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The Permanent Internet Tax Freedom Act

For nearly two decades, there has been an active conversation in the United States about the role of the Internet in commerce and daily life, and how the Government should or should not regulate that role. The Internet Tax Freedom Act is a prime example, first passed in 1998 and extended multiple times over the course of the ensuing 16 years.

In 2013, the Permanent Internet Tax Freedom Act was introduced to the House of Representatives by Rep. Bob Goodlatte of Virginia and four co-sponsors. This bill would enforce the provisions of the original law permanently and while it was passed first in 2014 and recently again on June 6, 2015 by the House, it has yet to clear the Senate. An extension has been passed on the original law four times in the interim.

What Does the Internet Tax Freedom Act Do?

While the law does impact to some degree ecommerce and sales made online, its primary role is to limit taxation on actual access to the Internet. The original 1998 law was designed to promote the general potential of the Internet as a commercial and educational hub for US citizens and barred any local, state or federal taxes from being imposed on Internet access.

It went a step further by blocking taxes that would only apply to the Internet such as bandwidth, email, content, or download taxes that could be applied to the volume of resources used by an individual online. This extended to some aspects of ecommerce in the form of any taxes that would be considered discriminatory. If a tax could be applied only online, the ITFA was often an issue, though there has been ongoing discussion about what is and is not allowed under the current statute.

What the Act Does Not Do

There is a misconception that the Internet Tax Freedom Act stops states from imposing taxes on sales made online. The specific language of the bill was that it could not impose discriminatory taxes on Internet use. Because many Internet sales can also be made via phone, mail order, or in physical locations and are taxed in those locations based on local sales and use tax rates, states are able to apply the same taxes online to digital purchases of physical goods.

Where the line becomes blurry and the confusion occurs is when taxation of online sales could be considered discriminatory, and how states establish nexus for transactions in their state. A recent case on "click-through" nexus is a prime example. Starting with New York’s 2008 implementation of the "Amazon law" and continuing with the court cases in Illinois overturning click through nexus on the basis of the ITFA superseding it constitutionally, there has been a lot of confusion on this topic.

What is Click Through Nexus and Why Does the Internet Tax Freedom Act Apply?

A seller must have a sufficient connection to the state charging sales tax (nexus) to be required to collect sales tax. The Supreme Court ruled in 1992 in Quill v. North Dakota that a seller must have some form of physical presence in a state. For most it means there is some form of physical location in that state – an office, a warehouse, employees on staff, or some other form of inhabitation within the state’s borders. Click through nexus doesn’t require a physical presence. Instead it forces Internet retailers to collect and pay sales tax to a state if an affiliate of that company drives traffic to their website that results in a sale.

In the Amazon case, this meant that thousands of Amazon’s "associates" in New York would make the retailer liable to collect sales tax on sales they generated. It actually resulted in Amazon shutting down their affiliate program in New York and some other states for this reason.

The reason all this matters is because in October, 2013 the Illinois Supreme Court ruled that the click through nexus law in Illinois was not valid because of the ITFA. If the ITFA becomes permanent and closes the remaining grandfather clauses it retains, this could become a factor for all states that currently have click through nexus.

Notably, the Marketplace Fairness Act, introduced into Congress in 2013, would enable state governments to collect sales and use tax from retailers who do not have a physical presence in their states. Currently, residents of the 45 states that have a sales and use tax are required to pay tax on their own online purchases. Because the onus falls on the buyer and not the retailer, compliance is low. The new law would increase compliance by shifting the responsibility from the consumer to the retailer while streamlining the process and making it easier for retailers to collect and pay the tax to each state.

What the Permanent Internet Tax Freedom Act Would Do

Because the original act was only initially enacted for three years, it has needed extension after each expiration. The new bill would make the law permanent and ensure that no discriminatory taxes would ever be collected on Internet use. It would go a step further and close some grandfathered States that were already collecting tax on Internet access before the first law was passed. This would apply to Hawaii, Ohio, North Dakota, Texas, South Dakota, and Wisconsin if the law is passed by the Senate.

The discussion around the Permanent Internet Tax Freedom Act will likely continue for the foreseeable future as the Senate discusses whether to pass the bill or to continue relying on extensions and allowing the grandfathered states to remain as such. Other factors such as the right of states to collect taxes on click through nexus will likely continue to be discussed in the courts as well as the lines between digital and physical commerce continue to blur.

This will continue to be an interesting and evolving situation for those responsible for collecting sales tax and those affected by the Internet taxation rates in some states, including ISPs who operate there.