It is obvious that the Internet has revolutionized the way many companies do business. Alongside the explosive growth of the Internet, many new business models have developed.
As business models progress, state laws have become ever more complex and the bright line test of nexus becomes blurred. Nexus refers to the level of contact that a taxpayer must have with a state in order for that state to be able to require the taxpayer to collect and remit sales tax. For sales tax collection purposes, nexus generally exists if the taxpayer has a physical presence in the taxing state.
Currently, Internet sales are the target of many state taxing authorities, particularly with the growing pressure on state budget deficits. Many online retailers do not collect sales taxes in all states to which goods are shipped, presumably because of their lack of physical presence in those states. Amazon, the largest online retailer in the United States, is no exception. Amazon's business model uses an affiliate program to generate business. The affiliates are independently operated websites that post ads with links to Amazon.com. In return, Amazon pays the affiliate a percentage of each sale that is generated by the ad or link.
New York was the first state to assert a sales tax collection responsibility on this Internet business model. In April 2008, the state enacted legislation that created a presumption that a retailer solicits business in the state "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." This new legislation, dubbed the "Amazon law," created a requirement for online retailers to begin collecting sales tax from their New York customers. Amazon and Overstock, another online retailing giant, brought a lawsuit against New York to overturn the new law; however, the suit was dismissed in January 2009. Amazon and Overstock appealed the dismissal, and in November 2010, the Appellate Division of the New York Supreme Court revived some (but not all) of the claims by Amazon and Overstock that the statute is unconstitutional. Specifically, the Appellate Division held that the Amazon law does not violate the Due Process Clause, Commerce Clause, or the Equal Protection Clause on its face.However, the Appellate Division reinstated the cases to determine whether the statute violates the Due Process Clause and Commerce Clause as applied to Amazon and Overstock.
Colorado also adopted an Amazon law. Initially, Colorado's legislation was identical to the law in New York, but lawmakers feared backlash from online retailers for requiring them to collect sales tax. As a result, Colorado required large online retailers to notify all customers of their use tax liability. An attempt to repeal this law was introduced in House Bill 1318 during May of 2011. The bill was approved by the Colorado House of Representatives, but failed to clear the Senate. However, Colorado won't be collecting any revenues from this law anytime soon, as a temporary injunction has been placed on this law by a federal judge.
Oklahoma imposed a watered down version of the law. Online retailers are only required to post a customer's use tax responsibility on their websites. Sales tax is not required to be collected, nor is there any additional reporting required, as is the case with the New York and Colorado laws. However, the Oklahoma law has a much larger reach; it applies to a much wider group of online sellers than does either the New York or Colorado Amazon laws.
Illinois has also taken action against online retailers. On January 6, 2011, the Illinois General Assembly passed House Bill 3659, which was signed by the governor on March 10, 2011. This bill revises the state's definition of a "retailer maintaining a place of business in the state" to include retailers who pay commissions or other consideration to persons in the state for referring potential customers to the retailer by a link on the person's Internet website, and is effective as of July 1, 2011. This revised law requires any retailer with a single Internet affiliate operating in the state to collect sales tax. In response to the signature of this bill, Amazon cancelled its affiliate program in Illinois.
Nevada is the most recent state to focus on online retailers. Currently, the responsibility for reporting and paying Nevada's sales and use tax on Internet purchases falls on Nevada customers. For purchases made over the Internet, Nevada customers must self assess Nevada's use tax and remit the tax owed to the Nevada Taxation Department. However, a coalition of hotel-casinos and small businesses has been created in support of shifting the sales tax collection responsibility to online retailers like Amazon. The intent of the law would be to aid in the collection of Nevada sales tax, as few Nevada customers comply with, or are even aware of, their current reporting responsibilities.
Alongside the recent wave of states attempting to pass "Amazon laws," we have also witnessed several other interesting developments related to this issue. For example, Amazon recently announced the closure of one of its distribution centers in Texas and the cancellation of all plans to expand operations in the state. This announcement was the result of a dispute with the Texas Comptroller over millions of dollars of uncollected sales tax. Amazon's dispute with Texas was not the result of an "Amazon law" passed by the state. Rather, Texas is asserting that Amazon has historically had the responsibility to collect sales tax on sales to Texas customers as a result of the activities of an in-state distribution center operated by an affiliated company. The state has recently taken this dispute a step further by passing House Bill 2403, which addresses nexus with respect to online retailers. Specifically, this House Bill requires the collection of sales tax by online retailers with a warehouse or distribution center in the state. The bill is currently awaiting signature, but illustrates the magnitude of this issue and the stance states are willing to take to raise revenue despite the economic costs of their actions.
For Amazon, the combination of high consumer demand and the closure of its Texas distribution center have forced the company to explore alternative distribution capabilities in other states. Although Amazon already operates distribution facilities in Arizona, Indiana and Washington, the company recently announced plans to open additional warehouses in each of these jurisdictions. Arizona and Indiana do not currently require Amazon to collect sales tax, which explains the logical appeal of these locations.
In addition to expanding in jurisdictions where Amazon currently owns distribution centers, the company is also contemplating opening new facilities in other states, such as Tennessee and South Carolina. The addition of these distribution centers represent significant capital investments and would generate jobs in each state, thereby contributing to the overall improvement of those local economies. Not surprisingly, Amazon is attempting to utilize these benefits as a leveraging tool to negotiate an exemption from sales tax collection responsibilities.
However, it doesn't appear as though either state has been completely willing to make the necessary concessions in its negotiations with Amazon. In April of this year, Amazon's plan for the South Carolina distribution center came to an abrupt halt once the state legislature vetoed a five year sales tax exemption for Amazon. However, more recently, South Carolina legislators voted to give Amazon the five year exemption from collecting sales tax after Amazon increased its commitment by agreeing to create at least 2,000 local full-time jobs and invest $125 million by the end of 2013 - that's up from 1,250 jobs and a $90 million investment. The Senate must still approve the bill, and although the governor opposes it, she has indicated that she will not veto the proposal, assuming it passes the Senate.
Conversely, Tennessee isn't backing down, even though Amazon is looking to build two distribution centers in the state. Tennessee's lack of support for a sales tax exemption is clear by the recent presentation of a bill that reiterates an existing nexus law that results in a sales tax collection requirement for Amazon.
What does all of this mean for businesses that sell via the Internet? It is clear that states are taking this issue very seriously and many states are following New York's lead. In terms of competition, it is possible that online companies could cancel their affiliate programs in the states that adopt Amazon laws. In addition, the growing expansion of these Amazon laws creates a challenge for new and small businesses planning to expand and market themselves throughout the country. Moreover, many commentators believe that these laws do not have the intended effect of increasing revenue. The Tax Foundation, a nonpartisan educational organization, found that, at least in the short term, the passage of these laws may actually lead to a tax decrease. That is, when Amazon pulled the plug on its affiliate programs in Rhode Island, Colorado, and North Carolina, these states actually experienced a decrease in personal income tax revenue that more than offset any gains seen on the sales tax side. Furthermore, the theory that these laws will "level the playing field" between "brick and mortar" stores and online retailers is also flawed.Online retailers must track sales from all 50 states whereas "brick and mortar" stores need only track sales for one state. This additional compliance burden results in additional costs incurred by online retailers.
In the end, only time will tell whether these Amazon laws will actually achieve the goal of generating revenue in states with budget shortfalls. However, it doesn't appear as though the states are willing to wait, and many would rather enact an Amazon law now in an attempt to generate revenue as soon as possible. For that matter, there is even a possibility that some states could attempt to further expand their nexus rules to other business models, such as television advertisements and infomercials. What remains clear is that taxpayers are not taking the Amazon laws lightly, and the business environment, along with the state tax laws applicable to online retailers, will continue to change in the future.
Jason Dannemiller is a Managing Director in the Seattle office of WTAS.He has over 15 years of experience providing both federal and state and local tax consulting services, primarily focusing on state income/franchise tax, sales and transaction taxes, and Washington gross receipts tax. He serves clients in a wide variety of industries, including technology, biotech, manufacturing, consumer products, real estate, energy and utilities, healthcare, sports franchises, and private and charter aircraft operations. Mr. Dannemiller focuses on delivering strategic business solutions for companies to use in efficiently managing their state and local tax burdens.