Amazon Bad News Behind Mask Of State Tax Win

Just in time for Halloween, a Seattle federal judge ruled on Monday (Oct. 25) in favor of Amazon.com—but the ruling's effect was actually against Amazon and every other E-tailer. Technically, Amazon won a legal victory; the court said it was unconstitutional for the North Carolina Department of Revenue to demand names and addresses and details about books, movies and music that customers bought from Amazon. But the judge also said the state could have exactly what it needs to calculate sales taxes: who bought things and how much they cost.

Amazon has dressed up that court ruling as a big victory for customer privacy. But now Amazon will have to cough up the customer data, and North Carolina will begin to go after Amazon's North Carolina customers to collect the taxes due—and you can bet that the revenuers will mention Amazon's name when the tax bills go out. Amazon is already collecting sales taxes in five states where it has physical operations. Therefore, a few more court victories like this one, and Amazon might be better off just collecting all state sales taxes itself.

U.S. District Judge Marsha Pechman made it clear in her decision that she wasn't getting in the way of North Carolina collecting taxes. She was only concerned with a government agency learning exactly what books and movies customers bought, which violates their First Amendment and privacy rights. Strip out the details, she wrote, and North Carolina can have its information.

"The Court is aware of the sensitive nature of this case," Pechman wrote in her ruling. "The declaratory relief issued here is of limited scope and cannot be interpreted to grant Amazon a free pass from complying with any valid tax law of North Carolina or elsewhere."

The bottom line of the decision: "To the extent [the North Carolina Department of Revenue] demands that Amazon disclose its customers' names, addresses or any other personal information, it violates the First Amendment only as long as (North Carolina) continues to have access to or possession of detailed purchase records obtained from Amazon" (emphasis added).

"The fear of disclosure of their reading, watching and listening habits poses an imminent threat of harm and chill to the exercise of First Amendment rights," the judge wrote.

For Amazon and other pure-play E-tailers, this ruling isn't exactly good news. A federal judge has ruled these companies have to open their sales records to state tax agencies, setting the stage for states to make a new run at sales tax revenue that has eluded them since the early days of E-Commerce.And even if states can't collect sales tax directly from E-tailers, there's now a good chance customers will end up with a tax bill—one that will have E-tailers' names all over it.

How did we get into this sales tax cat-and-mouse game? It's been going on since 1992, when the U.S. Supreme Court ruled that North Dakota couldn't collect sales tax from office-supply retailer Quill Corp., whose customers used Quill's custom software to order electronically. (Note: That was three years before Amazon.com—or pretty much anyone else—sold its first anything on the Web.) The Supreme Court said that a retailer has to have a physical presence in the state (a "substantial nexus" in legal parlance) before sales-tax liability kicks in, and Quill's floppy disks didn't qualify—and that only Congress could change that nexus requirement.

Ever since, out-of-state E-tailers have argued that they don't have nexus, brick-and-mortar retailers have fumed that Internet players don't have to charge sales tax and states have looked for ways around the Quill ruling to collect from E-tailers anyway.

For example, Barnes & Noble tried to argue that its E-Commerce operation was independent of its physical stores. That didn't fly in California courts. Amazon.com claimed its distribution centers in Texas were actually owned by a separate company that happened to have "Amazon.com" in its name and shared a corporate address with Amazon.com. That didn't fly either, and last month Texas sent Amazon a $269 million bill for uncollected sales taxes. (Amazon says it will fight the tax bill.)

Meanwhile, states have lobbied Congress to change the law (with no luck so far) and looked for new ways to establish nexus—especially for Amazon. New York found an opening with its "Amazon tax" law in 2008, which declared that E-tailer affiliates qualified as nexus. Amazon and Overstock.com both fought the law in court, lost and are appealing. Meanwhile, Amazon is collecting sales tax from its New York customers.

Seeing New York's success, North Carolina and Rhode Island tried a similar tack. Amazon responded by cutting off its affiliate programs in those states. Colorado passed a law requiring E-tailers to notify customers that they're required to pay the tax on what they buy online. Amazon's response: It dropped its Colorado affiliates. California also tried a tax-the-affiliates approach, which the legislature passed but was vetoed by the governor.

In the case of North Carolina, Amazon didn't just cut off affiliates. It also responded to the state's request for all information on all sales to state residents by sending the state information on every item sold except the names and addresses of the buyers.When the state demanded that information (so it could bill its residents for the tax), Amazon went to court on privacy grounds and this week won—sort of.

But it's a Pyrrhic victory. E-tailers really don't want to be involved in collecting sales taxes at all. (When North Carolina launched a sales-tax amnesty program for out-of-state E-tailers, only 6 percent of E-tailers signed up, according to the state.)

But now all North Carolina has to do is send a few CDs full of transaction data back to Amazon to satisfy the judge's ruling. (The state says it has already deleted the data from its computers.) Then Amazon will have to fork over reams of customer names. And next spring, North Carolina can send letters to residents saying, "You bought $117 of books, music and DVDs from Amazon.com, and now you owe sales tax on it." That isn't going to make customers feel happy about Amazon—especially when all that sales tax will be due at once.

What's worse, even though Amazon fought and won its great battle to protect customers' privacy, most of them won't get that message. They'll just hear that Amazon told the state about the books, music and DVDs they bought. Those customers won't know what Amazon didn't tell the state—just that the privacy of their online transactions was breached and Amazon must have been the one that did it.

There is a silver lining for Amazon, though. Now that Amazon has "won" its case, the door is open for North Carolina and other states with "Amazon tax" laws to go after other out-of-state E-tailers, too. That means Amazon will be turning over customer information, but so will all its E-Commerce rivals. With all E-tailers doing it, it won't really represent a competitive disadvantage.

Well, at least not a competitive disadvantage against other E-tailers. But will this be a powerful competitive weapon in the hands of brick-and-mortar rivals? Will those physical chains—think of Sears, which has already laid the groundwork for an anti-E-Commerce tax argument—tell consumers, "When you price compare with Amazon, don't forget to add in that wonderful bill you'll get from the state, when it asks for all your E-Commerce taxes at once. Buy from us today, you get your item—and no mailbox mayhem."

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