BILL ANALYSIS AB 178 Page 1 Date of Hearing: April 27, 2009 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Charles M. Calderon, Chair AB 178 (Skinner) - As Introduced: February 2, 2009 Majority vote. Fiscal committee. SUBJECT : Sales and use taxes: retailer engaged in business in this state SUMMARY : Expands the statutory list of retailers that are considered to be engaged in business in California and that, as such, are required to collect use tax on sales of tangible personal property (TPP) to California consumers. Specifically, this bill : 1)Provides that the term "retailer engaged in business in this state" includes any retailer with an agreement with a California resident under which the resident, for a commission or other consideration, directly or indirectly refers potential customers of TPP, whether by a link or an Internet website or otherwise, to the retailer, if the cumulative gross receipts or sales price from sales by the retailer to customers in California who are referred pursuant to these agreements exceeds $10,000 during the preceding four calendar quarterly periods. 2)Specifies that this provision shall not apply if the retailer can demonstrate that the resident with whom the retailer has an agreement did not engage in referrals in the state on behalf of the retailer that would satisfy the requirements of the commerce clause of the United States (U.S.) Constitution during the four quarterly periods in question. EXISTING FEDERAL LAW : 1)Authorizes Congress, under the commerce clause of the U.S. Constitution, to regulate commerce with foreign nations, and among the several states. The U.S. Supreme Court has held that the "negative" or "dormant" commerce clause also prohibits states from enacting laws that unduly burden interstate commerce. AB 178 Page 2 2)Provides per federal case law that, under the commerce clause, a retailer must have a "physical presence" in a state before that state can require the retailer to collect its use tax. EXISTING STATE LAW : 1)Imposes a use tax on the storage, use, or other consumption in this state of TPP purchased from any retailer. The use tax is imposed on the purchaser, and unless the purchaser pays the use tax to a retailer registered to collect the California use tax, the purchaser remains liable for the tax, unless the use is exempted. The use tax is set at the same rate as the state's sales tax and must be remitted to the Board of Equalization (BOE). 2)Specifies those retailers that are considered to be engaged in business in this state and that, as such, are required to collect use tax on sales of TPP to California consumers. Specifically, a "retailer engaged in business in this state" includes a retailer who: a) Maintains, occupies, or uses, permanently or temporarily, directly or indirectly, or through a subsidiary, or agent, by whatever name called, an office, place of distribution, sales or sample room or place, warehouse or storage place, or other place of business; b) Has any representative, agent, salesperson, canvasser, independent contractor, or solicitor operating in this state under the authority of the retailer or its subsidiary for the purpose of selling, delivering, installing, assembling, or the taking of orders for any TPP; or, c) Derives rentals from a lease of TPP situated in this state. FISCAL EFFECT : BOE estimates that this bill would generate $149.5 million annually in state, local, and special district revenues. COMMENTS : 1)The author states: California currently requires all of its businesses to AB 178 Page 3 collect and remit sales tax to the state. However, out-of-state internet retailers who have millions of dollars in sales generated from California residents are not required to collect sales tax on transactions. The current tax collection structure actually encourages companies with internet sales to move out-of-state so that they can get around our sales tax laws. This current loophole in law places California businesses at an unfair disadvantage while out-of-state businesses reap the benefits of our large consumer base, and simultaneously put brick and mortar stores out of business. Given our budget shortfall, California needs to be proactive in collecting taxes which are due and payable. New York State enacted a bill comparable to AB 178 and as a result New York has collected over $40 million dollars in tax revenue to date and expects to collect approximately $70 million by the end of the year. The Board of Equalization estimates that California would collect over $150 million if AB 178 were enacted. California's businesses are suffering a huge competitive disadvantage due to these online retailers. By not collecting sales taxes, out-of-state retailers automatically enjoy at least an 8.25% price advantage when competing for customers. In some cities, out-of-state retailers will have a 10.25% price advantage over California businesses. The loss of sales tax revenue to the state means that local communities who depend on this revenue source also suffer. These are funds that go back to communities, money that will strengthen our schools and enhance public safety. 2)Proponents state: This important bill helps clarify that out-of-state retailers with affiliates in the state of California in fact have nexus in California, and therefore must collect use tax. Amazon.com has hundreds, if not thousands, of affiliates in California who receive a commission on sales which they refer to Amazon. By any definition of nexus, they have many agents or representatives in the state, and must collect taxes upon sale. Right now, they are competing unfairly with thousands of California businesses. AB 178 Page 4 The language in this bill is patterned directly after New York [S]tate's language, which was determined by the first court of review to be legal, based upon a long line of cases which determine the basis for nexus. Amazon has appealed, but in the original court's review, all of their claims were dismissed on the law and facts, so it is likely that this issue will be resolved in the state's favor in an expeditious manner. (The U.S. Supreme Court has consistently declined to hear nexus cases, deferring to Congress). Significantly, Amazon began collecting use tax immediately for orders from New York residents, and, since this tax is due and payable in any case, the only possible adverse outcome for the state in the unlikely event that the state loses would be that Amazon would be relieved of its collection obligation in the future. Thus, California must be in a position to follow this lead, and join other states (Minnesota, Connecticut) which are considering the same approach. California took the lead successfully in determining that companies with stores in California could not isolate their on-line retailers from collection obligations, even if out-of-state, and the national practice now is that all retailers collect from their ".com" affiliates. In California, the many affiliates of Amazon and other retailers promote products and receive commissions upon sale, thereby meeting the statutory and judicial requirements for nexus. 3)Opponents state: This bill would strongly discourage non-California retailers from advertising on California-based websites via click-thrus. These click-thrus (the ability to "click thru" to the out-of-state retailer's website through a banner ad or other link) are a large source of revenue for California-based companies, clubs, community organizations, and other website operators. If this bill were to create nexus for non-California retailers using click-thrus, many California-based organizations would lose this source of revenue. By contrast, non-California website companies and organizations would still receive revenue for click-thru ads because retailers could still use these websites to access the California market without subjecting themselves to sales tax. This disparity between California-based AB 178 Page 5 websites and non-California-based websites would place California-based-websites at a competitive disadvantage. In addition to the loss of click-thru advertising revenue, AB 178 would place California companies that provide an online marketplace for buyers and sellers of tangible goods at a competitive disadvantage compared to non-California companies providing the same service. The bill extends state sales tax to out-of-state retailers that receive an indirect customer referral from a California-based company. This provision adversely impacts California companies that bring buyers together with out-of-state sellers. If the use of a California-based online marketplace will impose a duty to collect sales tax on out-of-state retailers, California-based online marketplaces stand to lose business to their counterparts in other states. As with click-thru advertising, the out-of-state retailer can access the California market just as readily from a Texas-based online marketplace as it can from a California-based counterpart. 4)BOE notes that: The state of New York, as part of its budget, enacted legislation in 2008 entitled "the Commission-Agreement Provision" that presumes a retailer "solicits" business in the state if an in-state entity is compensated for directly or indirectly referring customers to the retailer - language that is substantially similar to this measure. Last April, Amazon sued New York's taxation department. Then, in May, Overstock suspended its relationships with any affiliates that had a New York address. And in June, the company joined Amazon in its suit, challenging the constitutionality of the tax law. Both Amazon and Overstock contended that the law violates the Commerce Clause of the U.S. Constitution and the Due Process Clause of the Fourteenth Amendment to the Constitution and sought a permanent injunction prohibiting New York from enforcing the law. Seattle-based Amazon argued that it did not have a sufficient nexus (physical presence) in the state to be compelled to collect use tax and basically contended that the new law intentionally targets Amazon. Additionally, AB 178 Page 6 Amazon said the law is vague and overly broad because Amazon has no way of knowing whether its affiliates, who provide addresses in other states, are legal residents of New York. The New York Supreme Court [New York's trial court] dismissed both the Amazon and Overstock suits, ruling that the Commission-Agreement Provision does not broadly tax any and all Internet sales to New York consumers in that it requires a substantial nexus between an out-of-state seller and New York through a contract to pay commissions for referrals with a New York resident along with realization of more than $10,000 of revenue from New York sales earned through the arrangement. Further, the Court stated that the neutral statute simply obligates out-of-state sellers to shoulder their fair share of the tax collection burden when using New Yorkers to earn profit from other New Yorkers. 5)Committee Staff Notes: a) What is "physical presence" and why is it important? : i) There is, under existing law, a certain degree of ambiguity concerning when a state may legally compel an out-of-state retailer to collect the state's use tax on sales to state residents. ii) In Quill Corp. v. North Dakota (1992), 504 U.S. 298, the U.S. Supreme Court was asked to decide the constitutionality of a North Dakota law that imposed a use tax collection obligation on out-of-state retailers that advertised in the state three or more times in a single year. The Court invalidated the law, holding that, under the commerce clause, a retailer must have a "physical presence" in a state before that state can require the retailer to collect its use tax. iii) The "physical presence" test affirmed in Quill has complicated California's efforts to collect its use tax. For example, when a California resident purchases a coat from an out-of-state retailer through its catalog, the purchaser's use of the coat in California triggers a use tax liability. If the out-of-state retailer lacks a "physical presence" in California, however, California is AB 178 Page 7 constitutionally prohibited from requiring the retailer to collect the tax. If the purchaser fails to remit the tax, the purchase completely escapes taxation. It is estimated that this gap in California's sales and use tax system costs the state nearly $1.1 billion in revenues each year. iv) Revenue and Taxation Code Section 6203 specifies those retailers considered to be engaged in business in this state - in other words, it lists those retailers that are considered to have a "physical presence" sufficient to impose a use tax collection obligation. This bill would add to that list any retailer that has an agreement with a California resident, under which the resident, for a commission or other consideration, directly or indirectly refers potential customers to the retailer, if the cumulative gross receipts from sales by the retailer to customers in California who are referred exceeds $10,000 during the preceding four calendar quarterly periods. As noted above, this language is modeled after legislation passed in New York State last year. Committee staff is informed that there are other states currently considering following suit. v) Committee staff is informed that many "out-of-state" retailers currently use California residents, often referred to as "affiliates", to promote business. Sometimes, affiliate agreements are entered into directly between the out-of-state retailer and California residents. In other situations, they are mediated by an "affiliate network". It is Committee staff's understanding that affiliates engage in a wide range of activities. Some maintain websites that contain links to out-of-state retailers. Others engage in more active e-mail solicitation. Under this bill, any business that uses affiliates to generate substantial sales to California residents would be deemed to have a physical presence in this state. b) The arguments on both sides : i) Opponents state that, if this bill passes, it will cause out-of-state retailers to terminate their affiliate relationships with California residents. This, they argue, will place the jobs of California affiliates at AB 178 Page 8 risk in an already troubled economic climate. ii) Proponents of this measure note that many out-of-state retailers use California residents to drive business, take full advantage of California's consumer base, but refuse to collect California's use tax. This, in turn, places these companies at a competitive advantage vis-?-vis California-based businesses, which must collect and remit sales tax. Proponents essentially argue that, under existing law, the affiliate system works to reward companies whose business model is predicated on the fact that most consumers unlawfully fail to pay use tax. c) Who exactly would be considered an affiliate under this measure? : In its current form, this bill covers referral agreements under which the California resident receives a commission "or other consideration". This, in turn, has raised concerns that this bill might inadvertently include "cost-per-click" web advertising agreements. Committee staff understands that the author is working on amendments to address this concern. d) Related Legislation : ABx3 27 (Calderon) contains a provision similar to this bill, and also contains a provision that would further expand the definition of a "retailer engaged in business in this state" to include any retailer having a representative, agent, salesperson, canvasser, independent contractor, or solicitor operating in this state under the authority of the retailer or its subsidiary for the purpose of servicing or repairing any property. REGISTERED SUPPORT / OPPOSITION : Support American Federation of State, County and Municipal Employees, AFL-CIO Books 'n Bears Builders Booksource California Association of College Stores California Business Properties Association California Federation of Teachers California Labor Federation AB 178 Page 9 California Professional Firefighters California School Employees Association, AFL-CIO California Tax Reform Association EcoHome Improvement Kepler's Books & Magazines League of California Cities Mrs. Nelson's Toy and Book Shop Netflix Potter Books River House Books River Reader Sawyer's News Service Employees International Union Walnut Avenue Caf? 1 Individual Opposition Advice Company Amazon.com AOL Billy Fire LLC Blinkstar Media California Broadcasters Association California Chamber of Commerce California Independent Grocers Association California Manufacturers and Technology Association California Taxpayers' Association Coastal Cardiology Commission Junction, Inc. Creativity, Inc. Direct Marketing Association DMAF Consulting eBay, Inc. Entertainment Software Association Fuller Sound/CSS Music/D.A.W.N. Google Greater San Fernando Valley Chamber of Commerce Haldeman, Inc. Howard Jarvis Taxpayers Association HR Jungle Hydra Internet Alliance Irvine Chamber of Commerce Manheim Central California AB 178 Page 10 Motion Picture Association of America, Inc. Murphy, McKay & Associates, Inc. Ogletree's, Inc. Overstock.com Palm Desert Chamber of Commerce Panoptx Inc. Performance Marketing Alliance, Inc. on behalf of over 300 California Professionals Plan-it Interactive Recording Industry Association of America Risse Mechanical Schaaf Consulting Seawright Custom Precast, Inc. Silicon Valley Leadership Group Software Finance and Tax Executive Council St. John's Retirement Village Stephen P. McGee, Law Offices TechAmerica TechNet The Press-Enterprise ValueClick, Inc. VLSI Research, Inc. Westgate Hardwoods, Inc. Yahoo, Inc. 1 Individual Analysis Prepared by : M. David Ruff / REV. & TAX. / (916) 319-2098