May It Please the Mozzers,
There has been a lot of buzz surrounding New York's new law requiring online retailers to collect sales tax from their New York Customers if they engage affiliate marketers in that state.
The New York Times (original coverage and the Overstock fallout), the New York Post, Vastplanet, Cost Per News, and The Wired Blog represent a handful of the coverage out there.
Before we talk about Amazon's legal challenge to the new law, let's take a brief look at NY's new tax law:
I don't have any expertise in interstate tax law, but I thought I would read the leading case on the topic of sales tax and interstate commerce to try and get an idea of where Amazon's case might go. Amazon has three arguments that the law is unconstitutional, but I'm only going to look at whether the law violates the Commerce Clause of the U.S. Constitution.
The U.S. Supreme Court discussed interstate tax in 1992 in Quill Corporation v North Dakota. In that case, North Dakota tried to collect sales tax from a mail order office equipment company, Quill Corp., that didn't have any offices or employees in North Dakota and only contacted potential and actual customers through the mail. It wasn't an internet case, but you can see the similarities between mail-order office supply companies and what large online retailers like Amazon do. Well, the Supreme Court ruled that North Dakota couldn't force Quill to collect sales tax on purchases made by North Dakotans because Quill didn't have enough of a connection with North Dakota to give the state authority over it.
Sounds promising for Amazon, right?
Well, I dunno. In order to withstand a Commerce Clause challenge, the tax must apply to an "activity with a substantial nexus with the taxing State," among other things. The problem is that "substantial nexus" isn't clearly definable.
We know from the Quill case that a vendor whose only contacts with the taxing State are by mail lacks the "substantial nexus." However, the Court stated in Quill that "whether or not a State may compel a vendor to collect a sales or use tax may turn on the presence in the taxing State of a small sales force, plant, or office."
Thus, the question seems to be whether affiliates are like mail order catalogs or independently contracted salespeople. If they are like a mail order catalogue that merely advertises to potential customers, then it looks like Amazon has a great case. However, if they are more like independently contracted sales experts, then I think Amazon may have a difficult time winning its case on the commerce clause argument.
In the lawsuit, Amazon attempts to distance itself as much as possible from its affiliates and describes them as merely agreeing to show Amazon's advertising on their websites:
Regardless, I find it interesting that Amazon avoids describing all of the ways that talented, expert affiliates design their sites around the promotion of Amazon products. Top-performing affiliates do more than plop a link on a website; they craft websites by choosing a relevant domain and developing relevant, quality content specifically for the purpose of marketing the product and soliciting sales. After all, Amazon affiliates don't get paid unless you buy!
I'd like to throw the question out there. Are affiliates more like a mail order catalogue or an independently contracted sales expert?
Ultimately, it will be up to a judge to decide. The judge's decision will depend greatly on his or her understanding of what exactly affiliates do and the nature of their relationship with the vendor. I'm really curious what the practitioners think about this issue.
Thanks in advance for your feedback!
Best Regards,
Sarah
There has been a lot of buzz surrounding New York's new law requiring online retailers to collect sales tax from their New York Customers if they engage affiliate marketers in that state.
The New York Times (original coverage and the Overstock fallout), the New York Post, Vastplanet, Cost Per News, and The Wired Blog represent a handful of the coverage out there.
Before we talk about Amazon's legal challenge to the new law, let's take a brief look at NY's new tax law:
- The purpose of the law is to allow NY to collect sales tax whenever one of its residents purchases something from a large online retailer. Historically, large online retailers, like Amazon, who don't have an office, employees, or other physical presence in NY don't have to collect sales tax for purchases made in NY. NY is attempting to change this by making the use of affiliate marketers based in NY enough of a connection with the state to require these large online retailers to collect sales tax, even though they don't have the other traditional requirements like an office or sales team in the state.
- The law attempts to exclude small online retailers. You don't have to collect sales tax unless you have gross receipts of more than 10k per year from the sales referred to your site by your affiliates. Thus, if your affiliates make you less than 10k per year in sales to NY citizens, you don't have to worry about this law.
- The law doesn't specifically address "affiliate marketers." It applies to any NY resident who enters into an agreement with an online retailer to "directly or indirectly" refer "potential customers, whether by a link on an internet website or otherwise," in exchange for a commission or other compensation. Thus, affiliate marketers clearly fall within the purview of the law, but there is also potential for other more 'traditional advertisers' to trigger the sales tax collection requirements.
- NY's law did not occur in a vacuum. There has been an ongoing national effort to address internet sales tax issues. Basically, NY got tired of waiting for a nationalized tax regime and decided to forge ahead on its own. Undoubtedly, the other states are watching this situation very closely.
- NY has taken the position that these large online retailers should have been collecting sales tax all along. However, in its graciousness and magnanimity, it is promising not to go after the large retailers for uncollected past taxes so long as they register with the state and start collecting taxes by June 1, 2008. So, if the online retailers don't get on board, they could be subjected to costly back audits and penalties.
ARE AFFILIATES MORE LIKE MAIL ORDER CATALOGUES
OR EXPERT SALES PEOPLE?
OR EXPERT SALES PEOPLE?
I don't have any expertise in interstate tax law, but I thought I would read the leading case on the topic of sales tax and interstate commerce to try and get an idea of where Amazon's case might go. Amazon has three arguments that the law is unconstitutional, but I'm only going to look at whether the law violates the Commerce Clause of the U.S. Constitution.
The U.S. Supreme Court discussed interstate tax in 1992 in Quill Corporation v North Dakota. In that case, North Dakota tried to collect sales tax from a mail order office equipment company, Quill Corp., that didn't have any offices or employees in North Dakota and only contacted potential and actual customers through the mail. It wasn't an internet case, but you can see the similarities between mail-order office supply companies and what large online retailers like Amazon do. Well, the Supreme Court ruled that North Dakota couldn't force Quill to collect sales tax on purchases made by North Dakotans because Quill didn't have enough of a connection with North Dakota to give the state authority over it.
Sounds promising for Amazon, right?
Well, I dunno. In order to withstand a Commerce Clause challenge, the tax must apply to an "activity with a substantial nexus with the taxing State," among other things. The problem is that "substantial nexus" isn't clearly definable.
We know from the Quill case that a vendor whose only contacts with the taxing State are by mail lacks the "substantial nexus." However, the Court stated in Quill that "whether or not a State may compel a vendor to collect a sales or use tax may turn on the presence in the taxing State of a small sales force, plant, or office."
Thus, the question seems to be whether affiliates are like mail order catalogs or independently contracted salespeople. If they are like a mail order catalogue that merely advertises to potential customers, then it looks like Amazon has a great case. However, if they are more like independently contracted sales experts, then I think Amazon may have a difficult time winning its case on the commerce clause argument.
In the lawsuit, Amazon attempts to distance itself as much as possible from its affiliates and describes them as merely agreeing to show Amazon's advertising on their websites:
Amazon allows independent third parties located around the world to advertise Amazon.com on their own websites by joining Amazon's "Associates Program....." Under this program, advertisers can place one or more of a variety of different Amazon advertisements on their own websites. These Amazon websites generally have links enabling visitors to "click through" to Amazon's website from the Advertiser's website. All such advertisers operate independently from Amazon, and they alone choose the timing, format, and placement of the Amazon advertisement on their websites.Clearly Amazon is going out of its way to avoid characterizing affiliates as independently contracted salespersons. And that may be a very fair characterization for many of Amazon's affiliates. It's certainly true that the associates don't consummate the sales transaction and are not authorized to act as agent's of Amazon. But does all of this mean they don't solicit sales?
Regardless, I find it interesting that Amazon avoids describing all of the ways that talented, expert affiliates design their sites around the promotion of Amazon products. Top-performing affiliates do more than plop a link on a website; they craft websites by choosing a relevant domain and developing relevant, quality content specifically for the purpose of marketing the product and soliciting sales. After all, Amazon affiliates don't get paid unless you buy!
I'd like to throw the question out there. Are affiliates more like a mail order catalogue or an independently contracted sales expert?
Ultimately, it will be up to a judge to decide. The judge's decision will depend greatly on his or her understanding of what exactly affiliates do and the nature of their relationship with the vendor. I'm really curious what the practitioners think about this issue.
Thanks in advance for your feedback!
Best Regards,
Sarah
This is a hot subject. With many states being financially strapped by a soft economy you can bet that if NY is successful in this everyone else will be quick to pile on.
Clearly the Internet sales tax holiday isn't going to last forever, and I for one hope that congress addresses it before a complicated patchwork of state and local laws - and possibly double (or worse) taxation - are in place.
Sadly, politicians would rather lick a frozen flag pole than be the one to introduce or support a New Tax - even if it's the logical thing to do.
Before you thumb me down - I dislike taxes as much as the next guy - I'm just trying to be realistic.
Addressing Amazon first, I think the distinction for Amazon is further complicated because of the Amazon services. If the affiliate is using Amazon API's, Amazon Associates store (aStore), and other services, does it make claiming the independent distinction harder?
Risking some thumbs down, I do think the NY case is an important one, and I respect their ingenuity. Governments have to have revenue and the explosive online sales growth versus local store means the online sales tax is just a matter of time. With Sales Tax being avoided online, it'll only lead to increased income or property tax or even local sales tax. We're already seeing states and communities in a tax bind based on the fallout of the real estate market and the slow economy.
The problem I see is that states will have to agree to some common tax level, and avoid the complication of dealing with an online tax at a state/county/city/etc. level. As a small retailer, dealing with separate state revenue departments would be a nightmare, even apart from the shoppping cart technology aspect (which is definitely not an issue with Amazon, as they power other sites like Target.com).
So no matter how much we complain about the efficiency of government, we have to recognize the need for the revenue, the disadvantage of local businesses to online in charging tax, and the inevitability of the tax. Amazon should be working to resolve the issue in a fair manner instead of fighting the collection of the taxes.
I don't think siding with NY vs. Amazon is risking thumbs down. After all (IMO) the thumbs should reflect the quality of your comment, not the position. But I digress.
Another challenge is who collects the sales tax? States depend on tax revenue to pay for goverment services including operations and infrastructure. Since tax revenue is tyipically tied to the population of a state (more people means more services means more taxes) then each state will try to claim the Sales Tax on internet purchases.
For example, if a NY customer purchases from a California company, NY will claim taxes to support the customer's impact on the state while California will claim the taxes to support the Business' impact on the state. Who wins?
Agreed, the thumbs should be reflective of the thoughtfullness, accuracy, and tone of the comment.
Sarah, great article -- you've prompted my first comment in months here. I think its a huge stretch for the state to claim that affiliates are sales people. I think there is a range -- some do more than others to solicit a sale, but the comparison to a catalog producer (or even a newspaper) is far more appropriate.
Excellent write up and breakdown - quite intelligent actually. Not enough of this kind of logical discussion going on. This needs to be fought, for sure. States like New York needs to cut spending and gov't corruption instead of taxing people outside of their own misbegotten state. Stop electing idiots like Eliot Spitzer and the state will probably save quite a bit from gov't corruption.
Aside from that, more states should be worried about this than seeing how to get into the action. If other states like NY get active, states trying to woo businesses will find it harder and harder to find economic investment.
As for Amazon, I don't see how they can possibly be responsible for any of this to NY. If someone signs up for an independent sales distributor of a company, how is that company responsible for taxes? It would be the contractor responsible for taxes doing business in that state.
This kind of legislation would permeate into all kinds of businesses including MLM companies. The case could also be made that if a publisher is located in one state and publishes the ad of another company in another state, that company would need to pay taxes to the publisher's state. That's absurd and states reaching into the pockets of residents/companies of other states.
If this kind of thing does not get resolved with a federal resolution, then we're right back to 1781 and the whole arguments about interstate taxation etc. Back to 1861 and the idea of states rights - does 1 state have the right to reach into the pockets of another state?
I hate taxation and I say keep it free - let the states collect income tax. Too many states are too greedy and aren't doing more with less. Why are we - the PEOPLE - asked to do more with less, but not state gov't?
Amen!
It sounds like you live in California :-)
I bet if Amazon loses this, they'll revamp all affiliate contracts to circumvent language in NY's laws. I know I would. NJ is just as messed up though. I lived in So. NJ - I often yelled for SoNJ's seccession and join forces with Philly-PA. Lots of SoNJ residents are Philly transplants anyway.
I still say NY needs to be less greedy, do more with less - and stop electing corrupt officials like Eliot Spitzer to reduce gov't waste.
And let's face it: if NY is virtually the financial capital of the US, if not the world, what could NY possibly need more taxation for if they are spending taxpayer money wisely?
Do more with less!
...I hear whispers from the South saying "the South was right!"
(whistles dixie....)
Good writeup as ever, Sarah. I would think the definition of substantial nexus would also depend on what percentage of Amazon's sales come from affiliate marketers, particularly in the state of New York. Is it 5%? 15%? 50%? The larger the number, the harder a case I would think they'll have fighting this. The definition of whether the affiliates represent mail order catalogs or independent salespeople also likely varies by the individual site.
One big question for me is why aren't we hearing more about eBay on this? Wouldn't retailers outside New York who use eBay as a distribution channel and sell to customers in New York - and clear the 10k sales barrier - have as much risk or more as Amazon on this? I think it would be much harder to argue that eBay isn't an independent sales agent. Or am I missing something here?
Keep up the great work.
First, using GDP, New York is about 1/13th of the US economy, so let's say a retailer doing $10k of affiliate sales in NY earns $130k revenue total per year -- gross. That is much smaller than "small business." I recall some onerous taxation legislation in Illinois recently which defined "small business" as under $1MM of revenue, and that was too small. NY's share of $1MM would be about $75k.
Second, how might the judge decide between defining affiliates as advertisers or sellers? Will he consult experts, or use his own judgment?
This topic is a scary one. Beginning July 1, Washington state is going from an origin-based sales tax system to a destination-based one as part of the Streamlined Sales and Use Tax Agreement.
Washington becomes part of a larger consortium to not only collect sales taxes, but remit them to the correct jurisdiction and rate. You can read more at the Department of Revenue site for Washington State, dor.wa.gov (this site quotes Quill v North Dakota) or streamlinedsalestax.org
The important thing here is that small retailers have no clue how to implement these complex rules, and most eCommerce code packages can't handle the state-by-state rules.
And as long as individual state governments handle things the way NY and Washington State do, it will become harder and harder to implement the rules correctly, collect and send the right money, and stave off audits.
-LR
New York should get its spending under control, not tax those of us who make the internet what it is. The internet plays a significant role in the economy and we do not need to have our production taxed because politicians in New York are greedy and would prefer to suck more money out of us instead of actually using some responsibility in spending.
I'm certainly no legal eagle, but I am a big shopper at Amazon and I'm kicking myself that I didn't buy my Kindle before June 1st.
I have one question: if Amazon win their case against NY, will they return the collected tax individually to the customers who paid it? It would seem that the chance of getting back the tax, still makes Amazon a better bet than buying offline.
This will be a hard case for Amazon and one simple reason is because it's really hard not to call your affiliates contractors when you send them 1099's each year.
Really though, I am not sure how thought out this was by NY. It's a non issue for affilates unless all or most states follow suit. Given the virtual nature of affiliate marketing, how hard would it really be for an NY affiliate to set up residence or just a mail box in a neighboring state such as NJ, CT, etc. Amazon and others would really have no way to know where they actually reside. Furthermore NY will lose state income tax revenue due to this.
Even as a very small retailer, I wouldn't mind having to help collect sales taxes for other states as long as they make it easy for me.
We are talking about the Internet, and we are talking about computers. There's no imaginable reason why I should actually have to collect the money - let New York or any other state do that themselves. Require me to report the sale, fine. But why should I have to maintain complicated tables to figure out whether product X is taxable in state Y?
Simple answer: make me report the sale. Let the state itself collect the money.
You collect it because (I believe) you are responsible for the tax, not your customer. You are simply charging them the fee.
I'm not an accountant or lawyer, and I don't sell physical goods, but that's my understanding.
How are they planning on policing this? It is obvious if you are an Amazon or an Overstock, undoubtedly they would reach the 10k mark. But what if you are smaller online retailer? Are the affiliate networks getting involved at all to try and assist publishers in their networks? It seems to me that it would be hard to come after the smaller retailers....
PS thanks for the post it is the most beneficial one I have seen on the subject thus far.
It's a real Pandora's box for politicians in an election year....
What we really need for our economy right now is more taxes. How many of you have seen an increase in business this month due to the tax rebates?
What about states that don't have a sales tax? Why should their merchants have to collect sales taxes?
eBay? For the little sellers, it 's a garage sale, selling things for which a sales tax was already paid.
The whole interstate tax debate thing is interesting in light of the original intent of the constitution of making unhindered free trade between the states. The same reason we don't need passports to go the the next state. Am I wrong in thinking there isn't supposed to be tariffs (aka taxes) between states?
Internet-based businesses in each state pay taxes on their income, employees' income, etc. Shipping companies pay taxes in both the shipping state and the receiving state.
And what about foreign purchases? Let's see, if people have to pay sales tax on those internet purchases in the US, maybe they'll purchase it from another country. (services, downloadable programs, e-books, etc.)
I hope Amazon wins this one.
Great article that covers a lot of important issues. I totally agree with your point that this new law that New York States instituded is completely unconstitutional. This is always a very nicely written blog that I look forward to reading.