States are hurting for tax revenue. This has led several to expand the definition of a nexus, or a place of business, to try to collect more sales tax. In particular, New York, Hawaii, North Carolina, and Rhode Island all want members of affiliate programs to act as nexuses for the companies, like Amazon.com, that pay out commissions. California, teetering on something like bankruptcy, is next to go after affiliate programs.
That poses a problem for Amazon in particular as the largest online-only retailer. Amazon’s closest real-world equivalent for discount pricing and selection is Walmart, no matter how much that riles both companies. But Walmart collects sales tax everywhere it does business remitting it to the state and taxing districts in which each store is located. Amazon offers its customer an effective discount, as the firm is not required to (nor does) collect sales tax on behalf of most states in which its customers receive goods. That can amount to an extra 5 to 10 percent saving for the customer, depending on locality.
Currently, Amazon.com sales are taxed in Kansas, Kentucky, North Dakota, and Washington—its headquarters state. Its closest competitor for media (books, DVDs, and music), Barnes & Noble, operates stores in all states, and also collects sales tax everywhere for BN.com. Barnes & Noble tried to structure its online division separately to avoid being saddled with sales-tax nexuses, but had to abandon that years ago.
Amazon has driven some operational decisions based on sales tax. Its first massive warehouse was opened in Fernley, Nevada, even though it might have made more sense to put it in central California, closer to the state’s tens of millions of customers and Silicon Valley. But goods shipped from Nevada to California don’t have California sales tax levied on them.
Amazon’s strategy may be sinking, though. States are looking for revenue sources they haven’t tapped, and online sales represent a missing piece of the pie.
Between a federal law that limits taxes that can be levied on Internet business (especially services), and a 1992 U.S. Supreme Court decision that restricts how mail-order companies may have their goods taxed by states, you’d think this wouldn’t be low-hanging fruit. Think again. Affiliate programs run by Amazon and thousands of other firms may provide the thin edge of the wedge for the state taxman to crack the online sales oyster.
Affiliates programs let Web sites with no connection to a given business promote products and services in exchange for a typically monetary reward from the actual company, like 5 percent of a sale or $15 for a referred customer who sticks with a company for 90 days. There are likely millions of affiliate Web sites, which might range from a site on parakeets with links to parakeet paraphernalia to the New York Times, which links to online bookstores for books the newspaper reviews or lists.
Affiliates are probably best used at creating new customers for a business. The cost of acquiring new customers is often the largest marketing expense; keeping a customer is typically far cheaper. For the affiliate, the revenue can be anywhere from a few dollars a month to the underpinning of a large business.
The key question is whether affiliates count as a nexus. Until the last few months, no state would claim that a publisher (what the affiliate is called) acted as a representative for the purposes of doing business for the advertiser (the company running the affiliate program). Affiliates don’t handle merchandise, and the very fact that the nomenclature is advertiser/publisher makes the programs seem hands off.
But times are tough, and states are willing to push the issue. States have the right to collect sales tax from individuals who haven’t paid tax on an item they have purchased. This is called use tax, and every state that has a sales tax also tells its citizens that goods purchased from outside the state brought into the state for personal or business use (whether via mail order or by crossing a border and back) must have use tax paid.
States have had a long-running battle first with mail-order catalog firms, which shifted as catalogs become ecommerce stores and new companies arose online only. In 1992, the Supreme Court reaffirmed an earlier ruling that allows states to pursue sales tax only from businesses with a physical presence in the state, but it had no effect on use tax.
States see the use tax that they have not collected as revenue that’s gone missing, in a form of tax evasion. You’ll see prosecution for failure to pay use tax on big-ticket items, like boats, cars, and jewelry. In Washington state, as in many states, you can’t register a car until you show proof you paid sales tax in another state—if you bought the car in Oregon it doesn’t count—or pay Washington what the piper is due.
We have no income tax in Washington, but the state does have a use tax form for consumers, which I imagine the tax department receives at least 3 or 4 of per year. The state informs us that anything we buy for which sales tax wasn’t collected in another state or in Washington is subject to use tax—including, say, furniture purchased via Craigslist. (Businesses are more likely to pay use tax because it’s a section of the business and occupation tax form, and the state does conduct B&O audits.)
The gap for states is that it’s impractical to collect use tax, and unconstitutional to demand sales tax collection and remittance by companies that lack nexuses in the state. To jump that gap, states are thus justifying that affiliate programs constitute a nexus.
That seems a stretch. The Supreme Court decision has a number of tests and explanations about what a nexus should be, and was pretty clear that firms that only dispatch goods by U.S. mail or package-delivery services don’t have nexuses.
As independent, non-exclusive marketing agent, affiliates neither receive nor ship goods, and may be referring traffic largely or even entirely to people outside the state in which they live. I run a book price shopping service (isbn.nu), and I imagine that a large percentage of my customers aren’t in Washington state.
Amazon among other large retailers have gotten tough about this. The company filed suit in New York and is appealing a decision against them. The firm has severed all affiliate contracts in Hawaii, North Carolina, and Rhode Island, and is considering its moves as other states move forward.
The impact on consumers is both small and large. If California joins the movement, then a good quarter of Americans won’t be able to buy most goods online without paying local sales tax, which means people may buy less, depressing consumer sales or having less money in their pocket.
The upside is that if you’re not avoiding sales tax from an online merchant, you might find that a local store has about the same price as the online price, and that could boost local businesses at the expense of ecommerce. That’s not necessarily a bad thing.
Online stores and services could cancel all their affiliates in each state that adds the affiliate nexus provision, which negates the laws’ effect, but also reduces revenue coming into each state from affiliates who get an income stream from the various sites.
On the whole, it’s an ugly mess. The only saving grace is that the Supreme Court reserved to Congress the right to impose a federal solution to interstate sales tax. If Congress chose, they could require that all firms that ship from one state to another collect on behalf of and remit sales tax to the state in which a customer lives. Imposing the burden nationally and uniformly would reduce confusion.
But how likely is Congress to approve anything that smacks of a “new” tax right now, no matter how old it is?
(Disclosures: I worked at Amazon.com at the time it was developing the associates program, but had no connection with that program. I’m also a member of many affiliate programs as part of my book price-comparison site, isbn.nu. Since I’m in Washington, Amazon won’t need to take any action here.)
