**DESCRIPTION OF S. 442,**

**THE "INTERNET TAX FREEDOM ACT,"**

**AND A PROPOSED CHAIRMAN'S AMENDMENT**

**IN THE NATURE OF A SUBSTITUTE**

Scheduled for Markup

by the

SENATE COMMITTEE ON FINANCE

on

July 28, 1998

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

July 24, 1998

JCX-58-98 

----

**CONTENTS
INTRODUCTION		

I.	OVERVIEW OF S. 442 AND H.R. 4105		

II.	OVERVIEW OF PRESENT FEDERAL INCOME TAX, EXCISE TAX, AND TARIFF PROVISIONS RELATING TO THE INTERNET	AND STATE AND LOCAL GOVERNMENT TAXATION OF INTERNET	AND SIMILAR INTERSTATE SALES ACTIVITIES		

III.	DESCRIPTION OF CHAIRMAN'S AMENDMENT IN THE NATURE OF A SUBSTITUTE		

**INTRODUCTION**
	S. 442, the "Internet Tax Freedom Act," was reported by the Senate Committee onCommerce, Science, and Transportation on May 5, 1998 (S. Rept. 105-184).  S. 442 wouldimpose a moratorium on the ability of States and local governments to impose taxes with respectto Internet activity, both access to and transactions conducted on the Internet.  S. 442 furtherwould direct the Secretaries of State, Treasury, and Commerce, in consultation with privatebusiness and appropriate Congressional committees, to undertake a study of the appropriatetaxation of Internet activity, and would provide that it is the sense of the Congress that Internetactivity be a tariff-free zone.  Consistent with the jurisdiction of the Committee on Finance (the"Finance Committee") over issues related to interstate taxation by States and local governmentsand international taxation and trade, S. 442 has been sequentially referred to the FinanceCommittee through July 30, 1998. 

	Similar legislation, H.R. 4105, was passed by the House of Representatives on June 23,1998.

	The Finance Committee has scheduled a markup on July 28, 1998, to consider anamendment in the nature of a substitute to S. 442.  This document,(1) prepared by the staff of theJoint Committee on Taxation, provides an overview description of S. 442 and H.R. 4105 (Part I),an overview of present law (Part II), and a description of a proposed amendment in the nature ofa substitute to be offered by Chairman Roth (Part III).

**I.  OVERVIEW OF S. 442 AND H.R. 4105
**S. 442**

S. 442 (the "Internet Tax Freedom Act") would prohibit States and local governmentsfrom imposing any tax, license, or fee directly or indirectly on the Internet or interactivecomputer services between the date of the bill's enactment and January 1, 2004.  Thismoratorium would not apply to taxes on net income derived from the Internet (includinginteractive computer services), to fairly apportioned business taxes applied to businesses havinga business location within the taxing jurisdiction, or to the authority of States or localgovernments to impose any sales or use tax on transactions effected through the Internet if thetaxes (1) are generally applicable taxes and (2) are imposed in the same manner as is permittedon sales or transactions effected by mail order, telephone, or other remote means.

	S. 442 would direct the Secretaries of State, Treasury, and Commerce to consult withappropriate Congressional committees and the private sector to develop policy recommendationson the appropriate taxation (domestic and international) of Internet activity.  Theserecommendations would be required to be provided to the President within 18 months after thebill's enactment, and the President would be directed to transmit legislative recommendations tothe Congress within two years after enactment.

	Further, S. 442 would declare that it is the sense of the Congress that internationalagreements be negotiated providing that international use of the Internet is free from tariffs andtaxation.

**H.R. 4105**

	H.R. 4105 would prohibit States and local governments from imposing any taxes onInternet access, any "bit" taxes, or any multiple or discriminatory taxes on electronic commerceduring the three-year period beginning on the date of the bill's enactment.  The bill wouldexempt from this moratorium certain taxes currently imposed by the States of Connecticut,Wisconsin, Iowa, North Dakota, New Mexico, Tennessee, and Ohio, if those taxes are expresslyre-enacted during the one-year period beginning on the date of the bill's enactment.  A bit tax isdefined as any tax on electronic commerce expressly imposed on or measured by the volume ofdigital information transmitted or the volume of such information per unit of time transmittedelectronically.(2)   A discriminatory tax is defined as any tax on electronic commerce that is notgenerally imposed on transactions accomplished by other means or is not imposed at the samerate as other such transactions.  

	H.R. 4105 would establish an Advisory Commission on Electronic Commerce, composedof 31 members representing the Federal Government, States and local governments, and theprivate sector to develop legislative recommendations (to be submitted to the Congress withintwo years after the bill's enactment) on the appropriate taxation of Internet activity and otherremote area transactions (e.g., mail order or catalog sales).  The recommendations, oncesubmitted to the Congress, would be considered under special, expedited legislative procedures. The bill includes specific provisions identifying associations and industry groups to berepresented on the commission, and detailed rules governing actions of the commission.

	As with S. 442, H.R. 4105 would declare that it is the sense of the Congress thatinternational agreements be negotiated providing that international use of the Internet is freefrom tariffs and taxation.

	H.R. 4105 also contains provisions, not within the jurisdiction of the Finance Committee,regarding Federal regulation of the Internet and imposition of user fees.(3)

	H.R. 4105 was passed by the House of Representatives on June 23, 1998.

**II.  OVERVIEW OF PRESENT FEDERAL INCOME TAX, EXCISE TAX, AND TARIFF PROVISIONS RELATING TO THE INTERNET AND STATE AND LOCAL GOVERNMENT TAXATION OF INTERNET AND SIMILAR INTERSTATE SALES ACTIVITIES**
**Federal tax provisions**

Income taxation of the Internet

	There are no special Federal income taxes on Internet services.  The Federal income taxapplies to Internet services in the same manner that it applies to any other provision of services. Accordingly, the income received by an Internet service provider is includible in that provider'sincome for Federal income tax purposes.  Similarly, a business that pays amounts to an Internetservice provider generally may deduct or amortize (as appropriate) those amounts as an ordinaryand necessary business expense (assuming the other prerequisites for a deduction or amortizationare satisfied).

Federal excise taxation of the Internet

Present law imposes no special excise taxes on Internet services.  Access to andtransactions conducted on the Internet are subject to generally applicable Federal excise taxes inthe same manner as other taxable activities.  For example, present law imposes a three-percentexcise tax on certain communications services (i.e., local and long distance telephone service). Thus, amounts paid for telephone service connecting users to the Internet are subject to thisexcise tax in the same manner as other payments for telephone service.  Charges for actualInternet service are not subject to this tax, as long as the service provided does not otherwise fallwithin the statutory provisions governing the communications excise tax (e.g., voice quality localor toll service).

**International trade provisions**

	Present law provides no direction to the President regarding Congress' interest in or intentwith respect to the conduct of international negotiations regarding barriers to electroniccommerce.  Nothing in the law directs the President to include barriers to electronic commerceamong the barriers cataloged annually in the National Trade Estimates report prepared by theUnited States Trade Representative.  The National Trade Estimates report serves as acompendium of  foreign barriers to U.S. commerce and a presumptive target for futurenegotiations with our trading partners.

**State and local government taxation of interstate transactions**

Under the Constitution, a State or local government may impose taxes on sales that occurwithin its jurisdiction or on the use of property within its jurisdiction.  Approximately 6,600State and local jurisdictions impose sales and use taxes.(4)  A limited number of States haveapplied their sales or other excise taxes to Internet activity.  The allowable sales tax authority of aState or local government extends to mail order sales by out-of-State vendors to residents of theState if the sale is deemed to take place within the taxing jurisdiction.(5) There are, however,limitations on the methods State and local jurisdictions may employ to collect sales and usetaxes.

	State and local sales and use taxes are levied on the final purchaser, but are collectedprimarily through the vendor.  In the case of a sale by an out-of-State vendor, the U.S. SupremeCourt has held that a State or local government cannot constitutionally require the vendor tocollect and remit use taxes unless the vendor has a sufficient business nexus with the State.(6)Inthe *National Bellas Hess* case, the Court found that the required nexus was not present if thevendor's only connection with customers in the State was by common carriers or the UnitedStates mail.(7)  The Court based this conclusion on due process considerations and on theCommerce Clause of the United States Constitution, which reserves to Congress the power toregulate and control interstate commerce.(8)  The required nexus has been held to exist when thevendor arranges sales through local agents or maintains retail stores in the taxing State.

Subsequently, in 1992, the U.S. Supreme Court ruled that an out-of-state mail-orderhouse with neither outlets nor sales representatives in the State is not required to collect and payuse tax on goods purchased for use in the State.(9)  The Court ruled that the due process clause didnot bar enforcement of the State's use tax, but held that enforcing the State's use tax would beinconsistent with the Court's commerce clause jurisprudence.  The Court concluded by observingthat "the underlying issue is not only one that Congress may be better qualified to resolve, butalso one that Congress has the ultimate power to resolve."(10)

**III.  DESCRIPTION OF CHAIRMAN'S AMENDMENT IN THE NATURE OF A SUBSTITUTE**
	The Chairman's amendment would substitute the provisions described below for theprovisions of  S. 442, as reported by the Committee on Commerce, Science, and Transportation.

**State and local tax moratorium**

	In lieu of the approximately six-year moratorium provided in S. 442, the Chairman'samendment would prohibit imposition of State and local taxes on the Internet for a period ofthree years, beginning on the date of the bill's enactment.(11)  Taxes to which the moratoriumwould apply include any taxes on Internet access, any bit taxes, or any multiple or discriminatorytaxes on electronic commerce.

	The Chairman's amendment further would provide that this moratorium applies only totaxes imposed after July 28, 1998 (the date of Finance Committee action).  Thus, the amendmentwould not affect the ability of States or local governments to collect tax with respect totransactions occurring before July 29, 1998, or the rights of parties in any dispute concerningState and local taxation of Internet activity during periods before July 29, 1998.  Unlike H.R.4105, the Chairman's amendment would not grandfather any existing State or local taxes onInternet activity during the period of the moratorium.

**Sense of the Congress resolution on new Federal Internet taxes**

The Chairman's amendment would provide that it is the sense of the Congress that nonew Federal taxes like the State and local government taxes to which the three-year moratoriumwould apply should be enacted on Internet activity during the moratorium.

**International trade provisions**

	Like S. 442 and H.R. 4105, the Chairman's amendment would express the sense ofCongress that the President should continue efforts to ensure that electronic commerce remainsfree of tariffs, discriminatory taxation, and any form of discriminatory regulation.

	Unlike S. 442 and H.R. 4105, the Chairman's amendment would amend existing law todirect the United States Trade Representative, under existing statutory authority, to includebarriers to electronic commerce, among the barriers designated annually in the National TradeEstimates report.

**Establish national advisory commission**

	Similar to the provisions of H.R. 4105, the Chairman's amendment would establish anational advisory commission to study and recommend appropriate rules for international,Federal, State, and local government income and excise taxation of the Internet and othercomparable interstate or international sales activities, as well as appropriate tariff treatment ofsuch activities.

	The commission would be comprised of 13 members, as follows:

Federal Government representatives.-The Secretaries of State, Treasury, and Commerce,the Attorney General, and the United States Trade Representative, or the designee of each suchcabinet member would represent the Federal Government.

State and local government representatives.-A total four representatives of State and localgovernments would be appointed, one member each by the Speaker of the House ofRepresentatives, the Minority Leader of the House, the Majority Leader of the Senate, and theMinority Leader of the Senate.  

Electronic industry and consumer representatives.-A total of four representatives of theelectronic industry and of consumer groups would be appointed, one member each by theSpeaker of the House of Representatives, the Minority Leader of the House, the Majority Leaderof the Senate, and the Minority Leader of the Senate.

	Legislative history accompanying the bill would suggest that the Congressionalleadership coordinate their appointments to the commission to assure the broadest possible Stateand local government and private sector representation.

	The commission would be directed to submit its findings, with legislativerecommendations, to the Congress within two years of the date of the bill's enactment.  UnlikeH.R. 4105, the Chairman's amendment would not provide any expedited procedures forconsideration of the commission's recommendations.

	The Chairman's amendment further would direct the President to continue negotiationscurrently under way in a variety of fora regarding the regulation of the electronic commerce.  Theamendment would establish a set of concrete trade negotiating objectives designed to guide thePresident in future negotiations.  Those negotiating objectives would include the removal ofbarriers to trade in goods and services that are essential to the delivery of electronic commerce aswell as barriers to electronic commerce itself.

1.   This document may be cited as follows: Joint Committee on Taxation, *Description of S.442, the "Internet Tax Freedom Act," and a Proposed Chairman's Amendment in the Nature of aSubstitute to S. 442* (JCX-58-98), July 24, 1998.
2.   Taxes on telecommunication services (e.g., telephone access) would be specificallyexcluded from the moratorium. 
3.    Authorizing committees of the Congress may impose, or authorize executive agenciesto impose non-tax, or true, user fees that agencies may charge for specific services they provide. In general, a true user fee is a charge levied on a class that directly avails itself of a governmentalprogram, and is used solely to finance that program rather than to finance the costs ofGovernment generally.  The amount of the fee charged to any payor may not exceed the directcosts of  providing the services with respect to which the fee is charged.  There must be areasonable connection between the payors of the fee and the agency or function receiving the fee. Those paying a fee must have the choice of not utilizing the governmental service or avoiding theregulated activity and thereby avoiding the charge.  In order words, the fee can be viewed aspayment for a special privilege, as opposed to a mandatory charge (e.g., tax) imposed on thepublic at large for general or specified governmental purposes.
4.   Advisory Commission on Intergovernmental Relations, *Significant Features of Fiscal**Federalism, Vol. 1* (1995), table 27.
5. See*, e.g.,**McLeod v. J.E. Dilworth Co.*, 322 U.S. 327 (1944).
6. *National Bellas Hess, Inc., v. Department of Revenue of the State of Illinois*, 386 U.S.753 (1967) (henceforth referred to as *National Bellas Hess*).
7. *Id.*at 754.
8. *Id.*  at 760.
9. *Quill Corp. v. North Dakota*, 504 U.S. 298 (1992).
10. *Id.* at 318.
11.   The moratorium does not affect taxes, fees, and other charges imposed pursuant toFederal law.****