As New York lawmakers hash out the state’s budget, one contentious issue may have a dramatic impact beyond the Empire State: A provision requiring many online retailers to collect sales tax on state residents’ purchases.
The provision, now facing a coming vote as part of state legislators’ 11th-hour efforts to pass a state budget, could require e-tailers to collect taxes even if they have no employees or offices within the state.
If signed into law with the budget, the so-called “Amazon tax” would apply to merchants offering commissions in exchange for customer referrals, a practice known among Internet retailers as an affiliate program.
Many online retailers, such as Amazon, Barnes & Noble and Buy.com, have programs that allow individuals or organizations to include a link to the e-commerce site on their own Web page. The affiliate receives a commission for sales generated through the referral.
Especially if other states follow suit, the rules of e-commerce will change dramatically. Some warn that shopping online will become a less attractive proposition as the burden of tax collection shifts from the states to businesses.
Amazon has been lobbying vigorously against the bill, claiming that it would be unreasonably difficult to keep track of the complex web of state and local tax codes — while effectively raising taxes on consumers.
Additionally, while the provision merely shifts the onus of collection from the state to the sellers, Amazon executives told InternetNews.com in February that it would have the practical effect of increasing taxes on consumers.
A spokeswoman for Amazon this week said the company could not comment on the bill until it had a chance to review it in its final form.
The bill’s supporters, including trade associations such as the Retail Council of New York State, countered it simply shifts the onus of collecting the tax onto businesses.
To date, consumers have been responsible for reporting their own purchases from out-of-state companies on their state income tax returns and paying a use tax on those items.
Additionally, requiring Web businesses to collect sales taxes would level the playing field between bricks-and-mortar businesses and their online counterparts, according to Ted Potrikus, the Retail Council’s executive vice president and director of government relations.
“Collecting the sales tax on purchases made over the Internet is not a new tax,” Potrikus told InternetNews.com. “This is pretty much all I’ve talked about with the state legislators since February.”
He added that many bricks-and-mortar retailers also maintain e-commerce businesses — so they’re already required to navigate the intricacies of local tax codes when shipping items to any online shopper living in a state where they have a store.
“If [offline retailers] can figure out how to charge, collect and remit the right kind of sales tax in every jurisdiction in the country, I think the Internet companies can do the same,” he said.
The move comes as states are finding that the honor system of consumers’ reporting and paying use taxes is falling short. For one reason, many people do not know that they are required to report out-of-state purchases. Supporters of such bills also maintain it’s impractical for states to enforce collection on an individual level.
In the budget he submitted, then-Gov. Eliot Spitzer estimated that requiring businesses to collect Internet sales taxes would boost the state’s revenue by $47 million in 2008-09, and $73 million in 2009-10.
As the bill now stands, any e-commerce company that derives more than $10,000 of revenue from New York-based affiliate referrals will be required to collect sales taxes on all purchases shipped to New York addresses. Businesses will have to register as tax vendors by June 1.
Spitzer had introduced the idea in November in a memo from the state tax commission, but rescinded it the same day as media outlets began reporting the controversial new policy. Spitzer said it was not the right time to increase taxes on New Yorkers.
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“This is a gray area”
Even if passed into law as part of the state’s budget, observers say any New York online tax provision will rest on uncertain legal footing — and is likely to be challenged in state or federal court.
The 1992 U.S. Supreme Court ruling in Quill v. North Dakota held that only businesses with a physical presence in a state are required to collect sales taxes on purchases shipped there. Typically, companies have been deemed to have physical presence if they maintain a store, office or distribution center in the state, or if any employees are based there, such as a sales representative.
Amazon does not have any employees in New York, but the budgetary provision asserts that its affiliates are enough to constitute physical presence.
The budget, as submitted originally by Spitzer, singles out e-tailers who “enter into agreements with organizations under which the organization receives a commission if it includes a link on its Web site that connects the users to the Internet retailer’s Web site.”
According to the provision, those organizations are representatives of the company, and it asserts that “the extent of these local solicitation activities is easier to ascertain for the sellers than it is for the [state].”
But observers said the matter is far from cut and dried.
“It’s sort of this new definition of what a representative could be. It’s going into an area that hasn’t been touched on yet,” said Hugh Goodwin Jr., a state and local tax attorney and partner with international law firm DLA Piper. “This seems to me to be really pushing it. This is a gray area.”
Goodwin said that the definition of physical presence varies among states, and that New York has historically taken an aggressive stance on the issue.
Viewed in that light, the legal defense of the provision would be that it is not a new law, but rather a clarification of an old one. Affiliate programs of the kind employed by Amazon did not exist in 1992, when the Supreme Court ruled on Quill.
[cob:Special_Report]The crux of any legal challenge would be the definition of terms, where opponents of the provision would claim that affiliates should not be considered on a par with company employees, while New York would argue that it is within the boundaries of Quill.
The Quill case established the rule of physical presence, which New York claims it is updating to apply to a new economic model. Another Supreme Court ruling from three decades earlier could also be used to marshal a defense of the new tax provision.
In its 1960 ruling in Scripto v. Carson, the Supreme Court determined that independent contractors working in Florida on behalf of the Georgia-based Scripto pen company established a “nexus” in the state, and thus it was responsible for collecting sales taxes on purchases made by Florida residents.
The similarities between Scripto’s contractors and participants in an affiliate program such as Amazon’s — neither being full-time employees — may boost New York’s case in the event of a legal challenge. New York could, perhaps convincingly, claim that in taking commission for customer referrals, online affiliates act in the same capacity as Scripto’s contractors.
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The revenue crush and tax maze
States are pushed to measures such as New York’s tax law clarification from the need to turn red ink black.
“A lot of states are trying to get revenue from out-of-state companies,” said Joe Henchman, tax counsel at the Tax Foundation, a Washington, D.C.-based nonpartisan research and educational organization.
But Henchman warns against what he calls “exporting the tax burden to out-of-state companies.”
He argues that the current U.S. tax system, with about 7,400 different state and local sales taxing jurisdictions, is in desperate need of reform. In an age of global trade and point-and-click shopping, Henchman believes that a system of taxation based on geographical boundaries is a “square peg in a round hole.”
Henchman won’t be alone in lamenting the implications. In 2000, revenue officials from a number of U.S. states banded together in an effort to address bewildering discrepancies in which goods are taxed in different jurisdictions, and the rates at which they’re taxed.
The resulting Streamlined Sales Tax Project, which aims to put pressure on Congress to simplify the tax code, now counts 17 states as full members of its governing board and five as associate members. New York is not a member.
Like Streamlined, Amazon similarly argued in favor of simplifying tax rules while making its case to New York legislators. The company claimed that it did not object to collecting taxes in principle, but that the complexity of existing laws — once applied to Internet shopping — would entail unreasonable expense.
In addition to Washington state, where it is based, Amazon collects sales taxes on purchases shipped to North Dakota, where it has a call center. It does the same for shipments to Kansas and Kentucky, where it maintains distribution centers.
Bills based on recommendations from Streamlined have repeatedly stalled in Congress, and Potrikus of the Retail Council said Amazon’s show of support for the project was somewhat disingenuous.
“The national solution is so bogged down in different warring, bureaucratic factions,” he said. “It’s easy to take something that you know isn’t going to work and hold it up as a solution. Streamlined has become more of a dodge at this point than a solution.”
Henchman, who opposes the New York provision, doesn’t see Streamlined as a solution, either. He criticized the project for linking jurisdictions to nine-digit ZIP codes, which he said reinforces artificial and obsolete economic boundaries and fails to whittle down the number of tax codes to a level that merchants can be expected to navigate.
Absent the type of sweeping reform that Henchman envisions, or even the success of the comparatively moderate Streamlined project, states will be closely watching New York’s moves — to see whether lawmakers give the provision the thumbs-up, and if so, how it fares in an anticipated legal challenge.
Assuming the interpretation is not overturned, and if revenue rises as the governor’s budget predicts, other states can be expected to take a more aggressive approach toward e-commerce taxation.
“If New York adopts this, then other states are going to do it, too,” Henchman said.