A little more than a year has passed since New York State enacted the “Amazon law” requiring certain Internet retailers to start collecting New York sales or use tax, and the world of Internet retailing may never be the same. As indicated by the name commonly associated with the measure, from the outset the New York law was specifically designed to target internet retailers with affiliate marketing programs, most notably Amazon.com. As Internet retailing has developed, the use of affiliate marketing programs has become common for large online sellers. Through these programs, independent Web site hosts post links to a retailer’s Web site in exchange for a commission on referred sales. Long searching for ways to collect more sales tax revenues on Internet sales, other states have quickly moved to emulate the Empire State.
As previously reported in this Newsletter, New York amended the definition of a “vendor” required to collect New York sales tax in April 2008. See
Legislation Impacting the Taxation of Internet Sellers: New York’s Amazon Rule – Welcome to the Jungle, Vol. 8, Issue 3 (June 2008). This amendment increased the number of retailers required to collect New York sales tax by providing that an out-of-state seller is presumed to be a “vendor” if the seller has entered into an agreement with any New York resident representative who directly or indirectly refers customers to the seller in exchange for a commission or other consideration, and the seller’s gross receipts from all such New York referrals exceeded $10,000 in the preceding twelve months. The new definition specifies that, for purposes of the presumption, referrals include all referrals, whether made through a link on an Internet Web site or otherwise. This statutory presumption may be rebutted if the out-of-state seller can establish that the New York resident representative(s) did not engage in any New York solicitation activity on behalf of the out-of-state seller that would satisfy the nexus requirement of the US Constitution. Shortly after enactment of the Amazon law, the New York Department of Taxation and Finance issued administrative guidance providing that the presumption may be rebutted if the seller is able to establish that the only activity of its representatives in New York State on behalf of the seller is placing a link to the seller’s Web site on the resident representatives’ Web site and that none of the resident representatives engage in any solicitation activity on behalf of the seller targeted at potential New York customers. As a general matter, the presumption may be rebutted if: (1) the contract between the seller and the resident representative prohibits the representative from engaging in any solicitation activities in New York and (2) the seller annually collects a signed certification from each resident representative stating that the resident representative has not engaged in any prohibited solicitation activities in New York during the previous year.
The reaction to the Amazon law from some of the largest Internet retailers was immediate. Amazon.com began collecting sales tax on sales to New York residents. By contrast, Overstock.com refused to collect New York sales tax and instead terminated its relationships with New York affiliates. Both Amazon.com and Overstock.com filed suit, alleging that the Amazon law violates the Commerce Clause of the US Constitution, both facially and as applied, because it imposes a tax collection obligation on out-of-state sellers without substantial nexus with New York. They also contended that the provision violates the Due Process clauses of the Federal and State Constitutions, both facially and as applied, because it effectively creates an irrebuttable presumption of solicitation and is overly broad and vague. The New York trial court dismissed these claims in their entirety for failure to state a cause of action. Thus, even accepting all the facts alleged as true, the court found no basis upon which Amazon or Overstock could prevail. Amazon and Overstock have appealed the decisions of the trial court to the New York State Supreme Court Appellate Division. That appeal is still pending.
Emboldened by New York’s initial success in passing the Amazon law and defending it in court, no fewer than ten states have considered or passed similar legislation. For example, Rhode Island’s version of the Amazon law became effective as of July 1, 2009. The North Carolina legislature passed an Amazon law on August 5, 2009, and Governor Perdue is expected to sign the bill into law. State legislatures in California and Hawaii passed Amazon laws, but the bills were subsequently vetoed by Governors Schwarzenegger and Lingle, respectively. Other states that have proposed legislation similar to the Amazon law include Connecticut, Maryland, Minnesota, and Tennessee. In each of the foregoing instances, the legislation has been virtually identical to New York’s provision. The primary differences are that none of the proposals contain any guidance/standards for rebutting the presumption of taxability. Further, some of the states have sales thresholds that are lower than the $10,000 amount contained in New York’s Amazon law. For example, Rhode Island specifies a $5,000 threshold.
Although most states have attempted to address this issue through legislation, Illinois took a different approach. Illinois is proposing a regulation that would require out-of-state companies having contracts with Internet affiliates located in Illinois to collect and remit sales tax. In proposing the regulation without a legislative change, Illinois is taking the position that the newly articulated standard is merely a clarification or declaration of existing law and thus may be applied retroactively. It is also important to note that the Illinois proposal does not create a presumption of taxability that may be rebutted. Under the current proposal, any retailer with a single Internet affiliate operating in the state is per se taxable. Other states are undoubtedly considering Illinois’ approach.
Although the validity of these new provisions is being challenged, their mere existence may serve to increase sales/use tax collection by putting Internet retailers between a rock and a hard place. Once a state has an Amazon law on the books, internet retailers are essentially faced with two options, collecting the tax or eliminating affiliates. Most recently, several Internet retailers have chosen to limit their state tax exposure by cutting ties with in-state affiliates. For example, in July of 2009, Amazon.com and Overstock.com announced they were cutting ties with affiliates in Hawaii, North Carolina, and Rhode Island due to the states’ progress toward or success in enacting Amazon laws. Overstock.com also dropped its California affiliates, but reinstated them when Governor Schwarzenegger vetoed the Amazon law passed by the state legislature. As more states come into the fold, the ability to eliminate affiliates may become more problematic. However, if Internet retailers retain affiliates and do not collect tax, the resulting exposure can be disastrous if the laws are ultimately upheld. As a result, every company that uses affiliates to market its products will be confronted with the business decision of collecting sales tax or terminating its marketing affiliates in the states that adopt an Amazon law.
Physical presence, either of the company itself or its affiliates attempting to exploit a state’s marketplace on behalf of the company, is still the constitutional prerequisite for a state imposing sales or use tax collection obligations on such company. The location where an Internet website is maintained has little, if anything, to do with exploitation of the market surrounding that location. For example, a New York State resident just as likely, if not more likely, to arrive at and make a purchase on Amazon.com by clicking through a link posted by an Amazon affiliate located outside New York as within. The states’ attempts to conflate the mere physical presence of an independent third party with purposeful exploitation of the local market by an out-of-state retailer is not only constitutionally suspect, but it may also result in driving Internet marketing revenues from domestic providers to foreign providers that would not create nexus issues for out-of-state retailers. States that adopt such laws should consider their impact not only on the Internet retailers, but also on their own citizens who derive their livelihoods from providing marketing services to such retailers.
This article is one of several that appear in
North America Tax News and Developments, August 2009.