The New York State Court of Appeals, the state's highest court, recently held that New York's click-through nexus statute that presumes sales tax nexus for certain online retailers does not facially violate the U.S. Constitution under either the Commerce or the Due Process Clauses.1
Background
In 2008, New York was the first state to enact click-through nexus legislation.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.3
The click-through nexus statute was challenged by two large Internet retailers, Amazon.com and Overstock.com. 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 (though such program was suspended for those affiliates with New York addresses soon after the click-through nexus statute was enacted).
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.4 According to the trial court, Amazon's constitutional arguments were considered to be without merit. The same judge dismissed Overstock's complaint for the same reasons stated in the Amazon decision.5
On appeal, the Appellate Division of the New York Supreme Court affirmed the portions of the orders that dismissed the facial constitutional challenges and declared the statute constitutional on its face.6 However, the Appellate Division reinstated the cases to determine whether the statute violated the Commerce or Due Process Clauses as applied to Amazon and Overstock. Following this decision, Amazon and Overstock entered into "stipulations of discontinuance withdrawing their as-applied constitutional challenges with prejudice, which were deemed the final judgments." Amazon and Overstock appealed their facial constitutional challenges to the New York State Court of Appeals.7
Statute Does Not Facially Violate Commerce Clause
The Court of Appeals held that the click-through nexus statute does not facially violate the Commerce Clause. As explained by the Court, the Commerce Clause prohibits states from imposing an undue burden on interstate commerce, but taxation is allowed if there is not an improper burden.8 A tax is upheld when it is: (i) applied to an activity with a substantial nexus with the taxing state; (ii) is fairly apportioned; (iii) does not discriminate against interstate commerce; and (iv) is fairly related to the services provided by the state.9 In this case, only the substantial nexus test was at issue.
The U.S. Supreme Court has considered the substantial nexus requirement in a line of widely-cited cases. In National Bellas Hess, Inc. v. Department of Revenue,10 the U.S. Supreme Court held that a state could not impose use tax on an out-of-state mail-order business that did not have a physical presence in the state. In Quill Corp. v. North Dakota,11 the U.S. Supreme Court faced a similar issue concerning a mail-order business and retained the bright-line presence requirement from Bellas Hess for purposes of sales and use tax. While the Court of Appeals acknowledged that the physical presence requirement may be outdated because the world has changed dramatically since Quill was decided over 20 years ago, the Court of Appeals noted that this is an issue for the U.S. Supreme Court to consider. Accordingly, the Court of Appeals was bound by the U.S. Supreme Court's binding precedent in Quill.
The Court of Appeals explained that following the Quill case, physical presence in the state itself does not need to be substantial, but must be more than a "slightest presence."12 According to the Court of Appeals, the presence requirement is satisfied if economic activities are performed in the state by the seller's employees or on its behalf.13
In determining that the click-through nexus statute did not violate the Commerce Clause, the Court of Appeals noted that there are parallels between a mail-order business and an Internet retailer because both types of businesses are able to conduct their operations in a state without having a physical presence. According to the Court of Appeals, the click-through nexus statute satisfies the substantial nexus requirement because the out-of-state taxpayer is deemed to establish an in-state sales force through its click-through agreement. The Court of Appeals explained that solicitation in a state that produces a significant amount of revenue qualifies as more than a "slightest presence" in the state. The out-of-state sellers are collecting taxes that are difficult to collect from the individual purchasers. Furthermore, there is no risk of taxing a sale multiple times. As explained by the Court of Appeals, "[t]he bottom line is that if a vendor is paying New York residents to actively solicit business in this State, there is no reason why that vendor should not shoulder the appropriate tax burden."
Statute Does Not Facially Violate Due Process Clause
The Court of Appeals also determined that the click-through nexus statute does not violate the Due Process Clause on its face. As explained in Quill, Commerce and Due Process Clause challenges are "closely related," but physical presence is not required to satisfy the Due Process Clause. For due process, the "focus is on whether a party has purposefully directed its activities toward the forum state and whether it is reasonable, based on the extent of a party's contacts with that state and the benefits derived from such access, to require it to collect taxes for that state."14
Amazon and Overstock argued that the click-through nexus statute violated the Due Process Clause because the "statutory presumption is irrational and essentially irrebuttable." In rejecting this argument, the Court of Appeals noted that the New York Web site owners are compensated for referrals that result in purchases. Due to this direct correlation between referrals and compensation, New York residents are encouraged to actively solicit customers in the state. The Court of Appeals acknowledged that the presumption would seem less rational if the resident received "other consideration" that was not related to actual sales.15 However, because this decision was limited to a facial challenge, the fact that Amazon and Overstock could suggest a possible constitutional violation did not require that the statute be declared facially unconstitutional.
The Court of Appeals also rejected the argument that the presumption cannot be rebutted because it would be very difficult to prove that none of the New York affiliates is soliciting customers for the retailer. In support of its decision, the Court of Appeals noted that the New York State Department of Taxation and Finance has issued administrative guidance providing a method to rebut the presumption. The fact that it may be difficult for retailers to obtain the necessary information does not make the presumption impossible to rebut.
Commentary
The continuing click-through nexus litigation is being closely watched because of the proliferation of click-through nexus statutes that have been enacted and/or are being considered in many states.16 The fact that the highest court in New York has determined that the statute is constitutional on its face is significant and may support other states' efforts in enacting click-through nexus legislation.17 It is curious that Amazon and Overstock decided to stop pursuing their as-applied challenges. Other similarly situated taxpayers may make as-applied challenges to the New York statute, but the probability that these claims would be successful is not strong. While this decision is unfavorable precedent for taxpayers that want to facially challenge the constitutionality of click-through nexus legislation, we expect further challenges to these statutes currently applicable in other states, and potential consideration by the U.S. Supreme Court.
In a well-reasoned dissent, a justice contended that the click-through nexus statute is invalid under the Commerce Clause. The dissent explained that the New York Web sites are not the equivalent of sales agents soliciting business for Amazon and Overstock, but function as the media for Amazon and Overstock to advertise their products. As a result, "[t]he statute at issue here tries to turn advertising media into an in-state sales force through a presumption." The statute literally applies to all Internet advertising that links to a seller's Web site when there is an agreement for the referral of customers for a "commission or other consideration." The dissent argued that the "other consideration" language makes the statute unconstitutional, but the Department narrowly construes the statute to ignore this language. According to the dissent, this narrow construction should not save the statute. Also, the dissent explained that advertising was traditionally sold for a flat fee and sales agents were paid through commissions, but this has changed with the advent of the Internet. Today, it is efficient for the advertiser to compensate a Web site on the basis of its sales. The fact that the compensation is based on sales, in the view of the dissent, should not support a conclusion that the resident is functioning as an active sales agent.
Also in March, the U.S. Senate voted in favor of the concept of the Marketplace Fairness Act by a significant majority (75-to-24). The actual Marketplace Fairness Act18 was introduced in February and was offered as an amendment to the 2014 Budget Resolution by its sponsor, Senator Enzi. The insertion of the language of the Marketplace Fairness Act in the budget is symbolic since the Budget Resolution will not become law. By approving the amendment, however, the Senate's vote demonstrates widespread support for the concept of requiring remote sellers to collect sales tax and signals a growing trend in how the legislators view a vendor's tax collection obligation in today's marketplace.
Footnotes
1 Overstock.com, Inc. v. New York State Department of Taxation and Finance, New York State Court of Appeals, Nos. 33 and 34, March 28, 2013.
2 N.Y. TAX LAW § 1101(b)(8)(vi).
3 The New York State Department of Taxation and Finance has released administrative guidance on the click-through nexus statute. 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. The second memorandum provides that the presumption can be rebutted if the seller satisfies two conditions: (i) the parties' contract prohibits the resident representative from engaging in any solicitation activities in the state on the seller's behalf, and (ii) each resident representative submits an annual, signed certification stating that the resident has not engaged in any of the proscribed solicitation.
4 Amazon.com LLC v. New York State Department of Taxation and Finance, 877 N.Y.S.2d 842 (N.Y. Sup. Ct. 2009).
5 Overstock.com. Inc. v. New York State Department of Taxation and Finance, New York Supreme Court, No. 107581/08, Jan. 12, 2009.
6 Amazon.com, LLC v. New York State Department of Taxation and Finance, 913 N.Y.S.2d 129 (N.Y. App. Div. 2010). Note that the Amazon and Overstock cases were combined on appeal.
7 Because Amazon and Overstock decided to forego their as-applied challenges, the Court of Appeals only considered the facial challenges.
8 Matter of Orvis Co. v. Tax Appeals Tribunal, 654 N.E.2d 954 (N.Y. 1995), cert. denied 516 U.S. 989 (1995).
9 Complete Auto Transit v. Brady, 430 U.S. 274 (1977).
10 386 U.S. 753 (1967).
11 504 U.S. 298 (1992).
12 Orvis Co., 654 N.E.2d 954 (N.Y. 1995), quoting National Geographic Society v. California Board of Equalization, 430 U.S. 551 (1977).
13 Id.
14 Citing Quill, 504 U.S. 298 (1992).
15 The click-through nexus statute presumption applies if the resident receives a "commission or other consideration." N.Y. TAX LAW § 1101(b)(8)(vi).
16 Click-through nexus has been enacted by Arkansas, California, Connecticut, Georgia, Illinois, North Carolina, Rhode Island and Vermont (contingent on 15 or more states enacting clickthrough nexus legislation). Also, click-through nexus legislation has been proposed in many other states, including Florida, Hawaii, Indiana, Kansas, Maine, Massachusetts, Michigan, Minnesota, Mississippi and Utah.
17 Note that an Illinois trial court has ruled that the state's click-through nexus law violates the Commerce Clause and is preempted under the Supremacy Clause of the U.S. Constitution due to the federal moratorium against discriminatory states taxes on electronic commerce contained in the Internet Tax Freedom Act. Performance Marketing Association, Inc. v. Hamer, Illinois Circuit Court, First Judicial Circuit, No. 2011 CH 26333, May 7, 2012. This case has been appealed.
18 H.R. 684, introduced by U.S. Representative Steve Womack of Arkansas (with 39 cosponsors) on Feb. 14, 2013; S. 336, introduced by U.S. Senator Mike Enzi of Wyoming (with 19 cosponsors) on Feb. 14, 2013. For a discussion of the proposed Marketplace Fairness Act, see GT SALT Alert: Federal Legislation Re-Introduced to Authorize States to Impose Sales Tax Collection Requirements on Remote Sellers http://www.grantthornton.com/staticfiles/GTCom/Tax/SALT_Alert_files/Marketplace_Fairness_Act_2013_SALT_Alert.pdf.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
