By Allan Maurer

RALEIGH, NC—PART TWO—When states tax an out-of-state business by using some “ephemeral presence” such as advertising via associates’ Web sites, as in North Carolina’s so-called “Amazon tax,” it can end up being counter-productive. “At the end of the day, as these laws get sillier, the whole thing backfires,” says Bartlett Cleland, senior director of tax policy for TechAmerica, a major tech industry lobbying organization.

This is part two of an ongoing series. For part one, “Is North Carolina’s ‘Amazon tax’ all pain and no gain?” see: http://techjournalsouth.com/news/article.html?item_id=8205.

Such laws, sources say, can radically increase enforcement and compliance costs, not to mention the expense of defending a law against charges that it is unconstitutional. They may force some tax-paying businesses to leave the state and make it harder for others to raise money. In all, it can have a “chilling effect on innovation,” says Cleland.

The U.S. Constitution bars states from taxing businesses without a physical presence within their boundaries. The physical presence in a state is called “nexus.” But a later Supreme Court decision ruled that a company only needs a significant commercial presence, not buildings and employees.

Like New York and some other states, North Carolina recently passed a bill that says by advertising and selling products via their associates in North Carolina, out-of-state Internet retailers such as Amazon establish nexus and must pay sales taxes on goods sold in the state.

People pull up stakes
“Nexus is the place where the mistakes occur,” says TechAmerica’s Cleland. “Legislature’s need revenue and look around for what they’re not taxing. You get some wrong-headed thinking. These laws are increasingly hard to police and make it harder for small and medium-sized businesses to figure out what to do [those selling products through newly taxable out-of-state relationships with companies such as Amazon]. People avoid it altogether because it’s hard to comply with or pull up stakes.”

That’s exactly what a number of companies making significant income from Amazon associate relationships did. They moved out of state.

Sen. David Hoyle, chair of the state senate finance committee, says, “If people move, the same thing is going to catch them there. The U.S. Congress needs to fix this thing and create a level playing field.”

“What state taxing authorities are trying to do is establish nexus on any pretense,” says Raleigh serial entrepreneur Bob Butler, founder of www.reallywho.com and www.bestthinking.com, among other firms. “If you have a Web site and someone clicks through an Amazon link and you get a commission from Amazon on a sale, the state is saying that’s as good as you being an employee.”

When a state bases nexus on such a concept, however, it ignores the fact that Amazon or other affected out-of-state firms can just eliminate associate programs in the state—which Amazon in fact did after warning the state that it would. “States bake the new taxes into their projections and just ignore that Amazon just leaves,” says Cleland.

Avoidable taxes rarely paid
“The way NC did it is actually flawed even if you fully embrace the concept that Amazon, etc., should pay sales taxes just like brick and mortar stores,” Butler says. “You have to base nexus on something fundamental to their core business. Otherwise, they just stop doing it. Avoidable taxes are rarely paid. It’s pretty likely no tax will be collected.”

The effect of losing associate income , however, can be chilling on the prospects for many Internet startups, depriving them of the crucial early revenue they need to gain traction and impress venture capitalists or angel investors enough to raise money, Butler says.

“It actually undermines the Research Triangle area,” he notes. “With the venture structure here, you can’t raise money without some revenue. It doesn’t have to be a lot. In Silicon Valley, venture capitalists are willing to give you pre-revenue money. Here, you can’t raise money without some revenue. End of story.”

That affiliate money from sites such as Amazon is “The easy early money to get,” says Butler.

Another problem he sees is that the law makes the tax liability retroactive to the day nexus was established. So, any company out there, Google or some Wyoming Internet retailer who has someone from North Carolina click on an ad and buy something, can get a letter saying they have been selling in North Carolina and owe sales taxes.

“Whenever you get one of those letters, it can cause a huge tax liability,” says Butler. That gives the state considerable leverage to collect its taxes, but it also “Is a great destroyer of any type of capitalization,” says Butler.

The state maintains that all it is trying to do—in addition to raising badly needed money—is level the playing field between its brick and mortar retailers and Internet firms without a physical presence in North Carolina.

Sen. Hoyle, chair of the state senate finance committee, says it’s not fair that people who buy books at a Barnes & Noble store, for instance, have to pay state sales taxes, while a state resident buying the same book from Amazon does not.

Butler counters that the brick and mortar stores actually have advantages and says that argument is a “red herring.”

Who has an advantage?
“Amazon can’t give you coffee and cake and you have to wait 48 hours before you get the book,” he says. “What they’re really doing is taking away the field leveler that the Internet sites have.”

TechAmerica’s Cleland says, “The tech industry is very much willing to pay its fair share of taxes. But we are very opposed to these discriminatory practices that target our industry.” TechAmerica opposed this type of taxation from the beginning.

“We think the notion is wrong-headed and if you’re going to deal with nexus issues, it should be a national issue. We support having a federal law clarifying it so it’s not a question of whether you are doing business in New York, Arkansas or North Carolina and you can plan accordingly. Uncertainty drives up costs.”

In the meantime, he points out, “If this approach (to establishing state nexus) is being challenged in court, it doesn’t strike me as a wise course of action.”

He warns that many industries are very mobile these days. “States love to have professional services. Frankly, those tend to be the jobs that people really want in their state. People are not begging for a tobacco or auto industry.” But those professional services, he notes, “can pick up and go.”

Related Stories:

• Lawyers battle over Amazon Tax issue in Seattle court
• ACLU joins Amazon suit against North Carolina’s tax audit request
• Is North Carolina’s “Amazon tax” all pain and no gain?
• Amazon threatens to cut off NC associates if state tax bill passes
• New technologies leading states to tax firms for “economic presence”

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