As states struggle to balance their budgets and increase revenue in tough economic times, a new fight has been playing out over tax collection of online retailers.
Seattle-based Amazon.com Inc., the world’s leading Internet retailer, has been waging a war in the state of California.
No Tax for Online Retailers
Retail companies doing business online have largely avoided paying sales tax on behalf of their customers in most states, by citing in 1992 Supreme Court decision (Quill Corp. v. North Dakota), which declared that retailers must pay taxes in the states, which they operate.
The court ruled, when the Internet was still in its infancy and no Web retailers existed, that companies should only collect sales taxes in states which they have operations, which means a physical presence, with actual workers and offices or warehouses.
Essentially, the decision was based upon the rationale that taxes are a means to fund state-level governmental expenses and pay for social and governmental activities at the state level.
But if an individual or company cannot benefit from that activity—due to not residing in the state—they should not have to pay for that.
The 2004 Internet Tax Freedom Act (ITFA) will be in effect through November 2014. The law does not prohibit states from enforcing current Internet tax rules on businesses, but prevents states from imposing new tax measures.
For Amazon, it only collects sales tax in four states in which it deemed to have a major presence—North Dakota, Washington, Kentucky, and Kansas—while in other states, it sells its wares through affiliated companies, and other subsidiaries, which it argues, do not amount to “physical presence.” In addition, it collects and pays sales tax in the state of New York (more on that later).
But with the advent of e-commerce and an increase in online shopping, states and many economists believe that the failure to collect sales tax in the 45 states that have sales taxes amount to lost revenues. According to a recent study by the University of Tennessee, states are in total losing out on revenues of more than $11 billion.
Today, more than 11 states have enacted some form of sales tax collection law over Internet retailers. But California this month took the law further, interpreting the presence of any affiliate of an Internet retailer as having physical presence in the state.
With the new law, California seeks to collect sales tax revenues from some of the biggest Internet retailers, the biggest of which is Amazon.
Amazon, after dropping more than 10,000 affiliates in the state of California before the law came into effect on July 1, has taken its fight to the ballot box. The company introduced a referendum (called “AB 28x”) in California for voters to undo the law in the next statewide election.
For Amazon, this is a substantial fight worth billions of dollars in revenues. In a Securities and Exchange filing earlier this year, it said that any state-level legislation to enforce sales tax collection could “result in substantial tax liabilities for past sales, decrease our ability to compete with traditional retailers, and otherwise harm our business.”
The New York Precedent
The state of New York in 2008 passed a law requiring Internet retailers to pay sales tax on revenues made within the state.
Amazon, along with numerous other Internet retailers, have largely complied. And according to the state’s Department of Taxation and Finance, more than $250 million have been collected ever since.
But unlike the California law, New York did not seek to expand the definition of “physical presence.”
Amazon has challenged New York’s laws in court, and while the state’s trial and appeals court have both upheld the law, several cases in the lower courts are still pending.
Brick and Mortar Stores Behind the Opposition
Brick and mortar stores and big-box retailers have lined up in support of California’s new tax collection laws, with one of the biggest proponents being an organization called The Alliance for Main Street Fairness.
“Amazon will do anything and say anything to maintain the special deal that allows them forgo collecting sales taxes, while local retailers are required to do so,” said Danny Diaz, a spokesperson for the alliance, in a statement. The alliance seeks to represent small businesses and local “mom and pop” stores.
To go one step further, the organization blamed the recent demise of Borders Booksellers on Amazon. “Special treatment for Amazon.com is decimating job providers like Borders and countless small businesses across the country,” the alliance said in an online posting last week.
The alliance said on its website that it is funded by employers seeking a “fair and balanced approach concerning sales tax collection.” While a spokesperson declined to reveal the biggest funding contributors to the alliance, ZDNet, an Internet information website, revealed that some of the biggest big-box retailers are behind the alliance, including Wal-Mart Stores Inc., Barnes & Noble Co., Target Corp., and Best Buy Inc.
While few of those big-box retailers would traditionally be seen as an ally of small retail businesses, online retailers such as Amazon and Overstock.com do represent common enemies.
Their efforts are gaining support in multiple states as they battle to balance their budgets. Sen. Dick Durbin (D-Ill.) earlier this year said that he would support sales tax for online businesses. “Why should out-of-state companies that sell their products online have an unfair advantage over Main Street bricks-and-mortar businesses?” Durbin asked in a speech in April 2011.
But according to some small businesses in California, the new measure doesn’t just target Amazon, but also hurts Amazon’s affiliates, most of which are small businesses or charities based in California.
“Your local soup kitchen might put up a link on its website to some products on Amazon. When folks buy those products, the soup kitchen gets an affiliate commission. Now, they won’t get that money,” read a statement from Sacramento, Calif.-based CalWatchDog.
“Essentially this is a California small business tax, so ultimately it hurts businesses like ours,” Loren Bendele, who is CEO of Savings.com, said in a statement. “When Illinois passed this law, all the major players in our industry moved out of the state. I’m afraid this will have a similar impact on California and cause the tech industry to migrate to other states.”