Amazon, Overstock, Lose Round One Against NY Online Tax Law

Jan 21, 2009 7:58 PM  By

Amazon.com and Overstock.com have lost the first round of their lawsuits challenging a relatively new tax law allowing the state of New York to collect sales taxes from Web retailers with no physical presence in the state.

Overstock.com has already announced it will appeal the decision handed down last Tuesday by New York state supreme court Justice Eileen Bransten, who dismissed the suit in its entirety “for failure to state a cause of action.”

The law, signed into effect by New York Gov. David Paterson last April, requires out-of-state online retailers to collect state and local sales taxes when they makes sales to New York state residents. New York is the first state to impose such a law. It is expected that some or all of the 44 other states with sales tax will eventually pass similar laws.

The measure is expected to raise about $50 million a year for the state budget. Companies collecting less than $10,000 per year from New York residents are exempt.

Attorneys for Amazon.com and Overstock.com challenged the legality of the provision, arguing that it is bad for Internet commerce, due to the burden it places on merchants. They also allege it violates a 1992 U.S. Supreme Court decision, Quill Corp. vs. North Dakota, that says states are not allowed to require out-of-state companies to collect sales taxes unless the company has a physical presence, such as a store or warehouse, in the state.

In a statement, Jonathan E. Johnson, president of Overstock.com, indicated the company was willing to take the case all the way to U.S. Supreme Court.

Before the law took effect June 1, Overstock.com cut ties with 3,400 New York-based affiliates. This was done to shield the merchant from having to collect state sales taxes.

Jerry Cerasale, senior vice president of government affairs for the Direct Marketing Association, says the case will probably play out for a while longer, now that Overstock has announced its intention to appeal.

“This is a stretching of the definition of physical presence within a state,” Cerasale says. “The law as it currently stands in the U.S. — from the Quill decision — is that it’s an interference of interstate commerce for a state to require and out-of-state marketer to become an out-of-state tax collector. This is a means for a state to try and expand the definition of presence so that companies like Amazon.com and Overstock.com would become in-state marketers.”

What makes the law problematic, he says, is that it “defines any company with a Web site that directs customers to an out-of-state online merchant’s Web site, such as Amazon.com, as an agent working on behalf of that out-of-state merchant.”

“These are individuals who are simply referring potential customers to Overstock.com or to Amazon.com – from their site to Amazon’s/Overstock’s site,” he explains. “And they get a commission if there’s a sale.”

For example “if you’re a book reviewer in New York, and you tell visitors to your Web site they can purchase the book on Amazon.com, and you give them a link, and you collect a small commission on the sale, then you are acting as a sales agent for Amazon.com under the proposed law,” he explains. “They’re saying that creates nexus.”

Cerasale says New York “did qualify that a little bit by saying the affiliate has to do a little more than just be a passive bounce to the other site – but this expansive definition of referral marketing to create presence we see as problematic. We think it hurts the Internet – and it hurts how e-commerce works. So we support the positions of Amazon and Overstock.”

“Our view on this is there really is no presence for Amazon or Overstock in New York State,” he adds. “They have employees – but they don’t have agents.”

Cerasale says the DMA’s role for now is to educate merchants about the new law “so they can make their own decisions on how they want to set their businesses up — whether they want to continue with their current practices or discontinue them.”

The enforcement and reporting aspect of the new law is particularly problematic, he says. As other states move to adopt similar laws, it will require online merchants to keep track of which tax jurisdictions they are shipping to, and to collect the appropriate amount of tax for each jurisdiction.

“This will create a huge burden on the businesses, at a time when — clearly — you don’t want to burden Internet commerce,” he says. “We’re in a severe recession and the Internet is one of the more vibrant commerce engines of our economy. The last thing you want to do is put a damper on it.”

So how will the enforcement of the new law work?

“Simple: New York is going to audit you – no matter where you are located,” Cerasale says. “They’re going to come in and demand your records. Remember that when you’re a remote seller like Amazon — or any cataloger — you delivered the goods someplace. So if you delivered them to New York address, they’re going to come in and look at every single sale you had and see where it was delivered.”

Problem is, there are thousands of online merchants with more than $10,000 a year in sales.

“If every state does the same thing – and there are 44 states with a state tax – then every remote seller on the Internet is going to have to have a tax department to handle the audits from the 44 states.”

“Some of the states think that this online sales tax is going to lead them to a huge pile of money,” Cerasale says. “But the DMA did a study that shows that you have, at most, maybe $2 billion to $3 billion in collectable taxes – and even Forrester Research found it was about $3 billion. So it’s not as much money as the states think it is.”

Is it a forgone conclusion that other states will follow New York’s lead?

“I know other states are watching this, so I can’t imagine that they won’t try to do something similar,” he says. “Except that it could hurt their ability to attract businesses. They could drive businesses out. Look at what Overstock did – it severed its ties with everyone who they did business with in New York.”

“How much did that hurt the state? Hard to say,” he adds. “But you can be sure it hurt. So the states have to think about – what if the merchants change their model to avoid creating this nexus? What economic effect does that have on our state? It may cancel out anything they collect in revenue.”