Amazon and the Dormant Commerce Clause

"'Amazon is choosing to be a bully' by dropping affiliates instead of collecting taxes, said California Assemblywoman Nancy Skinner."
Miguel Bustillo & Stu Woo, Retailers Push Amazon on Taxes,  Wall St. J., March 17, 2011, at B1.


In a world of ever-tightening margins, Amazon and other online retailers enjoy an undeniable competitive advantage—they are not required to collect sales taxes in most states.  In response to this advantage, Wal-Mart, Target and other big-box retailers are now backing the Alliance for Main Street Fairness—a coalition fighting to change sales-tax laws in more than a dozen states.  The coalition has traditionally been associated with mom-and-pops, but with budget crises in practically every state, Wal-Mart and the other big-box retailers see an opportunity and are joining the fight.  While this strategy should benefit both brick-and-mortar retailers and state budgets, Amazon is quickly dropping affiliates and avoiding any obligation to collect sales taxes.

With these recent developments, many references have been made to the U.S. Supreme Court holding of Quill v. North Dakota, 504 U.S. 298 (1994).  In the case, a North Dakota statute required Quill and other mail-order retailers to collect sales taxes from customers in the state.  Quill did not have employees or tangible property in North Dakota.  The company solicited its business through catalogs, flyers, ads in national publications, and telephone calls.  Despite this limited contact with the state, the statute required all retailers engaging in regular and systematic solicitation of business in the state to collect sales taxes from consumers and remit them to the state.  Because Quill marketed its products to North Dakota residents, the statute applied.

Upon review, the U.S. Supreme Court examined two key constitutional issues.  First, it looked at the Constitution’s Due Process Clause, which focuses on the “fundamental fairness of governmental activity.”  In this context, the Court examined whether Quill’s connections with North Dakota were substantial enough to legitimate the requirement to collect sales taxes.  Because Quill had “purposely directed its activities at North Dakota residents,” the Supreme Court found that the sales tax requirement satisfied due process.  Next, the Supreme Court looked to the Constitution’s Commerce Clause, which authorizes Congress to regulate interstate commerce.  Over time, the Supreme Court developed an extension to this clause known as the dormant Commerce Clause.  This extension asserts that if Congress has the express authority to regulate interstate commerce, the Constitution prohibits state actions that interfere with it.  Examining this issue, the Court focused on whether the sales tax was applied to an activity with a substantial nexus to the state.  While a physical presence in the state was not required for Due Process, it was required to satisfy the Commerce Clause.  As a result, the Supreme Court struck down the statute.

Amazon is not a mail-order catalog company.  It is a billion dollar retailer that uses the ever-present internet to sell its goods throughout the country and the world.  Undoubtedly, any state would benefit from collecting taxes on Amazon’s sales.  The issue has been how to establish a substantial nexus when Amazon does not have employees or own property in most states.  To get around this, New York, Illinois, and other states have enacted statues asserting that the commissions Amazon and other online retailers pay to resident affiliates constitute a substantial nexus.

Some have questioned whether the presence of associates actually constitutes the substantial nexus required by Quill.  Amazon’s relationship with these associates is part of an online marketing movement called the performance marking approach (PMA).  Under the PMA, Amazon enters into an agreement with an “affiliate” that allows Amazon to place electronic advertisements on the affiliate’s website.  When visitors to the affiliates website click on the link and purchase from Amazon, a commission is paid to the affiliate without any substantial effort on its part.  The passive affiliate involvement has called into question whether these relationships constitute a substantial nexus.  The fact that a website owner resides in a particular state does not mean that the retailer-affiliate relationship produces sales in that state.  An Amazon affiliate in Michigan does not care if the commission she earns are from sales made to her fellow Michiganders or from Californians or Texans, nor is she specifically targeting those in Michigan.  Additionally, the advertising activity resulting from affiliate websites is not the equivalent of a sales force in the state.  Despite these arguments, Amazon was unsuccessful in challenging a New York statute that required the collection of sales taxes on these grounds.

Fueled by budget crises, Amazon’s failed challenge in New York, and increasing pressure from brick-and-mortar retailers, other states are enacting similar statutes.  However, sales tax revenues do not seem to be following.  Because statutes base their mandates to collect sales taxes on marketing relationships with in-state affiliates, Amazon is simply terminating the relationships in order to avoid the tax.  In addition to not collecting sales taxes from Amazon, states will also experience a drop in income tax revenues resulting from the affiliates’ lost Amazon commissions.

While the Supreme Court may address the issue of whether in-state affiliates constitute a substantial nexus, a more important question is whether the current approach to the Commerce Clause still makes sense.  In Quill, the Supreme Court alluded to the argument that forcing a retailer to comply with the 6,000+ taxing jurisdictions in the U.S. would create an undue burden on interstate commerce.  While this may be the case for smaller online retailers, the burden certainly would not prevent Amazon from engaging in interstate commerce.  With states in financial crisis and a constantly eroding concept of “in-state commerce,” does requiring online retailers to collect sales taxes really place an undue burden on interstate commerce?


For more on Amazon, sales taxes and the Commerce Clause, see Daniel Cowan, New York's Unconstitutional Tax on the Internet: Amazon.com v. New York State Department of Taxation & Finance and the Dormant Commerce Clause, 88 N.C. L. Rev 1423 (2010).

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