Synopsis — Are you up to date on the affiliate nexus tax? Or are you out of the loop? The advertising tax is already law in seven states, and will no doubt be picked up by more states in the near future, escalating the serious consequences it has on affiliate marketers.
In his article, “Defining And Debating The Affiliate Nexus Tax,” Geno Prussakov explains why it is important for Internet marketers to educate themselves on the subject. Prussakov recalls when the first bill to tax the online sales of companies with no physical presence in a state was introduced and explains the debate on the issue.
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Defining And Debating The Affiliate Nexus Tax
The Affiliate Nexus Tax is referred to in many different ways. The three most commonly used terms are:
1. Amazon tax — so called because the individual states hope to generate substantial sales tax income specifically from America’s largest etailer by introducing the tax;
2. Affiliate tax — referred to as such because it will affect all parties involved in the affiliate marketing channel, but especially affiliates themselves; or the
3. Internet sales tax — identified in this manner because of the wider subject of taxation.
However, the most appropriate way to define this tax is really as an “affiliate nexus tax.” The problem with calling it the Amazon tax is fairly obvious. Since the tax would concern all affiliates and etailers, using the word “Amazon” skews our focus from the problem as a whole to a particular merchant and their affiliate program. Likewise, referring to it as a tax on “Internet sales” does not uncover the full essence of the problem and somehow implies that it applies to all Internet sales. And “affiliate tax” is too broad, since it is the issue of “affiliate nexus” that essentially serves as the foundation for such legislative bills. And what is “nexus” in this context? The AICPA defines it as “the amount and degree of business activity that must be present before a state can tax an entity’s income.”
As the Performance Marketing Association puts it, the crux of current affiliate-related tax bills “is predicated on the idea that affiliates are extension of a merchant’s sales force and thus constitute nexus for that merchant” (more at http://bit.ly/AffNexus). The concept of nexus is understandably complex, but I believe that there is an inherent problem with this approach. Unlike affiliates in offline terms, online affiliates are not subsidiaries of merchants. They are neither being controlled by them, nor have close commercial or operating ties with the etailers that they promote. It is more appropriate to view them as advertisers who invest their time, money, and effort into advertising these merchants, being paid on a performance-basis only.
For these reasons, I prefer to use the terms “affiliate nexus tax” and “advertising tax” interchangeably. In fact, since affiliates are being unjustly singled out from the cohort of all other advertising channels (online and offline ones) that merchants use, the phrase “selective advertising tax” may actually be even more appropriate, but I will stick with the former two.
An Historical Overview Of The Situation
The debate and legal wrangling all started in New York state back in November 2007. At that time, Governor Eliot Spitzer attempted to introduce a bill to tax the online sales of companies with no physical presence in the state, but who were selling to state residents through online affiliate marketers who did reside there. In this bill, the presence of affiliates of a company was to be perceived as equivalent to the company having a physical presence in the state.
The idea did not take root right away, but Governor David Paterson revived it in March 2008, and the bill became law in April 2008. The very next month Amazon.com filed a complaint in State Supreme Court in Manhattan challenging the constitutionality of what the NY Times called the “novel definition of what constitutes a presence in the state” and objecting to the inclusion of “any Web site based in the state that earns a referral fee for sending customers to an online retailer.” The state maintained that thousands of the “hundreds of thousands” of Amazon’s affiliates are located in New York state. Overstock.com opposed the bill as well, but joined with hundreds of other online merchants in terminating thousands of affiliates to avoid collecting the tax altogether.
In 2009, the continuing economic crisis and decreasing online sales brought more bad news for affiliates. A New York judge dismissed Amazon’s lawsuit and the Overstock complaints, and since that time, multiple new states started considering, or have even ratified, similar affiliate nexus laws to help them deal with the deficits in their budgets. At the time I’m writing this article, a total of seven states already have affiliate nexus tax laws:
Arkansas Connecticut Georgia New York
North Carolina Vermont Rhode Island
Are Affiliate Nexus Laws Constitutional?
The question of the constitutionality of such laws has been continuously raised by Amazon since early 2008, and Overstock.com also picked up the argument in some of their press releases and letters on the matter.
When speaking about the constitutionality of affiliate nexus law, the case that is most frequently referred to as a precedent is the 1992 case of Quill Corporation, an office supply retailer, versus North Dakota. In that case, the US Supreme Court “reversed the lower court’s ruling, indicating that while Quill had met the minimum connection standard of the Due Process clause via the economic nexus, it had NOT met the sufficient nexus standard of the Commerce clause. The Court upheld its earlier ruling in National Bellas Hess, where it affirmed that substantial nexus exists only where there is a non-trivial physical presence in the state” (Source: SalesTaxSupport.com). In that instance and consequently Quill, the only connection was “through common carrier or the United States mail.” Therefore, in essence, the etailer must have a physical presence in the state in order to be required to collect a sales tax. Since this precedent-setting decision was made by the Supreme Court, it can be construed that unless Congress passes legislation to delegate broader powers to the states, it is unconstitutional for states to do so on their own.
As I was completing this article, the Performance Marketing Association won a lawsuit against the Director of the Illinois Department of Revenue where they challenged “the constitutionality of a new Illinois law that targets the business of online performance marketing as a basis for unlawfully expanding Illinois’ regulatory authority beyond its borders.” On April 25, 2012 Illinois Circuit Court Judge ruled that the Illinois affiliate nexus tax law violated the Commerce Clause of the US Constitution, declaring that “the activity described in the statute does not establish nexus.” For details see http://bit.ly/PMAwin.
A preceding federal judge ruling in Colorado is also worth mentioning here. Colorado Bill HB1193 originally attempted to establish affiliate nexus, but after active lobbying, the final version of the bill had all references to affiliates removed. Regardless of this attempt to make the bill more palatable, in early April of 2012, US District Judge Robert Blackburn ruled that such a law imposes “an undue burden on interstate commerce,” and declared it unconstitutional. Blackburn also added that “enforcing a reporting requirement on out-of-state retailers will, by definition, discriminate against the out-of-state retailers by imposing unique burdens on those retailers” (Source: Denver Post, April 3, 2012).
What Are The Implications For Affiliates?
Putting things in perspective, I believe we should be talking about two sets of implications: the immediate (state-specific) implications and the wider (national) ones. As experience has shown in the states where such bills become law, merchants (large and small) that do not wish to start collecting the additional tax tend to terminate affiliates based in the state which passes the law. This has caused thousands of companies to go out of business (or move to another state), but it also always leads to much wider consequences/implications.
The snowball effect is obvious. The number of states looking into such affiliate nexus tax laws has grown from one in 2008, to almost a dozen in 2009, to nearly half of all states either considering or already having such a law in place in 2012. The fact that the so-called “Amazon tax” isn’t yet knocking on any one state’s door right now is no guarantee it will remain this way for long. It’s almost a certainty that more states will look into going this route, and both merchants and affiliates should prepare in advance. Instead of a reactive approach (acting in response to a proposed bill), more merchants, affiliates, and affiliate networks should be proactive in tackling the issue.
A lot has been — and is being — written on the subject in various affiliate marketing forums and blogs (including mine). It is important for Internet marketers to educate themselves, and keep themselves updated, on the subject. Merchants should not terminate affiliates, but work out viable solutions. Customers generally do not mind paying an extra tax on top of their online purchase, and multiple online merchants are already doing it. Why not collect the tax then?
In addition, all affiliate marketers should be actively lobbying, writing to, and meeting with their state representatives and senators. There is big lack of understanding of the issue in legislative circles, and unless a pro-active approach is exercised, more state laws like this are inevitable. Positive results in Hawaii, New Mexico, Arizona, Maine, Colorado, and most recently in Maryland and Illinois, are encouraging, but more waves will undoubtedly follow. Therefore, unless you reside in states that do not collect sales tax (i.e., New Hampshire, Montana, Delaware, Oregon, or Alaska), you will want to be ready.
What Do I Think?
My personal opinion on the subject hasn’t changed since an interview I gave to Chatalyst in the spring of last year. When asked how I thought the tax legislation would play out, I said that, however unfortunate it is to admit, “I believe we’ll continue seeing new affiliate nexus bills proposed nationwide (most states still face bad budget shortfalls), affiliate marketers fighting for their jobs (winning some battles, and losing others), and only a carefully weighed federal solution can put a period in the sentence.” In the meantime, we want to be proactive in educating (ourselves on the developments, merchants on options other than affiliate termination, and decision-makers on the essence of the problem) and fighting.
Resources to Follow
These five resources will help you stay up-to-date on the latest affiliate nexus tax developments:
- Performance Marketing Association
- ABestWeb Affiliate Tax Law Forum
- Commission Junction Internet Retail Tax Section
- AMNavigator Blog