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Amazon Tax: Developments and Implications

Posted on 9.15.2009

by Geno Prussakov, AM Navigator

One of the biggest hot-button issues of online retail goes by many different names — “Amazon Tax” because of Amazon.com’s involvement in fighting it in New York and beyond; “affiliate tax” because it affects all parties involved in the affiliate marketing channel; and “Internet sales tax” because of the subject of taxation. But the most appropriate term is really “advertising tax.”

The inclusion of the word “Amazon” skews our focus from the problem to a particular merchant and its affiliate program. The word “affiliate,” on the other hand, generally implies a different meaning from what affiliate marketing relationships really entail. The 2002 edition of the “Compilation of State and Federal Privacy Laws” by Smith & Sulanowski states that, “the term ‘affiliate’ means any company that controls, is controlled by, or is under common control with another company.” Other sources refer to such elements as common ownership, control, and close commercial or operating ties which, in fact, make the traditional business/ legal definition of an “affiliate” almost antonymous to the online marketing meaning of the term. In the context of digital marketing, affiliates (sometimes called associates or publishers) are independent marketers who may choose to promote a business and be paid on a performance basis. They are the ones who choose what affiliate programs to promote or drop, what merchants to push aggressively, and on what merchants to spend less effort. They are selfmanaged, and generally not accountable to merchants for performance. They invest their own resources into advertising merchants, but are not involved in the process of a sale itself.

Due to the fact that affiliates are being unjustly singled out from the cohort of all other advertising channels of both online and offline merchants, the name “selective advertising tax” may be even more appropriate. But I have decided to go with “advertising tax” as the term to use here

Historical Overview
In November 2007, New York Governor Eliot Spitzer attempted to institute a bill to tax online sales of companies with no physical presence in the state, but that conducted business through New York-based affiliates. Spitzer argued that affiliates of a company should be perceived as equivalent to a company’s physical presence in the state. With backing from current New York Governor David Paterson, that bill became a law in April 2008. The next month, Amazon.com filed a complaint in the State Supreme Court in Manhattan challenging the constitutionality of the “novel definition of what constitutes a presence in the State,” and objecting to the inclusion of “any Web site based in the state that earns a referral fee for sending customers to an online retailer” (or hundreds of thousands of Amazon’s affiliates). Overstock.com opposed as well, but along with hundreds of other online merchants decided to terminate thousands of affiliates to avoid collecting the tax.

Along with the continuing economic crisis and slowing online sales, the year of 2009 brought more bad news for affiliates. A New York judge dismissed the Amazon lawsuit and Overstock’s complaints and other states started considering similar laws to help them deal with deficits in their budgets. California’s Assembly Bill 178, co-authored by Charles Calderon (D) and Nancy Skinner (D), was prepared in February 2009; at press time, the latest development was the ratification of the North Carolina Senate Bill 202. The latter has redefined the terms in North Carolina to include out-of-state merchants who reach $10,000 or more in yearly sales to North Carolina residents through North Carolina-based affiliates.

At press time, there were a total of 10 states either already affected, or considering advertising affiliate tax laws. Below is a list of these states and the statuses of the advertising tax bill in each:

• Calif. – vetoed by Governor on July 1, 2009
• Conn. – postponed
• Hawaii – vetoed by Governor on July 2, 2009
• Ill. – draft regulation issues on Dec. 2, 2008
• N.C. – in effect as of Aug. 10, 2009
• N.Y. – in effect as of April 2008
• Md. – dismissed by committee on April 13, 2009
• Minn. – vetoed by Governor on May 21, 2009
• R.I. – in effect as of June 29, 2009
• Tenn. – postponed


Constitutional or Not?
The constitutionality of such a law has been continuously questioned by Amazon since early 2008, and picked up by Overstock in some of its press releases and letters.

The case most frequently referred to is that of the 1992 case of Quil Corp. v. North Dakota. Back then, the U.S. Supreme Court held that taxing an out-of-state business violates the “Due Process and Commerce Clauses of the Constitution” which “prohibit a State from imposing the duty of use tax collection and payment upon a seller whose only connection with the State is through common carrier or the United States mail.” Therefore, it is said that an e-tailer must have a physical presence in the state to be required to collect a sales tax. And since the decision that set a precedent was made by the Supreme Court, it is also being held that unless Congress passes a legislation to delegate broader powers to the states, it is unconstitutional of states to do it on their own.

Whether the above assumptions are true or not, we see the nexus continuously being redefined to include electronic retailers that have no physical presence in the states, but advertise their products or services through affiliates.

Implications for Affiliates
Putting it all in perspective, we can define two sets of implications: (i) those on the immediate (state-specific) level, and (ii) those on the wider (nationally-spread) level.

Immediate Implications
Experience has shown that when such bills become laws, many merchants choose to terminate affiliates in the affected states rather than collect the additional tax. Recalling the state of New York experience, Overstock terminated New Yorkbased affiliates — as did CafePress, Foot-smart, Jewelry Television, uBid.com and hundreds of other merchants — in May 2008 after the state passed the “advertising tax” law. This not only caused thousands of companies to go out of business, but led to larger consequences.

Wider Implications
Recent research by the Center on Budget and Policy Priorities (cf: www.cbpp.org) predicts that, “at least 48 states have addressed or still face shortfalls in their budgets for fiscal year 2010 totaling $165 billion or 24 percent of state budgets.” It is becoming contagious to follow the New York example.

The snowball effect is already clear — the number of states looking into such anti-affiliate tax grew from one in 2008 to almost a dozen in 2009. As deficits grow and budgets get smaller, we are almost guaranteed to see more states consider this route. Both merchants and affiliates must be prepared. Instead of practicing a reactive approach, more merchants, affiliates and affiliate networks should be proactive in tackling the issue.

There is much written on the tax in various affiliate marketing forums and blogs (including mine), and it is important for Internet marketers to self-educate on the issue. At the same time, merchants should not be quick to terminate affiliates — instead, consider viable solutions. A recent poll by Shawn Collins, co-founder of the Affiliate Summit, showed that customers generally do not mind paying an extra tax on top of their online purchase — so why not collect the tax? Additionally, all affiliate marketers should be actively lobbying, writing to and meeting with their state representatives and senators.

There is a fundamental lack of understanding on the issue in the legislative circles, and unless a proactive approach is exercised, more state laws like this are inevitable. The positive results in Minn., Md., Calif. and Hawaii are encouraging, but more waves will undoubtedly follow. Are you ready?

About the Author: Geno Prussakov is a graduate of the University of Cambridge, author of “A Practical Guide to Affiliate Marketing” (2007) and “Online Shopping Through Consumers’ Eyes” (2008), popular speaker and affiliate marketing evangelist. Prussakov is the founder and CEO of AM Navigator, an outsourced affiliate program management (OPM) company.

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