April 26, 2012, 9:54 AM

‘Amazon tax’ is thrown out by a Chicago-area judge

The Illinois law tied online sales tax collection to affiliate marketing.

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An Illinois law mandating online sales tax collection by e-retailers that maintain affiliates in the state was thrown out Wednesday by a Cook County Circuit judge.

Judge Robert Lopez Cepero ruled that the Main Street Fairness Act, enacted in March 2011, was invalid because e-retailers do not create a physical presence, or nexus, in the state simply through affiliate marketing relationships. Affiliate marketing refers to the practice of web site publishers such as blogs earning a cut of purchases from Amazon.com Inc. and other retailers made via product links on the smaller sites. Federal law allows tax collection only from online retailers that have a physical presence in a certain state; generally, this has been interpreted as such operations as stores, offices and warehouses, a view reinforced by Wednesday’s ruling. The Illinois law and similar laws passed in other states attempt to widen what constitutes that physical presence.

The state’s Department of Revenue has estimated that collecting sales taxes under the levy, which was commonly called an Amazon tax because of the retailer’s prominence and large affiliate network, would bring in up to $170 million annually. State law already requires consumers to voluntarily remit such taxes to the state, but few shoppers do.

Cepero on Wednesday also said the Illinois law violates the 1998 Internet Tax Freedom Act, which generally prohibits certain types of taxes on web use and transactions until Nov.1, 2014, as well as the U.S. Constitution’s Commerce Clause, which gives the federal government oversight of interstate commerce.

The Department of Revenue was the defendant in the case. “We respectfully disagree with the court's ruling and are reviewing our appeal options with the Attorney General’s office,” says a spokeswoman for the revenue department. “We need to protect brick-and-mortar stores from an unlevel playing field.”

The California-based Performance Marketing Association was the plaintiff. The trade group for affiliate marketers argued that the Illinois law was “premature,” given the 2014 moratorium under the Internet Tax Freedom Act. “We are thrilled with the outcome of today’s proceeding and believe it paves the way for Internet marketing affiliates to get back in business in Illinois,” says Rebecca Madigan, the group’s executive director. “We commend Judge Cepero for his timely and thoughtful decision.”

The trade group estimates that 1,000 out-of-state retailers severed their ties with Illinois affiliates after the law was enacted, and that 9,000 affiliates were affected. “We do expect an appeal,” she says. “Our attorneys indicated this may go straight to the Illinois Supreme Court, since we won on constitutional grounds.

Neither Amazon nor the state’s Department of Revenue immediately responded to requests for comment.

Such laws in Illinois and other states have moved retailers such as Amazon, No. 1 in the Internet Retailer Top 500 Guide, and Overstock.com Inc., No. 27, to cut ties with affiliates rather than run the risk of having to remit taxes for online purchases.

Online discount provider CouponCabin.com, which provides digital coupons that would be subject to taxes under the state’s law, was based in Illinois but moved to Indiana because that state had no similar law. “This ruling places the responsibility for a solution back where it belongs: in Congress,” says CEO Scott Kluth. “CouponCabin continues to strongly support a federal solution to the taxation of all online transactions.”

Stephen Kranz, partner at Sutherland Asbill & Brennan LLP, will discuss the online tax issue at the Internet Retailer Conference & Exhibition 2012 in Chicago in June in a session titled “The new urgency for developing a state sales tax strategy.”

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