Out-of-State Amazon Must Pay New York Taxes

Despite calling a new tax rule discriminatory, Amazon loses its court battle and must continue to collect state sales taxes from New Yorkers.
Marie LeoneJanuary 23, 2009 has lost its battle with New York State, despite arguing it was the target of a recently passed tax rule. On January 12, State Supreme Court Judge Eileen Bransten dismissed a complaint made by Amazon accusing the state of imposing sales taxes on the company when no connection — or nexus — existed between the Internet retailer and the state.

To strengthen its case, Amazon also asserted that a tax rule signed into law in April 2008 was discriminatory because it was enacted solely for the purpose of collecting revenue from sales made through Amazon’s independent contractors, known as associates, tax expert Robert Willens told The law signed by New York Governor David Paterson last year is popularly known as the “Amazon law,” said Willens, who runs an eponymous tax consultancy.

But Amazon’s cries of foul fell on deaf ears, as the court sided with New York State, wrote Willens in a client advisory he released this week. The case, LLC v. New York State Department of Taxation and Finance (N.Y Sup. Ct. No. 601247/08),mainly focused on whether a “substantial” tax nexus was established through Amazon’s operating agreements with its associates.

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At first glance, it would seem that Amazon’s nexus argument appeared strong. In an advisory to clients, Willens pointed out that to establish nexus, the taxpayer must have a physical presence within the taxing state, and Amazon does not own property or maintain any offices or employees in New York. Further, simply basing the tax connection of an out-of-state retailer like Amazon on in-state advertising such as catalogs, magazine advertisements, or telemarketing usually is an insufficient argument on which to base a claim of tax nexus.

However, physical presence can be imputed by economic activity. One way to do that is to make a connection based on the in-state solicitation of sales by an independent contractor on the out-of-state retailer’s behalf, explained Willens. “Solicitation is the key,” he wrote. In its associate agreements, Amazon did not specifically prohibit in-state solicitation on its behalf, and the court found that fact, among others, compelling enough to rule against the Internet giant.

To gain a better understanding of the court ruling, consider the Amazon business model. Since 1995 Amazon has sold goods across the globe via the Internet. As part of its business plan, it also sells goods through the Websites of hundreds of thousands of associates. Essentially, associates use their own Websites to market products, but refer or link the buyer to Amazon’s Website to complete the transaction.

As part of a contractor agreement, Amazon pays associates a percentage of the proceeds for any Amazon sale referred through their Websites. Willens calculates that Amazon’s sales to New York customers originating from New York—based associate referrals is less than 1.5 percent of the company’s total New York sales.

The new tax rule says that an entity is “presumed to be soliciting business through an independent contractor” if the seller (Amazon) enters into an agreement with a New York State resident (the associate) and the resident receives a commission for referring potential customers to the seller. The law specifies that the referral can be direct or indirect, and can happen through a link on a Website. In a nutshell, the law “requires collection of New York taxes from New Yorkers by out-of-state sellers, like Amazon,” wrote Willens.

Begrudgingly, Amazon began collecting taxes from its New York customers but did so under “under protest.” The Internet company argued that the new law violates the commerce clause of the U.S. Constitution because it imposes tax-collection obligations on out-of-state entities that have no substantial nexus with New York. But the nexus argument fell apart once the state established that Amazon’s independent contractors are in-state solicitors, rather than “mere advertisers,” which was how Amazon characterized its associates.

But the court saw it differently. Most notably, Amazon did not contractually prohibit in-state solicitation on its behalf, wrote Willens. As a result, the commissions paid to associates for referring business to Amazon are considered incentives to generate revenue. If Amazon was allowed to avoid collecting sales-tax payments on the revenue it generated via associates, it would put other New York retailers at a disadvantage, reasoned the court.


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