Since 1935, use tax has served as a companion tax to the sales tax, applying to the use, storage, transportation or gift of any item that would be subject to sales tax if it were sold in California. The use tax is an obligation of the consumer, but has proven difficult to collect.
The lost revenue for state and local agencies has soared with the expansion of sales over the internet. Internet sales have more than tripled since 2000, with further increases projected. The Board of Equalization (BOE) estimates that more than $1 billion of use tax goes uncollected annually. As online commerce continues to grow, a solution to the “use tax gap” becomes increasingly urgent.
Out-of-state online retailers have a significant price advantage over in-state “brick and mortar” businesses when they avoid collecting use tax from their customers. In-state stores on the other hand must collect and remit sales taxes. This dynamic hurts our in-state businesses, jobs and government services.
State law requires retailers to be “engaged in business in this state” to collect and remit sales tax. The use tax, the same rate as the sales tax, is imposed on purchases not subject to sales tax (for example when items are purchased from out-of-state online vendors). While retailers are responsible for collecting sales taxes, the purchaser is responsible for paying use taxes. In an era of exploding internet sales, collection of the use tax has become problematic; although a voluntary “use tax” line has been on state income tax returns since 2000, BOE estimates that only one percent of consumers comply.
Three Pending Bills: AB 153, AB 155, SB 234
Each of these bills uses a different legal approach to try to improve use tax collection. Together these measures could increase use tax collection within California by several hundred million per year.
- AB 153 (Skinner), modeled on a similar statute in New York, attempts to create a local “click through nexus” by requiring that out-of-state retailers collect use tax if they have agreements with California-based retailers who refer potential customers to the retailer by website or internet-based links.
- AB 155 (Calderon), modeled on Colorado’s approach, focuses on the corporate relationship of a parent and subsidiary working together-a “commonly controlled group.” Use tax collection would be required on out-of-state retailers whose in-state sister companies perform design, development or solicitation of sales of personal property for the retailer.
- SB 234 (Hancock) attempts to avoid potential legal conflicts with the U.S. Constitution’s “Commerce Clause” by authorizing BOE, to the extent permitted by federal law and the U.S. Constitution, to require vendors to collect and remit use taxes. This “long arm nexus” approach asserts the state’s jurisdiction to determine who must collect use taxes and tests the maximum reach of the U.S. Constitution in this area.
Measures Build Upon Recent California Legislation
In the last several years, the California Legislature has enacted several measures to increase use tax compliance including:
- ABx4 18 (2009), which requires firms with more than $100,000 in gross receipts to file use tax returns with BOE.
- SB 858 (2010), which makes permanent a use tax line on the state’s income tax returns which allows filers to self-report use taxes due.
- SB 86 (2011), which provides a use tax “Look Up” table – an estimated amount due based on income level.
While helpful, these bills make only a small dent in the use tax problem. BOE estimated their impact at approximately $123, $9.2 and $10 million respectively.
A Big Money Battle: California is Not Alone
Uncollected use tax is a national problem. Amazon.com currently comprises half of the Internet sales of large firms without nexus in California and tax avoidance seems to be part of their business strategy. Please see “Sorry, Shoppers, but Why Can’t Amazon Collect More Tax?” for more background on the issue. With big money at stake, out-of-state online retailers are actively opposing all use tax collection bills, and history shows they can be expected to file legal challenges should any be enacted.
According to Forbes magazine, 87 percent of Americans live in a state where Amazon.com does not collect tax on residents’ purchases. Many states have tried to compel collection. “Click through nexus” legislation is pending in Illinois and being considered by Arizona, Hawaii, Minnesota, Mississippi, New Mexico, Connecticut, Texas and Vermont. Although legally barred this year from enforcing its recent law, Colorado requires non-collecting retailers to notify customers that taxes are due on purchases, and to collect taxes if it is part of a controlled group of corporations with a component member that is a retailer with physical presence within the state. In February, the Texas comptroller publicized the problem by delivering a $269 million bill to Amazon.com for back taxes.
As states have tackled the problem, out-of-state retailers have retaliated with lawsuits and economic sanctions. North Dakota’s use tax collection obligation was challenged and invalidated by the U.S. Supreme Court in 1992. Online giants Amazon.com and Overstock.com have cancelled their affiliate programs in many states that have adopted use tax collection statutes; both retailers have stated they will end relationships with California affiliates should these measures become law.
Roots of the Problem: Federal Court Decisions
The roots of the use tax collection problem traces back to interpretations of the “Commerce Clause” by the U.S. Supreme Court, including theCourt’s 1992 ruling in Quill Corp. v. North Dakota, 504 U.S. 298. This case focused on whether a state could require Quill, a catalogue sales company, to collect use tax on its sales to residents within North Dakota. The company argued that it should not be required to collect and remit the use tax because it had no physical presence or employees within the state. The Court agreed with Quill and ruled, consistent with earlier cases, that remote sellers/businesses that sell products to customers within a state or to other states, using the Internet, mail order, or telephone, without having a physical presence in the state where the product is shipped to cannot be required to collect and remit a use tax.
A portion of the Court’s reasoning in Quill stemmed from the existence of more than 6,000 jurisdictions throughout the United States (states, localities, and special tax districts) that levied a sales and use tax. The Court concluded that requiring remote sellers (without a physical presence in the state) to collect and remit use taxes would impose an undue burden on those companies and severely restrict interstate commerce. Yet the Court did clarify that Congress, through its authority to regulate interstate commerce, “is free to decide, whether, when and to what extent states may burden interstate mail order concerns with a duty to collect use taxes.”
Well-Intended but Problematic Approach: Streamlined Sales and Use Tax Agreement
Since Quill, states have struggled with how to collect use taxes and have explored various methods with which to establish nexus and physical presence. One significant effort has been Streamlined Sales and Use Tax Agreement (SSUTA) – a voluntary effort by approximately 20 states to simplify their sales and use tax systems.
In the short term, SSUTA is a voluntary arrangement in which member states agree to streamline statutes, processes and definitions, and businesses may seek to take advantage of these streamlined provisions by registering under the agreement, voluntarily agreeing to collect and remit use tax to the affected states and jurisdictions. Those active within the SSUTA believe that once simplification of various state’s sales and use tax systems has been demonstrated and achieved, that the states are better positioned to lobby Congress to reverse the Quill decision andrequire all remote sellers (that lack physical presence within those member states) to collect and remit use tax to the various states and jurisdictions.
The League reviewed the SSUTA in depth in 2009 and concluded that there are more questions than answers for California cities about potential participation. The specifics of the agreement were reviewed in detail, including recent amendments. The League concluded there are too many unknowns. While the agreement holds out the lure of capturing additional use taxes from remote sales, financial loss for cities may also occur due to the adoption of alternative definitions of what can be taxed, potential restrictions imposed on local tax rates, and other restrictions potentially applied to local utility user’s taxes. Furthermore, both the state and local government are at significant risk of losing authority to both the SSUTA board where it will have only one vote, and Congressional intrusion through initial legislation and future amendments.
Use Tax Collection Bills Worthy of Support
As detailed above, use tax collection is a complex issue with no simple solution on the horizon. Thus, states are left to do what they can to improve collection as permitted under the Constitution. The internet has dramatically changed the manner in which business is conducted, so it is expected that our laws -and perhaps future Court interpretations – will evolve with our changing economy. What was considered “a burden” on interstate commerce at one point may not be later.
Should AB 153, AB 155 and SB 234 be enacted into law and withstand potential judicial challenge they are likely to result in the collection of additional revenue for state and local agencies and level the playing field for California-based businesses. While awaiting broader solutions, these measures can be helpful.
To access League support letters, please visit the League’s website and type the bill number into the search box.
For more information on this issue, contact Dan Carrigg at (916) 658-8222.