A Taxing Situation

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Postby Dustin Stinett » 06/16/05 12:35 PM

A decision on May 31 by Californias 1st District Court of Appeals went against Borders Group, Inc., ruling that they would have to pay sales tax on all online sales to California residents, even though their Internet sales division is not located in this state.

Now before anyone runs off on a political rant: dont botherI will be watching. The issue here is not political per se (Red versus Blue or whether taxation is right or wrong; evil bureaucrats, yada-yada-yada). The issue is what affect this might have on Internet magic dealers in the (possibly) near future. This is a business issue: Consider taxation inevitable. Because of Californias stance on the issue, you can bet that other states (that collect sales tax) will take a long hard look at this ruling (Borders is already fighting similar cases in Nevada and Illinois according to the Securities and Exchange Commission). And while one recognizes that the tax collectors will target the big boys firstthe Amazon.coms of the worldthey are also very aware that little guys are less likely to litigate. (And you can bet that Borders will take this as high as they possibly can. And, can Amazon and eBay be far behind in the governments shooting gallery duck-row? But Dustin, theyre Internet only, arent they? Read on.) So in the mean time, the circling vultures will swoop in and devour the carrion left behind in the wake of this ruling.

Of course, is this a bad thing?

Brick-and-mortar book and music shops in California are hailing this ruling as a major triumph in their cause because the Borders/Amazon folks are not collecting sales tax (and thus do not spend any money on the administration of it; and as such do not have that overhead to pass on to their customer), so the brick-and-mortar retailer is put at a further competitive disadvantage. Sound familiar? (I used to have a small golf shop: I spent hours dealing with state and local tax crapand it was a small, part-time business.)

But, you might ask, doesnt this go against the 1992 U.S. Supreme Court decision that says retailers do not have to pay sales tax in states where they have no physical presence? Theres the rub: Borders has retail stores in California. Even though their separate Internet division (which has since been outsourced to Amazon) was not in California, the appellate court ruled that the two entities could not be considered separate. They shared a name, advertising, a similar logo, and corporate officers. In their decision, the court said, We conclude that the imposition of a use taxdoes not violate the commerce clause of the United States Constitution. (Maria P. Rivera, Judge.) The door is now open because what this ruling does is insinuate that even affiliates (or agents) sharing advertising, etc. constitute a physical presence (at least this may be how the California State Board of Equalizationthe tax collectors hereare reading it, according to some analysts). Apparently there are stores that act as agents for Amazon in California (displaying their advertising, etc.). That gives Amazon a physical presence here and as such could subject all of their California sales, whether online and mailed, or ordered online and picked up (or returned) at a store, to sales tax. Ouch.

So, what has this got to do with magic? Well, Houdinis Magic has a couple of stores in California (Irvine and San Francisco). Thats a physical presence. I dont know (and perhaps Geno will answer should he choose to do so), but if I order online, through his Nevada-based company, I probably do not pay a sales tax right now. With this ruling, Houdinis could become responsible for collecting sales tax on every online order from customers who reside in California. Plus (and Geno, this might hurt) apparently the State Board of Equalization is auditing past sales! (Another political warning: Yes, California is cash-strapped and revenue hungry and the reasons for that are politically charged. DO NOT GO THERE!) The Borders case was based on sales from April 1998 to September 1999. Thats a double-whammy, since Borders (and perhaps Houdinis should this happen to him and companies like his) was not given the opportunity to collect the sales tax from their customers. But, the companies are still liable for the tax. Also, if Nevada wins its case with Borders, Denny & Lees has an outlet in Las Vegas and an online presence. I hope Denny wasnt planning on moving into California. (Which is another problem: This is clearly going to curtail some business from doing physical business in California and other states that adopt this strategy for tax collection.)

And there is yet another rub: Were talking about brick-and-mortar shops with online ordering getting dinged. Internet-only magic dealersunless they have affiliates or agents in Californiawill continue to be exempt from this ruling, hurting the Denny & Lees and Houdinis that much more. Its what you might call a catch-22. Maybe (for the time being, anyway).

So, whats next? Since the 1992 U.S. Supreme Court ruling, it has been conservatively determined that state and local governments have lost $15 billion in tax revenue from online sales. And that number will only continue to grow. Theres one thing you can count on: Somebody is going to want their slice of the ever-growing e-commerce pie. If these cases reach the U.S. Supreme Court again (which I think you can count on, because if Borders goes the next stepto the California Supreme Courtregardless of the ruling, the loser might take their case further up the ladder), dont be shocked if they reverse their original ruling in an attempt to level the playing field. Remember, when that original ruling was made, the online playing field wasnt well defined at all: That is no longer the case. Furthermore, this could end up in congress: There are lobbyists out there who believe that all e-commerce organizations should collect sales tax for the state where the consumer lives. With todays technologies, this wouldnt be out of the realm of possibilities (the computer would do all the calculating for the business and they just write the check or make a transfer). And, there is always the possibility of a Federal sales tax on Internet sales. I can see Joel Grey singing Money [Makes the World Go Around] as I write this (it makes ze vorld go rrrround)

As Pete Biro says,

Stay Tooned!

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Postby Brad Henderson » 06/18/05 10:24 AM

This is not that suprising and in some ways makes sense (though I would rather it not be enacted).

I used to buy art through Sotheby's and Christie's. (Early 1990's) I would make purchases at auctions in NY. If I took possesion there, I paid sales tax. If I had the item shipped to KY, when I lived there, I paid none. BUT if I had the item shipped to Texas, where I was in school at the time, I DID have to pay because they had an office (a presence) in Dallas.

So, it makes sense that since Borders has stores in a state, purchases shipped to that state from another would require tax.

Also, Amazon has (or at least had) a partnership program where one could buy an item online and pick it up at a local bookstore. Though the purchase was made through the internet, one still paid tax upon pick up.

So, I don't see how this is totally different than that which was already on the books.

Or did I miss something (highly probable).

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Postby Richard Kaufman » 06/18/05 10:47 AM

This might be news in California, but I've seen notices from many companies that give a list of states where you'll have to pay sales tax if you order online or through a catalogue. The latter is something Dustin does not mention--ordering from catalogues has been going on for almost a century, long before any sort of sales taxation in this country. So, ordering something from "out of state" tax free is not a phenomenon that is in any way something new or something that is suddenly upon us because of the Internet.
The thing that HAS changed is the volume, the amount of dollars spent, and with states hurting for bucks it is only natural for them to try and tax the hell out of everyone and everything they can.
The US congress has repeatedly turned back efforts to tax sales on the Internet, and (I predict) will continue to do so. Eventually it will come down to a case decided by the Supreme Court over who actually has jurisdiction, the federal or state governments.
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Postby Guest » 06/18/05 10:58 PM

Adobe has been doing this for years.

Anold saw--"the power to tax is the power to destroy."

Postby Bill Palmer » 06/18/05 11:28 PM

Many software companies are required by law to do this. Microsoft, Adobe, Symantec and others all have a "presence" in more than one state, and are required to collect sales tax for those states in which they have a presence.

However, sales that are made on a wholesale basis to a reseller are not subject to sales tax. If you are a reseller, and you make a purchase for resale, but decided to remove a few items from your stock for personal use, then most states require that you pay sales tax on these items. There is nothing new or even sinister about what is taking place here. Even though I wish there were a way to make all internet sales tax exempt.

If a situation arises in which people with no presence in another state are required to pay sales tax to a state, there will be some heavy objections and it will be complicated. It's complicated enough paying sales tax in one state.

Technically, if you purchase an item in another state, and you pay no sales tax on it, in some states you are actually supposed to pay sales tax on it when you receive it. Few people do, though.
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Postby Dustin Stinett » 06/19/05 01:00 AM

Richard is correct in that I did not bring up catalog sales that have been a part of American commerce for a couple of centuries or so. Hes also correct in what is turning the tax collectors heads (and the legislators) is the numbersvery big (and growing) numbers. I hope his prediction about congress is correct, but I suspect that an Internet sales tax is a mere bargaining chip that will be played one day.

Brad: Yes, if you order online from a business in the same state as you reside, you pay a tax. Or, if you order from Amazon and pick it up at a store, you pay the tax. What I think you might be missing is the notion that because Amazon (and companies like it) simply HAS a deal with stores in California, that might constitute a physical presence. So anyone in California who orders onlineeven if it is to be mailed to themAmazon will be required to collect a sales tax from the buyer, even though Amazon is not a California-based company. Right now, they do not, so long as the item is delivered through the mail. That might change depending upon how this decision is interpreted by the tax collectors. I think that they will try to push it to its practical limits; charge the tax and see who challenges them in court.

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Postby Robert Allen » 06/19/05 08:01 AM

Having run a small mail order business in California in the past, the most annoying thing for me was the record keeping for paying the damned tax. At the end of the year you must divide the taxes you paid up, to the penny, between the state and each of the counties you shipped to. Now if you mail to say, Likely California, how do you even know what county that town is in? Oh, and shipping was taxable which make it hard to write the invoice until after the package was almost but not quite sealed. It was so annoying that I literally preferred not to do business with Californians; the volume was not so great for a small business that the extra hassle was worth it to me.
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