By: Patricia L. Bland
(Republished with permission of the Bar Association of Metropolitan St. Louis and the St. Louis Bar Journal.)
Estimates indicate that electronic retail sales in 2010 within the United States were approximately 8% of all equivalent retail sales, or a total of $134.9 billion.[1] This amount is nearly triple the amount of electronic retail sales made in the year 2000.[2] Further, electronic retail sales are expected to grow at five times the rate of sales from conventional brick-and-mortar retail stores for the period from 2010 to 2020.[3] Resulting from this increase in electronic retail sales is the complex issue of how to impose and collect sales tax revenue on these electronic transactions.
Experts believe that if every state imposed and collected a tax on all online sales, including electronic retail sales and electronic business to business sales, the states would cumulatively receive an additional $10 billion in revenues each year. [4] This could potentially reduce the average state's budget deficit by 17%.[5] Other estimates show that annual national losses of state and local sales tax on electronic retail sales could reach $11.4 billion by 2012.[6]
Because of the recent depressed state of the economy, states are looking for alternative ways to boost revenue and decrease annual operating deficits. One such method that states are considering is the increased collection of sales and use tax. States are trying to eliminate the inability to collect sales or use tax on electronic retail sales from out-of-state retailers. States are contemplating, and some states have enacted, new legislation which broadens the definition of who is subject to collection and remittance of tax under applicable laws so as to allow states to increase collection of sales tax on electronic retail sales.
This article will generally review the existing laws governing collection of sales and use tax revenue including any constitutional limitations on the states' ability to do so. The article will also discuss new and proposed laws affecting sales tax on electronic retail sales and concludes that the taxability of electronic retail sales needs to be addressed by federal legislation.
Application and Collection of Sales Tax and Constitutional Limitations on Out-of-State Sellers
Generally, a sales or use tax is imposed on all sales of tangible personal property. For example, in Missouri "Every vendor making a sale of tangible personal property for the purpose of storage, use or consumption in this state shall collect from the purchaser an amount equal to the percentage on the sale price imposed by the sales tax law in section 144.020 and give the purchaser a receipt therefor."[7] Other states have a sales or use tax similar to the state of Missouri, but with varying definitions of the goods taxable and the rate at which they are taxed. Some states, such as Alaska, Delaware, Montana, New Hampshire and Oregon, have no sales tax.[8]
Thus, the individual states are generally free to impose a sales or use tax on the sale, lease or rental of goods and some services. The Supreme Court, however, has provided that certain constitutional limitations prohibit states from requiring out-of-state retailers to collect and remit sales tax on sales to in-state residents.[9] Quill Corp. v. North Dakota addressed whether a Delaware corporation, which engaged solely in sales of office supplies by mail-order, must collect and remit use tax on property purchased for use in North Dakota.[10] The North Dakota law in question had been specifically amended to address the taxability of out-of-state mail-order suppliers and provided that any retailer who solicited the North Dakota consumer market by means of three or more advertisements within a 12-month period was required to collect and remit use tax because it was considered to be maintaining a place of business in the state.[11]
The Court in Quill held that while North Dakota had authority to tax out-of-state mail-order suppliers because its use tax statutes were consistent with the Due Process Clause, under the Commerce Clause the imposition of tax was an unconstitutional burden on interstate commerce.[12] The Court found that North Dakota could not require out-of-state mail-order sellers who had no other physical presence in the state to collect and remit sales or use tax. Quill affirmed the principal that there is a clear distinction between mail-order sellers, like the one in Quill, who communicate with customers in the state by mail, and those who have a physical presence in the taxing state.[13]
According to the Court, a tax such as the one in Quill will only be sustained under the Commerce Clause if the "tax (1) is applied to an activity with a substantial nexus with the taxing State (2) it is fairly apportioned, (3) it does not discriminate against interstate commerce, and (4) it is fairly related to the services provided by the State."[14] A retailer lacks the "substantial nexus" required by the Commerce Clause and fails the first part of the four-part test set forth above where its only contact with a state is by mail or common carrier.[15]
Similar to a mail-order vender, internet sellers generally lack a "substantial nexus" with a taxing state unless the seller maintains an office or other physical presence in the state. For instance, the nation's largest internet retailer, Amazon.com, LLC ("Amazon"), collects tax in only the five states in which it has offices - Kansas, Kentucky, New York, North Dakota, and Washington.[16] While Amazon has warehouses in six additional states, it avoids creating a "substantial nexus" in those states by owning the warehouses in a subsidiary and by creating an arms-length arrangement between Amazon and the warehouse/shipper subsidiary.[17] Further, Amazon is seeking specific legislation in South Carolina and Tennessee, two states in which it desires to build warehouses, which would statutorily exempt it from the collection of sales or use tax.[18]
Other cases demonstrate that a physical presence within a taxing state is necessary to establish a sufficient nexus with the state. In Scripto Inc. v. Carson, the seller had no offices or regular employees in the taxing state, but it employed independent contractors to solicit sales of its products.[19] The Court upheld a use tax on the out-of-state retailer ultimately disregarding the fact that the salesmen on behalf of the seller were not employees.[20] Similarly, the use of only one sales representative, although an independent contractor, is sufficient to establish a physical presence and substantial nexus under the Commerce Clause so as to subject the retailer to collection of out-of-state tax.[21]
The Amazon Affiliate Tax Laws
It is important to note that even if an internet seller is exempt from collecting and remitting sales or use tax on electronic retail sales, tax on that purchase is still owed to the state in which the purchaser resides. Purchasers are expected to report to their resident states all purchases made from out-of-state retailers and remit to their resident states the applicable use tax on those purchases. A low incidence of self-reporting coupled with the fact that it is difficult for states to identify purchases made by residents from out-of-state retailers make collection of use tax on electronic retail sales difficult. This is why states are investigating means to subject out-of-state retailers to their taxing regime.
The first state to attempt to do so was the state of New York. In an effort to raise revenue and decrease its budget deficit, New York amended its tax laws intending to sweep under its taxing authority most major internet retailers.[22] New York took aim at certain contractual relationships that Amazon had with in-state residents.[23] Amazon had a program whereby independent third parties ("Associates") could advertise Amazon's website on their own individual website.[24] When a visitor to an Associate's website clicked on the Amazon.com link and ultimately made a purchase from Amazon.com, in exchange for directing internet traffic to its website Amazon would pay a commission to the Associate.[25]
Given the difficulty under Quill to create a substantial nexus with out-of-state retailers, New York created a nexus by statute. The prior law in New York law considered those who solicited business in the state through independent contractors as retailers subject to collecting and remitting tax.[26] The new law, coined the "Amazon Tax Law," created a rebuttable presumption that internet sellers who have commission-based referral contracts with residents of the state of New York ("Affiliates") have a sufficient nexus with the state of New York and are considered as soliciting business through an independent contractor or other representative such that they are required to collect and remit tax on sales.[27]
Specifically, the Amazon Tax Law provides that if the seller has a contract which compensates a New York resident on a commission basis for referrals to the seller, "whether by a link on an internet website or otherwise," and if "the cumulative gross receipts from sales by the seller to customers in the state who are referred to the seller by [the Affiliate] . . .is in excess of ten thousand dollars during the preceding four quarterly periods ending on the last day of February, May, August, and November," then that seller is a retailer required to collect New York sales tax.[28]
A seller can rebut this presumption by showing proof that the Affiliate "did not engage in any solicitation in the state on behalf of the seller that would satisfy the nexus requirement of the United States constitution during the four quarterly periods in question."[29] To rebut the presumption, sellers must include in their agreements with Affiliates a provision prohibiting the Affiliates from "engaging in any solicitation activities in New York State that refer potential customers to the seller."[30] Additionally, each Affiliate must submit a signed certification, every year, acknowledging that it has not engaged in any solicitation within the state.[31]
Since the enactment of the Amazon Tax Law in 2008, four other states - North Carolina, Rhode Island, Illinois and Arkansas - have passed the same or similar laws.[32] As a result, internet retailers such as Amazon and Overstock.com, Inc. ("Overstock") have terminated its relationships with their Affiliates in those states.[33] By terminating those relationships, Amazon and Overstock hope to remove themselves from the taxing authority of those states. Multiple other states are considering similar legislation, and internet retailers have threatened to cut ties with Affiliates in any state that enacts similar laws.[34] In fact, in both California and Hawaii, fears that Amazon and Ovesrtock would cancel contractual relationships with Affilitates caused the governors of both states to veto legislation which would have adopted legislation similar to the Amazon Tax Law.[35]
The state of Colorado enacted legislation with a similar purpose but a different method of applying the tax.[36] However, a judge issued an injunction against that legislation in January 2011.[37] The Colorado law[38], which requires retailers who sell products to Colorado residents, but who do not collect and remit sales tax, to report to the state certain information about each customer, was held as both discriminatory and imposing an undue burden under the U.S. Constitution.[39] Accordingly, a preliminary injunction was entered against the enforcement of the new provisions of the Colorado law.[40]
With respect to the New York law, on April 25, 2008, just two days after the bill enacting the Amazon Tax Law was signed by the governor of New York, Amazon filed a complaint in New York alleging that the Amazon Tax Law was unconstitutional under the Equal Protection, Due Process, and Commerce Clauses of the United States Constitution.[41] It sought both declaratory and injunctive relief.[42] Overstock also filed a complaint asserting similar claims.[43] The state of New York moved to dismiss the complaints and the court agreed, dismissing the complaints in their entirety.[44] Amazon and Overstock appealed and argued that, under the Amazon Tax Law as applied, Amazon and Overstock lacked a "substantial nexus" with the state of New York as required by the United States Constitution leaving the Amazon Tax Law unconstitutional.[45]
The court upheld the lower court's dismissal of Amazon's facial challenge to the Amazon Tax Law under the Commerce Clause.[46] It also upheld facial challenges of the Amazon Tax Law under the Due Process Clause based on claims of irrebuttable presumption and vagueness.[47] With respect to their as-applied claims under the Commerce Clause, the court remanded the case and found that Amazon and Overstock should be afforded the opportunity to present evidence as to whether their Affiliates are actually soliciting business or merely advertising on their behalf.[48] The court also remanded the case for further discovery on the as-applied Due Process Clause claims.[49]
It is possible, if not likely, that, under the progeny of Quill, where catalogs, advertisements in national periodicals, and telephone calls were insufficient to generate in-state physical presence for the purpose of sales and use tax, so too will websites and web links be insufficient to create a "substantial nexus" that satisfies the Commerce Clause. The Affiliates under the Amazon Tax Law do not hold any authority to bind Amazon or Overstock; they are merely third parties who are advertising on behalf of the internet retailers and through which business is directed to Amazon and Overstock. Unlike the independent contractors in Scripto[50] and Tyler Pipe[51], the Affiliates are not agents of Amazon or Overstock which would give rise to a sufficient nexus within the state in compliance with the Commerce Clause.
Overcoming the Substantial Nexus test of Quill
Assuming that the Amazon Tax Law is ruled unconstitutional under Quill, what, if anything, then can be done to address the issue of collecting sales tax on electronic retail sales?
The first option, which is improbable and would take years to come to fruition, would be a reconsideration of Quill by the Supreme Court. This could happen if Amazon.com, LLC v. New York Dept. of Taxation and Finance[52] made its way all the way to the Supreme Court. The reason this option is improbable is that the Supreme Court has already indicated that it views the issue of taxation by the States under the Commerce Clause as one for Congress to resolve.[53] Specifically, the Court stated in Quill that "Congress is now free to decide whether, when, and to what extent the States may burden interstate mail-order concerns with a duty to collect use taxes."[54] Thus, it appears likely that the Supreme Court would not agree to hear any challenge to the substantial nexus test of Quill.
The second option is exactly that which the Supreme Court in Quill suggested - have Congress resolve the issue. Legislation was previously introduced in Congress that proposed to simplify the collection and remittance of sales and use tax.[55] Under H.R. 5660, Congress desired to have the federal government consent to the Streamlined Sales and Use Tax Agreement ("SSUTA").[56] By doing so, it would direct the states to also adopt the SSUTA. The SSUTA would authorize states that simplify their tax systems in accordance with the SSUTA to require sellers to collect taxes on all sales delivered in-state, regardless of the location of the seller.[57] It is anticipated that similar legislation will again be considered by Congress this year.[58]
The SSUTA began as a cooperative effort of several states to simplify sales and use tax collection.[59] Its purpose also includes creating uniform tax definitions and uniform sourcing rules for all taxable transactions.[60] Further, it imposes certain notice requirements for local and state sales tax rate changes.[61] Currently, twenty-three states have adopted some or part of the SSUTA.[62] However, participation in the SSUTA by internet retailers is completely voluntary at this time. Currently only 1,100 remote sellers have volunteered to begin collecting sales tax for those states that comply with the SSUTA.[63] This is not enough to make a significant impact on the collection and remittance of sales and use tax to states.
One of the main goals of the SSUTA is to provide retailers with a system in which they can pay state and local sales taxes to the states in which they sell their goods. The SSUTA creates certified service providers ("CSP") who calculate how much tax a seller must collect on sales and remit to individual states.[64] The CSPs are responsible for utilizing the data collected by the Streamlined Sales and Use Tax Governing Board, Inc. and calculating the sales tax due on sales by the member sellers. By agreeing to the SSUTA, internet sellers who use a CSP to calculate the tax due on their sales get the benefit of being held harmless from any miscalculations.[65]
Many argue that due to varying state and local tax rates, calculating the tax due on an out-of-state sale is almost impossible. However, sellers have stated that the "real burdens with collection are not sales tax rates but the different product definitions from state to state, different state and local tax bases, and the different rules and administrative procedures for registering, collecting, filing and remittance of sales taxes."[66] This is where the SSUTA is a success, requiring uniform definitions to the taxability of goods.
Whether the answer to the issues of collecting sales and use tax by the states is that Congress ultimately enacts the SSUTA, or whether some other legislation is more appropriate, it is clear that action is required by Congress. It appears that, more likely than not, the Amazon Tax Law will be held unconstitutional under Quill. Thus, New York and those states with similar legislation will be enjoined from enforcing the newly enacted laws. States will again be left unable to force internet retailers to collect and remit sales or use tax that is due and the problem will continue until the problem is resolved at the federal level.
[1] Katie Deatsch, As Web Sales Grow, So Should Spending on Technology, Report Says, Internet Retailer, http://www.internetretailer.com/2010/06/17/web-sales-grow-so-should-spending-technology-report-says, (Jun. 17, 2010, 12:18 PM)
[2] Jeff Nobbs, The REAL Numbers Behind the Internet Sales Tax Debate, Extrabux.com Blog, http://www.extrabux.com/blog/2011/04/the-real-numbers-behind-the-internet-sales-tax-debate/, (Apr. 13, 2011).
[3] Id.
[4] Id.
[5] Id.
[6] Donald Bruce, William F. Fox & LeAnn Luna, State and Local Sales Tax Revenue Losses from Electronic Commerce, The University of Tennessee Center for Business & Economic Research, http://cber.bus.utk.edu/ecomm/ecom0409.pdf, 3-4 (Apr. 13, 2009).
[7] Mo. Rev. Stat. § 144.635 (2000).
[8] William F. Fox, History and Economic Impact: Sales Tax History, University of Tennessee Knoxville, Center for Business and Economic Research, http://cber.bus.utk.edu/staff/mnmecon338/foxipt.pdf (March 13, 2002).
[9] Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
[10] Id. at 302.
[11] Id. at 302-303.
[12] Id.
[13] Id. at 311; see also National Bellas Hess, Inc. v. Dept. of Rev. of Ill., 386 U.S. 753 (1967).
[14] Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279.
[15] Quill at 311.
[16] Verne G. Kopytoff, Amazon Pressured on Sales Tax, NY Times, http://www.nytimes.com/2011/03/14/technology/14amazon.html?_r=2 (March 13, 2011).
[17] Amazon Negotiates Sales Tax Issue with Tennessee as Part of Warehouse Project, Nexus Negotiator, http://www.nexusnegotiator.com/blog/amazon-negotiates-sales-tax-issue-with-tennessee-as-part-of-warehouse-project/ (January 31, 2011).
[18] Kopytoff, supra note 16.
[19] 362 U.S. 207 (1960).
[20] Id. at 211.
[21] Tyler Pipe Indus., Inc. v. Washington State Dept. of Rev., 483 U.S. 232, 250-251 (1987).
[22] N.Y. TSB-M-08(3)(S) (May 8, 2008).
[23] Amazon.com, LLC v. N.Y. St. Dept. of Taxation and Fin., 913 N.Y.S.2d 129, 134 (N.Y. App. Div. 2010).
[24] Id.
[25] Id.
[26] N.Y. Tax Law § 1101(b)(8)(i)(C)(I) (2010).
[27] N.Y. Tax Law § 1101(b)(8)(vi) (2010).
[28] Id.
[29] Id.
[30] N.Y. TSB-M-08(3.1)(S) (June 30, 2008).
[31] Id.
[32] R.I. Gen. Laws § 44-18-15(a)(2) (2009); N.C. Gen. Stat. §105-164.8(b)(3) (2009) 2010 Ill. Legis. Serv. P.A. 96-1544 (West); 2011 Ark. Acts 1001.
[33] Paul Demery, Arkansas Governor Signs "Amazon Tax" Law, Internet Retailer, http://www.internetretailer.com/2011/04/05/arkansas-governor-signs-amazon-tax-law (Apr. 5, 2011, 2:39 PM).
[34] Id.
[35] W. David Gardner, California, Hawaii Governors Veto Online Sales Tax, Information Week Government, http://www.informationweek.com/news/government/state-local/218400233 (Jul. 2, 2009, 2:44 PM).
[36] Colo. Rev. Stat. § 39-21-112(3.5) (2010).
[37] Direct Marketing Assoc. v. Huber, 2011 WL 250556 (D. Colo. 2011).
[38] Colo. Rev. Stat. § 39-21-112(3.5) (2010).
[39] Direct Marketing, 2011 WL 250556.
[40] Id.
[41] Amazon.com, LLC v. N.Y. St. Dept. of Taxation and Fin., 913 N.Y.S.2d 129, 134 (N.Y. App. Div. 2010).
[42] Id.
[43] Id.
[44] Id. at 135-136.
[45] Id. at 136.
[46] Id at 137-138.
[47] Id. at 138-141.
[48] Id. at 143.
[49] Id. at 144.
[50] Scripto, 362 U.S. 207.
[51] Tyler Pipe, 483 U.S. 232.
[52] 913 N.Y.S.2d 129.
[53] Quill, 504 U.S. at 317-318.
[54] Id. at 318.
[55] Main Street Fairness Act, H.R. 5660, 111th Cong. (2010).
[56] Id. at § 2.
[57] Id. at § 3.
[58] Declan McCullagh, Democratic Senator Wants Internet Sales Tax, CNet, http://news.cnet.com/8301-31921_3-20052999-281.html (Apr. 12, 2011).
[59] Streamlined Sales Tax Governing Board, Inc., http://www.streamlinedsalestax.org/index.php?page=About-Us (last visited Apr. 29, 2011).
[60] Id.
[61] Streamlined Sales and Use Tax Agreement § 304-305, available at http://www.streamlinedsalestax.org/uploads/downloads/Archive/SSUTA/SSUTA%20As%20Amended%2012_13_10.pdf (December 13, 2010).
[62] Id. See also Streamlined State Status 01-01-11, Streamlined Sales Tax Governing Board, Inc., http://www.streamlinedsalestax.org/uploads/images/Streamline%20Map%201_1_11.jpg (last visited Apr. 29, 2011) (note that Arkansas is no longer considered a full member of the SSUTA as a result of its adoption of legislation similar to the Amazon Tax Law).
[63] Streamlined Sales and Use Tax Agreement Misconceptions and Misstatements, National Conference on State Legislatures (May 14, 2010).
[64] See Streamlined State Status 01-01-11, supra note 61 at § 501.
[65] See Streamlined Sales and Use Tax Agreement Misconceptions and Misstatements, supra note 62.
[66] Id.
