Paradise Taxed

Taxes are apparently inevitable, even in cyberspace. Last spring the Florida Department of Revenue decided that companies doing business over the Internet are subject to the state's sales tax. Gov. Lawton Chiles has delayed enforcement until July 1, 1997, to study the issue of Internet taxation. But the Internet will be taxed–it's only a question of how and how much.

Sales of tangible products on the Internet are still relatively small, roughly $500 million in 1996, but they are expected to explode in the next few years. Naturally, state and local governments want a piece of the action.

On the face of it, that seems like a difficult task. The U.S. Constitution prohibits states from taxing interstate commerce, so states can only levy a sales tax on companies that have a physical presence in the same state as the consumer. (This is why interstate mail-order sales are exempt.)

But that physical presence can be almost ephemeral. If a Colorado company sells software to a Dallas resident, but the program is downloaded from a Texas-based server, the company has to collect taxes on the grounds that the software never physically left the state.

States could also argue that Internet and on-line service providers such as CompuServe act, in effect, as independent agents of companies doing business on the Internet. Under this interpretation every company selling over the Internet would have a taxable telecommunications nexus in every state.

But CompuServe and other heavy hitters in the industry have their own ideas about how the tax system for cyberspace should be designed. A report by the Interactive Services Association, which represents major Internet and on-line companies, says taxes on on-line transactions should be levied on the purchaser, not on industry. The report also calls for uniform tax rates within states, and uniform standards and definitions throughout the country. Bruce Reid, director of excise and property taxes for Microsoft and the chairman of the ISA taskforce that developed the study, says, "Our underlying goal is uniformity throughout the 50 states–clear rules so that companies are able to comply and we know who's entitled to collect taxes."

Governments also have their reasons for making Internet taxes uniform. If local governments aggressively tax the Internet, they may find that their tax base disappears. The city of Tacoma, Washington, recently reversed a decision to subject on-line service providers to the city's 6 percent telecommunications tax because it was concerned about losing its business-friendly reputation.

So industry and government priorities may shift Internet taxation to the feds, with a national sales tax. State and local governments would howl, but a national sales tax would face fewer constitutional and administrative problems, and it would be uniform throughout the country.