No More (Tax) Free Lunch

Since the beginning of Internet commerce, the dirty little secret was that you could buy many things tax-free.  It all started with mail-order catalogs.  In 1967 the Supreme Court ruled that states could not require mail-order companies to collect sales tax if they did not have a physical presence in that state.  This ruling was reaffirmed in 1992.  Technically, you are required to pay a "use tax" on these out-of-state purchases, but rarely have state government ever followed up on it.

That may be changing.

In New York, then-Governor Spitzer decided that Amazon's Associates program amounted to a physical presence ("nexus" in legalese) in the state.  Associate programs, also called affiliate or referral programs, are systems that larger retailers use to drive business to their site.  I could write a rave review of my favorite camera lens on this site.  Someone reads that and says "I just gotta have it!"  They click a link and are taken right to the page on Amazon.com where they can buy the lens.  Amazon makes an easy sale, the user doesn't get bogged down in Amazon's A.D.D.-inspired front page and I get a little kick back for sending a hot tip Amazon's way, usually 3 - 6% of the sale.  This is how many price comparison website make money.

According to Spitzer, all those bloggers in New York who had Amazon links to the latest books they were reading amounted to Amazon having a physical presence in the state.  And now New York's State Supreme Court agrees.  It is requiring companies that do more than $10,000 of business in New York to collect sales tax on those transactions.

Does this mean the end of tax-free internet shopping for the rest of us?  Probably not.  It may mean the end of the Amazon Associates program in New York -- that was the reaction of Overstock.com -- though Amazon claims the program will remain unchanged.

New York officials estimate an additional $50 million per year in revenue from closing what they characterize as a tax loophole.  Washington State estimated they lost $260 million in 2007 to unpaid use taxes from mail order and e-commerce, but that same report also realizes that it would be prohibitively expensive to enforce payment, especially on individual purchases.

What next?  Most likely the ruling will be appealed, and since the complaint involves the Commerce Clause and the Due Process Clause, it could go as far as the U.S. Supreme Court. 

The North Dakota Supreme Court ruled was the "remarkable growth of the mail order business" going from a "relatively inconsequential market niche" to a "goliath" that gave them grounds to ignore the 1967 U.S. Supreme Court ruling in Bellas Hess v. Illinois.  The U.S. Supreme Count overturned that ruling in 1992, upholding Bellas Hess and requiring a physical presence to collect sales tax.  However, it also says that independent contractors that solicit business for a company constitutes a nexus in that state.

That will likely be where this case hinges: are associates independent contractors?  What about a website that simply provides ad space for Amazon?

I imagine most online retailers will be watching this case closely.