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States Grasping for Sales Taxes Sacrifice Affiliate Businesses July 10, 2009

Posted by federalist in Taxation.
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State governments dependent on sales tax revenue have begun desperate and counterproductive efforts to extend their taxing authority to out-of-state businesses.  Per the United States Constitution, states cannot levy taxes on subjects outside of their jurisdiction.  The Supreme Court has clarified (Quill Corp v. North Dakota) that a company must have a physical business presence in a state for it to be subject to the state’s taxing authority.

45 of the United States charge some type of sales tax, and many counties and cities levy additional sales taxes.  As far as I know sales taxes are always levied upon the consumer.  I.e., even though the seller is required to collect the tax, it is the consumer who is being taxed.  Therefore sales made to a buyer outside of a jurisdiction are exempt from sales tax.  Mail-order companies have always taken advantage of this fact:  When selling to a buyer in another state they do not have to collect sales tax, and this savings not only offsets shipping costs but can also make their prices more competitive against local sellers within the buyer’s state who must collect the sales tax.  Consequently “brick and mortar” businesses that typically serve local customers have fought alongside states to eliminate this “mail order tax exemption.”

States have attempted to reduce the out-of-state sales tax exemption by imposing a “use tax” in parallel with their sales tax.  Essentially the use tax obligates residents to pay their state’s sales tax on any goods they bring into the state that were not taxed when purchased.  However use taxes are rarely observed, and even more sparingly enforced (typically only against extremely valuable and conspicuous goods, or against individuals who are already under state scrutiny for other reasons).

Since it is far easier to coerce a large business into complying with sales tax collection than it is to enforce a use tax against individuals, states have been aggressively pursuing new theories to extend their jurisdiction over mail-order companies.  The latest attempts depend on the argument that marketing affiliates constitute a physical business presence.  New York and Rhode Island have already established laws to this effect.  Laws are also pending in Hawaii, North Carolina, and a few other states.  These laws are almost certainly unconstitutional, but it is unclear at this point whether the victims of the laws are willing to fight the states to the Supreme Court.  In fact, to avoid a fight Amazon, Overstock, and other large mail-order businesses have instead chosen to simply terminate their affiliate marketing programs in these states.

The Affiliate Nexus

Affiliates marketers are independent contractors that earn fees by referring business to a company.  Typically they are paid a commission when a customer they refer makes a purchase from a company.  The internet has made it possible for affiliate marketing to be done on a much broader scale than ever before, but the marketing practice predates e-commerce.  For example, realtors and lawyers have long collected referral commissions when they send a client to another firm.  States have not and still do not suggest that those referral arrangements establish a business nexus for tax purposes.  If law firm A in New York refers business to firm B in Rhode Island, New York does not claim on that basis that firm B has a physical presence in New York.

Yet states are now straining to argue that affiliate marketers in their state that refer business to mail order companies elsewhere somehow establish a physical presence of those companies in their state.  But these affiliates are not employees of the companies to which they refer customers.  Affiliates do not participate in business transactions between the customer and the company.  And affiliates often advertise on behalf of many different companies.  If an independent affiliate establishes a business presence for its clients in the affiliate’s state of residence, then the same argument must extend to all contractors of a business.  Suddenly all of its outsourced business services — legal, PR, payroll, etc. — could give it a “physical presence” in another state.  If my small business hires H&R Block to prepare my annual tax return, am I suddenly liable for collecting sales taxes from customers in every state just because Block has offices in every state?  Of course not.

The unfortunate collateral damage in these unconstitutional state sales tax campaigns includes numerous small affiliates, many of whom had productive businesses until their state legislatures threatened their clients.  Evidently it is cheaper for the likes of Amazon to cut off referrals from affiliates working in a particular state than to subject themselves to the obligation to collect sales taxes from all customers in that state.  The states will not get any new sales tax revenue by going after mail order companies in this fashion.  But they can instantly destroy the businesses of their own residents who were making a living from affiliate marketing.



1. federalist - July 10, 2009

The Performance Marketing Alliance addresses this issue.

2. federalist - July 12, 2009

This WSJ article notes the comparative advantage of Amazon over bricks-and-mortar competitors. Of course the tax advantage is most significant on valuable, easy-to-ship items.

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