Since 2000, many states have sought to find ways to force online stores to charge sales tax.  They call this attempt the streamlined sales tax initiative.  Almost a decade later, states have started creating laws compelling online businesses to collect sales tax for sales generated by affiliates.  Are these laws affecting affiliate advertising legal?

The Due Process Clause of the U.S. Constitution states no government shall “deprive any person of life, liberty or property, without due process of law.  The U.S. Supreme Court has ruled that a minimum connection between a company’s interstate activities and the taxing state.

The Commerce Clause of the U.S. Constitution expressly authorizes Congress to regulate commerce with foreign nations and among the several states.  The U.S. Supreme Court has ruled that the Commerce Clause prohibits states from taxing out-of-state business unless that business has a “substantial nexus.”

So, what’s a nexus?  A nexus is generally determined by the presence of three factors, i.e. sales, payroll and property.   Obviously, payroll is any employee based within a state.  Independent representatives do not constitute a nexus unless that representative collects monies or services the customer in any manner.  Sales requires payroll to be paid to an employee.  Property is defined as any physical property owned by the business.

New York created a law compelling online merchants to collect sales tax for sales made through affiliates.  Their reasoning is affiliates are sales agents of the company.   As a result, many businesses have ceased their affiliate programs in New York.  Amazon.com is currently fighting a legal battle in New York on this issue citing affiliates are advertising channels.

North Carolina, Rhode Island, Colorado and a few other states have created similar laws. Businesses have begun ceasing relationships with affiliates within those states.  Their reasons range from too much hassle to the burdensome range of sales tax laws within each state.

Now, here’s the kicker and something I told Oklahoma’s Tax Commissioner while serving on the Oklahoma Electronic Commerce Task Force.  Regardless of what the states want to do, the U.S. Congress is the only entity that can establish laws governing interstate business and taxation.  When the U.S. Congress does establish taxation laws, those laws will additionally apply to U.S. Territories.   Those U.S. Territories include Puerto Rico, U.S. Virgin Islands, Guam, The Marshall Islands and others.  That means if someone within a state made a purchase from a company in Guam, that person would need to pay sales tax to Guam.

Now, if New York wins against Amazon.com, we have to consider Google, Yahoo, Bing and all the other pay-per-click and cost-per-action advertising channels as a nexus for any business outside of New York.  The legal issues would quickly move to the U.S. Supreme Court as a class action lawsuit.

Is it legal to force a company to assess sales tax on orders through affiliates by claiming the affiliate is a nexus?  Under the U.S. Constitution and previous case law, the affiliate does not constitute a nexus.  States need to wake up to the new economy, embrace it and put all taxes (income, sales, luxury and all others) into a single pot from which to pay their bills.

We are not attorneys and this information should not be considered a legal opinion or used as advice. Please consult your local legal representative for advice.