December 6, 1999

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Internet Develops Its Own Tax Code
Online levies seem inevitable once business and government groups agree on a standard

By Charles Waltner

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Internet, Death, And Taxes

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he biggest standards battle in the history of the digital revolution is under way. It's a debate that could affect more than $1 trillion in revenue. But this fight isn't over hardware configurations or software protocols. It's about taxes.

The Internet is pretty much a tax-free zone--for now. But that can't last for long. What remains unclear is when taxes will be imposed, what kind of taxes, and which group of politicians will have control over the new tax rules.

The Internet's growth has put a spotlight on the glaring anomalies of U.S. tax laws that address the remote purchase of products and services. Governments--from the federal through local levels--and all types of retailers are examining the best way to address these seeming shortcomings. Ultimately, all parties are hoping to agree on a standard for addressing Internet sales taxes in a way that will protect local government revenue while making compliance simple and cost-effective for online retailers.

So far, the path to reaching such an agreement looks stupefyingly complex. Any change made in the tax law could cause problems in other areas of taxation policy, either creating a loss of revenue for local governments or demanding crippling compliance overhead from businesses.

"The nut of the problem is simplification vs. sovereignty, and that's a huge issue," says Kent Johnson, KPMG's national partner in charge of electronic commerce for state and local tax solutions. "How do you create a simplified sales-tax system without infringing on local governments' sovereignty to tax as they need to?"

Before the rise of the Internet, remote purchases mostly meant catalog or mail-order sales. Until now, businesses, consumers, and governments have been willing to live with the imperfections of how tax laws treat remote purchases, mainly because mail-order sales have not been large enough to prompt extensive efforts by governments to update their tax codes.

But the growth of E-commerce and its massive potential has made these anomalies look like fundamental flaws in U.S. tax codes to many observers.

"U.S. tax laws showed some cracks when mail order developed, but that's been multiplied a hundred times with E-commerce," says Paul Servidea, government-affairs director with NCR Corp. and co-chairman of the tax working group for the Computer Systems Policy Project, a Washington coalition of CEOs from leading U.S. information technology companies, such as Cisco Systems, Dell Computer, Hewlett-Packard, and Sun Microsystems.

The United States is not alone in its struggle to define E-commerce taxation rules. Many other countries also are struggling to integrate this new form of retailing into their existing tax systems.

There's a lot of money at stake in the domestic and global quest to address Internet taxation issues. A recent report by Forrester Research estimated that global Internet-commerce sales will reach $3.2 trillion in 2003 if business and governments effectively collaborate to solve issues raised by the Internet--such as taxation. But sales will reach only $1.8 trillion if business and governments fail to work in unison.

The debate on Internet taxation began in earnest in October 1998, when Congress passed the Internet Tax Freedom Act, which was sponsored by Rep. Christopher Cox, R-Calif., and Sen. Ron Wyden, D-Ore., and signed by President Clinton. 

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