Hawaii shoppers and businesses have long taken advantage of “tax-free” purchases from online retailers such as Amazon and eBay, but many legislators are trying to put an end to that free ride.
As cash-strapped governments hunt for more revenue, and online sales continue to grow, state legislatures across the country have passed “e-fairness” laws to collect taxes on remote transactions. Competing e-fairness bills stalled in the 2012 Hawaii Legislature and disagreements may again scuttle a compromise at next year’s session, but there is a big impetus from local retailers and others to pass legislation.
“The revenue to the government is a big issue,” says Carol Pregill, president of Retail Merchants of Hawaii, “but there’s a broad spectrum of reasons we’re doing this. … It also has to do with leveling the playing field for bricks-and-mortar retailers.”
Sherry Menor-McNamara, VP of government relations at the Chamber of Commerce of Hawaii, adds, “It’s about supporting local businesses and making sure (the excise tax) is not just a tax on bricks-and-mortar businesses.”
Even without the tax advantage, online retailers often have a leg up on traditional stores because of lower overhead and a broader audience. And “showrooming,” where consumers go to local stores to look at and test products, only to purchase them online, is a growing phenomenon that hurts storeowners.
“You know it’s having an impact because someone’s given it a name,” says Pregill. “It’s prevalent and it’s important. With all the smartphones and iPhones and all of these toys that shoppers use, I think it’s tempting to follow through with that because everyone wants to get the best price they can. All we’re asking for is that leveling of the playing field to make competition easier, fairer.”
Pregill also points out the local employment issue. “We’re talking about Aunty’s job, a cousin’s job, maybe even your own job.”
Not everyone supports e-fairness legislation, and its strongest opponent in the state Senate is Sam Slom, the only Republican in the chamber. “It’s a backdoor tax on the Internet,” Slom says. “People who support this argue that it’s a question of fairness and getting what is due to the state. I argue that it’s not; it’s just a burden on consumers and this state. It’s all about extracting more money from people instead of looking at improving the business climate in Hawaii.”
It’s impossible to know just how much states are losing in sales tax and related revenue because of remote transactions, but the National Conference of State Legislatures estimates the national total at $23.3 billion in 2012.
For Hawaii alone, estimates range from $25 million annually, according to Hawaii Department of Taxation, to nearly $150 million this year, according to a tax study completed for the 2010-2013 Hawaii Tax Review Commission, which has yet to make a recommendation on e-fairness legislation.
Show Me the Money
Under existing law, the U.S. Supreme Court has ruled, states cannot require remote sellers to collect sales and related taxes on goods purchased out of state. However, Hawaii law requires businesses and consumers to pay a “use tax” that is equivalent to the general excise tax on anything purchased remotely. Many, though not all, local businesses pay the tax on out-of-state purchases, but consumers almost never do, says Lowell Kalapa, president of the Tax Foundation of Hawaii.
“It’s not so bad for businesses making those (out-of-state) purchases because they get audited on a regular basis,” says Kalapa. “It’s the individuals, you and me, who say, ‘I didn’t have to pay tax on that because I bought it on Amazon.’ ”
A use tax is nearly unenforceable on consumers because states have almost no ability to track individual consumers’ purchases. However, Hawaii businesses that do not pay the use tax on time are assessed a percentage penalty, as well as interest.
In 1992, the U.S. Supreme Court reaffirmed past decisions by saying it was unconstitutional for states to force remote retailers to collect and pay sales and use taxes unless those retailers have substantial nexus, often defined as physical presence, in a state.
For example, Amazon has a warehouse in Pennsylvania, so it must collect and remit Pennsylvania’s sales tax; but Amazon has no physical ties to Hawaii, so, under that 1992 ruling, it does not have to collect Hawaii’s GET.
In its decision, the Supreme Court stated that the complexity of sales and use tax codes, along with the thousands of different taxing jurisdictions, would pose an undue burden on remote retailers, thereby hindering interstate commerce. However, the Supreme Court left open the option of Congressional legislation overruling the decision.
Simplifying Tax Codes
Because Congress has yet to move on the issue, states have become creative in their efforts to require remote retailers to collect taxes or to collect the tax directly from consumers. For nearly a decade, the Hawaii Legislature has been considering bills that would simplify the codes governing the state’s general excise tax and use tax to comply with the Streamlined Sales and Use Tax Agreement.
The agreement, which started in 2000 and now has 24 member states, is an initiative to reduce the burden of tax compliance on online retailers by simplifying sales-tax and use-tax administration in response to the 1992 Supreme Court decision.
State Sen. Carol Fukunaga has been championing the SSUTA approach in the Legislature since 2003. However, she won’t be able to make her case before the 2013 Legislature because she lost the Democratic primary in August for her redrawn district.
The SSUTA rationale is that if states simplify tax administration and subscribe to uniform definitions for goods and services, it will be much easier for remote retailers to handle tax collection for the various states.
Plus, modern tax software makes determining tax rates as simple as typing in a zip code, says David Campbell, CEO of Tax Cloud, an SSUTA certified service provider.
Opponents of the SSUTA approach, however, argue that, because Hawaii has an excise tax, not a sales tax, conforming to SSUTA requirements would require changing the GET into a sales tax.
“There’s a real difference between the retail sales tax and the general excise tax,” says Kalapa. “The whole issue is: Which approach is preferable for the state of Hawaii? That is: to keep our general excise tax as opposed to rewriting our law so it looks like a retail sales tax.”
“As long as the Streamlined Sales Tax is a confederation of sales-tax states, Hawaii will never fit in,” adds State Rep. Isaac Choy, a Democrat who supports a different approach to online use-tax collection. “If you look at Sen. Fukunaga’s approach to this, she would like to rewrite the tax code. And when every state in the union is envious of what we have, why in the world would we do that? … The tax would have to be in the double digits.”
Fukunaga disagrees, saying, “It really would not change Hawaii’s basic general-excise-tax law. For the purposes of Streamlined discussion, what we’re really talking about is a use tax. … For the most part, the only thing that would be affected is that we might have to tweak how we format our tax law for the GET, so we set off the use tax and the provision we are seeking to be in conformity with, in a slightly different formatting. But it won’t change the actual implementation of Hawaii’s tax law.”
Even if Hawaii does go the SSUTA route, there is a catch. Until the U.S. Congress enacts legislation – three bills were introduced last year – that authorizes SSUTA states to require remote retailers to collect taxes, SSUTA is completely voluntary.
Campbell, who has submitted testimony to support national legislation, says, “I think there’s a possibility something could happen before the election because other tax bills are going to be dealt with before the election, so there’s the possibility of a roll-up package of some sort, or this being attached to one of the other tax bills that will be going through. We’ve gotten several assurances from the sponsors that if it hasn’t gone before the election, it will be one of the topics that they’re going to be keeping a lot of pressure on after.”
Some states, including New York and Illinois, have adopted a more direct approach than SSUTA by expanding the definition of nexus to include some remote retailers. “Click-through” or “affiliate” nexus establishes a connection between a remote business and a state through an in-state affiliate. In other words, if Hawaii-based websites are paid commissions, in excess of a set dollar threshold, by Amazon for directing consumers to the Amazon website through online ads, Amazon would be recognized as having a Hawaii nexus.
“By enabling somebody to click, that establishes nexus,” says State Rep. Isaac Choy, who has introduced click-through legislation several times. “The Streamlined Sales Tax Agreement does not establish nexus, it’s a voluntary agreement. That’s the reason we’ve never adopted it. It doesn’t make sense.”
The click-through-nexus approach does not rely on Congressional legislation, but it has its own problems. In 2009, the Hawaii Legislature passed a click-through nexus bill. In response, Amazon discontinued affiliate advertising in Hawaii to avoid having nexus in the state. Gov. Linda Lingle later vetoed the bill and Amazon reinstated its affiliate program.
“The reason the (state) Senate has not favored that approach,” says Fukunaga, “is because as soon as that bill passed, Amazon and a number of other companies cut off their local affiliates. For those local affiliates, who are normally paying their Hawaii taxes, to be deprived of their income stream, seemed to us to be a really harsh way to try to get at the out-of-state retailers.”
Click-through nexus has been controversial in other states as well. When New York passed a click-through nexus bill in 2008, Amazon filed a suit challenging the law’s constitutionality, but it was upheld in both New York state court and the appellate court. However, Illinois’ similar legislation was found unconstitutional by a U.S. district court, leaving the question of legality in doubt.
Similar to click-through nexus, the state House has also considered an “economic” nexus bill that would establish a connection between a remote business and the state if the business has a minimum gross income from doing business with Hawaii residents, or does business with a specific number of Hawaii residents. The Legislature did not pass the bill, but Choy intends to re-introduce it next session.
An economic nexus law has been in effect in Washington state since 2010, but it only affects the business and occupation tax, a gross-receipts tax similar to Hawaii’s general excise tax, on professional services, loan interest or fees, and royalties. Business and occupation tax liability, as well as sales tax liability, for retailers, is still determined by physical presence nexus standards.
What Else Can We Do?
SSUTA and nexus expansion are the two most common approaches taken by states in their efforts to collect taxes on remote transactions, but a few other approaches have been considered.
In 2010, Colorado tried the “1099 disclosure” approach by requiring retailers that did not collect Colorado’s sales tax to report Colorado customers’ identities and purchase totals to the state. This law, however, was found unconstitutional by a federal district court that cited the 1992 Supreme Court decision.
Some states are also adding a use-tax line to their income tax forms. Though those states realize many residents will still not pay the use tax, the states believe the line will help with compliance and make people aware of their use-tax obligations.
Hawaii’s Department of Taxation has considered such a move, but “all these little things, these little changes, right now under the capabilities of the tax office, are monumental tasks,” says Choy. “In the future, it will be a click of the button. But it’s difficult now because their computer system is antiquated.”
Other states, like New Jersey, have made deals with Amazon that would defer Amazon’s tax-collecting duties for a year or two, in exchange for opening warehouses or distribution centers in the state. This, however, is done on an individual business basis and is likely unfeasible for Hawaii due to the limited market here.
No Perfect Solution
It is difficult to say in which direction Hawaii is headed in the e-fairness dispute. Both SSUTA supporters and nexus expansion advocates find flaws in the other approach and believe it’s only a matter of time until their respective bills become law. But they agree that the status quo must change.
“Retail sales for bricks-and-mortar stores increased maybe 2, 3, 4 percent a year for the past few years,” says Pregill. “But increases in Internet sales, e-commerce sales, are in the double digits. Especially in this kind of economy, the pie is not getting any bigger and we need to adapt to that.”
What a Federal Law Would Require
States that simplify their sales and use taxes are still unable to require remote retailers to collect and pay states’ sales and use taxes. In 2011, three federal bills were introduced in Congress that would allow conforming states to do so. None of the acts allow states to levy income, franchise or other taxes on remote retailers.
Marketplace Equity Act (53 cosponsors)
In order for states to require remote retailers to collect and pay sales and use taxes, states must:
- Include an exception for retailers who sell less than $1 million in annual gross sales nationwide, or less than $100,000 in the individual state;
- Define a single administrative body for sales- and use-tax remittance;
- Use uniform goods and services definitions; and
- Have a conforming tax-rate structure with either a single statewide blended rate; a maximum state rate; or an applicable destination rate.
Marketplace Fairness Act (19 cosponsors)
This act allows member states of the Streamlined Sales and Use Tax Agreement to require qualifying remote retailers to collect and pay states’ sales and use taxes. If a state chooses not to comply with SSUTA requirements, it can still qualify if it:
- Provides a single administrative body, audit for state and local taxing jurisdictions, and return form for sales- and use-tax remittance;
- Provides a uniform sales- and use-tax base among state and local taxing jurisdictions;
- Requires remote retailers to collect sales and use taxes for the applicable destination rate;
- Provides remote retailers with tax-collection software;
- Does not hold remote retailers liable for incorrect sales- and use-tax collections if the mistakes result from state error; and
- Includes an exception for retailers with less than $500,000 in gross annual remote sales in the U.S.
Main Street Fairness Act (five cosponsors)
This act allows SSUTA member states to require qualifying remote retailers to collect and pay each state’s sales and use tax when:
- At least 10 states with at least 20 percent of the U.S. population have joined the agreement (SSUTA already has 24 member states that comprise 33 percent of the U.S. population)
- Minimum requirements have been outlined and implemented by the Streamlined Governing Board; and
- Member states provide and maintain tax databases.
This act includes an exception for small sellers.
Other States Take Action
Streamlined Sales and Use Tax Members
Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin, Wyoming
States with Click-Through Nexus Laws
Arkansas, California, Connecticut, Georgia, Illinois, New York, Rhode Island
States with Economic Nexus Laws
California, Connecticut, Washington, Wisconsin
States with 1099 Disclosure Laws
Colorado, Oklahoma, South Dakota, Vermont
States That Put Use-Tax Lines on Tax Forms
Arizona, Illinois, New Jersey, Pennsylvania, Virginia
States with Amazon Deals
California, Indiana, Nevada, New Jersey, South Carolina, Tennessee, Texas, Virginia
How Much Is Hawaii Losing?
The 2010-2012 Hawaii Tax Review Commission asked William Fox, a professor of economics at the University of Tennessee, to write a report about how much the state has lost and will lose in GET and use-tax revenue because of e-commerce. Fox’s numbers are on the high end of similar Hawaii estimates.
You can find the entire report at tinyurl.com/8gfrzj2. Another outside report was done for the tax review commission by The PFM Group, a mainland consulting group. A draft version of its “Study of the Hawaii Tax System” can be found at tinyurl.com/8oq8bsg.
Which Online Retailers Collect Hawaii’s Tax?
The only online retailers listed here that regularly collect the state’s GE/use tax from their Hawaii customers are those that have stores in Hawaii: