May It Please the Mozzers,

There has been a lot of buzz surrounding New York's new law requiring online retailers to collect sales tax from their New York Customers if they engage affiliate marketers in that state.

The New York Times (original coverage and the Overstock fallout), the New York Post, Vastplanet, Cost Per News, and The Wired Blog represent a handful of the coverage out there.

Before we talk about Amazon's legal challenge to the new law, let's take a brief look at NY's new tax law:

• The purpose of the law is to allow NY to collect sales tax whenever one of its residents purchases something from a large online retailer. Historically, large online retailers, like Amazon, who don't have an office, employees, or other physical presence in NY don't have to collect sales tax for purchases made in NY. NY is attempting to change this by making the use of affiliate marketers based in NY enough of a connection with the state to require these large online retailers to collect sales tax, even though they don't have the other traditional requirements like an office or sales team in the state.
  
• The law attempts to exclude small online retailers. You don't have to collect sales tax unless you have gross receipts of more than 10k per year from the sales referred to your site by your affiliates. Thus, if your affiliates make you less than 10k per year in sales to NY citizens, you don't have to worry about this law.
• The law doesn't specifically address "affiliate marketers." It applies to any NY resident who enters into an agreement with an online retailer to "directly or indirectly" refer "potential customers, whether by a link on an internet website or otherwise," in exchange for a commission or other compensation. Thus, affiliate marketers clearly fall within the purview of the law, but there is also potential for other more 'traditional advertisers' to trigger the sales tax collection requirements.
  
• NY's law did not occur in a vacuum. There has been an ongoing national effort to address internet sales tax issues. Basically, NY got tired of waiting for a nationalized tax regime and decided to forge ahead on its own. Undoubtedly, the other states are watching this situation very closely.
• NY has taken the position that these large online retailers should have been collecting sales tax all along. However, in its graciousness and magnanimity, it is promising not to go after the large retailers for uncollected past taxes so long as they register with the state and start collecting taxes by June 1, 2008.  So, if the online retailers don't get on board, they could be subjected to costly back audits and penalties.

Since the passage of the law, Amazon has started a lawsuit to declare the law unconstitutional and Overstock.com has begun the process of dropping all of its NY affiliates to avoid having to deal with the law. Understandably, affiliate marketers are very concerned about the legislation; If other states follow NY's lead, affiliates will become corporate pariahs.

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I don't have any expertise in interstate tax law, but I thought I would read the leading case on the topic of sales tax and interstate commerce to try and get an idea of where Amazon's case might go. Amazon has three arguments that the law is unconstitutional, but I'm only going to look at whether the law violates the Commerce Clause of the U.S. Constitution.

The U.S. Supreme Court discussed interstate tax in 1992 in Quill Corporation v North Dakota. In that case, North Dakota tried to collect sales tax from a mail order office equipment company, Quill Corp., that didn't have any offices or employees in North Dakota and only contacted potential and actual customers through the mail. It wasn't an internet case, but you can see the similarities between mail-order office supply companies and what large online retailers like Amazon do. Well, the Supreme Court ruled that North Dakota couldn't force Quill to collect sales tax on purchases made by North Dakotans because Quill didn't have enough of a connection with North Dakota to give the state authority over it.

Sounds promising for Amazon, right?

Well, I dunno. In order to withstand a Commerce Clause challenge, the tax must apply to an "activity with a substantial nexus with the taxing State," among other things. The problem is that "substantial nexus" isn't clearly definable.

We know from the Quill case that a vendor whose only contacts with the taxing State are by mail lacks the "substantial nexus." However, the Court stated in Quill that "whether or not a State may compel a vendor to collect a sales or use tax may turn on the presence in the taxing State of a small sales force, plant, or office."

Thus, the question seems to be whether affiliates are like mail order catalogs or independently contracted salespeople. If they are like a mail order catalogue that merely advertises to potential customers, then it looks like Amazon has a great case. However, if they are more like independently contracted sales experts, then I think Amazon may have a difficult time winning its case on the commerce clause argument.

In the lawsuit, Amazon attempts to distance itself as much as possible from its affiliates and describes them as merely agreeing to show Amazon's advertising on their websites:

Amazon allows independent third parties located around the world to advertise Amazon.com on their own websites by joining Amazon's "Associates Program....." Under this program, advertisers can place one or more of a variety of different Amazon advertisements on their own websites. These Amazon websites generally have links enabling visitors to "click through" to Amazon's website from the Advertiser's website. All such advertisers operate independently from Amazon, and they alone choose the timing, format, and placement of the Amazon advertisement on their websites.

Clearly Amazon is going out of its way to avoid characterizing affiliates as independently contracted salespersons. And that may be a very fair characterization for many of Amazon's affiliates. It's certainly true that the associates don't consummate the sales transaction and are not authorized to act as agent's of Amazon. But does all of this mean they don't solicit sales?

Regardless, I find it interesting that Amazon avoids describing all of the ways that talented, expert affiliates design their sites around the promotion of Amazon products. Top-performing affiliates do more than plop a link on a website; they craft websites by choosing a relevant domain and developing relevant, quality content specifically for the purpose of marketing the product and soliciting sales. After all, Amazon affiliates don't get paid unless you buy!

I'd like to throw the question out there. Are affiliates more like a mail order catalogue or an independently contracted sales expert?

Ultimately, it will be up to a judge to decide. The judge's decision will depend greatly on his or her understanding of what exactly affiliates do and the nature of their relationship with the vendor. I'm really curious what the practitioners think about this issue.

Thanks in advance for your feedback!

Best Regards,
Sarah