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A Taxing Question

24 Feb, 2009 By: Chris Tribbey

While some physical retailers are reporting massive losses and closing their doors, online retailers are still booming during this recession, at least comparatively. Amazon.com enjoyed a wonderful fourth-quarter 2008, reporting in late January profit of $255 million. Netflix reported profit of more than $22 million during the same period. And eBay reported profit of more than $367 million for the quarter.

But the success of online retailers hasn’t gone unnoticed by states suffering from severe budget shortfalls. In April, the state of New York began requiring out-of-state, online retailers to pay taxes on purchases made in the state, even if they don’t have a physical presence there. Earlier this month, California lawmakers introduced similar legislation. Both skirt a 1992 Supreme Court ruling that retailers could not have use taxes imposed on them unless they had a significant physical presence in the state attempting to collect the tax. To get around that, the legislation establishes a retailer’s presence in the state by their advertising of business in that state.

“This legislation will close the current loophole in California tax law which allowed out-of-state companies to avoid collecting California sales and use tax,” said state Assemblywoman Nancy Skinner, D-Berkeley, co-author of the bill, when she announced it Feb. 2. “During this unprecedented fiscal crisis we cannot afford to lose sales tax revenue from out-of-state companies when our local businesses are struggling.”

But opponents of the new tax laws say they’re unconstitutional, unfair and force retailers to waste resources.

“We’re seeing a lot of legislation, and we’re doing everything we can to tell them it’s a bad idea,” said Fred Nicely, with the Council on State Taxation in Washington, D.C. “It’s poor policy. Overstock.com stopped employing people in New York, just to avoid it.” In May Overstock let go more than 3,000 affiliates based in New York in an attempt to skirt the law.

Even if an online business is rental based — such as Netflix and Blockbuster Online — they’re still selling a subscription service, and the laws apply to them too, Nicely noted. Blockbuster Online tells its customers it will “charge all applicable state and local taxes” and Netflix tells its customers: “The Netflix service has to be taxed in nearly every state, because we have physical property (the DVDs) in every state. Depending on your state, this may be a rental tax, sales tax and/or use tax. Of course, tax rates are different from state to state.”

Netflix CEO Reed Hastings told the New York Times in early 2008:  “We collect and provide to each of the states the correct sales tax.”

Netflix did not return a call requesting comment.

Budget shortfalls

According to a rough estimate from Forrester Research, online sales in 2008 made up about 8% of all U.S. retail sales, to the tune of more than $200 billion. The firm estimated that if online retailers collected sales tax on that, more than $3 billion could be raised for states.

“It would seem desperate times call for desperate measures,” said Forrester Research analyst Sucharita Mulpuru. “I think if New York state is an example, leaving no stone unturned, no one is spared, to meet a budget shortfall, Internet taxation is an easy target.”

Amazon sued New York over the law, but in January was handed a defeat in the state’s Supreme Court.
“Amazon chooses to benefit from New York associates that are free to target New Yorkers and encourage Amazon sales, all the while earning money for Amazon in return for which Amazon pays them commissions,” New York Judge Eileen Bransten wrote in her dismissal of Amazon’s case in January. “Amazon has not contested that it contracts with thousands of New Yorkers and that as a result of New York referrals to New York residents it obtains benefits of more than $10,000 annually.
“Amazon should not be permitted to escape tax collection indirectly.”

Amazon will have to challenge the ruling in the New York State Court of Appeals, while it pays the New York imposed tax. And while Judge Bransten offers a safe harbor suggestion to advertisers in her judgment — basically saying out-of-state sellers can refuse in-state advertising activities referring to them or on their behalf  — some believe it’s vague and will result in more suits.

“This safe harbor may not feel very safe until we learn what activities constitute solicitation or encouraging sales. [It’s] probably not solicitation if all you do is show everybody a display ad on your Web page,” said Steve DelBianco, executive director of NetChoice, a coalition of trade associations, businesses that operate mainly over the Internet, and online consumers. EBay, Overstock.com and Yahoo are among its more than 12,000 members.

“It represents an ill-advised overreach,” Del Bieanco said. “It’s an unreasonable burden. Overstock said ‘If you’re going to penalize me for advertising in your state, I’m not going to advertise.’”

Amazon would not comment on the ruling, however the company’s SVP and CFO, Thomas Szkutak, spoke about sales tax in a call with investors Jan. 29.

“In terms of sales tax, we collect in certainly a number of states in the U.S., many jurisdictions outside of the U.S.,” he said. “In fact, approximately half of our business today … we are actually collecting some type of either sales tax or value-added tax. And we have very good businesses in those geographies.”

The California bill, Assembly Bill 178, co-authored by Charles Calderon, D-Montebello, chairman of the state’s Assembly Revenue and Taxation Committee, would raise an estimated $55 million a year for California, and would exempt businesses making less than $10,000 a year. When a consumer buys something online, they are generally required to self-report a “use tax” on items. But more often than not, those taxes go unreported, and the new state laws attempts to stop that leak. But DelBianco said the law, just as in New York, unduly burdens retailers.

“If I’m a retailer in Virginia, and I advertise in your magazine, what California’s new law would do, by my virtue of advertising, they would consider you my agent and collect a tax,” he said.

Forrester’s Mulpuru said these new online tax laws might chase away many consumers, hurting businesses big and small.

“A significant number of consumers have said they would cut back on spending if there was additional sales tax,” she said. “It’s really important to keep in mind that average people use the Internet for a second or third source of income. They aren’t a big business, and they’ll be affected too.”

Streamlining taxes … for downloads too

In an attempt to streamline online tax rules at all levels — because counties and cities can impose their own local tax laws on Internet sales — the Streamlined Sales Tax Governing Board in Nashville, Tenn. is signing up states and retailers to simplify tax codes. More than 20 states and 1,116 retailers support the group’s efforts to simplify online tax collections. Wal-Mart and Borders are among the group’s ranks.

“We asked the retailers, what are the state governments doing that’s making things difficult,” said Scott Peterson, executive director of the group. “A big issue for retailers also is local sales tax … they’re allowed to have a sales tax just like the states.”

Peterson said that those companies dealing with non-physical product on the Internet — such as movie and music downloads — have their own set of concerns.

“One of the things brought to us by the movie industry was downloads. There are states that want to exempt them and states that want to tax them,” he said. “There are states that believe downloads are tangible property … There are some things you just can’t make simple. At least we can try to make it uniform.”

For downloads, more than a dozen states are collecting taxes from businesses such as iTunes and CinemaNow for downloaded property. Five of those — Utah, Tennessee, Nebraska, Indiana and South Dakota — enacted their download tax laws in 2008. Just on Feb. 18, Wisconsin joined the ranks, passing legislation imposing a 5% tax on downloads. In New York, Gov. David Paterson wants to impose a four-cent tax on downloaded content — including porn. And while an attempt to charge download taxes in California failed in 2008, legislators are reportedly looking at bringing the legislation forward again.

“California can try to close its multibillion dollar budget deficit by applying old manufacturing-based tax laws to e-commerce or by embracing the digital revolution with its high-paying jobs and income, property, capital gains and corporate tax revenue,” wrote Michelle Steel, a member of California’s Board of Equalization, the state’s tax board, in a Sacramento Bee editorial last year. “The music industry proved once before that old business models don’t work with new technology.”

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