In the continuing effort to try to shore up their budgets, many states are looking at Internet-based businesses as a source of potential funds. States have tried and failed before in their attempts to tax Internet-based businesses, seeing them as potential sources of untapped sales tax revenue, and have been rebuffed in every attempt, as the laws have been declared unconstitutional.
Rhode Island is the latest state to join in the effort, following a 2008 New York law defining 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, leading to lawsuits from Internet retailers.
In their lawsuits, Amazon and Overstock.com 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.
“We understand that many states have worked themselves into a serious budget crisis and thus are looking for any way to increase their revenues,” said Jonathan Johnson, president of online retail firm Overstock.com. “However, passing laws that are unconstitutional is not the way for them to solve their problems. Rather than try to make companies like Overstock.com their sales tax collectors, they should focus on ways to reduce their budgets. That’s what businesses do when they are in tough times.”
State Revenues Could Fall
Such taxes will actually hurt state revenues, Johnson says.
“These types of laws will have a negative impact on state revenues. Overstock.com and others like us will continue to terminate our affiliate advertisers in every state that passes affiliate nexus legislation. This will mean these small businesses–the affiliate advertisers–will suffer a loss income, and companies like Overstock.com will still not be collecting taxes for the states.”
Overstock and Amazon dropped hundreds of affiliate advertisers in Rhode Island and several other states this summer as the states moved to impose taxes on sales generated by affiliate advertisers. The companies had already dropped thousands of affiliate advertisers in New York after that state imposed its taxes in 2008.
Yet Johnson sees little direct impact on his firm.
“It won’t affect Overstock.com too much. Consumers find affiliate advertisers regardless of where they are based. We did not experience a significant change in affiliate sales when we terminated our [approximately] 4,000 New York-based affiliate advertisers. What states that pass these laws are really doing is forcing business [to move] outside their borders.”
Supreme Court Blocked Taxes
In Quill Corp. vs. North Dakota, the U.S. Supreme Court in 1992 ruled forcing out-of-state merchants to comply with thousands of state and local tax jurisdictions would be an unconstitutional barrier to interstate commerce.
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. The laws in question seek to designate local, independent Internet advertisers as giving the online retailers a physical presence, or nexus, that obligates them to collect the tax.
This leads to many problems as different taxing authorities (counties, municipalities, etc.) each have their own tax rates. Internet retailers have long argued the accounting for all of these different jurisdictions would be too cumbersome to handle, and that many small Internet retailers would be driven out of business if forced into this undertaking.
“We think the prospects [for Overstock.com’s lawsuit] are very good, but we recognize that we may need to appeal all the way to the United States Supreme Court,” Johnson said. “In the Quill case, the U.S. Supreme Court was very clear about what the law is in this area.”
Phil Britt ([email protected]) writes from South Holland, Illinois.