Are "Click-Through" E-Commerce Tax Laws Valid?
November 19, 2014
So far, 13 states have enacted "click-through" laws that require certain out-of-state retailers to collect sales taxes. But are those laws valid? A new report from Ryan Radi and Hans Bader of the Competitive Enterprise Institute questions their legality.
According to Radi and Bader, states collect a great deal of revenue from sales taxes; in 2013, sales tax revenue constituted 30 percent of total state tax revenue. Sales taxes allow states to require in-state retailers to collect sales taxes from purchasers and remit that revenue to the state. Some out-of-state purchases by residents are actually subject to what are known as "use" taxes, and citizens who make out-of-state purchases are supposed to report those purchases to their own state. But few people realize this requirement, much less follow it.
Internet purchases have become more and more popular and have enabled more purchases from out-of-state retailers. While many states would like to tax these online transactions, the Supreme Court has made clear that states cannot require out-of-state businesses to collect sales taxes from its residents, unless those out-of-state retailers have a "physical presence" in the taxing state. For example, an out-of-state retailer that employs sales representatives that actively solicit sales in a taxing state has been found to have physical presence. The Supreme Court has also said that advertising in a state is not enough to require a retailer to collect taxes.
To get around the physical presence requirement, states have taken a creative approach to requiring sales tax collections from online purchases by enacting so-called "click-through" statutes. Many online retailers -- most notably, Overstock.com and Amazon -- pay website owners to post ads on their websites which link to the retailer's website. According to a number of states, these independent site owners -- known as "affiliates" -- create "physical presence" in their states. Thus, the states have enacted statutes requiring those online retailers to collect taxes when shipping purchases to residents in the taxing states.
In 2013, New York's Court of Appeals upheld New York's click-through nexus statute, but Radi and Bader argue the decision was flawed. They argue that affiliates merely "passively" generate sales for online retailers. They do not actively seek out sales like a salesman does or contact customers, rather they merely allow an ad to sit on their website.
Radi and Bader also suggest that some state click-through laws could violate the Internet Tax Freedom Act (ITFA), a 1998 federal law that prohibits states from imposing discriminatory taxes on e-commerce, which it defines as "any tax imposed by a State…on electronic commerce that…imposes an obligation to collect…tax on a different person or entity than in the case of transactions involving similar…goods." Because mere advertising in a state is not enough to trigger a requirement to collect sales taxes, the authors explain that an out-of-state retailer that conducts a successful advertising campaign in a state would not be subject to the tax requirement, while an online retailer that utilizes an advertising affiliate would be. They note that an Illinois court struck down Illinois' click-through statute on this basis.
Source: Ryan Radi and Hans Bader, "From Overstock to Overtaxed: The Dubious Legality of State Click-Through Nexus Taxes," Competitive Enterprise Institute, November 2014.
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