Home -> Law Blog Directory -> Intellectual Property Law Blogs -> IBLS Internet Law Blog

Intellectual Property Law

: IBLS Internet Law Blog

Internet Advertisers Versus The Tax Collector

By IBLS Editor

It's not that the Internet is all we think about, but a tax law adopted by New York this spring ? and now being challenged in court ? could have major implications for the issue of who may be held responsible to pay state taxes for on online sales. And when it comes to taxes, surprises are hardly ever good news.

Faced with budgetary shortfalls, states are looking for new approaches to capture the sales tax that has been uncollected through online sales. In the current environment, online retailers generally do not collect sales tax if the purchaser is in a state where the retailer has no retail stores or other operations. If online retailers do not collect sales tax, purchasers often do not pay the use tax (tax imposed when an item is purchased out of state for use in state) that they should pay. And government-enforcement against on-line purchasers for a small amount of sales/use tax will not be cost effective for the states.

Why can"t the states just require the online retailers to collect the sales tax on the states' behalf as do the big box retailers like Wal-Mart and Target? The reason is that states cannot impose taxes that unduly burden interstate commerce. In a 1992 decision, the Supreme Court ruled that out-of-state retailers cannot be required to collect sales tax on purchases that are sent to states where the retailers do not have a physical presence. Quill Corp. v. North Dakota, 504 U.S. 298, 309 (1992). Online retailers like Amazon.com generally have no real or tangible personal property in states other than the state in which their headquarters are located.

Almost all online retailers, however, use a myriad of third party advertisers whose web sites place links directing visitors to the retailers' web site. For example, Amazon.com employs the "Associates Program," whereby advertisers place one or more Amazon advertisements on their own web sites. Amazon.com pays the advertisers a small commission for the referred sales. These referred sales account for approximately nine percent of the retailers' sales.

If advertisers directing Internet traffic to online retailers can be deemed agents or otherwise an extended arm of the retailers, then the retailers may be deemed to have a physical presence in the state where the advertiser is located, and thus be subject to the burden of collecting sales tax for that state.

This precise issue is now ripe for decision in New York. In April 2008, New York passed a new tax law providing that a retailer "shall be presumed to be soliciting business through an independent contractor or other representative if the seller enters into an agreement with a resident of this state under which the resident for a commission or other consideration, directly or indirectly refers potential customers, whether by a link on an internet website or otherwise, to the seller." The new law requires an out-of-state retailer like Amazon.com, which uses advertisers based in New York, to collect sales tax for all tangible goods sold to New Yorkers, even if the purchases have nothing to do with the advertising service provided by the advertisers.

After this new law was passed, Overstock.com severed its ties with approximately 3,400 New York-based advertisers as of June 1, 2008, the date that the new law went into effect. Amazon.com, on the other hand, kept its New York-based advertisers and started charging its New York customers sales tax.

Both Amazon.com and Overstock.com have sued New York for a declaration that the new statute is unconstitutional. Amazon.com claims that it is difficult, if not impossible, to identify whether a third party advertiser is a New York resident in its Associate Program. Even if Amazon can identify whether the third party advertiser is a New York "resident," Amazon.com claims that it would be impossible for Amazon.com to know whether each and every one of the linked third parties "directly or indirectly" engage in solicitation in New York.

That being said, it appears that technological advances, not available ten years ago when the Quill decision was rendered, make it easier for online retailers to administer and collect sales tax despite the difficulty of dealing with the variations in tax rates, allowable exemptions, and administrative and recordkeeping requirements. Many commentators have opined that the rules under Quill are antiquated, given the rapid development of technology and the Internet that have made sales across borders widespread. Until the Supreme Court rules again or Congress otherwise acts, states will continue to expand their tax bases under the existing system and taxpayers will continue to challenge the expansion. If the constitutional challenge made by Amazon.com and Overstock.com turns out to be unsuccessful, many states will follow New York to expand the sales tax basis.

Full post as published by IBLS Internet Law Blog on December 08, 2008 (boomark / email).