The Internet: To Tax Or Not To Tax

By Steven Camerino and Timothy Fortier

The fate of Internet taxation in New Hampshire is still unknown. However, we may have a better understanding what federal and state lawmakers intend to do with this important commercial medium in the next several months.

At the federal level, the current moratorium prohibiting states from imposing taxes on Internet transactions is set to expire. First enacted in 1998, the Internet Tax Freedom Act placed a three-year moratorium on the imposition of new taxes on "Internet access services" and other forms of electronic commerce. It also maintained for two years the authority of states, including New Hampshire, to collect Internet access taxes only if these taxes were imposed prior to October 1, 1998. In the 107Th Congress, this tax moratorium and grandfathered protection for state-imposed taxes was extended to November 1, 2003. With this moratorium nearing expiration again, the 108th Congress is entertaining several bills which would either extend the moratorium until 2008 or make it permanent and remove all grandfathering provisions.

At the state level, stuck in the fine print of the State's capital budget (HB 2), you'll find a small paragraph establishing a legislative study committee to look at the application of the communications service tax to the provision of Internet services. This committee is set to report its recommendations by November 1st of this year.

Readers may remember HB 705 from the most recent legislative session, which started out as a simple bill calling for a committee to study the impact of eliminating taxation of the Internet in New Hampshire. During its legislative gyrations, however, HB 705 was amended to look at the application of the communications services tax only and extended an exemption on Verizon's poles and wires from municipal taxation until July 1, 2004. The business community should be attentive since removal of this exemption will create a new tax opportunity for municipalities and these costs will be ultimately passed onto all customers of wireline telecommunications companies in the State.

At the center of both of these legislative deliberations will be talk of new taxes and the potential windfall of new revenues for state and local coffers. Estimates vary, but the potential revenue loss to government is in the billions of dollars annually as Internet sales and e-commerce activity continue to be exempt from sales tax imposition. Some lawmakers in Washington and Concord would enjoy tapping into the potential revenues that could be generated by taxing e-commerce and Internet-based transactions. Businesses and residents alike should watch very closely for any new developments in the way that these telecommunications services and Internet activity are taxed.

Contrary to the popular belief that the Internet is a tax–free haven, electronic transactions are already subject to a variety of State and local taxes. In fact, New Hampshire is one of about a dozen states that imposes a tax on Internet access charges. New Hampshire is not necessarily singling out Internet access services for taxation, yet our existing tax structure allows us to tax Internet access services because it satisfies the definition of taxable telecommunications.

New Hampshire imposes a seven percent tax on those who use two-way communications services. The Legislature originally enacted the Communications Service Tax (CST) in 1990 as a replacement for taxing the personal property of local telephone companies. Since 1997, the State has collected taxes from cable companies on Internet access as these services constituted "two-way communications" in the eyes of state tax officials. At 7%, the CST generated nearly $130 million in State revenues in the last budget cycle. Roughly $30 to $40 million of this total is attributable to Internet access services.

It should come as no surprise that New Hampshire residents strongly oppose taxing Internet activity. In 2000, a Washington-based research company conducted a poll of 400 New Hampshire residents to assess their views of the digital revolution's impact on their lives. Among their many findings was "New Hampshire residents are much more concerned that the government will tax and over-regulate the telecommunications market and Internet activity than they are about government under-regulating in these areas." In fact, The Progress & Freedom Foundation report concluded that "…among those who have browsed the Internet shopping mall and stopped to make a purchase, a remarkable 81% of New Hampshire residents want to keep the government's hand off the Internet." Public opinion is clear in New Hampshire – keep the Internet free of government intervention, taxation and regulation.

The fate of Internet taxation – whether it be a permanent ban, a continuance of a temporary moratorium, or a multistate compact approach which is also under consideration in Washington -- is still unknown. By November 1st , New Hampshire's business community should have a better feel where the federal government and our own State government will head on this important policy debate. To date, legislative resistance towards over-regulating and taxing Internet activity has enabled the Internet to grow exponentially and thrive as a tool for commerce and education. And that's the way it should be.

Steven V. Camerino is a director and shareholder in the law firm of McLane, Graf, Raulerson & Middleton, PA, and focuses his practice on energy and public utilities law. Timothy W. Fortier is governmental relations advisor with the firm. They can be reached at 603-226-0400 or at steven.camerino@mclane.com or tfortier@mclane.com.