Affiliate Programs and Taxes, Amazon

There has been some commentary in the media about Amazon.com’s decision to terminate Affiliates in North Carolina and Hawaii this month and to warn California & Connecticut of similar action in the face of pending tax legislation from those States. Amazon is currently appealing a 2008 judgment requiring the company to collect taxes on sales in the state of New York.

Most media articles are written from the angle that in the face of lowered revenue projections states are attempting to enforce collection of sales taxes on items sold to residents. Nice and simple but not the whole story.

Sales Tax

Just about every state has sales tax, most have use taxes and income taxes. Each state charges a different rate and charges sales tax on different items. Some states exclude food, or clothing for children under the age of 12, some exclude services, for example doctor visits and prescriptions. Hawaii does not call it a sales tax it is General Excise Tax and it is a use tax payable on everything, rent, your blood pressure medication, selling your old car, your burger at McDonalds, and your paycheck.

Sales tax gets even more complex when you remember that both incorporated and unincorporated cities and towns, villages, districts and municipalities can and do have sales taxes. In some large urban areas the tax rate can vary depending on your location in that city.

Main Street Retail

The bricks and mortar retailer knows what the tax rate is where his store is, that is all he has to worry about. Many non-internet retailers regard internet sales as competition with an unfair advantage even though most internet businesses either collect sales taxes from in state sales or factor them into the price and pay them themselves. A recent article in the Wall Street Journal says

“Consumers are supposed to pay tax for items they buy online, but state governments have no way of enforcing the law and cannot require out-of-state retailers to collect taxes if those companies have no “physical presence” in the state. North Carolina and California are trying to define marketing affiliates as commissioned sales representatives with physical presence in their states.”

I guess Hawaii is too far away for the Wall Street Journal to think about but the tax implications for companies who have marketing affiliates in Hawaii are far more serious than for any other state. That would be a whole separate article!

Marketing Affiliates

A marketing affiliate advertises a product. If a visitor to the marketer’s website clicks through on an Amazon advertisement to buy a product, Amazon sends the marketer a commission. The marketer pays income taxes on the commission to his/her state. If Amazon cancels all affiliates’ contracts, preventing them from receiving commissions the net result to the state is no income - no taxes.

That is not the whole story.

The states

Every state has a right to collect sales tax on residents who make out of state purchases, the tax is called a use tax and most people who have bought a car out of state are familiar with the process. With a vehicle purchase enforcement is easy for the state, no pay, no plates. However collecting the use tax on the CD you bought online is a lot harder, it is much easier for the state to go after the seller and force them to collect and remit.

Some states have declared intent to require the company paying commission to withhold income taxes from affiliates, this opens up a new can of worms with the IRS. Are the affiliates employees or independent contractors?

That is not the whole story.

Internet Sales

If your internet business makes sales nationwide and we all do, there would be a real headache just finding the correct tax rate for each sale. Determining what is taxable, where, and in what circumstances becomes a huge burden. For example does the taxation district require taxes be collected on shipping?  All the shipping or just the portion of the order which is taxable?

Sales taxes can not be reliably calculated by zip code because the taxation districts do not always correspond with postal districts. Collecting the tax is just the first step, each state, and taxation district within that state may require business or sales tax licenses to legalize the collection. Then the seller must remit the taxes collected, with corresponding paperwork, according to the schedule set by each taxation district.

If you sell on a venue who collects and pays the taxes? The venue like Amazon, or PayPal at point of sale on eBay?  Who pays for that service?  Who bears responsibility for errors and omissions?

That is not the whole story.

The skunk in the woodpile

In order to make a company collect sales tax, the company has to have a business presence in the state. The standard definition is an office with employees. Having this in-state office establishes what the law calls “nexus.”
What the North Carolina and Hawaii are proposing is to redefine nexus to basically meaning the company sent money to state residents for a business related activity. No office, no employees, just paid a state resident money. The potential impact is far larger than sales tax revenue.

Once nexus is established, the state would not only be able to force Amazon and other companies to collect sales taxes in future but they could require them to pay all past sales taxes that they didn’t collect from customers since the very first day nexus was established. With penalties and interest this could be millions of dollars.

This is why affiliates in those states have been terminated prior to the law being passed.

7/4/09 UPDATE: Supreme Court of the State of NY ruling in re: Amazon.com LLC v New York State Dept of Tax and Finance

Value Added Tax is not the answer!

I see comments saying that VAT (Value Added Tax) is the answer, obviously those who comment have a shaky grasp on the realities of VAT. Canadians and Brits can tell you all about VAT and hopefully one or two will, in the comments.

VAT is usually imposed at a national level generally with varying rates depending on the classification of the goods being taxed; essentials like food bear a lower rate, “luxuries” a much higher rate. It is too complex to be applied and collected by each individual state, although that probably would not prevent them from trying.
Value Added Tax is charged at every point goods change hands. For example lets look at my greeting cards (please). VAT is added at each stage from raw material to retail product sold in a shop. The manufacturers of card stock and ink pay VAT on the raw materials to make their goods, on sale they deduct what they paid in VAT and remit the balance to the taxing authority with supporting paperwork. The card manufacturer buys paper stock and ink, paying VAT in turn and makes the cards. A distributor buys the finished cards and pays VAT to the manufacturer, then sells them to a wholesaler who in turn sells them to the retailer and VAT is paid every time. When the retailer sells them VAT is collected yet again.

The direct results of VAT are much higher retail prices, outsourcing of manufacture overseas to avoid it and a need for many more government employees to apply and enforce it, all of whom have to be paid.

What to do?

You can read this, shake your head and say I have no affiliate income or my state isn’t planning this and carry on with your life until it comes down around your ears. Of you can sit down and write to your elected official and tell them an internet tax is not the way to tackle this, it places an unfair burden on internet sellers who pay taxes on instate sales. Here is a useful link.

If you live in North Carolina make a telephone call to find out if your elected representative actually ‘gets’ all the implications of this action.
If you live in Hawaii call, (808-586-0034) or email Governor Lingle, at governor.lingle@hawaii.gov before July 1st (do it now, today) and ask her to veto the law.

Y’all come back!

Henrietta!

UPDATE: Rhode Island affiliates terminated as of June 29, 2009. “This is a direct result of the unconstitutional tax collection scheme passed by the Rhode Island General Assembly with a veto-proof majority.” says Amazon.

4 comments.

  1. Once again Henrietta gives a clear explanation of the issue right down to the skunk lurking in the woodpile that nobody else I have read even saw.

  2. The mess I hear re: taxation in various states could be solved using a VAT tax. I think I heard about a move for an SST (Streamlined Sales Tax) in the U.S. recently.

    I have worked with VAT in Canada and Europe. Overall it has no negative impact on a business. The retail customer is the one to pay the VAT. In fact, as a business, VAT is beneficial to a business. Unlike most Sales taxes (a headache to administer in border and across borders) Any VAT PAID OUT, is reclaimed by a business against VAT collected.

    VAT does NOT favour outsourcing overseas, it does the opposite. It encourages IN-COUNTRY manufacturing and purchase. It favours EXPORT.

    In our case, as Canadians, we benefit from VAT in-country, and more-over with out-of-country sales. In fact our sales outside Canada ensure we are in a refund position with VAT most report terms.

    Personally, I think a SST, (or VAT) system would actually help businesses. I believe Amazon is, in fact, a supporter of SST at this time. It is the states, and municipalities which are hedging for position, blocking a more rapid implementation.

    I know of no country which has an “internet tax”. They only have sales taxes, import duties, value added taxes, and some local specific taxation levels.

    If the U.S levies an “internet tax”, that would be a first. I don’t think others would follow. They have already solved the issue with GST (goods and services tax, canada), or VAT (most european countries).

  3. Excellent article Henrietta except for the VAT portion. Vince is right about VAT credits for businesses in my experience. I do not know precisely how it is being transacted by the EU now, but up to the time I closed my German business some years ago I was credited for VAT paid counter balanced by VAT collected. I’m not really sure tho how VAT helps or not helps a business — it is more record keeping for the government.

    However, the main issue for us in the US seems to me to be nexus or physical presence definitions. The States that have enacted the affiliate actions appear to me to be in contravention to the Constitution’s Commerce clauses. The Congress may try to solve the problem by enacting an Internet wide sales tax, which to me also appears to have Constitutional problems. But then again I read the Constitution more closely than the fashionable way of it meaning whatever I need it to mean now.

    The solution for the States will probably need a Supreme Court decision redefining whatever nexus means and setting precedence we will live with for the foreseeable future. (Doesn’t mean the court will arrive at the logical/real/constitutional decision–only that it will be the law as interpreted.)

    Keep on truckin,

    TomH

  4. “Unlike the United States, the European Union never considered making the internet a tax-free zone.” see the details about their VAT at http://www.newrules.org/node/2241

    The Sales tax legislation now being discussed is a catching up of taxes that have always been payable. The problem is the intricate setup between states and feds regarding division of collected monies.
    In Canada we have GST (like a VAT) applied across the country (federal). PST (Provincial sales tax) is left to the provinces to administer and collect. Ontario has 8%. ONLY Ontario residents pay the tax, or any in-person purchase made here. If a tourist, they can apply for rebate. Some tourists have their items shipped to their homes, thus avoiding the taxation.

    If we sell to Alberta, there is no PST, just GST.
    What seems to be happening in the U.S. is that in order to catch up with internet sales, which to date have been somewhat FREE of taxes by design, the states wish to tax “as if” sold in state. The buyer was always responsible for sales tax on their out-of-state purchases, but this is not easily enforced. So they’ll hit the seller. Lazy and easy.

    Perhaps a better solution would be to have the couriers and carriers apply a sales tax at delivery. That way the tax gets collected on declared invoice value, Gov’t gets their share, and us internet sellers are off the hook? A sweet dream perhaps, but nice to dream.

    So far as how VAT helps business.

    I buy at auction for 5% less than private individual, as the GST is refunded later (or goes against that collected on sales).
    (I also purchase for 8% less than private, as we are PST exempt).

    Helps EXPORT: When I export an item, I receive a clear 100% refund on any GST paid on it’s purchase.

    Alleviates Liquidation costs: If I must sell items at a loss to clear stock, I recuperate the GST paid out.

    If items sold through auction, the auctioneer collects all taxes, None are due from us. Thus if I buy from private, sell through auction, there are NO tax liabilities (GST OR PST!). This little secret has proven very valuable. We can make a profit on sales, and still claim the GST from expenses - thus putting us into refund postion easily.

    To put it simply, by selling out of country, or at auction, we pocket an extra 5% on sales. It can get more complex than that when considering full business operations- but that’s the gist.

    Other than still having to deal with the part-timers, garage “salers”, and underground economy, the VAT-GST model has proven beneficial to our business. (And no taxation system, unless duly enorced can help with THOSE situations).

Post a comment.

Comments will be sent to the moderation queue.

To submit your comment, click the image below where it asks you to... Clickcha - The One-click Captcha