Baer Business Law – Greater Philadelphia Area – Intellectual Property Law – Business Law – E Commerce – Contracts – Trademarks – Copyrights

Let me give a shout out to my good friends at Gen3 Marketing, an affiliate marketing agency in suburban Philadelphia started by two former work colleagues who built up my ex-employer’s highly successful affiliate marketing program. I love catching up with these guys, not only because the food, beer and company are welcome, but also because talking with them helps me wrap my mind around what’s bubbling up in the world of online marketing.

This visit we talked about Colorado, object of the paeans of the late John Denver and also the latest battleground over the Internet sales tax or affiliate tax (also known as the “Amazon tax” because of the online retailer’s starring role in the drama). As everyone knows, the states are parched for revenue in the Great Recession, and the idea of solving fiscal problems by reducing spending is anathema. Moreover, in-state brick-and-mortar retailers have been smarting for years over the competitive advantage enjoyed by many online businesses like Amazon that do not charge sales tax. However, as the Supreme Court has held, states can’t simply require out-of-state retailers with no physical presence (or “nexus”) in the state to charge sales tax on purchases by state residents, since this violates the constitutional prohibition on burdening interstate commerce.

What a few states have done, following New York’s lead in 2008, is pass laws taking the position that the use of in-state affiliates — websites featuring links to refer Internet traffic to the out-of-state retailer’s site — amounts to having an independent sales force in the taxing state and provides the nexus needed for the state to constitutionally exercise its taxing power over interstate commerce. (Indeed, the New York statute used affiliate nexus to require the collection of tax on ALL online sales to New York residents, not just on those sales referred by in-state affiliates.) Online businesses, affiliates and their lobbyists in the Performance Marketing Association (PMA) countered that affiliate marketing should not be likened to engaging a force of door-to-door salesmen, but is actually nothing more than the rental of advertising space.

An attempt to challenge the constitutionality of the New York law failed in the New York Supreme Court in early 2009. (For more on this decision and the nuances of the New York law, which allows a safe harbor where affiliate sites feature a link to the online retailer but do nothing more to promote that retailer’s products, please check out my 2009 post on the Internet sales tax.) Rhode Island and North Carolina passed affiliate tax laws in 2009.

Amazon, to shield itself from sales tax nexus, has been terminating its affiliate relationships in the taxing states. While some affiliates are large, sophisticated businesses (sometimes with their own networks of sub-affiliate publishers), many are home businesses operated by bloggers and small website owners who have managed to monetize their site traffic to the tune of a few hundred dollars per month or more. Amazon’s understandable but still draconian response to the affiliate tax laws threatens an important source of income for these creative and enterprising individuals in difficult times.

Aggressive lobbying by the PMA and others has stalled or killed affiliate tax initiatives in other states, with California’s Governor Schwarzenegger vetoing the legislature’s bill last year. As of the date of this post, Rhode Island has reported collecting no revenue from its affiliate tax. With tax-and-spend fatigue growing on both the national and state levels, there is increasing recognition that the affiliate tax is punishing in-state web entrepreneurs while hardly filling state coffers.

Which brings me to Colorado. Colorado represents a twist on the affiliate tax paradigm. The PMA successfully lobbied to remove explicit affiliate provisions from the bill. As approved by the Governor and effective as of March 1, House Bill 10-1193 says nothing about affiliates or collecting taxes on sales referred by affiliates.

What it does is impose stringent tax notice and reporting obligations on retailers doing business in Colorado (a category which is broadly defined to include anyone “soliciting [transactions in tangible property], either by direct representatives, indirect representatives, manufacturers’ agents, or by distribution of catalogues or other advertising, or by use of any communication media, … or by any other means whatsoever”) that do not collect Colorado sales tax. These retailers are required to (1) notify annually by first-class mail all Colorado purchasers that sales or use tax is due for which they are required to file a return with the state, and provide these purchasers with detailed information itemizing taxable and exempt purchases, purchase dates, amount of each purchase, etc., and (2) file an annual statement for each purchaser with the Colorado Department of Revenue showing the total amount paid for Colorado purchases during the preceding calendar year. Failure to provide the required notices and reporting can subject an online retailer to penalties of up to $10 per violation (which could get expensive if a retailer has hundreds of thousands of customers in Colorado).

In response to passage of House Bill 1193, Amazon promptly terminated all of its Colorado affiliates. The reason was not immediately clear, since the bill’s requirements are not targeted to affiliate marketing and on its face applies to Amazon’s direct sales. In addition to punishing Colorado, I suspect Amazon also wanted to preserve its ability to argue that the bill unreasonably burdens interstate commerce and cannot be constitutionally applied to Amazon without an affiliate network to provide a ghost of an in-state footprint. (Recall that the New York Supreme Court didn’t buy the argument that affiliates are advertisers rather than an independent sales force, which is sufficient to create sales tax nexus.)

While Amazon’s actions may strike us as a bit churlish and heavy-handed, the plain fact of the matter is that laws like this are not revenue generators and impose unnecessary costs on businesses — devastating costs, in fact, when you see things from the affiliates’ point of view. While Baer Business Law welcomes the opportunity to assist marketers and publishers in the affiliate space on affiliate tax compliance matters, it is my firm belief that a crazy quiltwork of divergent laws benefits no one but lawyers. Rather, there should be a uniform Internet sales and use tax law, implemented either by act of Congress or by multistate participation in a streamlined sales initiative.

The impetus toward affilliate taxation has slowed somewhat, but as long as state legislatures continue to defer the day when they learn to operate like a business, they must continue to stretch their manicured fingers toward virgin sources of revenue. Of course, a public suffering from tax-and-spend fatigue may send a different message in November.

NOTE: The views expressed in this post are solely those of the author.