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New York's About-Face on E-Commerce Taxation

Just when it looked like the tax-free ride was over for online shoppers in New York, the state's governor changed his tune.

Late this afternoon, Gov. Eliot Spitzer's office released a statement rescinding the new tax policy that would have required online retailers to begin collecting state sales taxes starting Dec. 7.

"Governor Spitzer believes that now is not the right time to be increasing sales taxes on New Yorkers. He has directed the Department of Tax and Finance to pull back its interpretation that would require some Internet retailers that do not collect sales tax to do so," State Budget Director Paul Francis said in the statement.

The policy would have directly affected retailers such as Amazon and Buy.com that use affiliate marketing programs, where Web site operators include a link to an online retailer and receive a portion of any sales resulting from the click-through.

The governor's office would not comment on whether the legal challenges to the policy that the state could have faced played a role in Spitzer's decision.

"Gov. Spitzer probably sees the state as overreaching," NetChoice Executive Director Steve DelBianco wrote InternetNews.com in an e-mail.

Retailers would likely have challenged the tax policy on constitutional grounds, although such a fight could have taken years, said Catherine Fox-Simpson, tax partner at tax consulting firm BDO Seidman.

Spitzer's move could have come from fears that the policy would have run afoul of the 1992 U.S. Supreme Court ruling in Quill Corporation v. North Dakota, which held that "sales tax collection requirements cannot be imposed on an out-of-state corporation that does not have a substantial physical presence within the state."

DelBianco predicted that the policy, if enacted, "would fail the Supreme Court's [1992] Quill test, which held that state and local sales tax regimes are so phenomenally complex that they're an unreasonable burden on interstate commerce."

Many experts were anticipating that the policy would have a far-reaching impact with other states following New York's lead. As they look for new sources of revenue, more states can be expected to turn a hungry eye to the thriving e-commerce market, according to Fox-Simpson.

The legal theory behind the move claimed that online retailers use "representatives" to solicit sales. A representative can be a contractor, an agent or anyone else who directs traffic to an online retailer, according to the memo from the New York State Department of Taxation detailing the policy.

The new policy would have required any e-commerce site with a representative located in New York State to collect sales tax on items purchased by New York residents.

Under the policy, affiliates would have been treated as representatives of the company, which is enough to establish a physical presence in a state. As it stands, Internet retailers are only deemed to have a physical presence where they have established company operations, such as a distribution center or a sales staff.

The physical presence rule, established by the Quill ruling, has exempted a large portion of online transactions from state and local taxation. That is the loophole that Gov. Spitzer was seeking to close with the new tax policy.

One of the companies that would have felt the biggest impact from the new policy is Amazon. Through its Associates affiliate marketing program, Amazon provides more than 1 million Web sites with a link to its site in exchange for commissions of up to 10 percent.

If just one of these site operators lives in New York, the Internet retailer would have been required to register as a New York sales tax vendor.

The companies that would have been most affected by the policy didn't have a chance to react before Spitzer took it off the table.

Shortly before Spitzer's reversal, Patty Smith, a spokesperson for Amazon, told InternetNews.com that the company had only recently heard of the policy and that its tax division was looking into the matter.

"We haven't had a chance to evaluate the memo," Smith said, adding that it would undergo an internal review before the company would consider legal action or any changes to its affiliate program, she added.

Significantly, state taxes would have applied to all purchases made through the online retailer, not just those made by following a link from an affiliate.

"Perhaps the governor realized that Amazon would have had to collect sales tax on all their sales to all New York residents – not just sales triggered by these independent affiliates," DelBianco suggested.