Amazon’s (AMZN) New Tactic In An Old Fight

Amazon’s ongoing fight with state legislatures over sales tax collection has become a familiar story. In state after state, the company and legislators have followed the same script. But now, in California, both sides are looking for a different ending.

The sales tax war began in New York when lawmakers asserted that online retailers could be considered to have a physical presence in the state if they paid commissions to in-state “affiliates.” Amazon.com, Inc. (NASDAQ:AMZN), whose popular affiliate program was clearly the target of the law, is suing.

The issue of physical presence, or nexus, is significant, since the Supreme Court has said companies can only be required to collect sales tax in states where they have employees or facilities. Technically, consumers are required to pay the sales tax that out-of-state companies don’t collect directly, but in reality, almost no one does this.

As the New York lawsuit has slowly worked its way through the court system, Illinois, Arkansas, Connecticut, North Carolina and Rhode Island have all passed their own “Amazon laws.” Rather than starting duplicate lawsuits in multiple states, Amazon has responded in each case by ending relations with affiliates. Both sides lose in this situation. States don’t get the sales tax money they’re after and they risk Amazon affiliates moving their businesses, and their tax dollars, to other states. Amazon, meanwhile, loses referrals. But, for some reason – most likely pure desperation – states continue to pass these laws.

At first it seemed California would repeat this pattern. Gov. Jerry Brown signed a sales tax collection law on June 29, and Amazon immediately announced that it was terminating relationships with its approximately 25,000 California affiliates. But instead of ending there, the battle in the Golden State continued with Amazon seeking to take the issue to the streets through a voter referendum.

California’s new law differs from previous iterations by claiming that subsidiaries, in addition to affiliates, can be used to establish a company’s presence, even when those subsidiaries are not involved in any retail activity. While Amazon is itself based in Seattle and has no offices in California, its wholly-owned subsidiary A2Z does have offices in the state. Those offices house the software gurus responsible for development work on Amazon’s online music store and its top-selling product, the Kindle reader. Though Amazon has shown that it is willing to sever ties with affiliates, moving A2Z would prove harder.

In addition to the higher stakes posed by the subsidiary clause, California’s relatively easy ballot access makes the situation different from those Amazon has faced so far. A second lawsuit would be costly and redundant, but the possibility of a referendum lets Amazon take its case to a new audience.

Most likely, Amazon’s motivations are rooted more in self-interest than principle. Many voters who end up supporting the referendum will likely be guided by self-interest as well, looking to save a few dollars at the online checkout screen. But all of that self-interest may end up bolstering an important legal principle that is critical for small businesses.

For a large retailer like Amazon, the administrative costs associated with collecting sales tax are more or less negligible, making the main disadvantage higher costs for customers. For a smaller business, however, the burden of keeping track of the laws and tax rates of 50 states (with thousands of local variations in rates and taxable items) would be difficult or impossible to meet. Legislatures’ growing disregard for the nexus principles that limit tax collection responsibilities to in-state businesses poses a real threat.

Palisades Hudson has offices in only three states – Florida, Georgia and New York – but the nature of our business allows us to serve clients across the country and around the world. None of the states where we have offices apply sales tax to tax preparation services, so we never collect sales tax when we prepare returns. However, a few states, including South Dakota, West Virginia, and in some circumstances Ohio, do consider tax preparation services to be taxable. Without the protection of nexus rules, we would be required to track the relevant laws in each jurisdiction where we have clients.

While laws like the ones passed in New York, California and other states pay lip service to the fundamental principle of nexus, they disregard the physical presence test that the Supreme Court clearly laid out nearly 20 years ago in a suit brought by mail-order retailer Quill against the state of North Dakota. The affiliates that states are trying to use to attribute physical presence to out-of-state firms are individuals or independent companies that are paid commissions for delivering customers through “click-through” links on their own sites. If a state like Illinois can attribute nexus to Amazon through its commission-based affiliates, there is nothing to stop it from attributing presence to Amazon through the internet service providers whose facilities Amazon uses to reach customers in Chicago. North Dakota tried to do just that by attributing nexus to Quill via the phone companies and postal services Quill used to serve customers there; the Supreme Court said no dice.

Not every retailer opposes what states are trying to do. Not surprisingly, the companies that back states’ efforts to force Amazon to collect sales tax are the ones that already must collect sales tax nearly everywhere because they have stores nearly everywhere. Wal-Mart, Target and other big-box retailers claim that online retailers’ freedom from sales tax collection duties gives them an unfair advantage by allowing them to offer consumers what amounts to a discount.

It may be true that not collecting sales tax is one of the advantages of doing business online, but that doesn’t mean it is an unfair advantage. Physical stores also have advantages, like being able to offer products immediately with no shipping costs. But those are not unfair advantages; they are just the results of choosing to run a certain kind of business. There is no reason why governments should “level the playing field” by making online-only retailers pay the costs of a system whose benefits they have consciously foregone.

I hope California voters side with Amazon, not because I want Amazon or its customers to avoid taxes, but because nexus is an important principle that is worth defending. Without it, modern businesses can never know which far-off locality might claim jurisdiction over them or what burdens such a locality might impose. The conveniences and efficiency of modern communications will be lost in a tangle of revenue-seeking red tape.

• Become A Funded Futures Trader