Fight Over Affiliates

New battle lines form over sales taxes as states look online to raise revenue

To Overstock.com Inc. CEO Patrick Byrne, the battle over the so-called “Amazon Tax” on Internet sales received through online affiliates comes down to basic arithmetic.

The states that have such sales tax laws on the books—New York, Rhode Island and North Carolina—require Internet retailers to collect sales tax from all in-state customers if they also accept referrals from in-state affiliates that promote their products. But Overstock simply finds it bad business to continue accepting sales through the hundreds or thousands of affiliates it has in each of those states, Byrne says.

So unless those laws change in New York, Rhode Island and North Carolina, Overstock will no longer deal with affiliates based there.

Do the math

In New York, for example, affiliates represent about 1% of Overstock’s business and about 0.05% of its net profit there. But because New York represents about 10% of Overstock’s overall sales, it doesn’t make economic sense to maintain its affiliate relationships, Byrne says. Like other retailers facing the same issue, Overstock contends that charging sales tax scares away online shoppers.

“It comes down to, do we start charging sales tax on 10% of our business or give up 0.05% of our profit?” he says. “Even setting aside the additional costs of collecting and remitting sales tax, the economic effect is so horrible, it’s better to give up affiliate sales.”

That’s not the reaction state officials wanted when drawing up affiliate sales tax laws intended to raise tens of millions of dollars in tax revenue that they contend would otherwise go uncollected—more than $70 million a year in New York’s case, officials there say.

The affiliate sales tax laws—commonly referred to as the Amazon Tax because of the large effect they pose for online retailing leader Amazon.com Inc.—were designed to establish affiliates as equivalent to a physical presence maintained in a state by retailers receiving sales through those affiliates. According to a 1992 U.S. Supreme Court decision, a web-only retailer can only be required to collect sales tax from residents of states where the retailer maintains a physical presence.

A couple of months ago, affiliate tax laws appeared ready to go on the books in more states, providing a short-cut to requiring many online retailers to collect sales tax. There is a broader effort by the multi-state Streamlined Sales Tax Project to establish a national system that would require all Internet retailers to collect sales tax on orders from SST-compliant states, but that project has dragged on for several years.

Of particular note was the effort to pass an affiliate sales tax law in economically distressed California, which struck fear among opponents worried about seeing a second large state after New York get on board. But California reversed course amid rising controversy over the fledgling affiliate tax law movement, as Gov. Arnold Schwarzenegger of California decided to support local affiliate businesses in vetoing their states’ affiliate laws. Gov. Linda Lingle did the same in Hawaii.

Retailers at odds

Leading the charge against the affiliate taxes among online retailers are Overstock and Amazon.com, each of which is appealing a court decision early this year that upheld the constitutionality of New York’s law.

And though Amazon is collecting sales tax in New York while waiting out its court appeal, online jewelry retailers Blue Nile Inc. and Goldspeed.com Inc., along with many smaller retailers, have severed relationships with affiliates in states with affiliate tax laws. “Small retailers are pulling out left and right,” says Bill McClellan, vice president of government affairs at the Electronic Retailing Association, a trade group that represents retailers that sell through TV and the web.

The sales tax issue has divided retailers for years, with some chains with many bricks-and-mortar stores supporting sales taxes on online sales, hoping to eliminate an edge that web retailers enjoy. Several state retail associations representing retail chains have lobbied state governments in favor of the affiliate tax laws as a way to immediately begin forcing web-only merchants to collect sales tax in more areas, McClellan and others say.

But the National Retail Federation, though also dominated by large retail chains that already must collect sales tax on Internet sales from states in which they have stores, opposes the state affiliate laws as counterproductive to the goal of a national Internet retailing sales tax system formed under the SST, says J. Craig Shearman, vice president of government affairs for the NRF.

Frustration over SST

Affiliate tax supporters contend, however, that the SST project may never get supporting federal legislation. “States are frustrated with not moving forward with the Streamlined project, and not seeing enough new money collected, so this affiliate law is an easy sell for some legislators,” says Neil Osten, federal affairs counsel of the National Conference of State Legislators.

It has been difficult to establish a streamlined system because many states want their own rules, such as which food products are not taxed. Without a system with common rules and definitions, it would be a burden for retailers to collect and remit taxes in each state and local tax jurisdiction, and that makes it tough to win enough political support to pass federal legislation, says Jerry Cerasale, senior vice president for government affairs at the Direct Marketing Association, a trade group for Internet and direct-mail marketers that opposes online sales taxes.

Underscoring the states’ demands for action are estimates from the University of Tennessee that state and local governments will forfeit between $11.4 billion and $12.65 billion in uncollected sales tax by 2012 without a change in laws affecting Internet-based sellers. Although those estimates include business-to-business sales, supporters of the SST say it could recoup as much as 25% of the $12.65 billion.

The SST’s long-term hope is to include all 45 states that have a sales tax law, says Scott Peterson, executive director of the SST Governing Board. Today, 23 states are participating.

To win political support for federal legislation, the SST must prove to Congress that it can develop a system that makes it economically feasible for Internet and other direct retailers to identify, collect and remit sales tax across state borders. To do that, it has set out to streamline sales tax laws, including the definitions of what’s taxable, across its member states, and certified four software applications designed to process sales tax across multiple states for remote retailers.

There are about 168 retailers using sales tax collection software from vendors certified by the SST Governing Board. Those vendors are Avalara, StrikeIron Inc. (SpeedTax service), Exactor Inc. and Automatic Data Processing Inc. “There are probably thousands of other retailers collecting sales tax with their own software,” Peterson adds.

Retailers that want to use their own in-house tax-collection systems can download the sales tax rate for any tax jurisdiction within SST-participating states by entering a nine-digit ZIP code on the state’s web site, he says.

But many e-retailers still reject multi-state tax collection.

“Our online abandonment rates definitely go up when people see a sales tax charged by online merchants, but it’s not only the sales tax that’s a problem,” says Neil Kugelman, CEO of Goldspeed, which for now collects sales tax only on orders from its home state of New York. “It’s bookkeeping and filing, and every state has its own methods. It’s extremely burdensome for retailers to take this on.”

The impact on consumers, however, may not be that bad, says Colin Sebastian, who covers e-commerce stocks as senior vice president of equity research at Lazard Capital Markets. “Our checks with e-commerce companies that already collect sales tax indicate a fairly limited impact on buying trends,” he says, “as the key drivers of e-commerce are convenience and ease of use in addition to good value.”