Taxing Times by Chris Trayhorn, Publisher of mThink Blue Book, January 1, 2006 Back in the early days of the dotcom boom, rampant speculation arose about how or even if online sales should be taxed. For consumers, e-commerce was almost too good to be true: an ultimate extension of mail order, where any product could be ordered from an out-of-state seller with the click of a button, avoiding sales tax, albeit paying any shipping fees that were charged. However, since the mid-90s the e-commerce industry has evolved and U.S. economic conditions have changed, sparking legislators to make a serious push to implement some type of standardized tax code for purchases made online. As a source of potential revenue for state governments, the topic of Internet taxation cannot be overlooked nor can the impact it may have on online marketers and affiliates searching for profits in an increasingly competitive medium. According to a July 2004 research report from the Center for Business and Economic Research at the University of Tennessee, states are still losing billions of dollars in uncollected sales tax revenues from transactions that occur through electronic commerce. For 2004, the report estimates that states lost between $8.9 billion and $10.8 billion from e-commerce sales alone and predicts that this amount will continue to grow. By 2008, the report estimates that revenue losses from online sales will range anywhere from $11.8 billion to a high of $17.8 billion. These figures may sound high, but they are actually below the previous estimates made in 2001. At that time, forecasters didn’t factor in an economic slowdown and miscalculated on volume of business-to-business transactions, according to Neal Osten of the Federal Affairs Counsel, which was behind drafting the legislation known as the Streamlined Sales and Use Tax Agreement (SSUTA). The Legislation The SSUTA (outlined at www.streamlinedsalestax.org), became effective on October 1, 2005. It lays the groundwork for standardizing the way participating states define, charge and collect sales and use taxes. The idea behind SSUTA is that by taking the burden of sorting through tax jurisdictions away from retailers, the participating states could in turn ask federal lawmakers to introduce new legislation, which could challenge the 1992 Supreme Court decision that forbids states from forcing a business to collect sales taxes unless the business has a physical presence within their state. SSUTA required at least 20 percent of the population of states with sales tax to sign on in order to get rolling. At press time, 13 states had made all the changes in their sales and use tax statutes and administrative rules to comply. Those states are: Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, New Jersey, North Carolina, North Dakota, Oklahoma, South Dakota and West Virginia. Utah, Tennessee, Ohio, Arkansas and Wyoming are next in line to comply. “It is the intent of the SSUTA to treat all transactions in a competitively neutral manner,” explains the Federal Affairs Council’s Osten. “That is, sales, whether they are made in a brick-and-mortar retail operation or purchased online, are treated similarly for sales tax purposes. The agreement provides simplicity and some uniformity for out-of-state sellers in collecting a state’s sales taxes.” It’s important to emphasize that currently the agreement is voluntary for both states and sellers. “The states, whether they comply with the agreement or not, do not have the authority to require remote sellers (such as affiliates) to collect their sales and use taxes,” he says. Osten explains that until Congress passes legislation giving those states that have complied with the agreement mandatory collection authority, remote sellers, online or not, have the option to volunteer to collect for sales made in the states that have complied with the agreement as of October 1, 2005. If a remote seller volunteers to collect for one of the states in the streamlined system, they would have to collect for all the states in the system. Besides being compensated for collection costs, remote sellers that volunteer to collect are also given amnesty by these states if they may have had past collection responsibility in one or more of the states and did not collect sales taxes. After Congress passes legislation and makes sales tax collection mandatory, amnesty will no longer be granted. Basically, nothing really changed for online sellers on October 1 unless they volunteered to collect for states where they did not have physical presence. Osten says that even if a company has a physical presence in one of the 18 complying states, it is not required to abide by the new agreement, which brings about an interesting point – compliance. “The biggest problem that I foresee with collecting sales tax online is enforcement,” says Alan Townsend, a LinkShare affiliate and marketing manager for PersonalizationMall.com. “Who’s going to be responsible for determining who’s in compliance and who isn’t? There are so many opportunities here for loopholes it’s mind-boggling. What state is the business registered in? What state is the domain name registered in? Who is it registered to? What state is the site hosted in? What state do the products ship from? The only way for this to be fair and effective for the states and the businesses involved is to have all 50 states participate. But overall, I think the states are headed in the right direction to achieve their goal with the SSUTA; not that I’m for more taxes.” Taxation Inevitable Some say the push for online taxes was coming. It was just a matter of when. “I think the recent surge in interest by both old-world brick-and- mortar firms as well as by legislators to collect more taxes from Internet sales is, in the greater context, an awakening to the explosive growth and potential of online firms and our industry in general,” says John Lemp, CEO of online affiliate network Clickbooth.com. “Ten years ago, these types of laws were extremely unsuccessful. Even five years ago such laws would never have dreamed of passing, but now traditional firms are seeing the growth Internet companies are experiencing and how a law like this could slow migration of their customers to the Web. “In the shift from offline to online spending the big losers are the states that collect less tax,” says Ola Edvardsson, CEO of interactive strategy firm Performancy.com. “Since they are in the business of collecting taxes they are not going to sit by the sidelines and watch.” Dave Taylor, business blog strategist at Intuitive.com, adds that “arguably the situation is different today simply because the nation faces more debt with the war in Iraq, Hurricane Katrina and so on. Does that justify greater taxes? Perhaps.” The Burden Still, some worry about the impact this move will have on continued growth and how smaller businesses will handle the burden of dealing with complex tax regulations. “Whether this slowdown will be very minor or very large is still up for debate,” Lemp says. “Personally, I wouldn’t worry about the larger- and mid-sized Internet firms as they will respond to the market and growth will continue – it’s smaller firms or individual proprietors trying to keep up with compliance that worry me the most.” Townsend says he believes this is a Pandora’s box. Lemp agrees. “Even if these new laws are 100 percent successful in getting all 50 member states to enact them and they have consistency, they will still create enormous new costs and workloads for any small business attempting to sell products,” he says. “I have sold products in the past and the amount of paperwork and technological systems we had to create to keep up with one state’s laws was difficult enough for a small business. I worry more about the thousands of eBay sellers or small product sellers creating simple websites trying to sell products in their spare time or building product businesses from scratch. These are businesses with very limited resources and if significant amounts of those resources are tied up in purchasing compliancy software, hiring staff to file the sales and use paperwork with 50 separate states, then the new administrative and technological overhead could be too much for them.” Although Osten has said states will pay for all the collection costs, the other obvious burdens on business owners appear to be equally daunting. While the idea is to level the playing field, Lemp believes the opposite may happen. “Businesses that are attempting to comply and are located in states that are enforcing the new rules will attempt to compete with businesses in states not enforcing the rules or simply not complying, making an unequal playing field. Consumers are getting smarter than ever and will check prices at multiple sites and factor in sales tax and so forth when making purchases. If done right, eventually a more lenient national or at least uniform and extremely simple sales and use tax code would have much more success than what’s currently being presented.” Even Amazon.com, the king of online retailers, has stated it will not enforce the policy, bringing the competitive pricing issue further into the limelight. Affiliate Impact Besides all the possible logistical hurdles and potential negative consequences raised by the SSUTA, it’s important to note that the agreement does not even make clear what to tax or not to tax. Each state that complies with the agreement will still decide what’s taxable, according to Osten. The agreement only provides uniform definitions for the states to use to decide to tax or exempt an item. The agreement also does not define marketing and/or ad sales and any taxation thereof. On the marketing front, Townsend says, “most affiliates will not be directly affected in my opinion. The vast majority of consumers shop online for the selection and the convenience of shopping whenever and wherever they want. That’s not going to change. In addition to that, online retailers will always continue to offer promotions such as coupons and free shipping; they have to in order to stay competitive online. Even if you take the convenience factor out of the equation, consumers can still get a better deal online because of the great selection and retailer promotions.” Edvardsson agrees that affiliate marketers don’t have much to worry about. “It will have little direct effect on affiliates except if conversion rates go down in retail-based programs due to sales tax implementation,” he says. Furthermore, advertising inventory itself is unlikely to be affected. “Marketers that sell tangible products will be responsible for complying with these new laws,” Lemp says. That is if, in fact, it becomes law. “As far as I know, marketing, ad sales and intangible goods will not be taxed. These items should never be taxed, as a taxation system on them could possibly destroy certain industries. Intangible goods and payment systems such as PayPal do not have a physical delivery location and a location of origin can be near impossible to accurately calculate without losing significant percentages of sales.” On the larger e-commerce front, Townsend says, “Very few retailers promote the fact that you don’t have to pay sales tax if you’re ordering outside of their home state. I can’t recall the last time I saw a banner ad for a retailer that read ‘Shop here ” no sales tax!’ Instead, online retailers promote selection, value, convenience and service, just like offline retailers do. This is what consumers are looking for.” Additionally, shoppers will look at the total price regardless of taxes, shipping or other charges. Down the Road That’s not to say that there won’t be any long-term implications of either a voluntary or government-imposed online sales tax. “The long-term effect for established businesses will be a readjustment of the marketplace unless there is still a good chunk of competing businesses that are not complying – whether international, eBay sellers or businesses located in states without consistency,” Lemp says. “The long-term effect of using the current system will be a hindrance of growth for very small, growing businesses and sole proprietorships.” He says that as an affiliate network that works with more than 300 separate advertisers, anything that is affecting even a small portion of his affiliates could ripple back to impact his company. Though, he says, it’s not likely that the true effects of these laws would be felt for several years. “Internet marketers can continue to do what they do best – react to the marketplace,” Lemp says. “If new regulations are put in place, advertisers will need to respond to these regulations and the marketers that work with these advertisers will need to continue to work side by side with their clients to fulfill any new needs that may arise.” Townsend says that online retailers and affiliate marketers are smart and resourceful people and will likely invent new ways to survive. “The cost of entry into the online marketplace is much lower than it is for offline retailers,” he says. “This drives competition and ultimately better deals for the consumer. With or without sales taxes, online retailing will continue to grow for a long time to come.” DAVID COTRISS has spent the last 10 years writing about business, technology and entertainment for such publications as MIT’s Technology Review, Entrepreneur and Streaming Media. He has a B.S. in advertising from San Jose State University and currently resides in Los Angeles. Filed under: Revenue Tagged under: 09 - January/February 2006, affiliate marketing, affiliate networks, Features, Industry Trends, Legal, mtadmin, Taxation About the Author Chris Trayhorn, Publisher of mThink Blue Book Chris Trayhorn is the Chairman of the Performance Marketing Industry Blue Ribbon Panel and the CEO of mThink.com, a leading online and content marketing agency. He has founded four successful marketing companies in London and San Francisco in the last 15 years, and is currently the founder and publisher of Revenue+Performance magazine, the magazine of the performance marketing industry since 2002.