Amazon Drops California In Growing E-Commerce Affiliate Tax Law War

California joined other states in passing its own e-commerce affiliate tax law; Amazon.com responded by dropping all CA affiliates. Scrambling for tax money, states are trying to redefine 'physical presence' - and Amazon thinks it's unconstitutional.
Written by Violet Blue, Contributor

In the ongoing state-by-state battle over tax collection on affiliate website sales, this afternoon Amazon warned thousands of affiliates their revenue streams would be shut off if a tax bill would be signed into law. Mere hours later, Governor Jerry Brown signed the bill, signifying tough times ahead for many online business owners.

UPDATES at bottom of page show Amazon dropped affiliates effective immediately, and the American Bookseller's Association's reaction to what they see as a victory for e-fairness bills against companies like Amazon and Overstock.com. /End update.

States are scrambling for cash, so it's no surprise they see a pot of gold in e-commerce sales. Brick and mortar sites - such as Wal-Mart - that have failed to grasp the opportunities Amazon created with programs (like Affiliates) are out for blood.

Essentially, certain states have grubbed for tax money by passing laws that expand the definition of physical presence. They are specifically targeting e-commerce sites that work with affiliates - more specifically, websites that partner with Amazon as Affiliates to earn commissions from individual sales.

As a small business owner, I was among many that received a letter from the State of California last year telling me I owed retroactive tax on three year's worth of any and all purchases I made from out-of-state businesses. I did the hard work, totaled the receipts and paid the state - almost all of my purchases were through Amazon.

I also, like many, pay my yearly state and federal tax on my Amazon Affiliate income.

What's happened is that U.S. states have extended "nexus" to include areas of e-commerce it didn't previously address.

Amazon's Jeff Bezos: It's Unconstitutional

It's not as simple as saying that Amazon is "trying to avoid paying sales tax." In fact, that's not the case at all. The new state laws are specifically for affiliates: Amazon collects sales tax in Kansas, Kentucky, New York, North Dakota and Washington - the states where Amazon has stores or offices.

Look closer, and you'll see that Amazon is fighting state-by-state battles against increasingly irrational legislation. In one instance, Amazon fought alongside the ACLU to keep customer records private when North Carolina tax collectors demanded private purchase information.

Last year Colorado signed a new law that extended nexus to e-commerce affiliates. The law required online retailers like Amazon to give Colorado residents a bill on how much they owe in sales tax on web purchases, and provide summaries of individual web purchases to the state. Amazon responded, as like with California, for better or worse, by cutting off its Colorado affiliates.

Amazon CEO Jeff Bezos believes the actions of the states to be unconstitutional and that this should be resolved at the federal, not the state level.

At the ShopSmart Shopping Summit held in New York last month Bezos stated,

"In the U.S., the Constitution prohibits states from interfering in interstate commerce, and there was a Supreme Court case decades ago that clarified that mail-order companies, because the Internet didn't exist then, would not be required to collect sales tax in states where they didn't have what's called a nexus."

Bezos also flat-out stated that Amazon would like Congress to create a national sales tax system, and said Amazon would support the ongoing Streamlined Sales Tax Initiative. Its aim would be to unify sales tax practices in all U.S. states.

Nexus, Server Location and "Unintended Consequences"

What states have been doing to individually try and get a slice of the e-commerce tax pie has shown how little lawmakers know about the e-commerce space, or the direct effects of their tax-grabbing laws on many levels.

In late 2010, the mighty state of Texas tried to slap Amazon.com with a $269 million invoice from the state, encompassing four years of sales to Texas residents.

Amazon fought back (they sued), and the SEC launched an investigation. Amazon tried to make a tax deal with Texas, which fell through.

This was after Texas Governor Rick Perry vetoed a bill similar to the one just signed in California. Perry said the law would have resulted in "unintended consequences."

In 2010, Texas simply started going after companies big and small for selling goods (like music) - to collect taxes on purchases made by Texas residents.

The big fish included Amazon, smaller fish included software company Daz3D. On October 1, Daz3D told their customers that while they wanted to fight it, they didn't have a lot of resources to pursue these ends, and were going to be charging Texas residents sales tax from then on.

The state's changes were noticed a week after Daz3D's bad news was announced, by CPA, author and tax media pundit Diane Kennedy, who raised an alarm on her blog.

Once she'd spoken with with the Texas Comptroller's office she was even more worried about what this might mean for websites simply hosted in Texas. Kennedy was also astonished to see Hostgator Tweet that they were okay because they weren't "physically present" in Texas.

Rackspace proceeded with a bit more caution, and contacted their tax advisors and the State office before issuing this statement where the Comptoller's office backed away from anyone just using a server for hosting - but that it did include the sale of data being housed on servers in Texas. Rackspace blogged,

The Comptroller's Office has indicated that the language was not intended to be construed as so broad as to extend nexus to anyone using a server in Texas. William Hamner, Director of Tax Administration indicated that the agency's intent is not to extend nexus to a person simply using a third-party server in Texas for an activity such as webhosting.

However, since taxable items are subject to taxation in both electronic and physical form, the sale of data, such as music files, housed on a Texas server could create nexus for the owner of the data.

In Kennedy's opinion, they couldn't be more wrong.

This might not be the same form of nexus that Texas tried to apply to Amazon, but Amazon has now had plenty of scrapes with states applying nexus in a variety of ways to the digital retail giant in the past - such as with North Carolina.

The Affiliate Tax War: Bad For Everyone's Business

The Amazon Affiliate program has benefitted webmasters and Amazon alike: affiliates get revenue, and Amazon gets product-specific deep links, along with strong editorial content to socially encourage purchase and use of other Amazon products, such as Kindle readers and books.

California is only the latest victim in the affiliate tax wars: Amazon has been forced to cut affiliate ties with Texas, Colorado, Connecticut, Arkansas, Illinois, Hawaii, Rhode Island, and North Carolina.

As a longtime Amazon Affiliate, small business owner and a published author, I'm one of the many people that will lose significant business over Amazon's withdrawal of its affiliate program from California. So will bigger fish, such as Adam Carolla, whose podcast gets a significant income from the program.

It is estimated that at least 10,000 Amazon Affiliates - small business owners, like me, already paying state and federal tax on the affiliate income - have lost their revenue stream. Not to mention the potential growth opportunities for expanding California businesses.

At 12:21 PST, all Califiornia Amazon Affiliates received an email including the following:

For well over a decade, the Amazon Associates Program has worked with thousands of California residents. Unfortunately, a potential new law that may be signed by Governor Brown compels us to terminate this program for California-based participants. It specifically imposes the collection of taxes from consumers on sales by online retailers - including but not limited to those referred by California-based marketing affiliates like you - even if those retailers have no physical presence in the state.

We oppose this bill because it is unconstitutional and counterproductive. It is supported by big-box retailers, most of which are based outside California, that seek to harm the affiliate advertising programs of their competitors. Similar legislation in other states has led to job and income losses, and little, if any, new tax revenue. We deeply regret that we must take this action.

As a result, we will terminate contracts with all California residents that are participants in the Amazon Associates Program as of the date (if any) that the California law becomes effective. We will send a follow-up notice to you confirming the termination date if the California law is enacted. In the event that the California law does not become effective before September 30, 2011, we withdraw this notice. As of the termination date, California residents will no longer receive advertising fees for sales referred to Amazon.com, Endless.com, MYHABIT.COM or SmallParts.com.

We have enjoyed working with you and other California-based participants in the Amazon Associates Program and, if this situation is rectified, would very much welcome the opportunity to re-open our Associates Program to California residents. We are also working on alternative ways to help California residents monetize their websites and we will be sure to contact you when these become available.

The "big-box retailers" they're referring to specifically incude Wal-Mart. Three hours after the email went out, Governor Jerry Brown signed ABx1 28 into law.

To call it an ignorant and short-sighted move is an understatement so massive, it's frightening. While I don't depend on my Amazon Affiliate revenue, I know a good many California small business owners that do, including ones that have put man hours and significant investment into curating, maintaining, and promoting Amazon storefronts - and not just the "A-Stores."

Unintended consequences, indeed.

UPDATE: I received an Associate email from Amazon at 9:41 PST including this - the stoppage of California Associate revenue is effective immediately - and my heart goes out to those I know that have just had their income taken away literally overnight:

Unfortunately, Governor Brown has signed into law the bill that we emailed you about earlier today. As a result of this, contracts with all California residents participating in the Amazon Associates Program are terminated effective today, June 29, 2011. Those California residents will no longer receive advertising fees for sales referred to Amazon.com, Endless.com, MYHABIT.COM or SmallParts.com. Please be assured that all qualifying advertising fees earned before today will be processed and paid in full in accordance with the regular payment schedule.

You are receiving this email because our records indicate that you are a resident of California. If you are not currently a resident of California, or if you are relocating to another state in the near future, you can manage the details of your Associates account here. And if you relocate to another state in the near future please contact us for reinstatement into the Amazon Associates Program.

We have enjoyed working with you and other California-based participants in the Amazon Associates Program and, if this situation is rectified, would very much welcome the opportunity to re-open our Associates Program to California residents. As mentioned before, we are continuing to work on alternative ways to help California residents monetize their websites and we will be sure to contact you when these become available.

Additionally, Richard Soderberg points out to me that part of this law (AB 28X) may be applied retroactively "pursuant to these agreements is in excess of $10,000 within the preceding 12 months" (PDF link).

SEE ALSO: Search expert Danny Sullivan from Search Engine Land has written an angry, brilliant post that captures the anger of Affiliates that have now been dumped by Amazon in An Open Letter To Jeff Bezos On Terminating The Amazon Affiliate Program In California. It's a must-read.

UPDATE June 30: The American Bookseller's Association has sent a triumphant email to brick and mortar retailers - bookstores - calling the passage of AB 28X a victory for e-fairness bills against companies like Amazon and Overstock.com. In their statement, they claim that Amazon's firing of its Associates was unnecessary:

AB 28X is a broader law than affiliate nexus laws passed in other states and, as such, will require Amazon.com to collect and remit sales tax to the state because of its subsidiaries in the state.

In a statement, Assembly Member Nancy Skinner, sponsor of the affiliate nexus portion of AB 28X, said, “This is a great day for California business. With the signing of e-fairness, California employers are no longer at a competitive disadvantage with out-of-state, online-only companies. Amazon.com and Overstock.com should do the right thing and play by the rules just like our California businesses do. Severing affiliate ties won’t change the fact that under our e-fairness they will still need to collect sales taxes. We hope that Amazon and Overstock rethink these bullying tactics.”

Image by Kevin Dooley, under Creative Commons 2.0 Generic license, via Flickr.

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