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Jul 01

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Taxing the web: A chess match California will lose

California Governor Jerry Brown calls taxing web-based retailers “a common sense idea”. Unfortunately for Mr. Brown and California legislators, winning a chess match takes more than common sense. It requires thinking a couple moves ahead. The “tax the web” chess match is something that Internet-based retail giant Amazon.com thought through long ago. California legislators and Governor Brown did not.

On Wednesday, Jerry Brown signed bill AB 28X into law. This bill requires internet retailers who have affiliate companies in California to pay sales taxes on California purchases.

The bill is an attempt to side-step an 1992 Supreme Court ruling, Quill Corp. vs. North Dakota. In that case, the State of North Dakota attempted to force Quill Corp, located outside of North Dakota, to pay taxes on sales to North Dakota customers. North Dakota argued that even though Quill Corp. had no physical presence in the state, some North Dakota customers used a software program to check Quill inventories and place orders (somewhat akin to how customers use the Internet to order from Amazon.com today).  North Dakota felt this provided sufficient grounds to tax Quill Corp.  The Supreme Court disagreed.

Amazon.com has a large network of affiliates who have websites that refer business to Amazon. The owners of these websites make money when a customer clicks through to Amazon and makes a purchase. California believes this association provides sufficient grounds for the State of California to tax Amazon. However, Amazon’s follow up move demonstrates how unessential these affiliates are to Amazon’s business. According to the Orange County register, 25,000 such affiliates received termination letters from Amazon.com Thursday morning. The letter informs its affiliates:

…we will terminate contracts with all California residents that are participants in the Amazon Associates Program as of the date (if any) that the California law becomes effective.

Affiliates who made a substantial amount of money from their arrangement with Amazon (a minor portion of the 25,000 affiliates, to be sure) are now looking for ways to re-establish their revenue stream. Doing so will require that they remove their business from California. The letter states further:

If you are not currently a resident of California, or if you are relocating to another state in the near future, you can manage the details of your Associates account here. And if you relocate to another state in the near future please contact us for reinstatement into the Amazon Associates Program.

The Los Angeles Times reports that the legislation is expected to raise $317 million in revenue for California. This estimation assumes that Internet sales into California will not be affected by the legislation. It also ignores the effect that such high-profile legislation may have in driving more business from California.

With unemployment rates hovering around 12% already, California’s move has some people scratching their heads. In January of this year, Forbes magazine gave major California cities four of the top 10 spots for “America’s worst job markets”(San Diego #7, Los Angeles #6, Sacramento #5, and Riverside #2).  As recently as May of this year, ChiefExecutive.net called California the worst state for business, noting that California’s spending is 18.3% of the state’s GDP, among other things.

About the author

Eric Madsen

Mr. Madsen is a Chartered Financial Analyst (CFA) charterholder and a Manager at Fulcrum Inquiry, a finance and economics consulting firm that performs economic damages analysis involving commercial litigation, financial investigations, business valuations, and forensic accounting. He also holds an MBA from the UCLA Anderson School of Management and a B.S. in Economics. He conducts expert analysis in finance and economics. Mr. Madsen may be contacted at 213.787.4122 or at emadsen@fulcrum.com.

Permanent link to this article: http://betweenthenumbers.net/2011/07/taxing-the-web-a-chess-match-california-will-lose/

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