Delaware discount cigarette

The annual conference of the North Eastern States Tax Officials Association (NESTOA), held in Wilmington, Delaware, September 9-12, 2002, provided a comprehensive survey of recent tax developments.

E-Commerce and State Income Tax Collection

William Bryan, New Jersey Division of Taxation, discussed how the rise in electronic commerce challenges the states' ability to collect state income tax. Bryan indicated that private business is using nontraditional methods in distributing products, particularly selling goods and services over the Internet. For example, publishing companies now provide an option for customers to order and download a book over the Internet rather than making a phone or mail order and having the book shipped through the mail. According to Bryan, Internet sales create a problem because the Internet purchase orders do not indicate a state of delivery; therefore, the receipt for the Internet sale is unassignable. Thus, according to Bryan, companies are not apportioning the unassignable sales when determining state income tax liability. Bryan stated that companies should capture the unassignable receipt sales in the numerator when apportioning the sales factor for state income tax liability purposes. Bryan suggested that states should provide a safe harbor only for sales with receipts that the company can identify a state of delivery for. In addition, Bryan suggested that states create a uniform approach to what companies must record when making Internet sales to make it easier for companies to track the situs of delivery for state income tax apportionment purposes.

Additionally, Bryan stated that passage of the Jurisdictional Certainty Over Digital Commerce Act (H.R. 2421) and/or the New Economy Tax Fairness Act or NET FAIR Act (S. 664) will hinder the states' abilities to collect state income tax and apportion Internet sale and service transactions. The Jurisdictional Certainty Over Digital Commerce Act would grant the federal government the responsibility and authority to regulate digital commerce transactions and would prohibit a state or political subdivision from enacting or enforcing any provision regulating digital commerce. In addition, the Jurisdictional Certainty Over Digital Commerce Act would prohibit the federal government from delegating the responsibility of regulating digital commerce to the states. "Digital commerce" means a commercial transaction for a good, product, or service that is transferred or delivered in its entirety by means of the Internet.

The NET FAIR Act would prohibit the imposition of state and local sales and use taxes on interstate commerce unless the entity engaged in the interstate commerce has substantial physical presence in the taxing state. However, the NET FAIR Act states that substantial physical presence does not exist if the only business activities within the taxing state include (1) the presence or use of intangible personal property in the state; (2) the use of the Internet or an Internet service provider in the state to maintain, take, or process orders; and (3) affiliation with a person within such state or the use of an unaffiliated representative or independent contractor in such state. In addition, under the NET FAIR Act, the substantial physical presence of one entity would not be attributed to another entity unless the relationship between the entities resulted from the consent of both that one entity may act on the other's behalf and subject to its control, and the relationship relates to the activities of the entity within the taxing state.

Tobacco Tax Collection and Enforcement

Matt Tomalis, Federation of Tax Administrators (FTA), Felicia Hoeniger, Connecticut Department of Revenue, and Bruce Kato, New York City Department of Revenue, discussed state and local cigarette tax collection and enforcement methods. Tomalis stated that many states increased tobacco taxes for fiscal year 2003 to raise revenue and fill budget shortfalls. However, according to the panel, cigarette taxes are often avoided by sellers, distributors, and end-users because of Internet sales and lack of compliance with the Jenkins Act, 15 U.S.C. 375. Hoeniger said that the Jenkins Act regulates the interstate sale of cigarettes and should apply to Internet sales. However, according to the panel, in practice, Internet sellers do not comply with the reporting requirements set forth in the Jenkins Act. As a result, states are not realizing the intended revenue expected by raising tobacco taxes. According to Kato, the federal government and states must increase their enforcement methods.

Hoeniger specified two types of Internet sellers: (1) the standard business sellers, who sell over the Internet; and (2) the purported Native American Indian sellers, who claim that they are not subject to the requirements of the Jenkins Act. Hoeniger stated that enforcement methods against those sellers purporting to be American Indians creates uncertainty when it comes to enforcement actions because enforcement agents, state or federal, must determine, first, whether these sellers are subject to the Jenkins Act, and, second, if they are, how the enforcement agents demand compliance when it is necessary to enter American Indian reservations, where they have no authority. According to Hoeniger, in light of the uncertainty of whether the Jenkins Act applies to Internet sales and sales by American Indians, states are looking to alternative methods to track sales of cigarettes and enforce tax compliance. For example, Connecticut passed legislation requiring transporters of cigarettes on public highways to have documents and invoices within the vehicle indicating tax compliance. If a transporter lacks the necessary documentation, the cigarettes will be deemed contraband and seized. In addition, Hoeniger said that states are targeting shipping companies, such as UPS and Federal Express, to track Internet sales and gain information on the locations of sellers and consumers.

Kato stated that New York City and State, which have a combined cigarette tax rate of $3 per pack, are challenged by cigarette smugglers who attempt to avoid tax compliance. According to Kato, the smugglers are purchasing cigarettes in southern states, like Virginia, with nominal cigarette taxes, and transporting the cigarettes to sellers in New York and other northern states. Kato stated that the smugglers buy under the Jenkins Act limits to avoid state reporting requirements, which include a statement indicating the name and address of the person to whom shipments were made, the brand of cigarettes shipped, and the quantity of cigarettes shipped. Kato stated that once the smugglers sell to the retailers, the retailers do not pass the discount on to their customers, and pocket the tax. Kato said that New York City estimates a $40 million loss in cigarette tax revenue because of smuggling. As a result, New York City is increasing civil penalties for cigarette tax abatement and creating bounty rewards for public citizens who report retailers that avoid tax payments.

Tomalis stated that federal legislation is pending that will strengthen the enforcement measures of the Jenkins Act. According to Tomalis, the legislation will assign enforcement of Jenkins Act compliance to the Bureau of Alcohol, Tobacco, and Firearms (currently the Justice Department is responsible for enforcement) and increase penalties for violating the Act. Business v. State: Responses to the Changing

Environments and the Corporate Income Tax

Bob Thompson, New Jersey Division of Taxation; Charles Drury, E.I. duPont de Nemours & Co.; Douglas Lindholm, Council On State Taxation (COST); Stephen Cordi, Maryland Comptroller's Office; Stanley Arnold, New Hampshire Department of Revenue; and Arthur Rosen, McDermott, Will & Emery discussed appropriate and inappropriate responses by businesses and states to the changing financial and business environment. According to Drury, four factors are affecting today's business environment:

* the growing global competition for customers;

* the pressure on businesses to increase profits because of falling stock prices;

* revelations of corporate wrongdoing in the media; and

* political candidates using negative corporate images, such as corporate accounting tricks, insider trading, and lack of reporting compliance, to gather campaign support. According to Thompson, the four factors affecting the states are

* fiscal crises;

* the shrinking of department of revenue staffs;

* the pressure for departments of revenue to act as service agencies, as opposed to regulatory agencies, and treat taxpayers as clients; and

* federal legislation limiting states' abilities to tax.