The Appellate Division of the New York Supreme Court partially has affirmed the dismissal of complaints filed by Amazon.com and Overstock.com challenging the constitutionality of the statutory "Amazon rule" that presumes sales tax nexus for certain online retailers.1 The Appellate Division held that the Amazon rule does not violate the Due Process Clause, Commerce Clause or Equal Protection Clause on its face. However, the Appellate Division reinstated the cases to determine whether the statute violates the Due Process Clause and Commerce Clause as applied to Amazon and Overstock.
Background
In 2008, New York enacted a sales tax nexus provision for Internet retailers that is commonly called the "Amazon rule."2 The definition of "vendor" was amended to include Internet retailers that actively encourage Web site owners residing in New York to advertise for the Internet retailer in return for a commission on sales resulting from the followed link. A presumption of taxability exists if the Internet retailer generated more than $10,000 through these referrals during the last four quarterly sales tax periods. The presumption may be rebutted if the Web site owner did not engage in any solicitation in New York that would result in a finding of nexus under constitutional standards.
Amazon operates a retail Internet business and ships items to buyers worldwide, including buyers located in New York. Amazon does not own property in New York, maintain any New York offices or have employees who work or reside in the state. An "associates program" created by Amazon allows associates to maintain links to Amazon.com on their own Web sites and compensates the associates by paying them a percentage of the sales proceeds. Similar to Amazon, Overstock operates a retail Internet business and does not have any stores or employees in New York. Overstock has a program that allows "affiliates" to provide links to Overstock.com in exchange for a commission when the customer purchases merchandise from Overstock.
Two days after the statute was enacted, Amazon filed a complaint seeking declaratory and injunctive relief on the grounds that the statute was unconstitutional because it violated the Commerce, Due Process and Equal Protection Clauses. Overstock filed a complaint alleging that the statute was unconstitutional because it violated the Commerce and Due Process Clauses.
The trial court granted the state's motion to dismiss Amazon's complaint in its entirety. According to the trial court, Amazon's constitutional arguments were considered to be without merit.3 The same judge dismissed Overstock's complaint for the same reasons stated in its decision for Amazon.
On appeal, Amazon argued that the statute violated the Commerce Clause as applied to it because it lacked "substantial nexus" with the state. Amazon also argued that the statute violated the Due Process Clause both facially and as applied because it created an irrational, vague presumption that could not be rebutted by evidence to the contrary. Finally, Amazon claimed that the statute violated the Equal Protection Clause because it targeted Amazon in bad faith. Overstock argued that the statute violated the Commerce Clause both on its face and as applied to Overstock. Also, Overstock argued that the statute violated the Due Process Clause on its face because of its vagueness.
Statute Does Not Facially Violate Constitution
The Appellate Division held that the statute did not facially violate the Commerce, Due Process or Equal Protection Clauses.
Commerce Clause Facial Challenge
Article I, Section 8, Clause 3 of the U.S. Constitution expressly authorizes Congress to "regulate Commerce with foreign Nations, and among the several States." A tax is upheld when it is (1) applied to an activity with a substantial nexus with the taxing state, (2) is fairly apportioned, (3) does not discriminate against interstate commerce and (4) is fairly related to the services provided by the state.4 To satisfy the substantial nexus requirement for purposes of sales and use tax, an entity must have a physical presence in the taxing state.5 However, the physical presence does not need to be substantial.6 The entity must have more than a "slightest presence" in the state, but the nexus requirement is satisfied if the entity has economic activities in the state performed by the entity's personnel or on its behalf.7
In finding that the statute does not violate the Commerce Clause, the Appellate Division determined that the statute imposes a collection obligation on an out-of-state vendor only where the vendor enters into a business-referral agreement with a New York resident, and the resident receives a commission based on sales in New York. The statute does not target the out-of-state vendor's sales through agents who are not New York residents. Also, the Appellate Division noted that the resident must engage in solicitation for the out-of-state vendor. Passive investment is not sufficient under the statute.
Due Process Facial Challenges
The Appellate Division rejected the argument that the statute violated the Due Process Clause because it creates a presumption that is irrational and cannot be rebutted by evidence to the contrary. The statute makes presumptions that an in-state solicitation occurs when an in-state representative is paid a commission after a New York purchaser uses its Web site to access the out-of-state vendor's Web site and make a purchase. The Appellate Division determined that this presumption is not irrational. Further, the in-state representative has the opportunity to prove that it did not engage in active solicitation.
The Appellate Division also disagreed with the argument that the statute is void for vagueness. Amazon challenged the term "or indirectly" that is included in the discussion of referrals and "other consideration" that is used in the discussion of compensation to the in-state representative. Overstock challenged the words "or indirectly" and complained that "solicitation" is not defined in the statute. The Appellate Division concluded that the words "or indirectly" did not present any confusion. As explained by the Appellate Division, an in-state buyer can be referred by the in-state representative "directly" to the out-of-state vendor by a click on its Web site. The words "or indirectly" mean by a manner other than a direct click. The Appellate Division also determined that "other consideration" was not confusing. This term could include a bonus program, or discounting of the vendor's goods if purchased by the representative, either in lieu of or in addition to the direct payment. Finally, even though the Internet has changed the manner of conducting business, the word "solicitation" still has a clear meaning.
As-Applied Constitutional Challenges Must Be Further Considered
Prior to considering the as-applied arguments, the Appellate Division addressed the state's argument that the claims were not ripe for judicial review. The state argued that the statute had not been applied to Amazon or Overstock because an enforcement action had not been started. In rejecting this argument, the Appellate Division noted that the state had clearly indicated that it intended to enforce the statute against Amazon and Overstock. Also, the state argued that Amazon and Overstock had not exhausted their administrative remedies. The Administrative Division held that review was warranted at this stage because Amazon and Overstock were conducting ongoing businesses and needed clarification regarding their tax obligations.
Commerce Clause As-Applied Claim
According to Amazon and Overstock, the Commerce Clause was violated when the statute was applied to them. Amazon and Overstock argued that the statute could not be applied to them in a constitutional manner because their in-state representatives merely advertised on their New York Web sites. Amazon also argued that its sales to New York residents that were referred by associates constituted less than 1.5 percent of its total sales to New York residents. According to Amazon, this revenue was not "significantly associated" with its ability to do business in New York.8 Due to the fact that there was inadequate evidence in the record to make these determinations, the Appellate Division reinstated this claim for further consideration.
Due Process As-Applied Claim
Amazon and Overstock made a Due Process Clause challenge based on their argument that the statue was irrational and cannot be rebutted by evidence to the contrary as applied to them. The Appellate Division noted that the determining factor would be whether it is irrational to conclude that the agreements with in-state representatives are sufficient to establish that the representatives will engage in any activity that constitutes solicitation that satisfies the substantial nexus requirement. The Appellate Division remanded this claim so that Amazon and Overstock will have the opportunity to show that the in-state representatives merely advertise and do not solicit business.
Equal Protection As-Applied Claim
The Appellate Division rejected Amazon's argument that the statute violated the Equal Protection Clause because it was being treated differently from two of types of entities that were similarly situated: (1) out-of-state retailers that advertise in New York but do not use an associates program and (2) out-of-state retailers that advertise in New York and use an associates program, but compensate their advertisers on a flat fee basis. Amazon's claim that it was being targeted failed because Overstock was treated in the same manner. Also, Amazon was not similarly situated to out-of-state retailers that did not have an associates program like its own.
Commentary
The Amazon litigation in New York is being closely watched because other states have either enacted their own Amazon rule or are considering this type of legislation.9 The fact that an appellate court has determined that the statute is constitutional on its face is significant, although it is likely that the litigation will be considered by the New York Court of Appeals, the state's highest court. The probability that the as-applied claims will be successful is not strong. However, this decision may encourage taxpayers to make as applied challenges in New York and other states with Amazon rules. The fact that the constitutionality of the statute has been upheld may further encourage other states toenact this type of legislation next year, even though it is likely that this particular litigation ultimately will take several years to resolve. Also, affirmation of the Amazon rule may harm the uniformity efforts of the Streamlined Sales Tax Project (SSTP).
A trend of state courts upholding the facial constitutionality of a tax statute but allowing taxpayers to make as-applied constitutional challenges is beginning to emerge. For example, a similar approach was taken in the recent New Jersey throwout rule case.10
Footnotes
1 Amazon.com, LLC v. New York State Department of Taxation and Finance, New York Supreme Court, Appellate Division, No. 601247/08, Nov. 4, 2010; Overstock.com v. New York State Department of Taxation and Finance, No. 107581/08, Nov. 4, 2010.
2 N.Y. TAX LAW § 1101(b)(8)(vi); TSB-M-08(3)S, New York State Department of Taxation and Finance, May 8, 2008; TSB-M-08(3.1)S, New York State Department of Taxation and Finance, June 30, 2008. This provision is referred to as the "Amazon rule" by many tax professionals because the provision appears to target companies like Amazon.com and other online retailers outside New York that pay New York advertisers commissions for sales generated from advertisements that link to online retailers' Web sites.
3 For a full discussion of the trial court's decision, see SALT Alert (01/19/09).
4 Complete Auto Transit v. Brady, 430 U.S. 274 (1977).
5 National Bellas Hess, Inc. v. Department of Revenue, 386 U.S. 753 (1967); Matter of Orvis Co. v. Tax Appeals Tribunal, 654 N.E.2d 954 (N.Y. 1995), cert. denied 516 U.S. 989 (1995).
6 Orvis Co., 654 N.E.2d 954 (N.Y. 1995).
7 National Geographic Society v. California Board of Equalization, 430 U.S. 551 (1977); Orvis Co., 654 N.E.2d 954 (N.Y. 1995).
8 See Tyler Pipe Industries, Inc. v. Department of Revenue, 483 U.S. 232 (1987).
9 Amazon legislation has been enacted in North Carolina (N.C. GEN. STAT. § 105-164.8(b); N.C. GEN. STAT. § 105-164.3(33c)) and Rhode Island (R.I. GEN. LAWS § 44-18-15(a)(2)).
10 Whirlpool Properties, Inc. v. Director and Pfizer, Inc. v. Director, New Jersey Superior Court, Appellate Division, Nos. A-1180-08T2 and A-1182-08T2, July 12, 2010. For a detailed discussion of this case, see SALT Alert (07/22/10).
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