Sales Tax Collection by Online Vendors

By Roger Douglas, J.D., and Paul McGovern, CPA, Orange County, CA

Editor: Lorin D. Luchs, CPA, J.D., LL.M., a retail online vendor, recently suffered a setback in a New York court ( LLC v. N.Y. State Dept. of Tax. & Fin., No. 601247/08 (N.Y. Sup. Ct. 1/12/09)), where it was contesting a newly enacted New York statute requiring online vendors with no direct physical presence in New York to collect sales tax on goods sold into the state. The court dismissed Amazon’s complaint for failure to state a cause of action.

The law requires vendors to collect sales tax on tangible personal property or services sold into New York (NY Tax Law §§1105, 1131). Under Article 28 of the New York Tax Law, a vendor is defined as “[a] person who solicits business either:

(I) by employees, independent contractors, agents or other representatives . . . and by reason thereof makes sales to persons within the state of tangible personal property” (NY Tax Law §1101(b)(8)(i) (C)). In a Technical Service Bureau Memorandum, New York provided new rules regarding who is presumed to be a vendor (TSB-M-08(3)S (5/8/08)). Under the rules, a rebuttable presumption that the vendor of tangible personal property or services is soliciting business through an independent contractor is created if:

  • The vendor enters into an agreement with a resident of New York whereby the resident directly or indirectly refers potential customers to the vendor via a link on an internet website or otherwise in exchange for a commission or other consideration; and
  • The vendor’s cumulative gross receipts from sales to these referred customers are in excess of $10,000 over the previous four quarters.

This presumption is rebuttable if the vendor can show that the New York resident representative did not engage in any solicitation in New York on the vendor’s behalf that would create nexus under the U.S. Constitution during the previous four quarters.

The New York Department of Taxation and Finance provided additional guidance on how to overcome this presumption in TSB-M-08(3.1)S (6/30/08). Under this guidance, a contractual provision between the vendor and a New York resident independent contractor prohibiting the representative from solicitation activities in New York is insufficient to rebut the solicitation presumption. Instead, in conjunction with a contractual prohibition, the New York representative must submit an annual, signed certification to the vendor stating that the representative has not engaged in any prohibited solicitation activities in New York during the previous year. Thus, it appears that a vendor may rebut the presumption of solicitation if the taxpayer has a contractual prohibition on sales within New York by the resident independent contractor and such resident files annual certifications containing the aforementioned information.

Amazon did not have any property or employees working or residing in New York. The company conducted a certain amount of New York sales through agreements with other businesses (associates) that operated various websites. Amazon entered into agreements with thousands of associates located across the United States. Potential associates submitted an application to Amazon and, upon acceptance, entered into an operating agreement with Amazon. The operating agreements classified the associates as independent contractors.

Amazon gave associates the right to place an Amazon product link on their respective websites. The Amazon links allowed internet users to directly purchase Amazon goods from associates’ websites. Amazon paid the associates a referral fee for all Amazon sales consummated through such product links. The operating agreements did not prohibit associates from soliciting goods on Amazon’s behalf in New York. Amazon estimated that less than 1.5% of its sales in New York were attributable to activities of New York–based associates.

Amazon determined that it was potentially a vendor under the new law through its agreements with New York–based associates and began collecting the sales tax under protest. Amazon asserted that the law violated the federal and state constitutions’ Due Process and Equal Protection Clauses. All these claims were dismissed by the court. Further, Amazon claimed that the law was unconstitutional because it imposed a tax collection obligation based on activities that were insufficient to create a substantial nexus under the Commerce Clause. Thus, the issue was whether Amazon’s use of independent contractors constituted a physical presence and thereby a substantial nexus in New York, despite the fact that Amazon had no actual physical presence in the state through property, employees, or otherwise.

Substantial Nexus

The court stated that Amazon had substantial nexus with New York through its contracts with associates providing a New York address. The important distinction is that these associates referred or solicited business in New York on behalf of Amazon. If these New York–based associates provided a different service for Amazon that was unrelated to the referral of business, it appears that Amazon would not have nexus with New York for sales and use tax purposes. The court reasoned that substantial nexus can be “manifested by . . . economic activities in the taxing State performed by the vendor’s personnel or on its behalf” (quoting In re Orvis Co., 654 N.E.2d 954 (N.Y. 1995)) and that physical presence in a state can be actual or imputed. Further, it reasoned that Amazon should not be permitted to escape tax collection indirectly through the use of an incentivized New York sales force when it would not be able to avoid tax directly through the use of New York employees engaged in similar activities.

The question remains whether Amazon can have substantial nexus with New York despite lacking direct physical presence in the state. The U.S. Supreme Court dealt with similar issues in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and Scripto, Inc. v. Carson, 362 U.S. 207 (1960).

The Supreme Court held in Quill that a state tax will be valid under the Commerce Clause if the tax:

  • Is applied to an activity with substantial nexus with the taxing state;
  • Is fairly apportioned;
  • Does not discriminate against interstate commerce; and
  • Is fairly related to the services provided by the state.

Generally, a physical presence is required before a state can impose sales or use tax upon an out-of-state vendor.

In Scripto, the Supreme Court held that a state may impose a use tax collection obligation on an out-of-state company that had no property or employees in the taxing state. Scripto dealt with a Georgia corporation that sold products into Florida through independent brokers residing in Florida. The brokers solicited orders in Florida and sent them to the Georgia vendor for acceptance. The vendor compensated the brokers on a commission basis and gave each broker sales materials and samples of its products. The contracts between the vendor and brokers stated that the brokers were treated as independent contractors.

The Florida comptroller levied a tax on the vendor alleging that it failed to collect a use tax under Florida law. The vendor protested, alleging that it did not have sufficient nexus with Florida to justify the tax. The court noted that all aspects of the sale except the actual acceptance took place in Florida. Further, it noted that the brokers were not regular employees; however, the court determined that such a distinction was without constitutional significance. The court reasoned that the contractual classification of the brokers as “independent” did not change their local function of solicitation on the vendor’s behalf. The court stated that to make such a distinction under the constitution “would open the gates to a stampede of tax avoidance.”

Various state courts have also weighed in on this issue. Similar to Scripto, these cases addressed whether an out-of-state vendor creates nexus in a taxing state through the use of independent contractors in that state. Similar to Amazon, in many of these cases the out-of-state vendor had no property or employees in the taxing state, but the use of independent contractors that solicited sales in the taxing state created a physical presence, thereby giving rise to substantial nexus. See, e.g., Lanco, Inc. v. Director, N.J. Div. of Tax’n, 908 A.2d 176 (N.J. 2006), cert. denied, 127 S. Ct. 2974 (U.S. 6/18/07); Dell Catalog Sales L.P. v. Taxation and Rev. Dep’t of N.M., No. 26,843 (N.M. Ct. App. 6/3/08), cert. denied sub nom. Dell Marketing L.P. v. New Mexico Tax’n and Rev. Dep’t, S. Ct. Dkt. 08-770 (U.S. 3/23/09).

Future State Tax Implications

From the rules described above, requiring an out-of-state vendor with no in-state property or employees to collect sales and use tax on in-state sales that are made by independent agents is not a new concept. However, the application to an online distributor of goods is relatively new. The rationale is that the activities of an out-of-state online vendor are analogous to an out-of-state mail-order catalog vendor for purposes of determining substantial nexus.

New York’s victory in Amazon creates a potential revenue source for states with budget deficits. Other states may enact statutes similar to New York to generate tax revenue. California, Connecticut, Hawaii, and Minnesota have recently proposed legislation to tax online vendors in a manner similar to New York. Thus, the issue remains as to how many states, including the District of Columbia, will follow New York and require online vendors using commissioned independent agents to withhold sales and use tax. The application of these rules is still limited to out-of-state online vendors to the extent that they enter into an independent agent relationship and that agent is physically located in the taxing state.

From a business standpoint, another issue is that, based on Amazon, online vendors may have to identify the physical location of the independent agents they contract with to determine if they have state sales and use tax collection obligations. The cost of tracking these agents could significantly increase the operating costs of certain businesses and also cost the businesses in the form of lost sales. Tax practitioners should be alert for potential changes in state law similar to those in New York that could change their clients’ state sales tax collection obligations.


Lorin Luchs is a partner in National Tax Services of BDO Seidman, LLP in Bethesda, MD.

Unless otherwise noted, contributors are members of or associated with BDO Seidman, LLP.

For additional information about these items, contact Mr. Luchs at (301) 634-0250 or

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