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Reason Foundation

NY Internet Sales Tax Is Illegal - and Bad Business

Overstock cuts ties, Amazon.com sues New York over sales tax

Steven Titch
May 21, 2008

Call it one of former Gov. Eliot Spitzer's parting shots at the consumers of New York.

Attempting to close a $4.3 billion budget deficit, Spitzer, last November, attempted to ram through a questionable law that would allow New York State to collect sales taxes from out-of-state merchants - particularly those who sell on the Internet. Although his initial attempt failed, and Spitzer has since left the scene, his corrosive taxation idea survived to pass the New York State Legislature this spring.

The new law affects New York residents, who will begin paying an average of 8 percent in taxes on their online and catalogue purchases from out-of-state retailers. Moreover, the law imposes tax collection burdens on out-of-state businesses, something that has always been constitutionally prohibited.

Most catalogue and e-commerce shoppers realize that states can't impose sales tax collection burdens on a business that has no physical presence, or "nexus," in that state. The legal reasoning, affirmed in 1992 by the U.S. Supreme Court in Quill Corp. v. North Dakota, was that more than 6,000 separate sales and local tax jurisdictions in the United States amounts to an unreasonable burden on interstate commerce. In short, the court said, attempts to force out-of-state merchants to collect state and local sales taxes are unconstitutional.

Using overreaching definitions that border on the absurd, however, the state legislature decreed that if an on-line merchant uses a New York-based Web site to advertise, refer or link electronically to the merchant's site, the merchant, de facto, has a physical "nexus" in the state.

How's that again? By virtue of this law, on April 15, Web-based retailers across the country such as Amazon.com, eBay, Overstock.com, not to mention thousands of smaller operations who contract with Web sites based in New York State for ads, buttons or hot links, became New Yorkers overnight, at least for tax purposes.

For example, Amazon.com, through its 'Amazon Associates' affiliate marketing program, provides hundreds of thousands of Web sites with a link to its site in exchange for commissions of up to 10 percent. Amazon reckons about it has 10,000 affiliates with New York addresses. Online retailers who use New York-based Web sites for advertising and referrals have until June 1 to register as New York businesses or risk civil or criminal action.

The backlash has already started. On April 25, the same day it registered with the state if only to be in compliance, Amazon.com filed a lawsuit in the New York State Supreme Court, challenging the law on, among other points, the Quill ruling. Meanwhile, rather than register, Overstock.com reportedly is severing all business ties with advertising affiliates in New York State, potentially costing real New York businesses - those owned by New York voters - millions of dollars in lost commissions.

One hopes the court makes a quick decision in favor of consumers and small businesses. Beyond running counter to Quill, the law's convoluted method of defining physical presence by virtue of an association with another New York business defies common sense. Even existing New York law holds that advertising alone does not equate to having a "nexus."

The downside, of course, is that, if the law is upheld, other cash-strapped states will attempt to imitate the New York model. That would be unfortunate because, in addition to adding needless cost and compliance burden on U.S. Internet retailers, at a time of slowing economic growth, the tax would take more money out of consumers' pockets. It would also divert revenue away from many small entrepreneurs seeking opportunities in Internet and e-commerce, and for whom commissions from Amazon and other large retailers are an important source of quick and early cash flow.

If New York State, as so many of its lawmakers want, is to gain a foothold in the digital economy and be the state that is home to the next Google, Amazon or Yahoo, this tax is no way to do it.



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