Generally a state may only collect sales or use taxes if there is a “substantial nexus” between the seller and the state imposing the tax. The substantial nexus requirement arises from the United States Constitution, which gives Congress the exclusive right to regulate interstate commerce. As the U.S. Supreme Court explained in the 1992 decision, Quill v. North Dakota, before the Constitution’s adoption, “state taxes and duties hindered and suppressed interstate commerce; the Framers intended the Commerce Clause as a cure for these structural ills.”
In modern practice this means two things: first, a state cannot use its tax policies to discriminate against out-of-state commerce; second, a state cannot tax a transaction that has no real connection – i.e., a substantial nexus – to the state itself. This latter requirement is an ongoing source of tension in the age of Internet commerce, as online retailers can sell millions of dollars worth of goods in a state where the company maintains no physical or legal presence.
The “Amazon” Tax
One battlefield in this tax war is the use of affiliate or “click-through” marketing programs. Most people are familiar with these types of programs. A website contains an ad for goods available for sale at another website, such as Amazon; the user clicks the ad, purchases the product, and the affiliated website operator receives a commission from Amazon.
More and more states are contending that this advertising relationship alone creates a “substantial nexus” with an out-of-state retailer justifying the collection of sales or use tax. This past January, Illinois announced its second effort to collect such taxes. Illinois legislators made their initial attempt in 2011, asserting sales and use tax jurisdiction over any “retailer having a contract with a person located in this State under which the person, for a commission or other consideration based upon the sale of tangible personal property by the retailer, directly or indirectly refers potential customers to the retailer by a link of the person’s Internet website.”
A trade association representing affiliate marketers challenged Illinois’ action as a violation of a federal law prohibiting “discriminatory taxes on electronic commerce.” In an October 2013 decision, the Illinois Supreme Court agreed with the challengers and nullified the state law. The Illinois General Assembly responded in August 2014, passing a revised law allowing retailers to present evidence their referral activities are “not sufficient to meet the nexus standards of the United States Constitution.” The new law also applies to “promotional codes distributed through the [retailer’s] hand-delivered or mailed material,” such as catalogs. This requirement is intended to address the Illinois Supreme Court’s finding the earlier law singled out Internet-only promotions.
Under the new Illinois law, which took effect on Jan. 1, any out-of-state retailer that “made cumulative gross sales of $10,000 during the preceding four quarterly periods to customers referred by persons located in Illinois,” must register and pay state use taxes. Note the $10,000 threshold is based on the location of the affiliates, not the customers. So if an Illinois-based website’s referrals lead to $10,000 in sales for the out-of-state retailer, the retailer is liable for Illinois use tax even if only $5,000 of those sales were actually made to people living in Illinois.
Comments will be approved before showing up.