Amazon/Overstock Gamble May Pay Off

I was surprised to notice how silent Amazon (AMZN) appeared to be vis-à-vis New York’s new tax law during the company's earnings call yesterday.  Thomas Szkutak, Amazon’s Senior VP & CFO, brushed off questions regarding the tax issue as “too early to comment.”  By contrast, in Overstock’s (OSTK) latest Q2 2008 earnings call transcript, the company had much to say about the issue.  What really caught my attention was when Jonathan Johnson, Overstock’s SVP, stated that the New York State Senate had voted to repeal New York’s most recent tax law which would put this whole mess behind us. 

For those of you who weren’t aware, New York State passed a new law that went into effect on June 1, 2008.   The law, dubbed “the Amazon tax,” requires all internet companies with affiliates in NY State to charge sales tax on shipments bound for New York.  The State expects this to increase tax revenue by $50 million. 

Why is this law a problem?  Well, according to the Supreme Court’s 1992 ruling in Quill v. North Dakota, companies are obligated to charge sales tax only for states where they have a physical presence.  That is why New Yorkers may have noticed that they need to pay sales tax when making an online purchase from sites like Best Buy (BBY), Circuit City (CC) or Barnes & Noble (BKS), but not from sites like Amazon, Buy.com, Overstock and others.  The former group has a presence in virtually every state, while the latter set does not. Technically, New Yorkers were always supposed to pay sales tax on purchases from sites like Amazon to the government, but since the web stores weren’t forced to collect the tax, few actually paid.

New York State has found a way around this law by stipulating that New York based affiliates could be constituted as a “physical presence,” though until now, they have generally been interpreted as advertising vehicles.  Affiliates get paid a commission for driving a customer to online stores.  Websites like Amazon have thousands of such affiliates. 

Why is this law important?  It means that one of the major advantages that a company like Amazon had over a company like Barnes & Noble is that they did not have to charge sales tax to New Yorkers.  This often resulted in a lower overall price.  Now these companies do need to include tax and it remains to be seen if their more price sensitive customers may no longer be as loyal.  I, for one, am not.   And while a $1.00 sales tax on a book may not be enough to dissuade a customer from making a purchase, tax on a laptop, which could easily add over $100, might. 

So how have companies responded? The harshest response came from Amazon and Overstock, which have independently filed lawsuits against New York State challenging the constitutionality of the new law (note: by filing independently, they are forcing New York to defend themselves against two lawsuits rather than one; a considerably more expensive undertaking).  Meanwhile, most sites such as Amazon and Buy.com have complied and as of June 1^st, have been charging sales tax to many an unsuspecting New Yorker.   An email to each of these companies inquiring as to why the sites now charge NY sales tax resulted in an almost identical response which can be summed up as:  New York passed this law, if you have a problem with it, contact them.  As a result, I am sure I was far from the only one who complained to the New York Legislature about this. 

Overstock, followed by other online retailers were even more creative and decided to dump its 3,400 New York affiliates.  Not only did this protect the company from having to charge sales tax in NY, but it sent a clear message to Albany: keep this law and you will hurt New York small business owners.  As a result many sites like 5StarAffiliatePrograms.com have started a grassroots effort to pressure New York to repeal the law.

There are a lot of online shoppers in New York, and while Amazon and Overstock complain that such a law is unconstitutional or too hard to implement, what it really comes down to is that 10% or more of their customer base is affected by this new law and may defect to the competition.  This poses a major threat to these companies’ profitability which is already being affected by the economic downturn.

Why should those of you who do not live in New York care?  If you ever want to ship an item to a friend or relative in NY, you’ll have to shell out a little extra for NY sales tax, one of the highest in the country.  Even worse, if New York gets away with this law, other states may follow.  California has already considered implementing an “iTunes tax” which would have charged tax on all music downloads, but the law was defeated in committee.  At least for now.

So where do we stand at this point?  It seems that Overstock and Amazon’s gamble may have paid off.  Faced with angry customers, worried affiliates and looming lawsuits, New York State may be about to back down.   The Senate voted unanimously on a bill to repeal the law and the bill has now been passed on to the Assembly for review.  But there is a long way to go until the battle is over. Regardless of what happens, I will likely never see the $15.11 in sales tax I just paid to Amazon for my most recent order.

Disclosure: The author is Seeking Alpha's director of marketing, and owns stock in Amazon.

Comments

[NormanQ]

I'm only halfway through my morning coffee....But what exactly is the gamble AMZN/OSTK are taking? Filing a lawsuit in New York? In the state that has the most lawyers per capita, that is not exactly a gamble. Lawsuits are as NY as the Yankees and Donald Trump.

[5starAffiliatePrograms]

Boaz, thanks for linking to the right place at 5 Star. That article has lots of advice about what New York residents and affiliates can do to try to help push the tax law repeal through. It still has a long way to go.

Also in the right sidebar there is a link to extensive coverage about the New York tax law issue, primarily from an affiliate marketing viewpoint. So many merchants nationwide have dropped their NY affiliates to try to avoid paying the tax, that many affiliates are losing a lot of income and some of them are even having to go out of business over this.

Also there is a big meeting in NY on the 28th to discuss the issue and try to come up with some options. Lots of affiliates will be there, some merchants and affiliate managers, at least one attorney and hopefully a sympathetic assemblyman or 2.

Thanks for bringing this issue up again and thanks for your support.

Linda Buquet

[najdorf]

Good points. However, I would note that the decision to file separate lawsuits is probably more about AMZN management's desire to avoid providing any assistance to a competitor and reduce the risk of winding up spending any significant time in the same room as the utterly insane OSTK management.

[nima]

as the owner of a brick and mortar bookstore, i think all this outcry about the new york state ruling is a little ridiculous. if you want to argue that there should be no sales tax at all because it's regressive than i'm on board with that. but the current set up is especially regressive because only those people with credit cards and online access are able to buy tax free. also the state is basically subsidizing out of state businesses at the expense of local businesses that contribute to the community in many ways. not to mention the lost revenue for schools and roads etc. that has to be made up for somewhere, like more expensive parking tickets. if there was just a flat national sales tax or no sales tax at all, the affiliates wouldn't have to loose their businesses, as it is they're sort of caught in the middle which sucks.

[zev]

Nima

Parking tickets go to the municipality, not the state. The reality is that a company outside of New York State cannot be told by New York what to do. it would be like Belgium passing a law that says Americans must mow their lawns every day. It make no sense. I'm not sure why they even complied. If they want to help the brick and mortar stores, as they should, then they should lower their taxes and make them less than New Jersey, so people from there will come to new york to shop and not the other way around. Simple business practices. Lower your prices, get the customers.

[fsaldanha]

I lived in Connecticut until 2005. In 2004 I received a letter from the tax authorities informing me (and millions of state taxpayers) that we would have to pay taxes on all online purchases of items that would be used in Connecticut (?!). If I remember correctly it was called a "use tax." This was not restricted to Amazon.com or to retailers that had a presence in Connecticut. If CT can get away with this then NY will surely get away with taxing Amazon.com.

[David477]

This was a great summary of the situation. New York State's decision is only gong to hurt NY based affiliate businesses and will end up costing tax payers much more if they try to fight the lawusits. The law was a bad decision on their part. Thanks for bringing this issue to our attention.

[David477]

Question: A friend who runs a NY based affiliate business was part of the group kicked off of Overstock because of this law. He said he was going to avoid the whole problem by incorporating in Delaware. Would this work?

[DavidJackson]

Excellent article.

[mvkarl]

nima's comment makes the most sense to me. Support no tax, a national flat tax or get congress to pass a law to make collection of use tax mandatory. Local brick and mortar stores will continue to lose to the internet unless the field is leveled. Without local sales tax revenue states will have to make up the deficit by increasing property tax, fuel tax etc. In the end you will still pay the $15.11 one way or another.

[dumb money76]

I agree with Nima. What the amazon tax does is it closes a tax loophole, which may seem bad if you are enjoying the loophole like the author seems to be, but trying to make it seem that there is an argument is based on the claim that the law will be bad for the businesses in the state is ridiculous. This new law levels the playing field between internet companies that can get away without charging tax and currently are enjoying record profits, and the brick and mortar companies located in the state, that currently have to charge tax, which makes it hard to compete. Also, it is not that you currently have a right to not pay tax, the reality is that even without the new law, new yorkers are still supposed to be paying sales tax when they purchase from these companies. This law is just currently not being enforced. The argument that Overstock stopping it's New York affiliates will hurt businesses in New York, shows that they do actually have a presence in the state and thus should not get special benefits. I would be all for a flat tax or even no tax, but it does not seem right to have a loophole to allow some companies to operate without charging tax is not fair, and stacks the deck against the companies that are located in the state.

[marysch]

I am also against the Amazon Tax. You can be sure that I emailed
my opinion to both NYS Gov. Pataki and my district assemblyman.
Election time is coming up. We need to clean house!

[marysch]

Ooops. Where am I? I mean Gov. Paterson.

[davewj2o]

The majority of voters in NY are bloodthursty for more government services. If you are a legislator here and wish to cap spending you will be promptly voted back to your farm. So, there doesn't appear to be an answer for NY until it collapses.

Water always takes the easiest path. Us savy NY'ers have learned that if you're buying a big ticket item, have it shipped in and save almost 10%. You can't stop free enterprise. The Soviet Union tried until there were more black market vendors and legit.

If the NY legistature were really concerned about local vendors they can make it easier for them to compete in many ways . . . but they won't.

[Lisa]

I purchased some books and CDs from Amazon to be delivered to my address (NY), and found for the first time that Amazon is charging me sales tax. In the past, I've bought big ticket items -- particularly electronics -- from AMZN because it's much cheaper than purchasing locally, largely due to the sales tax difference. Now I'm not sure I'd do this. Wonder whether this will have a big impact on AMZN's sales until it's resolved.

Any update on what's going on with the sales tax issue?

[BoazBerkowitz]

AUTHOR’S UPDATE:

Thank you all for your comments and thank you to user "dumb money 76" for providing some interesting contrast to my article. Mr. (or Ms.) dumb money 76, you are correct on several points. As I mentioned in the article, New Yorkers have always been required to pay sales tax on their online purchases but few if any do. In a similar vein, people are supposed to pay income tax on the profits they make from selling their old junk at garage sales or on eBay. But again, few do. What I failed to mention however, is that one has to keep in mind why brick and mortar stores charge sales tax. The money is used for services that benefit these stores such as maintaining roads, repairing electricity, trash collection, etc. Amazon, Overstock and other sites based outside of NY receive no such benefits. NY's "Amazon Tax" may be closing a loophole in the law or even leveling the playing field as you suggest, but I'm not convinced Amazon should be subsidizing the government services that Barnes & Noble receive in NY. And is it really leveling the field? There are advantages and disadvantages to buying an item online besides sales tax. A customer may save on the sales tax but at the same time, they may have to pay much more for shipping and/or endure lengthy ship times. And in the spirit of true competition, Barnes & Noble should not petition that Amazon be forced to charge sales tax as well (brick and mortar companies have been lobbying for this law for years) but rather should be forced to find creative ways at competing with Amazon on their own core strengths (price is one of Amazon's core strengths not theirs). For instance, one way Barnes and Noble successfully accomplished this has been by offering Manhattan customers same day delivery, something Amazon's business model could never offer.

Perhaps a solution would be to charge sales tax to all customers with the tax revenues going to the website's home state. For instance, Overstock is based in Utah, so it might make more sense for them to charge Utah sales tax on all sales which could be used to subsidize services within their own state, not New York. But of course that would involve a huge overhaul of our current tax laws. But am I against a sales tax as some readers have suggested? As a consumer, I of course prefer paying lower prices for items but as a U.S. citizen I appreciate the value that paying taxes offers to society. But those who made this accusation are missing the point. The question isn't whether Amazon should be charging tax to New Yorkers, the question is whether New York's new law is technically illegal? And regardless, is it bad for New York? While I am no law expert, I think it is a stretch to claim affiliates qualify as a legal presence. And yes, I do think it can hurt NY businesses. First of all, if NY succeeds in keeping this tax on the books, other states are virtually guaranteed to pass similar laws of their own. Which means people may shun NY based internet companies, for those based in states that haven't passed such a law. Additionally, larger internet stores will likely follow Overstock's lead and shun them as well. Overstock may have been trying to send a message to Albany that the law will hurt NY businesses, but it was also a simple mathematical equation. As explained in their most recent earnings call transcript (seekingalpha.com/artic...), they calculated that they would lose more business by charging sales tax to New Yorkers than they would by abandoning their NY affiliates. If NY actually fights the lawsuits and wins, I think we will be seeing Amazon employ the same math and if their calculation brings the same result, Amazon’s affiliates will be out the door as well. Why haven't they done this yet? Amazon is very focused on customer service and my hunch is that they believe NY will either back down or lose the lawsuit. If that happens, there will be no need to kick out their NY affiliates and will have generated tremendous goodwill by not having done so. Especially in light of Overstock's abandonment of theirs. Plus many of Overstock's 3,400 NY affiliates will likely join Amazon now that Overstock has closed its doors to them. When this all blows over, many of them will probably choose not to rejoin Overstock. So as much as I hate paying more at Amazon, I thin this was a good move for them.

As for the user “Lisa” who requested an update, there unfortunately isn’t much to report. While a bill to repeal the law has passed the Senate by a wide margin (voting 6-24-08), it wasn't passed until the last day of New York's Session. The bill still needs to be approved by the Assembly to become law and that can't happen before the next Session which will not be until January, 2009.

Meanwhile, I’m afraid my article may have been overly optimistic. Even if the bill to repeal the tax passes the Assembly, according to Saul Hansell at the NY Times (bits.blogs.nytimes.com.../), it seems that Governor Paterson will likely veto it. So at the end of the day, those that want to see the Amazon tax repealed may have their hopes hinge on the outcome of Amazon and Overstock's lawsuits. And that could take a long time to resolve. It will also cost NY taxpayers a lot of money in lawyer's fees. Unfortunately, New York is very creative at finding ways to charge sales tax and if they lose the lawsuits, they'll likely find some other way to increase tax revenues. Anyone else remember when New York State sent agents to stake out New Jersey malls in 1992 to record NY license plate numbers? They were trying to crackdown on New Yorkers crossing the border to save on the lower taxes. It makes me wonder if New York would be more effective in increasing tax revenues by being competitive and actually lowered the NY tax rate. Then maybe our neighboring states would be flocking to NY stores instead of the other way around.