The debate over the “Amazon Tax” continued this week with the company announcing, as many expected, the cancellation of Connecticut-based affiliate marketing contracts. The changes impact website operators who are linking to Amazon and receiving a commission based on the sales those links generate.
Amazon is not required to collect sales tax on items purchased by Connecticut residents. The reason is the result of two U.S. Supreme Court rulings that took place in 1967 and 1992 – before the dawn of E-commerce. In both cases, the court determined that in order for a state to collect sales tax from a business, that business must have a physical presence in the state.
“The court in 1992 was reluctant to change the rules of taxation for the mail order business because this entire industry was accustomed to those rules and the feeling of the court was that any change in the law ought to come from Congress,” said Daniel Gottfried, a tax partner with the Rogin Nassau law firm in Hartford.
Amazon, founded just two years after the 1992 decision, benefited greatly from the massive investment in E-commerce properties in the early 90’s. Congress was reluctant to do anything to slow the growth of a burgeoning industry that was fueling a booming Internet economy, well before many Americans knew the web even existed. The federal government did pass legislation banning taxes on Internet service providers, but today there appears to be a common misconception that the federal legislation also pertained to sales tax on goods purchased on the Internet.
Affiliate Marketing Comes of Age
As the World Wide Web exploded, so did the community of online content providers. Amazon in 1996 launched an incentive program called “Amazon Associates” that gave website operators the opportunity to publish links to Amazon products in order to earn a commission on any business they send to the online retailer. Websites run Amazon advertisements for free and are paid only when a visitor clicks the ad and purchases something, a process later called “affiliate marketing.” Amazon holds a patent on the affiliate marketing process.
Amazon’s affiliate program remains one of the most robust (and lucrative) in the industry, paying a minimum 4 percent commission on just about every item on the site. Volume incentives also drive the rate of payment higher for sites that generate a large number of sales.
Affiliate marketing is a large part of the modern retail marketing strategy, as millions of sites are essentially providing billions of advertising impressions for free in the hopes of earning sales commissions. Just about every online retailer offers some form of commission incentive.
Taxed States Eye Taxing Dotcoms
With struggling states looking for new revenue opportunities, Amazon’s $34 billion in mostly untaxed annual revenue is an attractive target. In the years since Amazon started the affiliate program, hundreds of millions of people have grown comfortable with the idea of using credit cards online, and the amount of money spent on the Internet has exploded. Consequently, billions of dollars in yearly retail purchases have moved out of the local brick and mortar stores — where sales taxes are charged and local jobs are dwindling — and up to the tax-free cloud where software has replaced most of the jobs. State governments are desperate to make up for that lost revenue.
Many brick and mortar retailers (both large and small) have long contended that Amazon’s lack of retail space gives the online retailer an immediate 6 percent price advantage as they are not required to collect the sales tax. Amazon currently collects sales tax in four states where they have a physical presence: Kansas, Kentucky, North Dakota, and Washington state.
But Amazon also collects sales taxes in New York – the result of legislation passed in 2008 that declared affiliate marketers as a physical presence for the purposes of sales tax collection. Amazon is contesting the law but thus far has been unsuccessful in overturning it.
“So that’s opened the floodgates for the states to enact these taxes,” Gottfried said, “What’s interesting from a pragmatic point of view is that Amazon turns off all affiliates in that state and the state gets no sales tax revenue. Most critics believe that this doesn’t raise any revenue except on paper.”
In many ways the problem of sales tax for online retailers is the result of a significant non-compliance on the part of Connecticut taxpayers. Residents who purchase goods from an out-of-state retailer are required to pay a “use” tax equal to the sales tax rate. Few people do so.
“If everybody self-assessed the use tax, this would be a non-issue. There’d be no holes in the revenue,” Gottfried said.
He suggests that a voluntary use tax payment on an income scale would be more efficient for taxpayers and more effective for the government. That would avoid taxpayers being required to sift through a year’s worth of receipts to come up with what might only be a few hundred dollars of tax obligations.
Is it over for bloggers?
Amazon is not the only affiliate marketer to sever ties with Connecticut websites – Overstock.com and a few dozen other online retailers also terminated relationships.
But many more that have Connecticut warehouses and stores are staying put as they are already compliant with the law. Apple Inc. has a retail presence in Connecticut and therefore already collects sales tax on sales to Connecticut residents. Other retailers such as Sears, Best Buy, and Walmart also will continue their affiliate programs.
But because those retailers with smaller physical infrastructures also have lower prices, shoppers might prefer to visit affiliate sites operated in other states to find the best deals. Amazon was also known for having the highest and least restrictive commission rates in the industry.
All eyes will continue to be on the ongoing legal battle (now in its third year) between Amazon and the state of New York. Efforts also are under way in Congress to require retailers to charge customers their state’s sales tax. A multi-state consortium also has been formed to help make the process of collecting and distributing taxes easier. Connecticut is not yet a member of that consortium.
CTTechJunkie Podcast #2: Getting to the Bottom of the Amazon Tax
Listen by clicking the play button on the audio player below, and below the audio player is the chatroom conversation that took place during the live broadcast.