A judge has tossed out a legal challenge to a New York law requiring out-of-state companies to collect sales taxes for the state. The ongoing court fight could become a landmark case determining the future of Internet commerce.
Seattle-based Amazon.com, which was joined in its suit by Utah-based Overstock.com, argued a 1992 U.S. Supreme Court decision, Quill Corp. vs. North Dakota, should apply to the current case.
The decision in that case declared the Commerce Clause of the U.S. Constitution forbids states from requiring companies to collect sales taxes unless the company has a physical presence in the state—such as a store or warehouse.
Amazon has never had a corporate physical presence in New York, and Overstock cut ties with all of its 3,400 New York-based affiliates before the law took effect on June 1, 2008.
Yet New York State Supreme Court Justice Eileen Bransten dismissed their suit, saying “there is no basis on which Amazon can prevail.” The judge also wrote she was tossing the case because Amazon failed to “state a cause of action.”
Amazon has had no comment about the decision, but Overstock said it is prepared to appeal all the way to the U.S. Supreme Court.
Legal, tax, and Internet experts sharply criticized Bransten’s decision and expressed hope for a reversal on appeal.
Pete Sepp, vice president for policy and communications at the Alexandria, Virginia-based National Taxpayers Union, called the ruling “one of the most important tax-related matters in the last 50 years of judicial history.”
“If [the Amazon ruling] it is upheld by the U.S. Supreme Court, the Quill decision will have had a huge hole blown clean through its heart, and taxpayers will be the ones in cardiac arrest,” Sepp said.
“Taxpayers were already stuck in the sea of revenue-hungry sharks trying to put an even bigger bite on their wallets for shopping out of state,” Sepp continued. “This decision, if allowed to stand, would open the door on the cage and make taxpayers shark food.”
Establishing a ‘Nexus’
New York claims a taxing “nexus” exists with Amazon because state residents have links on their Web sites to Amazon’s online book, music, and movie store. The state calls those residents “affiliates.”
But Matthew Cheng, founder and president of New Jersey-based eCoupons.com, says such a standard sets a troubling precedent.
“It would not be difficult to argue that Ogilvy, Agency.com, and other Madison Avenue advertising companies are also agents of online retailers,” Cheng said. “If online retailers kick out New York affiliates to avoid this tax, will New York target one of its biggest industries to generate a buck?”
Cheng added it is now “very common” for online companies to ban New York affiliates.
“In fact, many retailers have added language into contracts stating that affiliates cannot have corporate or personal property in New York,” Cheng said.
Causing Economic Harm
George Pieler, a senior fellow with the Institute for Policy Innovation in Lewisville, Texas, said the judge had no reason to dismiss the case for “failure to state a cause of action,” because the law harms the business plans of online retailers such as Amazon and Overstock.
“The decision will cause economic harm and confusion,” Pieler said. “Businesses, for one thing, have to figure out if they are meant to be covered under New York’s unique definition of ‘nexus.’ And they face real, ongoing costs today, even if the law is ultimately overturned.”
The judge’s ruling comes at a bad time economically, Sepp added.
“State revenue authorities were determined enough in pursuing taxpayers for out-of-state purchases before the economy turned sour,” Sepp said. “Now they are absolutely relentless.”
Escape from New York
Cheng, who recently moved his business headquarters out of New York, said the law will only hasten the migration of other firms out of the state.
“Targeting businesses that utilize affiliates based in New York is ultimately counter-productive because it only serves to drive business out of the state,” Cheng said. “New York is now losing companies whose business models depend on affiliate marketing, and [the state is losing] the resulting taxes these businesses generate.
“New companies will hesitate to set up shop in New York or hire remote New York employees for fear of being considered a New York-based company. And companies will decide to no longer do business with firms based in New York,” Cheng said.
Wearing Business Down
Sepp says he hopes Bransten’s decision will be overturned on appeal, but he worries about how long businesses can keep up the legal fight.
“Part of the problem in this controversy is that the state of New York has almost unlimited resources—tax dollars—to continue with their case, while Amazon and Overstock are limited by real-world financial concerns,” Sepp said.
“Just like the IRS wears down individual taxpayers by using every means of appeal until they win, New York’s tax officials seem bent on exhausting their opponents in court,” Sepp said.
Other States May Follow
Pieler said there are “rumors” Congress will eventually intervene and attempt to clarify the rules of interstate commerce, lest more states start imposing Internet sales taxes piecemeal.
“I expect no big, dramatic developments, but stay tuned,” Pieler said. “We may see continued efforts to erode the protection Quill gave to cross-border sales like New York’s. It seems to be an issue coming up in Florida right now.
“States are scrambling to find new tax revenue, rather than cut spending to deal with their own fiscal hangovers,” Sepp said. “And to many politicians, Internet sales taxes look like an easy target.”
James G. Lakely ([email protected]) is a research fellow at The Heartland Institute and managing editor of Infotech & Telecom News.