House Judiciary Hearing: Exploring Alternative Solutions on the Internet Sales Tax Issue

by Ingmar Law Goldson on Mar. 20, 2014

Tax Sales & Use Tax 

Summary: This is a synopsis of the March 12, 2014 congressional hearing on alternatives to the Marketplace Fairness Act, and a legal analysis of the the due process problems with the Marketplace Fairness Act.

House Judiciary Hearing: Exploring Alternative Solutions on the Internet Sales Tax Issue

Yesterday, March 12, 2014, was the 25th anniversary of the World Wide Web. To celebrate this momentous occasion, Congress held a three and a half hour hearing in its honor (but maybe it was just a coincidence). The Marketplace Fairness Act, or MFA, is currently the primary solution to the internet sales tax issue in front of Congress. If any person or business felt like they would not be impacted by the Marketplace Fairness Act, they surely would be affected by at least one of the alternatives discussed at the hearing. As a result, the hearing room was packed. Even the overflow room with a live feed was full. See the line for entry in the hallway:

Crowd waiting for MFA congressional hearing.

Crowd waiting for MFA congressional hearing.


The esteemed panel of experts included:

Stephen P. Kranz – Partner in McDermott Will & Emery LLP

William E. Moschella – Shareholder in Brownstein Hyarr Barber Schreck, LLC

James H. Sutton Jr. – Shareholder in Moffa, Gainor, & Sutton, P.A.

Joe Crosby – Principal at Multistate Associates incorporated

Andrew Moylan – Outreach Director and Senior Fellow at R Street Institute

Chris Cox – Counsel for NetChoice and Partner in Bingham McCutchen LLP

Each panel member gave a 5-minute initial testimony outlining the problems in the Marketplace Fairness Act then proposed solutions to those problems. After the initial testimony, members of Congress were allowed time to ask questions and things got more interesting.

I.                    BACKGROUND

Under current law, a state may not impose sales and use tax obligations on a business with no physical presence in that state. The Marketplace Fairness Act is proposed federal legislation that would grant states the power to tax businesses on all retail sales into their state, even if the business has no physical presence in the state. This means that “clever” consumers would no longer be able to go window-shopping at a store only to return home and make their purchase online to avoid paying sales tax.

The Quill decision, which affirmed the physical presence standard, gives many internet-based companies with little physical presence the opportunity to make most of their sales without collecting sales tax. Many view this as an unfair advantage for internet-based companies. However, the purchaser who avoided paying sales tax on those sales is legally obligated to pay the complementary use tax on those purchases.[1] The use tax compliance rate for individuals is estimated to be somewhere around 1%. Many people, including many members of Congress according to yesterday’s hearing, do not even know about their use tax compliance obligation.

The main problem with the law as it stands today is that the states are losing out on one of their main sources of revenue: sales tax. Billions of dollars slip through the states’ fingers every year because of online sales that are not subject to state sales tax. In recent years, states have been passing various laws attempting to circumvent the Quill physical presence standard. Each of these tax jurisdiction-stretching, Quill-nullifying laws is at least suspicious in the eyes of the Constitution.

II.                  OPENING STATEMENT

The hearing started with an opening statement by Bob Goodlatte, Chairman of the House Committee on the Judiciary. Congressman Goodlatte of Virginia said that the “no physical presence, no sales tax” rule has led to the suffering of brick-and-mortar stores across the country. Recent news of Radio Shack and JC Penney stores closing hundreds of locations provided good anecdotal evidence for Senator Goodlatte and many other speakers during the hearing. Congressman Goodlatte stated that even though the internet sales tax problem needs to be addressed and fixed, the Marketplace Fairness Act has 3 major issues:

1. Opposition From the Public. People do not want to pay the tax upon purchase, even though they are required to pay the complementary use tax.

2. Tough Compliance. Integration costs make compliance extremely burdensome, partly because of the 9,600 taxing jurisdictions in the United States.

3. Multiple Audit Exposure. If a business has to comply with 50 different states, and many more local taxing jurisdictions, how do they handle audits coming from everywhere?

I noticed one glaring omission from this list. What about the questionable constitutionality of the MFA? It would be a serious issue if upon its enactment the MFA is halted by a preliminary injunction and ultimately found unconstitutional. In the bill’s current form, it suffers from a potentially fatal due process flaw. See more under section V.


1. Stephen Kranz – Mr. Kranz told a brief history of the internet sale tax problem and mentioned that National Bellas Hess was “affirmed” by Quill (a correct statement that can lead to a due process misunderstanding which I discuss in section V). Though he did not promote any particular solution or alternative to the MFA, Mr. Kranz  primarily argued against origin sourcing and encouraged Congress to pass a good federal framework to address the internet sales tax problem while protecting remote sellers.

2. William Moschella – Mr.  Moschella testified that the MFA is an unfair stretching of state jurisdiction and proposed a solution modeled after the Webb-Kenyon Act of 1913. Webb-Kenyon prohibited the shipping of alcoholic beverages into states that prohibited alcohol. The state tax version of Webb-Kenyon would prohibit a business from shipping into a jurisdiction without complying with that jurisdiction’s tax laws. Basically, this proposal will keep companies from selling into a state or jurisdiction without collecting its sales tax.

3. James Sutton – Mr. Sutton began by stating that his testimony will be against his own interests because the passage of the MFA would result in an explosion of business (sales tax litigation/controversy and audit defense) for his firm. After telling a hypothetical horror story involving criminal penalties that could include jail time from a remote state, Mr. Sutton proposed CPR, or Consumer Private Reporting. This proposal would impose reporting requirements on remote sellers rather than collection and remittance obligations. With CPR, the states would use a reporting system that accumulates information about remote purchases. The private information regarding the purchase would never leave retailer. As North Carolina learned in 2010, collecting such personal data on all internet purchases would have a chilling effect on free speech, and is a violation of the first amendment.

4. Joe Crosby – Mr. Crosby said that simplification is the only solution to level the playing field. He stated that this can be accomplished with interstate sale agreements between the states like the SSTA (Streamline Sales Tax Agreement). With Mr. Crosby’s proposal, there will be two distinct classes of retailers; nexus sellers and remote sellers.

5. Andrew Moylan – Mr. Moylan proposed origin sourcing. Origin sourcing would require internet sellers to charge sales tax at their home jurisdiction (or state) rate, and remit the tax to their home jurisdiction (or state). It is unclear, or undecided, how the home jurisdiction will be determined. The home jurisdiction could be that from which the product is shipped, the state of incorporation or formation, or the jurisdiction with the most employees. Mr. Moylan argued that this system is already in place for brick-and-mortar stores because they charge sales tax where they are located and remit the tax to the jurisdiction where the store is located (unless of course the brick-and-mortar store makes the sale online).

6. Chris Cox – Mr. Cox, a former congressman, started his initial testimony by telling his history with this issue, stating that he was the lead sponsor of the original Internet Tax Freedom Act in 1998. Like Mr. Moylan’s proposal, Mr. Cox proposed origin sourcing. Mr. Cox said his proposal reflects how “home rule” works in certain states, where the sales tax is collected and remitted in the jurisdiction of the purchaser (for intra-state sales only). Under this proposal, the remote seller will collect the sales tax of the home jurisdiction then remit the sales tax to that home jurisdiction. Mr. Cox ended his initial testimony by characterizing the MFA as bad legislation that would result in “intolerable compliance burdens” for businesses across the country.

IV.                 INSIGHTS FROM Q&A

Origin Sourcing Hate. Mr. Kranz’s primary purpose at this hearing seemed to be to discredit origin sourcing, and almost everybody was on board with him. Panelists and members of Congress expressed concern that origin sourcing would result in a “race to the bottom” where internet companies would simply relocate to jurisdictions without sales tax. Further, Mr. Kranz indicated that simple tax planning would restore any problem that origin sourcing would try to correct. Mr. Moylan responded that Congress could provide protections to keep such tax planning from being effective, but nobody seemed receptive to that idea. Origin sourcing was also characterized by Mr. Kranz as a tax on production rather than consumption, and indicated that origin sourcing is similar to a VAT. Mr. Cox disagreed, stating that origin sourcing is absolutely a consumption tax, as it taxes transactions based on where they choose to consume the goods purchased.

Limiting a state’s power to tax their residents’ purchases is such a steep hill to climb politically, and that plan may have its own constitutional issues. Origin sourcing is an interesting idea, but it does not seem to be a viable option.

Some People REALLY Hate Origin Sourcing. During Q&A, I felt sorry for Mr. Moylan. His proposal was remarkably similar to Mr. Cox’s, but Mr. Moylan received the brunt of origin sourcing criticism. Congressman Bachus of Alabama went on a head-scratching tirade about origin sourcing directed at Mr. Moylan. The tirade did not make much sense, but it showed how passionate arguments can get for proposals that are a far departure from the status quo. Unfortunately for Mr. Moylan, he did not have the benefit of being a former member of the House like Mr. Cox

Everybody Wants a Change. None of the panelists and none of the participating members of Congress are happy with the current state of internet sales tax. Mr. Kranz emphasized on numerous occasions that if Congress does nothing, then the states will continue to erode theQuill decision by passing laws to circumvent it. Most of the members of Congress who spoke told stories of how unfair online competition is hurting brick-and-mortar stores in their jurisdictions. Congressman Issa of California stated that Congress has a mandate to act, as regulation of interstate commerce is a power given to Congress in the US Constitution.

Software is Key.  With the MFA and the ideas proposed in the hearing, software is key. In some cases, panelists argued that software can ease the burdens of integrating a federal law that mandates sales tax collection into business. A main argument against the MFA and similar proposals is that businesses cannot keep up with the constantly-changing 9,600 taxing jurisdictions. It would be a compliance nightmare. But Mr. Kranz argued that existing software can look up the correct sales tax rate and apply it at the point of sale.

There is another side of the software argument that Mr. Moylan raised. Even if a system provides this software to online companies, will the software be able to determine what is actually taxable in each of the 9,600 jurisdictions? A unique product or service would have to be analyzed in the framework of dozens of taxing jurisdictions to come up with the correct answer. Will the software be able to do that?

Is This a Tax Increase? During Q&A, a few members of Congress expressed concern that passage of the MFA or any of the alternatives would be an increase in taxes. Congressman Farenthold of Texas said that the MFA “smells” like a new tax because it was not being collected before. The taxes already exist, and people are already required to pay them. The MFA and other proposals are not increases in taxes; they are enforcement mechanisms for existing taxes.

V.                 THE DUE PROCESS PROBLEM

Yesterday’s hearing would have been the perfect forum to discuss the due process issue, one of the main reasons why there may need to be an MFA alternative. This due process issue could render the law unviable and unconstitutional. There were only a few brief due process mentions in the hearing. An hour and a half into the hearing, Mr. Kranz mentioned the fact that Congress does not have the power to regulate due process, and that they cannot remove due process protection. To panelist Andrew Moyland’s credit, he mentioned a “slippery slope to unbound state jurisdiction” during his initial testimony.

The due process issue is clear when comparing the relevant U.S. Supreme Court opinions,National Bellas Hess and Quill. These cases held that a state’s collection of sales tax from remote sellers has two constitutional limitation problems: the Commerce Clause and the Due Process Clause. In National Bellas Hess, the Supreme Court analyzed the two clauses as if they were the same standard, and held that physical presence is needed to satisfy both the Due Process Clause and the Commerce Clause. Twenty-five years later in Quill, the Court revisited the same issue, and made a ruling on a case with substantially similar facts. In Quill,the Court upheld the physical presence standard, but the holding was not actually the same. The Court held that physical presence was still requirement under the Commerce Clause, but no longer a requirement under the Due Process Clause.

The Court did not go into much detail about why the Quill company did not need physical presence in North Dakota in order to be subject to its taxing jurisdiction for due process purposes, it only went as far as to say that Quill’s contact with the state of North Dakota (through mailing catalogues and mere solicitation) “is more than sufficient for due process purposes.” Unfortunately for everyone who participated in the hearing yesterday, the Court did not explain what would be less than sufficient for due process purposes. If we simply state that Quill “affirmed” National Bellas Hess, we are making light of the serious due process ambiguity that puts the MFA’s viability in question.

The problem with the due process ambiguity in Quill and in modern state tax jurisprudence is that it is unclear whether or not a single sale, assuming there is no other contact in the state, is sufficient minimum contact to pass due process muster. Passage of the MFA would assume a single sale is enough minimum contact for a state to impose their taxing jurisdiction on a business. But the federal appellate courts in the northeast have struggled with this issue when analyzing the constitutionality of the PACT Act (Prevent All Cigarette Trafficking Act). Considering the federal appellate courts have not come to a consensus on this issue, and the Supreme Court has not ruled on this issue, we cannot be certain that one sale is enough minimum contact to be able to impose a sales tax. Of further concern: how specific is tax jurisdiction? Is it broad enough to include criminal penalties?

While Congress has the power to regulate interstate commerce, they do not have the power to regulate due process. If the U.S. Supreme Court rules that a single sale is not enough minimum contact to meet due process constraints, effectively limiting state taxing jurisdiction, then the Marketplace Fairness Act would be unconstitutional in its current form. Whether you are for or against the MFA, this issue is of supreme importance.

VI.                CONCLUSION

Many ideas, concerns, and arguments were exchanged in a civil forum with experts and lawmakers face-to-face. People are talking about this issue, and congressional hearings on the matter are instrumental in making sure Congress addresses the internet sales tax issue by passing a good law.

Of the proposals, the CPR (Consumer Private Reporting) proposal of James Sutton seems to be the most practical and viable. Depending on how CPR is structured, it would either mitigate or completely do away with the due process concerns that I expressed above. If CPR requires businesses to only report information directly to remote states and jurisdictions, then it is much more likely to pass constitutional muster than a law that would require the business to collect tax, remit tax, and incur liability from a remote jurisdiction. If CPR requires businesses to report to a federal agency that then disperses the information, then the law would not stretch state taxing jurisdictions at all, arguably dispelling the due process issue all together.

Opponents of CPR will attack it on privacy and first amendment grounds. Exposing the purchasing habits and reading habits of each resident purchaser of a state is a valid concern. When North Carolina attempted to compel Amazon to turn over these types of records on their residents, a federal judge ruled such an action a violation of the first amendment – a chilling effect on free speech. But as Mr. Sutton testified, CPR would not allow any purchasing data to even leave the retailer’s computer system.

Under the status quo, states can audit a company and see the purchase data of their residents. Perhaps establishing a system like CPR that sanitizes personal purchase information could even alleviate some of the privacy issues that are already present in state audit protocols.

Software would be key, because if  consumer private date is erased, taxability of the product in foreign jurisdictions would still have to be determined. Unique products that fall in a grey area of taxability will cause difficult problems with CPR, as they would with the MFA.

One thing is for sure: “It’s time that we solve this crisis.” – Congressman Johnson.


Ingmar Goldson, Esq. 3/13/2014

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