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April 25, 2011

How The Current Sales Tax War Involving Amazon May Affect All Ecommerce Websites

Amazon.com and big box retailers such as Wal-Mart and Target are locked in an all-out war over the collection of sales taxes. And cash-strapped states are also backing changes in sales tax laws in more than a dozen states.

While small ecommerce websites are relegated to observe the struggle from the sidelines, the impact of these changes on them could be huge.

Background – Sales Taxes v. Use Taxes

For starters, regarding sales taxes, the general rule is that a state may tax goods sold within its borders to the extent permitted under the U.S. Constitution. Sales taxes are collected by sellers on the sale of tangible property within the seller’s state. So, for example, a consumer in California who buys a widget from a local retailer pays a sales tax that is collected by the retailer.

Use taxes compliment a state’s sales tax and are imposed so that a consumer would theoretically have nothing to gain by shopping out-of-state. It works like this: in the above example, if the consumer purchases the widget out-of-state (say from online retailer in New York), he/she would be liable to pay a use tax on the purchase at the same tax rate as if the purchase had been from a California retailer.

The catch is that while sales taxes are mandated to be collected by retailers, use taxes are imposed directly on consumers, and most do not report and pay a use tax on out-of-state purchases. The result: states lose significant tax revenues on out-of-state purchases of tangible goods. Because individuals generally fail to pay use taxes, states have sought to find ways to impose a sales tax collection burden on the out-of-state retailer.

In 1992, the US Supreme Court ruled that states could only require out-of-state retailers to collect a sales tax if they have a “nexus” (i.e. a physical presence) in the state. The Supreme Court reasoned that the current patchwork of approximately 7,500 taxing jurisdictions in the United States is so complex that it would place an unreasonable burden on out-of-state retailers to charge and collect sales taxes.

Should Online Retailers Have to Charge Sales Tax?

The current battle focuses on what constitutes “nexus”, which the big box retailers and various states want to expand from a merely a physical presence in a state to states in which a website has marketing affiliates (even though they do not have a physical presence).

One example is Illinois which recently passed a new law that requires an out of state retailer to collect sales tax if it employs marketing affiliates in Illinois. Amazon retaliated by reportedly terminating approximately 9,000 affiliates to avoid collection of sales taxes in Illinois, just as Amazon had done previously when Hawaii, North Carolina and Rhode Island passed similar legislation.

Following Amazon’s termination of its Illinois affiliates, it’s been reported that Wal-Mart and other big box retailers offered to work with the terminated Amazon affiliates. This action has led to Amazon’s claim that the real reason for the tax law changes is to allow big box retailers to poach its affiliates.

States reply that it’s just a question of “fairness.” Why put brick and mortar businesses at a competitive disadvantage?

Conclusion

For small ecommerce companies watching from the sidelines, the potential effect of the current trend in state sales tax laws could be huge in terms of the cost to comply.

Moreover, one of the key reasons for the explosion of entrepreneurial activity on the Web is that there’s a relatively low barrier to entry. If these laws become universal, many start-up entrepreneurs may simply conclude that it’s really not worth the hassle.


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