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In law school, we learned that nexus is the most important factor in determining whether items may be properly taxed for purposes of sales tax. Remember Bloomingdales by Mail LTD. V. Commonwealth of Pa. Dept. of Revenue? The nexus requirement for the imposition of sales tax for mail order and Internet orders has also been affirmed in the U.S. Supreme Court in National Bellas Hess v. Illinois and Quill v. North Dakota. This idea of nexus — increasingly difficult to prove in a paperless, virtual society — has resulted in millions of dollars of forgone revenue in many states, such as Pennsylvania, that have chosen not to pursue sales tax on Internet sales. But that might be about to change. Last month, Internet retailers received official notice from the state of New York that they may have to register with the state and begin collecting sales tax. Previously, companies that didn’t have a store or “physical presence” in New York were not required to collect sales tax. That is more or less still the case — with one significant tweak: New York law now presumes to redefine what constitutes a “vendor” on the Web. The new legislation in New York now presumes that a seller that makes taxable sales of tangible personal property or services in the state is a vendor for purposes of collecting sales tax if both of the following conditions are met: • “The seller enters into an agreement or agreements with a New York State resident, or residents under which, for a commission or other consideration, the resident representative directly or indirectly refers potential customers to the seller, whether by link on an Internet Web site or otherwise. A resident representative would be indirectly referring potential customers to the seller where, for example, the resident representative refers potential customers to its own Web site, or to another party’s Web site which then directs the potential customer to the seller’s Web site,” and; • “The cumulative gross receipts from sales by the seller to customers in New York State as a result of referrals to the seller by all of the seller’s resident representatives under the type of contract or agreement described above total more than $10,000 during the preceding four quarterly sales tax periods.” (New York State Department of Taxation and Finance Office of Tax Policy Analysis Taxpayer Guidance Division TSB-M-08(3)S ). Clever, huh? What New York has done is rather than try to overcome the presumption that taxation of Internet sales is an unfair burden on interstate commerce (the prior arguments in favor of sales tax), the state has instead expanded the definition of vendors to affiliates, representative and agents to establish physical presence. If any vendor under that test qualifies, then the online retailer must collect tax on the whole of purchases made in the state. Some online retailers are crying foul. In May, online giant Amazon.com filed suit against New York, claiming that the new law goes too far. Amazon claims that the law is “overly broad and vague.” Further, since Amazon has thousands of affiliates, it argues that it is impossible to determine which of its affiliates are actually in New York state. In the interim, however, Amazon has agreed to comply with the new law. Overstock.com followed suit at the end of the month. However, rather than agree to comply with the new law, Overstock announced that it would no longer extend its affiliate program to residents of New York in order to avoid having to collect sales tax. More than 3,400 Overstock.com affiliates were advised that they would no longer be able to advertise with the company. Will other major retailers follow? I’m not certain. Despite the noise that many are making, I think other retailers may engage in some “wait and see” until these cases go to trial. I think a more important question is whether other states, such as Pennsylvania, might follow New York’s lead. In a slow economy, states are looking to find other ways to increase revenue. Increases in tax revenue beat the option: cutting spending for programs or raising personal or real estate taxes, angering taxpayers. And the money must come from somewhere: Remember that states may not operate at a deficit, unlike the federal government. Traditionally, states have been slow to embrace the idea of Internet taxation. Nexus issues notwithstanding, the idea of taxing Internet sales is not popular. In California, an assemblyman, Charles Calderon, was nearly run out of town for suggesting that the state consider imposing a tax on new media downloaded from the Internet. Calderon’s bill targeted goods like iTunes (which are currently exempt from tax), claiming that sales tax should apply equally to online and in-store purchases. As you can imagine, in the heart of tech country with giants like IBM and Apple as taxpayers, the idea didn’t get far. Calderon’s argument for taxing Internet sales focused on the idea that many of the same products that could be bought in a store escape taxation when purchased over the Internet. He is completely right. Not only are states losing sales tax revenue with this policy, states may also be losing corporate tax revenue: the lure of no sales tax to the customer may pull revenue away from local retailers. Of course, most states, like Pennsylvania, have a “use tax” that requires the end purchaser to pay the equivalent of sales tax on items that they buy without paying tax at the sale. This means that those sales made over the Internet are still subject to use tax paid by the residents of the state. Practically, this doesn’t happen: Consumers are not paying use tax on items purchased over the Internet. So what makes the most sense for states? On the one hand, the increased revenue would be welcome for states struggling to meet program budgets — the revenue is otherwise being lost. On the other hand, increased administrative costs may cause online retailers to flee from the state, taking business with them, just as Overstock.com has done. And make no mistake: Collecting sales tax in every state or municipality with an affiliate or agent is a complicated calculation for online retailers. This is at the heart of Amazon’s argument. The rules governing sales tax are subject to the individual charters and rules within each state or municipality — and the rates are constantly changing. To keep up with those changes would be an administrative nightmare. It will be interesting to see the outcome of the Amazon.com and Overstock.com cases, but don’t plan on it any time soon: I predict appeals to the Supreme Court, no matter the verdict. In the meantime, I’ll be watching to see how other states react to the legislation and the resulting uproar. I suspect our government officials in Pennsylvania, including Governor Rendell, will be watching, too. Kelly Phillips Erb is a founding shareholder of The Erb Law Firm. She is a member of the bars of New Jersey and Pennsylvania and the Tax Supper Club, and she presents regularly on a wide range of topics before local and national organizations. Phillips Erb authors the blog “Taxgirl,” available at www.taxgirl.com.

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