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State taxation issues are similarly clouded. As a rule, a state must satisfy the nexus requirement under the due process and commerce clauses of the U.S. Constitution in order to tax an out-of-state business. The Commerce Clause, which would likely govern any Internet tax analysis, requires a "substantial nexus" and connection for the imposition of taxes. In construing the meaning of "substantial nexus," the Supreme Court has relied upon the determination of physical presence. The Court has applied this test to the mail-order industry (which bears a strong resemblance to Internet commerce), where the only contact with the taxing state is by mail or "common carrier."

In the 1992 case of Quill v. North Dakota, the court held that simple contact with a common carrier does not constitute a sufficient nexus with the taxing state. The Court noted that the sufficiency of a nexus "may turn on the presence in the taxing state of a small sales force, plant or property." In fact, Quill has been interpreted as permitting taxation of a mail-order company that sent employees to install software and make repairs subject to a service agreement (Orvis Co. Inc. v. Tax Appeals Tribunal of the State of New York). Other courts have held that maintenance of offices, warehouses, equipment, and personnel in a state create a sufficient nexus.

The logical argument in favor of Internet commerce holds that Internet commerce and the mail-order business are analogous. The argument posits that the Internet operates like a common carrier such as a shipper or courier. Obviously, states will attempt to discount the analogous nature of these two industries in an effort to protect their tax bases.

Some state and local officials want to maintain their ability to tax Net services. The National Governors Association and the U.S. Conference of Mayors are among the groups already working on a uniform state law package to deal with Internet taxation. The National Governor's Association is in favor of a flat tax system for e-commerce sales.

For further discussion of legal issues relevant to online commerce, see Chapter 21 of Creating Stores on the Web, 2nd Edition.

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