Collecting Sales Tax

Amazon and the Internet Sales Tax

As many of you know, Amazon has been battling different states regarding its refusal to pay a state’s sales tax.  Throughout its history, Amazon has refused to collect any sales tax for states in which it has no physical presence, but states are finding creative ways to force Amazon and other online retailers to collect their sales tax.  For those who are unaware of this situation, here’s a primer on the situation and why this may be important to your business.

So why is this happening now?

Business has come a long way in the past decade, particularly e-commerce.  What was once an expensive startup venture is now accessible to almost any entrepreneur with an idea.  Consequently, now that e-commerce has become so ubiquitous and now that the sputtering economy has caused governments to squeeze every penny they could get their hands on, state governments are looking for ways to “enhance” their revenues through these online retailers.  40-five states require some form of sales tax and depend heavily on these taxes to fund government expenses.  Generally, the seller is responsible to collect and remit that tax to the state, but online retailers have been immune from this requirement.  The University of Tennessee estimates that states are losing out on $11.4 billion in sales taxes due to this situation. 

So why are Internet retailers not required to collect a sales tax?

An Internet transaction is treated a bit differently from a normal store transaction.  Under the 1992 case, Quill Corp. v. North Dakota, the Supreme Court ruled that a state cannot require a retailer to collect its sales tax unless the retailer has some physical presence within that state.  Be it a company office/store or a company employee soliciting business within the state, a retailer must maintain some sort of physical presence within the state to be taxed by that state.  This is the closest the Supreme Court has gone in drawing a line on when a state can force a retailer to collect a sales tax or not. 

Intuitively, this makes sense.  Taxes are meant to fund government expenses, but if an individual or corporation cannot receive any benefit from that government expense, then that individual or corporation should not be taxed for that expense.  For example, a book store in California theoretically benefits from the state government by having the roads to and from the store maintained, by being protected from criminals and natural disasters, and by having an educated populace to hire its employees (yes, some of these are stretches, but these remain benefits nonetheless).  But a Nevada retailer who sells books over the Internet and ships them directly to a California consumer does not receive any of these benefits.  For this reason, online retailers were not required to collect sales taxes from out of state consumers unless the retailers had some physical presence within the state. 

So internet transactions are free from any sales tax?

Not quite, somebody has to pay the tax and so states require consumers to calculate and remit the sales/use tax themselves.  As you can imagine, most consumers did not bother to calculate and pay the tax and states are not going to spend precious resources to enforce an eight per cent sales tax against a consumer who purchased a 10 dollar item.  But when all internet transactions are added together, the state ends up missing out on a whole lot of money (it is estimated that California is losing roughly $1.9 billion in sales tax). 

So what are the states doing in response?

States need this money and are now finding creative ways to structure their tax codes to ultimately require Internet transactions to include a state’s sales tax.  So far, 11 states have enacted some legislation to tax these online retailers, mainly targeting the big fish. 

As mentioned above, states must establish that an online retailer has some physical presence within the state.  And so states have targeted online retailers who have some sort of affiliate program that funnels business from an affiliate to the online retailer.  Essentially, the new laws have interpreted an affiliate as a representative of the online retailer and so any affiliate within the state represents a physical presence by the online retailer.  Amazon, the largest online retailer, has challenged this law in New York.  In other states, Amazon has simply cut off its affiliation program in these states.

California recently enacted a much broader law that includes any independent subsidiary that is located within the state (let’s say a warehouse or research lab) as constituting a physical presence within the state by the online retailer.  Although Amazon (and others) has yet to challenge this provision and has instead initiated a referendum against this law, Amazon (and others) may eventually challenge or simply relocate these subsidiaries to more “friendly” states. 

Colorado has attempted to require online retailers to submit a list of all significant purchases by Colorado residents, and in response, Amazon has challenged this law. 

So what does this mean to my online business?

For most online businesses, not much . . . at least right now.  As mentioned above, these laws are targeting the big fish and so unless your affiliate/referral sales revenue from one of these states is significant, these laws will not apply to your online business.  However, if these court challenges rule in favour of these states, then watch out. 

The federal government may provide a national solution to all of this online tax issues, but with so many other concerns on its plate, this solution will not happen anytime soon. 

More importantly, however, the Internet remains uncharted territory.  In theory, the Internet is a separate location and not part of any state or country.  Transactions that occur in the Internet cannot be claimed to have occurred in a state or country.  Many brick and mortar businesses see this as an unfair advantage, and are lobbying hard for governments to begin defining and regulating this space.  This “Internet Sales Tax” is just the beginning of this struggle, so online businesses should stay tuned.  

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