Legal Matters: Removing the Confusion Surrounding State ‘Amazon Laws’
State legislatures continue to experiment with novel nexus legal theories in their persistent drive to compel use tax collection by retailers located beyond their borders. The most recent state efforts are aimed directly at online retailers through passage of so-called "Amazon laws."
States With Web Affiliate Nexus Laws
To date, six states have adopted web affiliate nexus laws, which amend their definition of "retailer" or "vendor" or "engaged in business in this state" to include internet merchants who 1.) enter into agreements with residents of the state for referral of potential customers via a link on the resident's website to the out-of-state retailer's website and 2.) pay "a commission or other consideration" for this referral service. The states that have adopted such laws are New York, North Carolina, Rhode Island, Arkansas, Illinois and Connecticut. Several other state legislatures are considering similar bills.
The legal theory underlying these new laws dates back to a 1960 United States Supreme Court case, Scripto v. Carson, in which the high court ruled that the presence of 10 commissioned sales agents in Florida created nexus for a Georgia company, despite the fact that the sales agents were independent contractors and not employees of the Georgia company.
Scripto assigned an exclusive sales territory to each of its manufacturer's representatives. The salesmen were furnished catalogs, samples and advertising materials. They regularly solicited sales and took customer orders, which were then sent by the salesmen to the Atlanta office for acceptance and fulfillment. Scripto argued that because its sales agents were independent contractors and not employees, their presence in Florida didn't create nexus for the out-of-state seller.
The Supreme Court rejected Scripto's argument and concluded the following: "True, the 'salesmen' are not regular employees of appellant devoting full time to its service, but we conclude that such a fine distinction is without constitutional significance." Borrowing on the reasoning used in the Scripto decision, states that have adopted web affiliate laws maintain that in-state website owners (often referred to as "publishers") are the modern day electronic equivalents of the commissioned sales agents in the Scripto case.
Laws Create an Assumpiton of Nexus
Of course, a web referral relationship is much more passive than the active solicitation and order taking done by the Scripto salesmen. Most states that have enacted Amazon laws are aware of this difference, so their web affiliate nexus statutes stop short of declaring that any company with an in-state publisher must collect state taxes. Instead, the legislation only creates a "presumption" that a remote seller has nexus in the state if it enters into a contract with an in-state resident for referral of prospective customers via a website link. The burden of proof then switches over to the retailer, who must present evidence (usually in the form of a certification signed by each in-state affiliate) that none of its publishers engage in solicitation activity on behalf of the internet merchant.
Amazon.com challenged the New York statute in New York state court on the grounds that the law violated the "substantial nexus" standard set forth in the Supreme Court's famous 1992 Quill decision, which requires that a retailer must have a "physical presence" in a state before it can be required to collect that state's sales tax. An intermediate appellate court concluded, however, that the presumption approach used in the New York statute didn't result in a violation of the Commerce Clause, which states the following: "The obligations imposed by the state to collect the tax only arise when the paradigm shifts from advertising to solicitation. Thus, until such time as the out-of-state vendor produces a certification from every one of its New York representatives that they have not engaged in solicitation, the facial challenge based upon the Commerce Clause must fail …"
In effect, the New York court ruled that because it's not unreasonable to assume that some web affiliates engage in "proactive solicitation" and aren't mere "passive" advertisers, it's reasonable for the legislature to adopt a statutory presumption that some of the in-state publishers are engaged in nexus-producing sales solicitation activity on behalf of the out-of-state internet retailer. The remote seller has the opportunity to counter that presumption by presenting evidence that no active solicitation, in fact, occurred. The Amazon case in New York hasn't yet reached that state's highest appellate court, so the Commerce Clause issue remains unresolved in that state.
Terminating Web Affiliates to Avoid the Statutory
Rather than having to assume the burden of obtaining certification from all in-state web affiliates attesting that they haven't engaged in solicitation activities (and running the risk of not being able to do so), many online retailers have simply decided to terminate their relationship with affiliates in New York, North Carolina, Rhode Island, Arkansas and Connecticut and have also informed their affiliate networks to exclude publishers in those states from participating in their advertising programs.
The web affiliate laws may be self-defeating. If online retailers terminate their agreements with publishers, the state doesn't benefit from any additional tax collection by these companies. The state will, however, lose income tax revenue that the publishers would otherwise have paid on the commissions they would have earned. Moreover, good jobs move out of state as affiliates relocate to states that haven't enacted web affiliate nexus laws.
Illinois' web affiliate law doesn't employ this same "presumption" approach to establish nexus. Instead, the Illinois statute provides that the mere presence of an Illinois web affiliate, with nothing more, gives rise to an obligation on the part of an out-of-state seller to collect use tax on all of its sales into the state. In other words, the absence of any additional in-state solicitation activity on the part of in-state publishers is irrelevant. The Illinois law is even more vulnerable to a constitutional challenge than the New York-style laws. In response to the Illinois law, many internet retailers have terminated their affiliate agreements with Illinois publishers.
Pay for Performance
vs. Pay Per Click
Do these Amazon laws apply only to performance-based compensation arrangements or to pay-per-click (PPC) compensation arrangements as well? The first of the so-called Amazon laws was enacted in New York. In a Technical Services Bulletin (TSB) issued by the New York Department of Taxation and Finance shortly after the new law was passed, the department stated that the law doesn't apply in those situations where the compensation for the link isn't "based on the volume of completed sales generated by the link."
For example, the TSB describes a linking relationship where the compensation is "based only on the number of clicks on the link … whether or not sales are made." According to the TSB, such PPC compensation doesn't give rise to a statutory presumption of nexus. Consequently, if the owner of a paid search website is compensated on a PPC basis, according to New York's current interpretation of its law, that web referral relationship shouldn't fall within the scope of the New York law.
North Carolina, Rhode Island, Arkansas and Connecticut's statutes employ the same language as the New York law ("for a commission or other consideration"), but their departments of revenue haven't issued similar TSBs clarifying their interpretation and application of the new laws. Because the statutory language is essentially the same as in New York and, in fact, was modeled after the New York legislation, it would be logical to interpret these state laws in the same way (i.e., that PPC relationships don't create a presumption of nexus), but it's conceivable that an aggressive state tax auditor from one of those states will maintain that the words "other consideration" apply to any form of compensation, including a fixed fee paid every time a referral occurs from a website owned by an in-state resident to an out-of-state retailer's website, whether or not a sale occurs.
The compensation provision in the Illinois web affiliate statute is slightly different from those in New York, North Carolina, Rhode Island, Arkansas and Connecticut. The Illinois legislation refers to "a commission or other consideration based upon the sale of tangible personal property by the retailer."
The plain statutory language appears to apply only to compensation arrangements where the Illinois website owner is compensated through a formula determined by or based upon the number of sale transactions or the dollar value of sales resulting from the link referrals they generate.
In other words, the statute requires that a sale occur in order for the website owner to be compensated for his or her services. Consequently, the Illinois law doesn't extend to PPC arrangements that don't require a sale in order to trigger or measure the fee arrangement.
George S. Isaacson is a senior partner at Brann & Isaacson, a direct marketing law firm. Reach George at firstname.lastname@example.org.