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Amazon, or online, tax will hurt small business

BY JONATHAN I. EZOR | Jonathan I. Ezor is director of the Touro Law Center Institute for Business, Law and Technology.

May 2, 2008

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When news of the new "Amazon Tax" spread, most New Yorkers probably thought it just meant they'd have to start paying a little more when they ordered online merchandise. But the law, passed in Albany last month, is likely to have a far greater effect on small businesses than it is on consumers.

The Amazon Tax - so called because Seattle-based Amazon.com currently doesn't charge or collect tax for purchases made by its many New Yorkers customers, but will have to under the new rules - requires out-of-state online retailers with $10,000 or more in sales to New Yorkers to start collecting New York sales tax. The law is meant to increase tax revenues and to even the playing field for New York-based online retailers, who already collect the tax. The more likely result, though, is losses for New York's small online businesses that currently earn money from referrals through "affiliate programs," and for others in the state as well.

Affiliate programs are a combination of advertising and marketing that is unique to the Internet. In an affiliate program, an independent Web site links to an online store or a particular product, using a specially coded link. If a user clicks on the link and purchases an item, the site making the referral gets a commission. Because of the simplicity of these programs, they are most often used by bloggers, small Web sites and even schools to generate modest amounts of additional income from retailing without having to actually operate a store or fulfill orders. Unlike resellers or sales reps, online affiliates don't usually provide any service or support to the customer, other than getting them to the product. Retailers benefit by paying only for advertising that actually leads to sales.

Traditionally, mail-order and online retailers have collected sales tax for shipments into each state where they had some kind of presence, a concept known as "nexus." Until now, nexus has meant having physical offices, employees, service providers or inventory located in New York. When Maine's L.L. Bean opened its retail store in Albany, for example, it had to start charging sales tax for mail-order purchases shipped into New York State. The new law expands nexus to include out-of-state online retailers with New York-based affiliate program members.

The whole justification for tax based on nexus is that when a business benefits from a state's laws - like with contract law and police and fire protection of store locations - it should pay for the privilege. Affiliate relationships, though, are almost always established through automated systems, and the merchant may not even care with which sites it is affiliating. What's more, the affiliate agreement generally provides for the retailer's state law to control the terms. The physical location of the affiliate is essentially irrelevant.

Critics of the new law say it is unworkable because tracking multiple sales tax rates is difficult - particularly for smaller retailers - while supporters counter that software tools are making this easier. But the reality is that Amazon and other merchants with affiliate programs won't bother adding the additional capability to collect New York tax; instead, they'll take the far easier step of blocking any New York-based site from their affiliate programs. The result will be a tremendous loss of income for the numerous small New York businesses now participating in affiliate programs.

The law will also hurt companies like New York City-based LinkShare, which generates revenue by managing others' affiliate programs. And it may make it harder for New York-based online retailers to find their own affiliates.

If New York wants a larger share of online sales tax revenues, it should focus on making the state more attractive for online retailers to set up shop here, and improve enforcement of existing tax laws. Instead, the Amazon Tax will hurt New York's small online businesses and entrepreneurs, and ultimately may lower overall tax revenues, while strengthening New York's reputation as being unfriendly to small businesses. Before it goes into full effect and the damage is done, the governor and legislature should delete the Amazon Tax.

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