Overstock, Amazon Fight Online Sales Tax

Published August 1, 2008

Overstock.com has become the second online retailer to mount a legal challenge against a New York law that effectively defines them as state-based merchants, forcing them to collect sales tax on purchases made by consumers who reside in the Empire State.

A new statute passed by the New York legislature April 9 attempts to circumvent a 16-year-old U.S. Supreme Court ruling that prohibits a state from collecting sales tax from any merchant that does not have a “nexus,” or physical location, within the state.

The statute defines any New York-based third party who collects a commission on sales to an out-of-state merchant through referrals, specifically “clickthroughs” from Web site advertising, as an in-state “nexus” for that merchant. The statute went into effect April 15.

Threatens Net Ad Model

Paying commissions for Web clickthroughs that result in sales has become a common model for online advertising. Amazon.com, through its Amazon Associates affiliate marketing program, provides hundreds of thousands of Web sites with links to its site in exchange for commissions of up to 10 percent. Amazon estimates it has about 10,000 affiliates with New York addresses.

Retailers who use New York-based Web sites for advertising and referrals had until June 1 to register as New York businesses or risk civil or criminal action. The average sales tax in New York is 8 percent.

“Online companies are experimenting with a number of advertising-based models to help generate sales and support content,” said Braden Cox, policy counsel for NetChoice, a coalition of trade associations, eCommerce businesses, and online consumers.

“New York’s new sales tax law strikes a blow at one of these ways–referrals through Web site affiliates–and imposes an entirely impractical burden on out-of-state online companies either to prove that affiliates are not soliciting business or collect and remit sales taxes on all sales to New York residents,” Cox said.

Shifts Burden to Business

The statute is little more than an attempt to shift the burden and cost of sales tax collection to merchants, said Steve DelBianco, vice president for public policy at the Association for Competitive Technology (ACT). Most states, including New York, require consumers to self-report purchases from out of state and pay sales taxes on them, although states rarely enforce the rule, he said.

ACT opposes the tax and, as a member of the American Legislative Executive Council’s Telecom and IT Task Force, has proposed model legislation that would allow states to legally protect targeted resident merchants from aggressive sales tax laws enacted in other states.

Challenged Over Commerce Clause

Amazon.com, though registering in New York to be in compliance, immediately responded with a lawsuit, claiming the statute runs counter to Quill Corp. v. North Dakota, a 1992 U.S. Supreme Court decision that found forcing out-of-state merchants into a situation where they would have to comply with as many as 6,000 state and local tax jurisdictions would be an unconstitutional barrier to interstate commerce. Overstock’s suit challenges the New York statute on the same grounds.

“The applicable United States Supreme Court cases on the question of whether the state can collect taxes under these circumstances make it clear that New York cannot constitutionally require Overstock.com to collect these taxes,” said Mark Griffin, Overstock.com general counsel, in a statement.

In their suits, Amazon and Overstock both say they can’t determine whether affiliates are actual legal residents of New York or whether their Web sites are hosted within the state, nor can they control the affiliate Web sites or determine whether a specific ad is a direct or indirect solicitation for business.

Overstock brought its suit against the state in June and has begun terminating its relationships with its 3,400 New York affiliates, informing them it is specifically because of the new statute.

Alternative Offered

The National Retail Federation (NRF), despite its support for frameworks such as the Streamlined Sales Tax Project (SSTP), a program adopted so far in 18 states that offers a simplified way for out-of-state merchants to collect sales taxes voluntarily, has announced its opposition to the New York statute.

“It’s a bad idea,” said Maureen Riehl, vice president of NRF’s government and industry relations council. “We think New York is taking the wrong approach.

“The term ‘affiliate’ was left undefined in order to give broad latitude to the [New York] Department of Revenue to decide on a case-by-case basis,” Riehl said. (See sidebar.) Unlike SSTP, which NRF says will create a fair playing field between brick-and-mortar retailers and their online competitors, the New York law will hurt all businesses, she said.

The tax itself grew out of the state government’s attempts to close a $4.3 billion budget deficit. Former Gov. Eliot Spitzer (D) last November attempted to push through similar legislation.

Although the initial attempt failed and Spitzer has since left office, the taxation idea survived to pass the state legislature this spring.

Steven Titch ([email protected]) is a telecom policy analyst for the Reason Foundation.