State & Local Taxes
On June 28, 2011, California Governor Jerry Brown signed a “click-through nexus” law requiring out-of-state online retailers to collect sales tax on all taxable sales of tangible personal property made through internet-based referrals (CA AB 28, Laws 2011). In response, Amazon.com and other online retail giants advised their California associates of the termination of their contracts. Such a move not only could have circumvented application of the new law to Amazon (and other online retail companies), it also threatened to negatively affect many California businesses that relied on the commissions and fees generated from Amazon’s associates program during these tough economic times.
Under an agreement reached September 9, the California legislature delayed for one year the requirement that online retailers collect use tax from their customers in the state (CA AB 155, Laws 2011). Amazon in turn relented in its drive to put the issue before state voters in a repeal referendum. But the war is far from over, as Amazon lobbies for a federal law allowed for under California’s postponement act.
The Amazon Law
CA Rev. & Tax. Code Section 6203(c)(5) imposes a sales tax collection obligation on out-of-state retailers that contract with California persons to receive referrals for potential purchasers of tangible personal property in exchange for a commission or other consideration. This was originally effective June 29, 2011, and is now delayed until September 2012. The new law presumes out-of-state retailers to be engaged in business in California (i.e., have nexus) under such contractual arrangements if:
- The total cumulative sales price from all of the retailer’s sales, within the preceding 12 months, of tangible personal property to purchasers in this state that are referred pursuant to all of the agreements with a person or persons in this state, is in excess of ten thousand dollars ($10,000).
- The retailer, within the preceding 12 months, has total cumulative sales of tangible personal property to purchasers in this state in excess of five hundred thousand dollars ($500,000). [CA Rev. & Tax. Code §6203(c)(5)(A)]
California’s law is modeled closely after N.Y. Tax Law Section 1101(b)(8)(vi), which was enacted in 2008 and was the first attempt at a click-through nexus law. The only significant difference between the two laws is that the California law also requires an out-of-state retailer to have over $500,000 in total sales of tangible personal property in the state (which is consistent with California’s bright-line economic nexus rule imposed under CA Rev. & Tax. Code Section 23101(b)(2)).
Amazon.com is widely known as an online retailer of tangible consumer goods. The company established an associates program that allows participating associates to run ads for Amazon.com on their own websites that contain links to Amazon.com. Amazon pays associates a fee or commission on sales Amazon makes to customers that click through to Amazon.com from links in the ads on their websites. People who wanted to participate in the program were required to submit an application with the company and enter into an operating agreement providing that the company’s status was that of an independent contractor. In Amazon.com LLC v. New York State Dep’t of Tax’n and Fin., 877 N.Y.S.2d 842 (N.Y. Sup. Ct. 2009), Amazon challenged the New York law as facially unconstitutional and as unconstitutional as it applied to Amazon on commerce, due process, and equal protection grounds.
A facial constitutional challenge requires the alleging party to prove that a particular law is absolutely unconstitutional and that no set of circumstances exists under which the law would be valid. Amazon argued that New York’s new nexus law was facially unconstitutional because it imposed a sales tax obligation on out-of-state retailers based on activities that were insufficient to establish nexus under dormant Commerce Clause jurisprudence. The court disagreed with Amazon’s argument because it found that the law was drafted in a manner that required meeting certain conditions precedent before it would apply to any one taxpayer. As the court stated, “The statute is targeted at requiring tax collection when an out-of-state seller avails itself of the benefit of in-state contractors compensated for referrals.”
Alternatively, Amazon argued that the law was unconstitutional as it applied to its particular facts and circumstances. Amazon contended that its activities within the state did not rise to the level of physical presence (as required under Quill Corp. v. North Dakota, 504 U.S. 298 (1992)). The company maintained that the agreement with its associates provided for only advertising and that associates were not compensated for soliciting sales but rather for allowing Amazon to place its links on their website. According to the court, the fact that the company did not request or prohibit its associates from engaging in solicitation was not relevant. The court stated that
Amazon [chose] to benefit from New York Associates that [were] free to target New Yorkers and encourage Amazon sales, all the while earning money for Amazon in return for which Amazon [paid] them commissions. Amazon [did] not discourage its Associates from reaching out to customers or contributors and pressing Amazon sales.
In short, the court held that Amazon should not be allowed to circumvent its tax obligations through the use of independent contractors when such obligations would have attached had the company used actual resident employees.
Next, the company argued that the New York law violated the Due Process Clause because it created a statutory presumption of nexus. Legislative or statutory presumptions attempt to infer the existence of one fact from proof of another. To withstand a constitutional challenge, such presumptions must provide some rational connection between the fact proved and the fact that is presumed. Amazon argued that there was no rational relationship between the fact triggering the presumption under the law—the existence of contracts with New York residents who are paid commissions to make referrals—and the fact presumed—that New York residents would solicit sales from other New York residents.
The court rejected Amazon’s argument, finding that there was a reasonably high degree of probability that associates would solicit business and encourage sales and that it was not irrational to presume that some of the New York associates would solicit business within New York from New York residents. The court also found that Amazon’s argument was undermined by the fact that the presumption was by its terms and effect rebuttable and that out-of-state sellers could avoid being subject to the law by establishing that none of their associates engaged in New York solicitation.
Finally, Amazon argued that the statute was unconstitutional under the Equal Protection Clause because the statute targeted the company. As the court explained, a successful equal protection claim requires the party alleging the violation to show that through the statute, the government has intentionally treated it differently from others similarly situated without any rational basis for the difference in treatment. Based on the fact that the company did not raise any allegations in its complaint that the state treated it any differently than other similarly situated taxpayers, the court found that Amazon had failed to prove an Equal Protection Clause violation.
The court dismissed all of Amazon’s claims. The company filed an appeal with the New York Appellate Division, which remanded the case to the trial court for further proceedings regarding the as-applied-to Due Process and Commerce Clause issues (Amazon.com LLC v. New York State Dep’t of Tax’n and Fin., 913 N.Y.S.2d 129 (N.Y. App. Div. 2010)). However, the Appellate Division affirmed the lower court’s holdings on Amazon’s facial constitutional challenges.
Significance for California
The Amazon case, although not considered mandatory authority for California jurisprudence purposes, is persuasive, especially because the language in the California statute is similar to New York’s. The company has asserted that only a nominal percentage of its overall California sales are generated from referrals from its California associates. However, California’s click-through nexus law would require Amazon to begin collecting sales tax for all California sales, regardless of whether the sale was made through the referral program. State analysts have estimated that the new law would have generated $83 million in additional tax revenue from Amazon alone in 2011.
Five other states have introduced similar click-through nexus legislation over the past two years. Unless the click-through nexus concept is held to be unconstitutional or Amazon and other retailers succeed in a federal solution, it is expected that more states will follow suit. California AB 155 provides that if by July 31, 2012, Congress does not pass a law authorizing states to require out-of-state sellers to collect sales tax on sales of goods to in-state purchasers—or if it does and California does not implement that law by September 14, 2012—CA Rev. & Tax. Code Section 6203(c)(5) will take effect the following day.
Mark Cook is a partner at SingerLewak LLP in Irvine, CA.
The editor would like to offer a special thanks to Christian J. Burgos, J.D., LL.M., for his assistance with this column.
For additional information about these items, contact Mr. Cook at (949) 261-8600, ext. 2143, or firstname.lastname@example.org .
Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.