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Posted by on Jul 1, 2011 in Economy, Law, Politics | 17 comments

Cash-Strapped California Goes After Internet Sales

It’s July 1, the first day that a new California law will require online retailers like Amazon and to collect sales taxes on purchases by California citizens. The real victim is not the California consumer, however, but California affiliate businesses:

Many of about 25,000 affiliates in California, especially larger ones with dozens of employees, are likely to leave the state, said Rebecca Madigan, executive director of trade group Performance Marketing Assn. The affiliates combined paid $152 million in state income taxes last year, she pointed out.

Government officials estimate that the new law (ABX128) will raise $317 million annually. The Governor signed the state’s $129-billion budget package on Thursday. Thus, the estimated tax is a whopping 0.2 percent of the budget package, and that’s assuming affiliates do not leave the state.

Leading the charge for the bill – no surprise, bricks-and-mortar retailers:

“You can’t give one segment of retail a 10% discount every day. It’s just not fair,” said Bill Dombrowski, president of the California Retailers Assn., a major player in a coalition of large and small stores supporting the legislation.

However, California-based eBay was successful in getting its “affiliates” exempt if they sell less than $500,000 in products a year. One could argue that the state of California has, therefore, handed a local company an economic advantage over a “foreign” one (eBay v Amazon).

In 1992, the U.S. Supreme Court ruled (Quill Corp v North Dakota) that states can collect sales tax from firms only if they have a “physical presence” in the state.

Indeed, in recent years Congress has considered legislation that would “overrule” the Bellas Hess rule… Congress is now free to decide whether, when, and to what extent the States may burden interstate mail order concerns with a duty to collect use taxes.

The California legislation defined physical presence as a commission check (which, of course, is not a check and might not even be wired to a bank that is physically located in California) or related company (for example, Amazon’s Lab126 Inc. in Cupertino developed the Kindle and its search arm is headquartered in Palo Alto).

The foundational legal case, Bellas Hess, was argued in 1967 and does not directly apply to Amazon:

The appellant, National Bellas Hess, is a mail order house with its principal place of business in North Kansas [386 U.S. 753, 754] City, Missouri. It is licensed to do business in only that State and in Delaware, where it is incorporated. Although the company has neither outlets nor sales representatives in Illinois, the appellee, Department of Revenue, obtained a judgment from the Illinois Supreme Court that National is required to collect and pay to the State the use taxes imposed by Ill. Rev.Stat. c. 120, 439.3 (1965).

Note that the Supreme Court decision said that the out-of-state retailer should not have to collect the tax if there is no nexus, no physical connection.

But the buyers? That’s another matter.

Californians are supposed to be voluntarily pay those sales taxes on their state income tax forms.

California law requires tax … on items purchased out-of-state for use in California. […] The use tax, which was created in July 1935, is a companion to California’s sales tax that is designed to level the playing field between in-state retailers who are required to collect tax, and some out-of-state retailers who are not. Use tax, just like sales tax, goes to fund state and local services throughout California.

Amazon and Overstock have filed a lawsuit in New York, where a similar law passed (but without the subsidiary focus). In 2010, it was Colorado affiliates getting their pink slips after a similar law passed.

The Tax Foundation criticizes the “affiliates mean you should collect taxes” meme. For example:

Amazon taxes do not level the playing field between brick-and-mortar and Internet-based businesses because they require Internet-based businesses to track thousands of sales tax bases and rates while brick-and-mortar businesses need to track only one. (2010, pdf)

I am more and more convinced that America’s patchwork system of taxes and benefits is broken — broken at the federal, state and local levels. For example, if California’s political leadership had truly wanted to treat all business equal, they would not have exempted eBay from the new tax bill legislation. And I ask you: how many news articles have mentioned that Californians are supposed to be paying those taxes voluntarily?