February 24, 2010, 12:00 AM

Drs. Foster and Smith drops affiliates in anticipation of online tax law

As California lawmakers discuss taxing online sales, Drs. Foster and Smith, an online pets supplies retailer, has cancelled its nationwide affiliate program.

As California lawmakers again discuss taxing online sales, Drs. Foster and Smith, an online seller of pet and aquatic supplies, has cancelled its entire, nationwide affiliate program in response. It’s one of the most dramatic moves yet by a web retailer worried about the effects potential impact of cash-strapped states moving to tax online sales.

“The sudden nature of the move by California to reintroduce legislation late last week and to push for a quick vote, emphasized the ever-changing nature of this issue and our need to be ahead of such votes and decisions,” Drs. Foster and Smith wrote in a letter to affiliates this week. The e-retailer, No. 100 in the Internet Retailer Top 500 Guide, said it was canceling its affiliate program as of Monday, Feb. 22.

Drs. Foster and Smith was reacting to a sales tax bill that has won state Senate approval and is now before the state assembly. It would force web retailers that work with California-based affiliates to apply the state sales tax-which has a minimum rate of 8.25%--to sales made by California consumers. Existing law requires California-based online retailers and out-of-state retailers with warehouses or offices in the state to charge sales tax on online purchases.

California Gov. Arnold Schwarzenegger, a Republican, threatened in July to veto similar legislation after such online retailers as Amazon.com, No. 1 in the Internet Retailer Top 500 Guide, and Overstock.com Inc. said they would cancel their California affiliate programs if the law took effect. Legislative and press estimates put the number of Amazon affiliates in California at 25,000. Amazon declined to comment on the 25,000 figure.

“The imposition by state and local governments of various taxes upon Internet commerce could create administrative burdens for us, put us at a competitive disadvantage if they do not impose similar obligations on all of our online competitors and decrease our future sales,” said Amazon in its most recent annual report.

Schwarzenegger’s spokesmen have given signals that he will veto this new bill. But, even if he does, it seems unlikely the issue will go away given that California faces a budget deficit of about $20 billion. The California bill could raise an estimated $150 million annually from online sales, according to legislative and press estimates.

“Why is California trying to grab money wherever it can? Because California is broke,” says Jonathan E. Johnson III, president of Overstock, No. 28 in the Internet Retailer Top 500 Guide. Johnson says Overstock cut ties with more than 4,000 affiliates in New York after that state passed a similar law, and will do the same in California or any other state that starts collecting taxes from online sales.

For Drs. Foster and Smith the issue is not only the potential loss of revenue from consumers making fewer purchases as a result of the tax, but also the complications of collecting taxes imposed by a variety of agencies and districts, whether local, state or special-service areas, such as those enacted to fund stadiums, says Gordon Magee, the retailer’s Internet marketing and media manager. Those various agencies would have different deadline dates for sales tax remittances and potentially significant penalties for missing those deadlines.

“With the number of states looking at this kind of thing, it’s important not to be on the wrong side of a date when things get started,” he says.

Drs. Foster and Smith also is concerned that applying sales tax to online retailers, even if only through affiliates, will lead to the imposition of corporate income taxes for online retailers, Magee says.

The pet supply retailer had a couple of thousand affiliates nationwide, Magee said, each of which earned commissions between 8% and 15% for sales driven through their links to Drs. Foster and Smith. “They did a nice piece of business for us,” he says, declining to be more specific.

States seeking ways to shore up budgets are using a 1992 U.S. Supreme Court decision to bolster their efforts to tax online sales. The ruling enables states to require sales tax collections by online retailers that have a physical presence, such as a headquarters office or distribution center. Backers of online sales taxes argue that affiliate programs constitute a presence, or nexus in legal terms, and that requiring online retailers to collect sales tax eliminates an unfair advantage they have over stores.

Supporters of the California tax bill say there are other advantages for the state. Lenny Goldberg, executive director of the California Tax Reform Association, which supports the tax, says the loss of affiliates will result in more shoppers buying goods from California-based merchants instead of through links to out-of-state online retailers. “The tax is good for California, it’s good for state business,” he says.

The National Retail Federation, reflecting the view of many retail chains, supports sales taxes on online retailers. The views of many bricks-and-mortar retailers were expressed this week by Edward Lampert, chairman of Sears Holding Corp., in his annual letter to stockholders. “I would propose that there be a leveling of the playing field for e-commerce merchants. Either we all collect taxes or nobody collects taxes,” Lampert wrote. “If state and local governments are going to require retailers like Sears and Kmart to collect sales taxes and not retailers like Amazon.com, they should recognize that over time their sales tax base will erode significantly and that they place companies who have chosen to locate stores locally at a competitive disadvantage.”

Drs. Foster and Smith is No. 105 in the Internet Retailer Top 500 Guide. Sears owns Kmart.

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