz club called "The Blue Note."65  They were suing King because he had a Web site online for his Missouri jazz club, "The Blue Note."  The court said that New York could not obtain personal jurisdiction over King because "the mere fact that a person can gain information on the allegedly infringing product is not the equivalent of a person advertising, promoting, selling or otherwise making an effort to target its product in New York."66  Also, the court stated, "that mere foreseeability of an in-state consequence and a failure to avert that consequence [by restricting New Yorkers' access to the web site] is not sufficient to establish personal jurisdiction."67  In addition, King did not derive any benefit from New York nor did he have any reason to foresee being haled into court in New York.68  The court concluded that an Internet web page is not sufficient to establish long-arm jurisdiction in New York.69
 The case Hearst Corp. v. Goldberger70 parallels the Bensusan analysis.  The district court held that "the mere creation of a web site, without more, does not constitute sufficient contacts to provide it with personal jurisdiction over Goldberger."71
 In CompuServe, Inc. v. Patterson72 the court found personal jurisdiction to be proper under an Ohio long-arm statute over a Texas man.73  In that case the Texas man was a subscriber to a network service in Ohio.74  However, he also entered into a separate contract with the Ohio company that would allow him to sell his software over the Internet.75  His product was also advertised through the network service and he sent the software to Ohio a number of times.76  The court concluded that the Texas man had "reached" out to Ohio from Texas and had ongoing contacts with Ohio.77  Thus, he was subject to the jurisdiction of the Ohio courts under the Ohio long-arm statute.78
 In Panavision Int'l, L.P. v. Toenpen,79 a Cybersquatter - a person who reserves domain names of companies in hopes of selling or leasing it back to the company - reserved Panavision's trademark.  He was asking for $13,000 to sell the domain name back to Panavision.80  Panavision replied by taking him to court in California.  The Court held that jurisdiction was "proper because Toeppen's out of state conduct was intended to, and did, result in harmful effects in California."81  Since the defendant was interfering with Panavision's business and California is Panavision's principal place of business, the court concluded that the defendant was "running a scam directed at California."82
 The final case to be examined is Maritz, Inc. v. Cybergold, Inc.83  In this case the defendant owned a Web site upon which it posted information about its new service.84  The purpose of the new service is to have people sign on to a mailing list and include some personal information.85  Then the defendant will provide the user with a personal electronic mailbox and will forward the user advertisements that match the user's interests.86  This suit was brought as a trademark dispute.  The court held that the defendant was subject to personal jurisdiction under Missouri's long-arm statute.87  The court states that the intent of the Web site was to reach and transmit advertisements to all Internet users.88  These contacts are of such quality as to favor personal jurisdiction over the defendant.89  Furthermore, the court found that the defendant had transmitted information into Missouri over 130 times, which suggests that it was purposefully availing itself to the privilege of conducting activities in Missouri.90
 These cases show that the existence of a Web site alone that can be accessed anywhere is not enough for a state to obtain personal jurisdiction.  The person over whom jurisdiction is being sought must purposefully avail himself to the privileges of conducting activities in that state.  He must also have a reasonable expectation that be could be haled into court in that state.  Finally, there must be some sort of regular or continuous contact with the state in order for jurisdiction to be obtained over him.

V. Current Legislation

The Internet Tax Freedom Act was passed in October 1998.91  It imposes a three-year moratorium on all Internet taxes.92  The purpose of this act is to allow the Internet to continue its astounding growth rate until it reaches a level where the imposition of taxes will not seriously hamper its effectiveness.  Legislators see the Internet as an incredible resource capable of astounding benefits to society.  Because of this, they want it to develop free of any restrains for a few more years so that it can reach more of its potential and better handle an imposition such as taxation.  In October of 2001 the moratorium on Internet taxes will lapse and states will be allowed to impose taxes on Internet transactions.

A. Recent State Internet Sales Tax Proposals
 Many states had or were in the process of passing laws and regulations regarding the taxation of Internet transactions.  After the passage of the Internet Tax Freedom Act the laws and regulations have no effect.  However, these documents provide an excellent guide to what states are likely to impose after the expiration of the ITFA.  In addition, some state agencies and committees have created proposed legislation and reports that advocate post-ITFA sales tax policies.  A few state proposals and regulations are presented below.

The Electronic Commerce Advisory Council proposed a strategy for altering the sales tax policy to deal with electronic commerce.93  First, the Council advised state and local governments to follow the basic tax policy principles of neutrality, low rates on a broad base, transparency and easy implementation.94  Second, it recommended that state, federal and local governments harmonize and rationalize income and sales tax laws to eliminate double taxation and reduce compliance costs.95  The Council also advocated the creation of federal legislation that would allow states to require out-of-state vendors to collect and remit sales taxes when they ship goods into their states.96  The Council advances the policy of taxing tangible property only.97  It claimed that an attempt to collect sales taxes on intangible goods would be inherently difficult for merchants and, hence, would not be feasible or cost effective.98

 The Department of Revenue Services has outlined its current policies regarding sales and use taxes on electronic commerce.99  Online purchases of tangible goods are to be assessed Connecticut sales and use taxes.100  Taxes on software downloaded by the purchaser must be calculated and remitted by the purchaser unless the seller is in Connecticut, in which case the retailer will collect and remit the sales tax.101  In addition, software downloads incur charge for being a taxable online access service.102

 The Oklahoma Tax Commission amended its regulations regarding Internet-related services and transactions.103  In general, sales of services or tangible goods are taxable in the same manner as any other sale through another communication method.104  However, exceptions to this rule are clearly stated.  For example, charges for providing access to the Internet, creating, designing or storing data for a web-site, data manipulation and sales of advertising on the Internet are all free of sales tax.105  Sales made via the Internet that are not shipped into Oklahoma but are transferred to the buyer solely through the Internet are not taxable.106  That is, intangible goods are not assessed a sales tax.  The Oklahoma physical presence requirement was modified so as to provide that an Internet vendor who's only contact with the state is the existence of the web-site on the Internet is not enough for Oklahoma to force the vendor to collect and remit sales taxes to the state.107

 The Virginia House of Delegates proposed legislation that would keep Internet services free from taxation.108  The legislation would exclude intangible goods, Internet access services and other related electronic services from sales taxation.109  The purpose of this proposal is to align the taxation of Internet activities with that of the existing tax code.110  In the existing code only tangible goods and services relating to those goods are taxed.111  Therefore, any tangible goods purchased via the Internet and the services connected the sale would be imposed a sales tax where any intangible goods purchased via the Internet and the corresponding services would not.
It is easy to see that states are not in agreement when it comes to Internet sales tax policy.  However, there are some similarities among the proposals.  Most states want to tax tangible goods and services whether or not they were purchased via the Internet.  Also, most states agree that intangible goods and services should not be taxed.  In addition to state proposals many scholars and commentators have offered possible solutions.

VI. Proposed Solutions

There are many proposed solutions to the electronic commerce sales and use tax dilemma.  Some of the solutions focus on applying traditional tax practices to the Internet, while others attempt to create a new system or support a tax-free environment for Internet transactions.  A handful of these solutions are discussed.

A. Consumption Tax
 Professor John L. Mikesell of Indiana University proposed that electronic commerce should be taxed in the same manner as non-electronic commerce is taxed.112  He states that, "The fact that the transaction might be electronic has no bearing on the fundamental consumption tax logic."113  This method's primary goal is to determine what should be taxed and apply that standard to any type of transaction whether or not it is in electronic form.114     The way in which this method would tax particular activities is outlined below.

1. Internet Service Providers
 Under this approach access to Internet Service Providers (ISPs) would be taxed "on the same basis as other communication services."115  That is, taxation of access to ISPs would be taxed when the customer is a household and not taxed when the customer is a business.116  Thus, the tax would be a consumption tax.117

2. Mail-Order as a Model
 This solution would have all electronic transactions, of tangible or intangible goods, taxed in the same manner as mail-order purchases are taxed currently.118  Purchases from in-state vendors would incur a sales tax while purchases from out-of-state vendors would incur a use tax.119  The taxing state would always be the destination state.120  To achieve these ends, the author proposes that Congress should revise the physical presence standard of Quill to allow states to more easily require out-of-state vendors to collect and register use taxes.121   Also, this method encourages states to adopt a single statewide tax base to ease the burden on out-of-state vendors of calculating the proper use tax rate.122

3. Sales Tax Restructuring
 Mikesell's solution also encourages states to restructure their existing sales tax policies and align them with consumption tax principles.123  States should tax household consumption and exempt business purchases from taxation.124  Finally, the determination of whether a tax should apply to a transaction should be based on the identity of the purchaser as a household or a business and not on the type or means of the sale.125

B. Destination Based Sales Tax
 Charles E. McClure Jr. set forth a general plan for states to follow in redesigning their sales and use tax in order to solve the tax assignment problem.126  The plan proposes fundamental changes in the current state sales tax systems that can be applied to electronic commerce but not restricted to it.127  These changes are to be made while continuing to ensure state fiscal sovereignty.128

1. The Tax Assignment Problem
 In solving the tax assignment problem one must, McClure states, "consider four derivative questions: (1) who chooses the taxes levied by subnational governments; (2) who determines the base(s) of subnational taxes; (3) who sets the rates; and (4) who administers the taxes."129  He also considers two subsidiary questions that must be considered in altering the existing sales tax systems: "(2a) who determines the definitions to be used in establishing a subnational tax base and (4) who determines the procedures to be employed in administering subnational taxes."130  McClure argues that for an effective rationalization of state sales taxes, the states must give up control over the subsidiary questions and retain total sovereignty over the first four questions.131
 McClure set out rules that states must not violate in reforming their sales tax policies.  The states cannot substantially interfere with interstate commerce.132  Also, sales taxes should only be imposed on sales to individual consumers and not on sales to businesses.133  Sales taxation should be destination based as opposed to origin based.134  This is so for three reasons: (1) the benefits of public expenditures are related most closely with household consumption, thus the state where the consumers live should have the right to the sales tax base; (2) origin based taxes distort the location of economic activity, unless they are levied at uniform rates; and (3) origin based taxes put the producer who must pay them at a competitive disadvantage compared to producers who do not have to pay sales taxes.135

2. A Rational Sales Tax System
 McClure outlined the characteristics of a rational sales tax system.  The first is that state laws must be made simpler and more uniform.136  The old use tax system made it virtually impossible for out-of-state vendors to collect state and local use taxes.137  One way that uniformity could be achieved, according to the author, would be for the states to adopt a uniform set of definitions of products used in determining each states tax base.138  Each state would not have to treat each product in the same way, they would only have to say whether that product is taxed or not.139  This system would allow out-of-state vendors to easily determine what goods in each state are taxed.140
 Another proposed simplification is a combined state and local sales tax rate.141  This also would make the task of collecting use taxes much easier for remote vendors since they would no longer have to determine the rate of each local tax.142  Finally, it is suggested that compliance and administrative procedures should be made simpler.143  A consolidation in tax filing would greatly decrease the burden on remote vendors.144
 The second characteristic of a rational tax system is the elimination of sales and use taxes business inputs.145  McClure believes that all business purchases should be exempt from tax.146  Exempting business inputs from taxation would eliminate double taxation and would allow in-state businesses to compete on a level playing field with out-of-state vendors.147
 McClure concludes that the only effective solution is a cooperative solution resulting in more uniformity and simplicity.148

C. Seller-State Option
 Terry Ryan and Eric Miethke proposed a solution to the electronic commerce sales tax dilemma that would impose a tax in the vendor's home state.149  The reasoning behind this approach is that the remote vendor is using its Internet site as an invitation to enter its home state and shop in its store in that state.150  Thus, the customer leaves his home state and electronically travels to the seller's home state where he can browse through the vendor's products and make a purchase before returning home after the transaction has completed.151  This reasoning is analogous to a situation in which a non-Internet, out-of-state vendor advertises its products in the customer's home state but in order to purchase its products, the customer must travel to the vendor's home state.152  In this situation under current tax laws, the transaction would be subject to the vendor's state's sales tax.
 The authors state that a federal statute would be necessary to achieve the seller-state system.153  The statute would have to declare that the state in which an Internet vendor resides has the sole option to impose transaction taxes on any transactions that vendor conducts over the Internet.154  In addition, the use tax of the customer's state would be abolished.155  Under this system the place of shipment makes no difference whatever. 156
The authors set forth the attribute they deem most important in a proposed Internet tax system as "global harmonization with other taxing systems."157  They go on to say that, "Harmonization promotes the generally accepted tax 'values' of voluntary compliance, ease of administration, and minimization of multiple taxation."158  Their solution purports to meet all of these goals.159

1. Problems Resolved by the Seller-State Option
 The authors describe a number of the tax problems that would be resolved by their seller-state option plan.  First, the Internet vendor would only have to collect at one tax rate and on one tax base.160  This would greatly reduce the burden on the seller.161  Second, this approach would maximize the amount of tax collected by states.162  This is possible because additional transactions would be taxed under the new system that escaped taxation under the old nexus standard.163  The nexus standard would always be met in a seller-state system because the vendor is physically located in the taxing state.164  Also, noncompliance with the tax laws would be reduced because of the ease of administration and enforcement of the seller-state tax by taxing officials.165  Finally, not only would states be able to tax exports, but also uniform state tax rates would not be needed and local taxes could be imposed.166
 Additional problems solved by the seller-state option, according to the authors, includes the elimination of double taxation and a harmonization of tax laws around the world.167  The European Union is converting its tax system from a value added to an origin-based tax.168  The seller-state option would be completely compatible with the European system and would then eliminate the double taxation of goods purchased in Europe.169  Also, this strategy would protect the local communities' fiscal sovereignty.170  The purchaser's right to privacy would also be protected since only billing information would be necessary to complete the transaction.171

2. Will Internet Vendors Simply Move to the Best Tax Rates?
 The lone policy issue that the authors point to as the major concern of seller-state option skeptics is whether Internet companies will simply move their businesses to states where little or no sales tax is imposed.172  The Authors respond to this concern by explaining that tax rates have always varied across jurisdictions and that has not hurt Main Street business.173  They also point out that businesses must look to factors in addition to sales tax rate such as other tax impositions on the business and non-tax factors that may affect the company's willingness to relocate.174
 Finally, the authors argue that the seller-state option may be the only solution that meets the requirements of substantive due process.175  They state that the minimum contacts and purposeful availment tests would be met in every case where the seller-state is the taxing entity.176  They also contend that destination based tax policies will have the same trouble meeting due process standards as use tax policies on mail-order businesses have had.177

VII. Suggested Approach

The approach for implementing the sales tax to Internet transactions recommended by this paper is a hybrid of many of the existing methods.  The proposed method is destination based.  The destination state will assess its sales tax on the purchase of a good.  Tangible property purchased over the Internet would incur a sales tax that would be collected and remitted by the seller.  All tangible property, even that purchased out-of-state, would be assessed a sales tax that is collected and remitted by the vendor.  Also, intangible property would be treated in the same way as tangible property. To accomplish these goals a number of requirements must be met.
 First, Congress should enact legislation that would soften the bright line test of the Commerce Clause.  The purpose of this legislation would be to allow states to force out-of-state vendors to collect and remit sales taxes to the purchaser's state.  If this were done states would obtain tax revenue from transactions that would previously gone untaxed.  Individuals would no longer be required to collect and remit use taxes to the state.  Hence, the problem states face in the mail-order industry where individuals are unaware of their duty to pay use taxes and do not pay them would be eliminated.
 For this legislation to be successful, logistical considerations must be taken into account.  It must be possible for out-of-state vendors to easily determine the amount of tax each purchaser must pay.  In the current system each state and local government could have a different tax rate.  Plus, these rates are subject to frequent change.  States must be required to do one of two things.  First, they must make the tax rates throughout their state uniform.  With this policy in effect, vendors could easily find the proper tax rate to assess an individual by merely determining his state of residence.  Local governments would lose some amount of sovereignty through this method.  However, the amount of tax revenue that would be generated could more than offset the sovereignty concerns.
 The other option would be to require that states provide the applicable tax rate for every community in their state to out-of-state vendors.  If states did not comply they would not be able to force the out-of-state vendors to collect and remit their sales taxes.  This option would be very difficult to enforce and possibly impossible to accomplish.  Therefore, creating a uniform state rate is preferable.
 Finally, one more element is necessary for this solution to be effective.  When purchasing goods online consumers will be required to divulge the state in which the products will be used.  Without this information the out-of-state vendor will have no way of determining the appropriate amount of tax to charge.  It will also be necessary to allow the vendor to verify that the information the purchaser submitted is accurate.
 Under this method states could realize the large amounts of revenues that had once evaded them.  Also, the burden on the out-of-state vendors would be reduced and would comply with the Commerce Clause.  Finally, the sales tax revenues could be channeled to the state where the goods and services are being used.

VII. Conclusion

The advent of the Internet has raised many new, exciting and difficult issues.  Lawmakers, scholars and judges will have to determine if this new entity can be adapted to fit traditional legal doctrines or whether a new set of policies should be created to adapt to the Internet.  In the realm of the tax law, the Internet has served to illuminate existing tax problems.  If traditional tax policies are applied to Internet transactions, states will lose billions of dollars in revenues.  In addition, the confusion surrounding the tax law will only increase.
 To effectively handle Internet commerce the tax law must undergo serious change.  The federal, state and local governments must work together to create a flexible, fair, broad reaching, and non-inhibitive tax system.  Congress should act to eliminate the confusion surrounding state authority over out-of-state vendors.  States need to establish uniform tax rates.  Only with these fundamental changes will Internet transactions be taxed fairly.


1 Peter Coy, You Ain't Seen Nothin' Yet: The Benefits to the Economy of E-commerce are Boundless, Bus. Wk., June 22, 1998, at 130, 130.
2 Press Release, IntelliQuest Internet Study Shows 100 Million Adults Online in 2000 (March 3, 1999) <>.
3 WWITS - Worldwide Internet/Online Tacking Service (visited March 8, 1999) <>.
4 IntelliQuest Internet Study Shows 100 Million Adults Online in 2000, supra note 1.
5 Id.
6 Robert D. Hof, The "Click Here" Economy, Bus. Wk., June 22, 1998, at 122, 123.
7 Charles E. McClure Jr., Electronic Commerce and the Tax Assignment Problem:  Preserving State Sovereignty in a Digital World, 98 State Tax Notes 70-21 (April 13, 1998).

8 Black's Law Dictionary 1339-40 (6th ed. 1990).
9 Black's Law Dictionary 1543 (6th ed. 1990).
10 Quill Corporation v. North Dakota, 504 U.S. 298, 312.
11 Id.
12 386 U.S. 753 (1967).
13 Id.
14 Id.
15 Id.
16 Id.
17 386 U.S. 753 (1967).
18 Id.
19 Id.
20 Id.
21 Id.
22 386 U.S. 753, 757 (1967).
23 430 U.S. 274, 279 (1977).
24 Id.
25 Id.
26 Id.
27 Id.
28 430 U.S. 274, 284 (1977).
29 Id.
30 504 U.S. 298 (1992).
31 Id.
32 Id.
33 Id.
34 Id.
35 504 U.S. 298, 307 (1992).
36 Id.
37 Id.
38 ACLU v. Reno , 929 F. Supp. 824, 830.
39 ACLU v. Reno, 929 F. Supp. 824, 831.
40 Id.
41 Id.
42 Id.
43 Id.
44 ACLU v. Reno, 929 F. Supp. 824, 833.
45 Id.
46 Id.
47 Id.
48 Id.
49 ACLU v. Reno, 929 F. Supp. 824, 834.
50 Id.
51 Id.
52 Id.
53 Id.
54 ACLU v. Reno, 929 F. Supp. 824, 835.
55 Id.
56 Id.
57 ACLU v. Reno, 929 F. Supp. 824, 836.
58 See, Hof, supra note 5.
59 Coy, supra note 6.
60 See, Hof, supra note 5.
61 John L. Mikesell, Retail Sales Taxes and Electronic Commerce: Is There Hope?, 98 State Tax Notes 56-41 (March 24, 1998).
62 Id.
63 937 F.Supp. 295 (S.D.N.Y.1996).
64 Id.
65 Id.
66 Id.
67 Id.
68 937 F.Supp. 295, 300.
69 Id.
70 1997 WL 97097 (S.D.N.Y. Feb. 26, 1997).
71 Id.
72 89 F.3d 1257 (6th Cir.1996).
73 Id.
74 Id.
75 Id.
76 Id.
77 89 F.3d 1257, 1266.
78 Id.
79 938 F.Supp. 616 (C.D.Cal.1996)
80 Id.
81 Id.
82 Id.
83 947 F.Supp. 1328
84 Id.
85 Id.
86 Id.
87 Id.
88 947 F.Supp. 1328, 1332.
89 Id.
90 Id.
91 Internet Tax Freedom Act, 105 S. 442 (1998).
92 Id.
93 California Electronic Commerce Advisory Council, "If I'm so empowered, why do I need you?" Defining Government's Role in Internet Electronic Commerce (November1998) <>.
94 Id.
95 Id.
96 Id.
97 Id.
98 Id.
99 Connecticut Department of Revenue, Connecticut Department of Revenue discusses sales and Use Taxation of the Internet, 98 State Tax Notes 91-5 (May 12, 1998).
100 Id.
101 Id.
102 Id.
103 Oklahoma Tax Commission, Oklahoma Tax Commission Amends Sales and Use Tax Rules, 98 State Tax Notes 122-32 (June 25, 1998).
104 Id.
105 Id.
106 Id.
107 Id.
108 Virginia House of Delegates, Virginia HJ 36 would State that Internet Services Should Remain Free from Taxation, 98 State Tax Notes 31-20 (February 17, 1998).
109 Id.
110 Id.
111 Id.
112 John L. Mikesell, Retail Sales Taxes and Electronic Commerce: Is There Hope?, 98 State Tax Notes 56-41 (March 24, 1998).
113 Id.
114 Id.
115 Id.
116 Id.
117 Mikesell at 43.
118 Id.
119 Id.
120 Id.
121 Id.
122 Mikesell at 45.
123 Id.
124 Id.
125 Id.
126 Charles E. McClure Jr., Electronic Commerce and the Tax Assignment Problem: Preserving State Sovereignty in a Digital World, 98 State Tax Notes 70-21 (April 13, 1998).
127 Id.
128 Id.
129 Id.
130 Id.
131 McClure at 23.
132 Id.
133 Id.
134 Id.
135 Id.
136 McClure at 24.
137 Id.
138 Id.
139 Id.
140 Id.
141 McClure at 26.
142 Id.
143 Id.
144 Id.
145 Id.
146 McClure at 26.
147 Id.
148 Id.
149 Terry Ryan & Eric Miethke, The Seller-State Option: Solving the Electronic Commerce Dilemma, 15 State Tax Notes 881 (October 5, 1998).
150 Id.
151 Id.
152 Id.
153 Id.
154 Ryan & Miethke at 882.
155 Id.
156 Id.
157 Id.
158 Ryan & Miethke at 882.
159 Id.
160 Id.
161 Id.
162 Id.
163 Ryan & Miethke at 883.
164 Id.
165 Id.
166 Id.
167 Id.
168 Ryan & Miethke at 884.
169 Id.
170 Id.
171 Id.
172 Id.
173 Ryan & Miethke at 886.
174 Id.
175 Id.
176 Id.
177 Id.