Online Sales Taxes Emerging as New York Court of Appeals Shoots Down Overstock and Amazon’s Constitutional Objections

May 01, 2013   
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In a March 28, 2013 decision, New York’s highest state court, the New York State Court of Appeals, held that New York’s “click-through” nexus statute, Tax Law § 1101 (b)(8)(vi), does not violate the United States Constitution under either the Commerce Clause or Due Process Clause. [A copy of the opinion can be found here.] This click-through nexus statute, typically referred to as the “Internet Tax”, extends state income taxability to internet retailers who employ website owners residing in New York to advertise for them. The growing popularity of click-through nexus liability and general e-commerce taxability nationwide has become problematic for major ecommerce sites such as Overstock and Amazon, and resulted in significant increases in tax exposure for internet retailers that utilize click-through advertising to increase traffic to their websites.

What is a “Click-Through” Nexus?

So what exactly is this “click-through” or “affiliate” Nexus? In 2008, New York was the first state to enact this form of legislation. The basic premise of this legislation is to update the way in which state governments assert sales and use tax guidelines to reflect advancements in modern technology. The New York legislature was able to accomplish this by amending the Tax Law. More specifically, the New York legislators amended the statutory definition of “vendor” under this law to include:

A person making sales of tangible personal property or services taxable under this article (“seller”) shall be presumed to be soliciting business through an independent contractor or other representative if the seller enters into an agreement with a resident of his state under which the resident, for a commission or other consideration, directly or indirectly refers potential customers, whether by a link on an internet website or otherwise, to the seller, if the cumulative gross receipts from sales by the seller to customers in the state who are referred to the seller by all residents with this type of an agreement with the seller is in excess of ten thousand dollars during the preceding four quarterly periods.

(Tax Law § 1101 (b)(8)(vi)). This definition was further clarified by a memorandum issued by the New York Department of Taxation and Finance [a copy of the memorandum can be found here] which made it clear that the presumption of taxation is rebuttable if the web site owner did not engage in any solicitation in New York that would result in a finding of nexus under constitutional standards.

Amazon and Overstock’s Failed Attempt to Challenge Tax Law

The establishment of this “click-through” nexus was challenged by two of the biggest internet retailers, and two days after the statute was enacted in New York in 2008. Both retailers argued that although they ship items to buyers worldwide (including New York), neither has any employees who work or reside in New York and neither maintains offices or property in New York. On the other hand, both Amazon and Overstock maintain affiliate programs whereby associates can maintain links to the respective retailers home pages in turn for a commission based on sales.

Amazon challenged the Tax Law on the grounds that it was an unconstitutional violation of Commerce, Due Process, and Equal Protection clauses. Overstock filed a complaint raising the same issues. These challenges were dismissed in both instances at the trial level. On appeal, the New York Supreme Court affirmed portions of the dismissals, but reinstated the case to determine if the statute violated the Commerce or Due Process Clauses. Amazon and Overstock then appealed their facial constitutional challenges to New York’s highest court, the New York State Court of Appeals.

In deciding the case, the New York State Court of Appeals wrote that it was bound by the U.S. Supreme Court’s holding in Quill Corp. v. North Dakota 504 U.S. 298 (1992), which found that physical presence in the state itself did not need to be substantial in order to establish a nexus with that state. All that is required is more than a “slight presence.” In Quill, the Supreme Court found that a mail-order business that solicited business in a state absent any other physical presence was sufficient to satisfy the nexus requirement. Drawing parallels between Quill‘s mail-order business and the internet retailers’ in-state solicitations, the New York Court of Appeals found that the presence requirement was satisfied so long as economic activities were performed in the state by a seller’s employees or on its behalf. As such, no facial violation of the Commerce Clause occurred.

Similarly, the New York Court of Appeals found that there were no facial violations of Due Process under Quill. The Court of Appeals determined the Commerce and Due Process challenges to be “closely related” and noted that physical presence was not necessary to trigger the Due Process Clause. In support of this holding, the Court of Appeals noted that under Amazon and Overstock’s compensation schemes, New York website owners were paid directly for referrals that resulted in purchases. The Court of Appeals determined that this direct correlation between compensation and referrals illustrated that New York residents were encouraged to actively solicit customers in the state, thus subjecting them to state taxes.

Growing Popularity of Internet Taxation

New York is not the only state that is aggressively moving toward the expansion of click-through taxation. Since 2008, click-through nexus statutes have grown in popularity and spread to several other states. Many states have similarly revised their definitions of terms such as “vendor,” “maintaining a place of business,” and “doing business in” to include remote sellers into their definition of characters susceptible to that respective state’s nexus requirement. Currently, Arkansas, California, Colorado, Connecticut, Georgia, Illinois, New York, North Carolina, Rhode Island, and Vermont have similar click-through statutes. Additionally, Florida, Hawaii, Indiana, Iowa, Kansas, Maine, Massachusetts, Michigan, Minnesota, Mississippi, New Mexico, Pennsylvania and West Virginia have introduced nexus legislation that target remote sellers.

The complete erosion of internet tax exemptions seem to be imminent as states that are in desperate need of funds are looking for new ways to collect additional tax dollars. However, this trend is not just prevalent in state legislatures. In fact, there is currently an Internet Sales Tax law called the “Marketplace Fairness Act” advancing through the United States Congress that would effectively allow 45 states and the District of Columbia to demand that online retailers collecting more than $1million per year in sales collect sales tax on all purchases – irrespective of the internet retailer’s physical presence in a specific state.

This bill is expected to pass the Senate soon and has been projected to result in the collection of between $22 billion and $24 billion in additional tax revenue. The National Retail Federation and many brick-and-mortar retailers are supporting these initiatives due to the loss of traditional retail sales to the online marketplace. They also argue that uniform taxation across these different sales channels could help level the playing field between all retailers.

Small businesses and e-commerce sites, on the other hand, are not as thrilled. There are approximately 9,600 individual tax jurisdictions throughout the United States, all of which have unique tax laws and regulations. While there is significant infrastructure and software to help businesses keep track of the different applicable tax regulations, one can expect significant switching costs for implementation and training – costs that will likely hit small internet businesses and start-ups the hardest.

In support of small business e-commerce sites, EBay has most recently become a part of the efforts to fight these proposed taxing schemes. Recently, EBay CEO, John Donahoe, urged EBay’s merchants to write their respective congressmen and express their disagreement with the legislation. Donahoe has made the claim that the proposed tax legislation would be harmful to small businesses and suggested that the threshold for this tax be raised from the proposed $1 million per year in sales to $10 million per year in out-of-state sales and less than 50 employees. This proposal that could be considered reasonable when, as John Donahoe noted, Amazon makes more than $10 million of sales every 90 minutes.

Concluding Thoughts

As this issue progresses, it will be interesting to see how courts will reconcile internet tax legislation like the Marketplace Fairness Act with the “more than a slight” presence requirement outlined in the Quill holding. The expansion of internet taxation seems to be inevitable, and in the event that the Marketplace Fairness Act becomes law, there will be even less of a connection between the respective taxing jurisdictions and internet retailers. Consequently, we may see the Quill case interpretation broadened; further altering the historic interpretation of the Commerce Clause to keep pace with modern technology.

While consumers and small businesses will likely feel the effects of this proposed legislation the most, it is important to note that irrespective of internet retailers’ presence, the responsibility has been on consumers to report uncollected taxes on internet purchases from day one – a responsibility that has for the most part been ignored. In the states’ defense, they are not creating any new responsibility to pay taxes or arbitrarily taxing retailers, but rather attempting to reconfigure legislation so as to ensure that these sales taxes are actually being collected. From an economic standpoint, this should not be very shocking. About $20 billion in uncollected tax funds are being left on the table, an amount that is too large for states desperately seeking additional revenue to overlook any longer. Long story short, it looks like the free ride may be over for savvy shoppers and the internet retailers who have shifted tax savings to their customers.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience litigating against the IRS and the U.S. Department of Justice and have appeared before the U.S. Tax Court, the various U.S. District Courts, the U.S. Court of Federal Claims, and the various U.S. Courts of Appeal. You can contact an attorney by emailing us at or by calling us at 305.350.5690.