As struggling retailers consider alternative

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1 The Expansion of E-commerce: Addressing Sales Tax Complexity with Technology By Brandon L. Wells Brandon Wells discusses the consequences of sales and use tax compliance resulting from the expansion of e-commerce and proposes addressing the compliance burden through the use of advanced technology like Extensible Business Reporting Language (XBRL). Brandon L. Wells, MBA, MSAT, CPA, is a consultant with a tax software solutions and services provider. He may be contacted at brandon@wellscpa.com or B.L. Wells As struggling retailers consider alternative strategies aimed at increasing sales, the nation s taxing jurisdictions are desperately searching for ways to increase tax revenues. The current state of the economy has frequently been placed on a level with that of the Great Depression of the 1930s. Historically, the Great Depression is significant for multiple reasons, including the fact that it was during the Great Depression that the state sales tax was first imposed. States struggling to operate during the economic crisis of the 1930s found the sales tax as an effective measure for improving the state s fiscal condition. Originally intended as a short-term remedy, the sales tax has evolved over the decades to become a primary source of revenue for many state and local governments. Today, the scene is familiar with both retailers and governments once again struggling to improve their fiscal condition. In many situations, both are looking to the consumer sale as the solution, with one seeking to generate sales and with the other seeking to collect tax on the sales. Growth and Benefits of E-commerce A common strategy used by retailers to increase sales has been to engage in e-commerce. Throughout the past decade, many retailers have combined the 41

2 The Expansion of E-commerce brick-and-mortar business with an online business. Today, approximately 3.5 % of total U.S. retail sales are derived annually from an e-commerce sales channel. 1 However, the percentage of retail sales attributable to e-commerce can be much greater for major national retailers such as Barnes and Noble, the nation s largest bookseller. For example, Barnes and Noble reported in its latest annual report that Barnes & Noble.com receives over 365 million visits annually generating approximately 9% of total retail sales. 2 Amazon.com, which operates primarily on the World Wide Web through retail Web sites, generates its source of revenue almost entirely from e-commerce sales. 3 Most major and many small retailers not only have a physical presence, but also now have a universal presence created by their Web site. Retailers understand that in addition to , news, research, and a myriad of other activities, millions of consumers are using the Internet for purchasing goods and services. This trend has grown substantially with the advent of the Internet and the World Wide Web. No longer is a business s physical presence required to market, sell, and deliver products and services to a remote consumer. Consider the consumer who completes the purchase of a product from a retailer s Web site. The consumer has the flexibility to complete a variety of purchases from anywhere and have the merchandise shipped to a completely different location. The Internet business model is effective for several reasons. The Internet provides a low cost standard, has a universal reach, and acts as an effective distribution channel. Overall, the Internet has become an effective tool for creating growth in not only a domestic market, but an international market as well. One of the key reasons for the growth in e- commerce is attributed to the solution a Web site provides to an otherwise highly fragmented industry. For example, many businesses operated by smaller retailers are riddled with a great number of small buyers and sellers. Traditional specialty retailers have been limited in the ability to profitably expand within a multi-state environment. However, 42 Adoption of an XBRL taxonomy for sales tax purposes could provide the standard necessary for developing an industry-specific taxability category database capable of facilitating the calculation, collection, reporting, and other sales tax compliance functions. with the development of technologies supporting business operations, retailers have the ability to significantly expand marketing opportunities. An advanced Web site acts as a hub which brings together multiple buyers and sellers into a potentially influential network capable of generating a considerable number of sales. Consequences of E-commerce The expansion of e-commerce would appear to benefit not only the retailer, but also the taxing jurisdictions. A large number of sales is what gives the sales tax its substantial revenue-generating capability. However, e- commerce has proven to have its own unique sales tax implications. For example, the traditional definition of nexus from a state tax perspective has been severely challenged. Nexus is being argued beyond the traditional physical presence concept to include alternative varieties including economic nexus, affiliate nexus, and agency nexus. Contrary to the speed at which the Internet and World Wide Web have grown, the sales tax issues related to e-commerce have yet to be sufficiently resolved. Perhaps the argument can be made that as a percentage of total retail sales, e-commerce is still insignificant. However, online shoppers are becoming more common as they find value in the online shopping experience that is only improving. Despite the anticipated growth in e-commerce, the current state and local sales tax regime still resembles something of the antiquated technology that existed prior to the advent of e-commerce technologies. Chronologically, consider the history behind the emergence of e-commerce technology with the emergence of the related sales tax issues that have been debated over the same period. The intent and extent of the early use of the Internet and World Wide Web was limited to research and development including academia and governmental use. In the early 1990s, traffic on the Internet was largely electronic mail and bulletin board related. The creation of graphical Web browsers, such as Internet Explorer, quickly followed as a means to make the

3 Internet and World Wide Web more accessible. Commercialization of the Internet and World Wide Web was inevitable as businesses identified opportunities to adapt the Internet and World Wide Web technologies to sell products and services. However, initial use of the Internet was governed by the Acceptable Use Policy of the National Science Foundation Act of Commercial traffic over the Internet was actually illegal until Introduced by Congressman Rick Boucher (D-VA), Boucher s bill provided for an amendment to the National Science Foundation Act of In late November of 1992, President George H.W. Bush signed the bill that cleared the way for commercial development of the Internet. Ironically, in that same year, the Supreme Court ruled in Quill Corp. v. North Dakota 4 that a state could not compel an out-of-state retailer to collect and remit sales tax. Since then, the opportunity taxing jurisdictions have of equally benefiting from e-commerce has been severely limited. Today, state and local taxing jurisdictions are looking for ways to redefine nexus in order to collect what otherwise appears to be lost tax revenue. Considerable Costs of Sales Tax Compliance Consistent with the facts in Quill, one of the most defensible arguments against the present state sales tax regime and the suggestion that remote retailers be required to collect sales tax is that such a requirement imposes considerable costs of compliance due to the complexity inherent in the current state sales and use tax system. Due to the nature of most multi-state retail businesses, multiple sales tax related issues can be identified as contributing to the considerable costs of compliance including the difficulty in: accurately and efficiently determining product taxability for multiple jurisdictional locations; accommodating sales tax complexity associated with future business growth; addressing the audit risk exposure inherent with operating in multiple jurisdictions; administering customer tax exemptions; and timely updating sales tax rates and rules affecting product taxability calculations. In light of the complexities, consider the recent advances in technology which have allowed businesses to effectively address many of the issues and complexities that were originally associated with businesses conducting e-commerce. For example, improvements in technology have significantly reduced the risks surrounding transaction security and privacy. The difficult and costly task of integrating existing and new systems has also been greatly simplified. Even global market issues such as language and currency conversions have been improved with technological advances. Clearly, improvements in technology that have addressed many of the complexities and issues associated with e-commerce can be adapted and leveraged to address the complexities and burdens associated with sales tax compliance. A commonly cited solution to addressing sales tax compliance burdens has been to develop a more simplified and uniform system of sales taxation. Most retailers would agree the current state and local tax regime is complex. Prior to the Internet and the World Wide Web, a multi-state presence was generally limited to only large retailers. Now, even a small retailer can sell on an interstate basis. The complexities of the sales tax system and the resulting burden are probably much more pronounced for the small retailer than for the large retailer, creating an even greater issue as e-commerce continues to create and benefit an increasingly large number of small retailers. However, have observers of the system focused too much on the issues surrounding complexity in the system itself? Extensible Business Reporting Language (XBRL): A Proposed Solution to Sales Tax Compliance It has been suggested that technology has more implications for sales and transactional taxes than for any other U.S. tax. 5 One argument is that technological advances have the potential to significantly reduce sales tax compliance costs for retailers as well as provide taxing jurisdictions with significant cost savings. 6 Currently, the following technological developments have helped to facilitate tax compliance: 1. address-based databases linking postal codes with taxing jurisdictions for purposes of accurately calculating tax based on where the sales transaction originates from and is shipped to, 2. universal product databases and other merchandise databases which are leveraged for purposes of accurately determining products and services Journal of State Taxation 43

4 The Expansion of E-commerce sold and linking products and services to specific taxability rates and rules, and 3. comprehensive sales tax rate and rule databases that provide sophisticated retail systems with robust sales tax calculation capabilities. Despite existing databases capable of reducing sales tax compliance costs, the retail industry does not currently have a uniform taxability database capable of standardizing specific product taxability. For example, most retailers independently develop a custom product taxability hierarchy from which all products and services are then mapped for taxability purposes. This mapping activity provides for thousands of products to be associated to thousands of sales tax rules. However, the hierarchy varies widely among retailers. A retailer may maintain anywhere from a few to several hundred product or service categories for taxability purposes. The definition of these retailer-defined categories also varies widely across the industry. Adoption of an XBRL taxonomy for sales tax purposes could provide the standard necessary for developing an industry-specific taxability category database capable of facilitating the calculation, collection, reporting, and other sales tax compliance functions. Based on a taxonomy of Extensible Markup Language (XML)-compatible tags, XBRL is a language used to simplify the exchange of information between systems. 7 These taxonomies are the dictionaries used by XBRL. For example, financial data is primarily transferred or represented as blocks of text. XBRL provides a uniform, descriptive tag for each financial data element represented. XBRL is likened to a bar code for financial data. 8 The XBRL taxonomy forms a database of industry and company-specific tags that can effectively describe a company s financial data. The result of XBRL is a universal language of interactive data. 9 Various regulatory agencies and governmental organizations have mandated the use of XBRL resulting in the steady adoption of XBRL for reporting business information using Web technologies. 10 Once adopted, XBRL forms a complex database of multiple XBRL taxonomy components including a schema which provides information about the financial data elements and the associated attributes as well as additional tables storing information related to data element presentation, calculation, definitions, labels, and any taxonomy extensions. 11 The SEC is an example of an organization that has been recently influenced by emerging XBRL technologies. The SEC has continued to influence technology by pursuing an extensive initiative involving XBRL. 12 As a regulatory agency, the SEC continues to promote regulations that appear to drive the technology initiatives of many organizations, especially those of public companies. A primary drawback to XBRL is the immediate implementation costs that can be expected to be incurred for adopters. Initially, an organization will be required to incur a significant number of hours creating templates and mapping XBRL tags to existing data elements. Other drawbacks to XBRL include the costs associated with maintaining the data tags and eventual costs associated with the eventual retrieval and analysis of the XBRL-tagged data. However, XBRL is being developed by an international nonprofit consortium as an open standard, free of licensing fees, making it a cost-effective solution. With XBRL, sifting through a financial data becomes relatively easy. With XBRL, retailers could have a uniform language for facilitating sales tax compliance functions including calculating, collecting, and filing sales tax. Each respective taxing jurisdiction could utilize a uniform language based on an industry standard for receiving and analyzing sales tax data. A provider of sales tax compliance software could incorporate the XBRL taxonomy complete with specific taxability category tags to accommodate the thousands of products and services offered by common and specialized multi-state retailers. The taxability category database could then be integrated with a retailer s merchandising system for purposes of linking each product and service to specific sales tax rates and rules. Once tagged, the sales transactional data could then be easily transferred between internal and external systems for sales tax reporting and compliance purposes. The primary benefits of an XBRL standard for sales tax purposes would include a data standard for transferring sales tax information between retailers and taxing jurisdictions and overall streamlined compliance for retailers. For now, the sales tax implications of e-commerce are not going to disappear. Addressing the burden of sales and use tax compliance through the use of advanced technology like XBRL rather than complete simplification of the current sales tax system benefits not only the retailer engaged in e-commerce, but also preserves the ability of the taxing jurisdictions to achieve economic objectives and address the unique circumstances of the state and local government through the use of a flexible sales tax system. 44

5 En d n o t e s 1 U.S. Census Bureau, Quarterly Retail E- Commerce Sales 1st quarter 2009, available at 2 Barnes and Noble, 2008 Annual Report. 3 Amazon.com, 2008 Annual Report. 4 Quill Corp. v. North Dakota, SCt, 504 US 298 (1992). 5 William F. Fox, LeAnn Luna and Matthew N. Murray, The SSTP and Technology: Implications for the Future of the Sales Tax, 61 National Tax Journal 823 (Dec. 2008). 6 Id. 7 XBRL International, XBRL Taxonomies, available at last visited Aug John Stantial, ROI on XBRL, Journal of Acc o u n ta n c y, June 2007, at Nikki Swartz, The SEC s IDEA: Replace EDGAR, In f o r m at i on Ma n ag e m e n t Jo u r n a l, Nov.-Dec. 2008, at Troy J. Strader, XBRL Capabilities and Limitations, Th e CPA Jo u r n a l, Dec. 2007, at XBRL International, XBRL Taxonomies, available at last visited Aug David T. Copenhafer, Technology s Expanding Role in SEC Compliance, Th e CPA Jo u r- n a l, May 2005, at 17. This article is reprinted with the publisher s permission from the Jo u r n a l o f Stat e Ta x at i on, a bimonthly journal published by CCH, a Wolters Kluwer business. Copying or distribution without the publisher s permission is prohibited. To subscribe to the Jo u r n a l o f Stat e Ta x at i on or other CCH Journals please call or visit wwwcchgroup.com. All views expressed in the articles and columns are those of the author and not necessarily those of CCH or any other person. Journal of State Taxation 45