Hybrid-origin sourcing: Is a change in the method of collecting sales tax on the horizon?
As we reported, states are increasingly focused on uncollected sales and use taxes as a means to increase tax collection revenue, especially the collection of sales taxes related to e-commerce transactions.
The Tax Foundation estimates that Americans spent about $263 billion on Internet retail purchases in 2013, which represented a 15 percent increase over the previous year. The growth of Internet commerce is expected to continue, and Internet retail sales are expected to represent a larger share of the $4.5 trillion spent annually on retail consumption.
While the imposition of sales and use taxes has been a common feature of state and local tax regimes for a long time, the manner in which retail transactions are conducted has evolved significantly. General state sales taxes first became prevalent during the Great Depression because of the collapse of revenues from property taxes. By 1940, 22 states and Hawaii had adopted a sales tax. Today, 45 states and the District of Columbia impose a statewide sales tax. In addition, there are 9,998 sales tax jurisdictions nationwide that impose a form of local sales tax. In total, taxpayers paid $259 billion in state sales tax and $70 billion in local sales tax during 2013.
In every state imposing a sales tax except three, the sales tax is structured as a tax on the consumer’s purchase of tangible personal property not exempted; meaning the sales tax is charged on most goods but few services. Further, of those states, almost all impose the sales tax based upon a destination sourcing sales tax regime. This means that the location of the sale is considered the location where the consumer receives the good. Destination sourcing is based upon the idea that the sales tax is borne by the consumer purchasing the item and therefore should be based upon where the consumer resides.
The Chairman of the House Judiciary Committee, Robert Goodlatte, recently circulated draft legislation addressing the collection of tax on remote sales. The terms of the draft legislation, Online Sales Simplification Act of 2015 (the Draft Act), differ from previous iterations of the sales tax legislation, such as the Marketplace Fairness Act of 2013, which adhered to destination sourcing of sales. The Draft Act proposes utilizing hybrid-origin sourcing (Hybrid) as the basis for collection of sales and use taxes. Under the Hybrid model the sale would always be sourced as the taxing jurisdiction of the seller. Adoption of a Hybrid approach would significantly transform the structure and collection of sales and use taxes in the United States.
The Draft Act provides that a state may require collection of sales tax on a remote sale (e.g., an Internet sale by a seller without a physical presence in the destination state) only if: the state is the state of origin for the remote sale and the state is a party to a distribution agreement, which will be developed by participating states. The distribution agreement among the participating states would establish a clearing house by which the sales tax revenues are shared among the participants. If a state does not become a party to the distribution agreement, it is not allowed to levy a tax on a remote sale and will not receive a distribution. In addition, subject to certain exceptions, the destination state would not be allowed to impose any additional tax if the remote seller collects the tax pursuant to the terms of the Draft Act.
A remote seller based in a participating state would collect the tax on its sales at the rate and according to the rules in seller’s location, the “Origin State.” The tax collected by the remote sellers would be remitted to the Origin State, which would then send the taxes collected and information about the remote sale to the clearinghouse. In turn, the clearing house would distribute the funds to the destination state. It is unclear what would happen to sales taxes collected on sales into states not participating in the distribution agreement.
Some additional concerns with the Draft Act will need to be addressed and clarified prior to voting to adopt the Hybrid method, and transforming the structure and collection of sales and use tax. For instance, a method to collect a sales tax for sales originating from the five states which do not impose sales tax (i.e., Alaska, Delaware, Montana, New Hampshire, and Oregon) will need to be developed. That method will also need to determine which items qualify for a sales tax exemption as these rules vary by taxing jurisdiction.
Opponents of the Draft Act also assert that a Hybrid model problematically transforms the sales tax into a business tax because compliance will be legally and economically shifted to businesses. Imposition of taxes under the Hybrid method would impose a tax based upon production but distribute based upon consumption, which may result in distortions in state tax revenues and present opportunities of tax arbitrage.
Further, the Draft Act will need to pass Constitutional muster and comply with both the Commerce Clause and the Due Process Clause. In its present form, there appears to be the potential that customers in the same state could be taxed at different rates based upon the seller’s Origin State. Also of concern is that customers in states with no sales tax may, in effect, pay a sales tax if their purchases are from remote sellers in states with a sales tax. Finally, clarification will be needed as to whether a state that imposes a higher rate of tax than an origin state should be precluded from collection a use tax on the differential.
McDonald Hopkins will continue to follow developments and changes as the Draft Act and comments from industry groups makes its way through the legislative process.