BILL ANALYSIS Ó AB 153 Page A Date of Hearing: March 21, 2011 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Henry T. Perea, Chair AB 153 (Skinner) - As Introduced: January 18, 2011 VOTE ONLY Majority vote. Fiscal committee. SUBJECT : State Board of Equalization: administration: 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)Imposes a use tax collection obligation on any retailer that enters into an agreement under which one or more persons in this state, for a commission or other consideration, directly or indirectly refer potential customers to the retailer, whether by an Internet-based link, a website, or otherwise, provided the cumulative sales price from all of the retailer's sales within the preceding 12 months to customers in California who are referred exceeds $10,000. 2)Specifies that this provision shall not apply if the retailer can demonstrate that the person with whom the retailer has an agreement did not engage in referrals in the state on the retailer's behalf that would satisfy the requirements of the Commerce Clause of the United States (U.S.) Constitution. 3)Provides that an agreement under which a retailer purchases advertisements from a person in this state, to be delivered on television, radio, in print, on the Internet, or by any other medium, is not an agreement described above, unless the advertisement revenue paid consists of commissions or other consideration that is based upon sales of TPP. AB 153 Page B 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 or discriminate against interstate commerce. 2)Provides per federal case law that, under the dormant 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 sales tax on retailers for the privilege of selling TPP, absent a specific exemption. The tax is based upon the retailer's gross receipts from TPP sales in this state. 2)Imposes a complementary 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 State Board of Equalization (BOE). 3)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, the term "retailer engaged in business in this state" includes any 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 AB 153 Page C 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 : The BOE notes that its revenue estimate for this bill is subject to "considerable uncertainty." Moreover, there could be a delay in collections due to potential litigation challenging this measure. In a purely static world with full retailer compliance, BOE estimates increased state and local revenues of $152 million in fiscal year (FY) 2011-12 and $317 million in FY 2012-13. These estimates are based on the combination of (1) the amount of revenues currently being collected in New York, adjusted for California's larger economy, and (2) increased revenues associated with out-of-state retailers that sell to California consumers on eBay that would have a use tax collection obligation under this bill. COMMENTS : 1)The author has provided the following statement in support of this bill: AB 153 would clarify state laws to require internet based non-California merchants with a network in the state to collect sales tax on purchases shipped into California. This bill would play a significant role in leveling the playing field for California businesses and would help secure needed revenue to support essential local services. AB 153 will provide a much needed boost to hundreds of brick and mortar businesses in the state. For several years, local businesses have been calling for an equitable resolution to this issue. While they collect and pay the sales taxes their communities rely on, out-of-state, online retailers do not, and their avoidance has cost the state billions of dollars a year. While these out-of-state online retailers entice shoppers with so-called "tax-free shopping," local retailers pay their fair share of taxes and do hundreds of other things - some financial, some non-financial - to support local activities. California businesses are the backbone of our economy and AB 153 Page D we cannot continue to put them at a disadvantage to mega online retailers who use loopholes from our outdated laws to reap the benefits of our large consumer base. It's estimated that retail businesses physically based in the state - and employing California workers - are losing $4.1 billion in sales in 2010 to online-only retailers. The state needs to end this loophole and give all businesses the chance to compete in California on an even playing field. 2)Proponents state, "For too many years, out-of-state retailers have exploited the ability to avoid collecting sales tax even when companies like Amazon have substantial presence in the state of California. ÝAB 153] will be an unusual win-win: good for revenue for the state and for the many businesses in California which are at a disadvantage from this tax avoidance strategy. The fact is, Amazon has thousands of affiliates and direct properties in the state, and in our view should already be collecting tax. ÝAB 153] will clarify that such a presence establishes sales tax nexus, as is appropriate." 3)Opponents state, "If AB 153 were to pass and create nexus for non-California retailers using click-throughs, a principal source of revenue for California-based companies and organizations would end as out-of-state retailers severed their California ties. Non-California website companies and organizations would become the ultimate beneficiaries of AB 153 because the out-of-state retailers would simply switch to using their websites to access the California market and avoid the state's use tax laws." 4)BOE has provided the following comments in its staff analysis of this bill: a) Is this form of affiliate nexus constitutional? : "Nineteen years have passed since the court rendered its decision in Quill. However, the manner in which business is done now has changed dramatically compared with the commercial landscape at the time that case was decided. The New York Appellate court has determined that these provisions are not unconstitutional on their face. However, there is still some question with respect to New York's provisions (after which this bill is modeled) whether they are constitutional as they are applied. Until the court ultimately decides that the physical presence AB 153 Page E requirement affirmed in Quill is outdated, and renders a new decision to reflect today's marketplace, there is at least some question whether this form of affiliate nexus will be ultimately found to be in conformance with the dormant commerce clause." b) In addition to firms like Amazon, provisions could impact many other out-of-state retailers who sell tangible items on eBay or other similar online marketplaces domiciled in California . "As currently worded, the provisions would apply to those out-of-state retailers that are not otherwise engaged in business in California but that sell goods to California consumers through online sites maintained by California residents when all of the conditions in the bill are met. An out-of-state retailer's sales through eBay, for example, where eBay refers potential purchasers for a commission or other consideration to the retailer by a link or otherwise, could fit within the provisions of this bill (eBay is a California "resident"). If those sales exceeded $10,000 within the previous 12 months, that out-of-state retailer would be considered "engaged in business" in this state under this bill. As a retailer engaged in business in California, the retailer would be required to register with the BOE and would have the duty to collect the use tax on all of his or her sales to California consumers - whether through eBay or otherwise." c) Affiliates' concerns . "According to information obtained from Performance Marketing Association, California has about 25,000 affiliates who derive income from agreements with out-of-state retailers that potentially could be negatively impacted by this bill. Their concern relates to the fact that many out-of-state retailers with affiliate programs will terminate their agreements with them should California enact this provision. Overstock.com did, in fact, terminate its affiliate program in New York - the first state that enacted this "click through nexus" provision, and Amazon terminated its affiliate programs in Rhode Island and North Carolina when those states enacted provisions similar to this bill. Amazon even terminated their relationship with Colorado's affiliates when the Colorado Legislature enacted provisions to impose an information reporting requirement on remote retailers that do not have nexus in Colorado. And, a "click through AB 153 Page F nexus" bill is currently awaiting the Governor's signature in Illinois, and Amazon has informed its affiliates there that Amazon's affiliate program with them will terminate should the bill become law. And, more importantly, we have also obtained written confirmation directly from Amazon that confirms that it will terminate its relationship with its California affiliates should California enact this provision." d) What are other states doing ? "In addition to pending legislation in Illinois on this "click through nexus" provision, several other states are considering adding a similar provision: Arizona, Hawaii, Minnesota, Mississippi, New Mexico, Connecticut, Texas and Vermont. Also, a bill to repeal its "click through nexus" provision has been introduced in Rhode Island." 5)Committee Staff Comments: a) California's Use Tax : Since 1933, the state has imposed a sales tax on California retailers for the privilege of selling TPP, absent a specific exemption. The tax is based upon the retailer's gross receipts from TPP sales in this state. In 1935, California adopted a complementary "use tax" on the storage, use, or other consumption of TPP purchased out-of-state and brought into California. The use tax was designed to protect California merchants who would otherwise be at a competitive disadvantage when out-of-state retailers sell to California customers without charging tax. Unlike the sales tax, the use tax is imposed on the purchaser and not the retailer. Unless the purchaser pays the use tax to an out-of-state retailer registered to collect California's use tax, the purchaser remains liable for the tax. The use tax is set at the same rate as the state's sales tax and must be remitted to the BOE. b) Impediments to Collection : The most practical way for a state to enforce its use tax is to have retailers collect the tax at the time of sale. However, there is considerable ambiguity regarding the circumstances under which a state may legally compel an out-of-state retailer to collect use tax on its behalf. This ambiguity has its origins in the Commerce Clause of the U.S. Constitution, AB 153 Page G which charges Congress with regulating commerce among the several states. The U.S. Supreme Court has held that, by implication, the Commerce Clause also prohibits states from enacting laws that unduly burden interstate commerce. 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 negative Commerce Clause, a retailer must have a "physical presence" in a state before that state can require the retailer to collect its use tax. The "physical presence" test affirmed in Quill has complicated California's efforts to collect its use tax. For example, when a California consumer purchases a coat from an out-of-state retailer through its catalog or online store, the consumer'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 constitutionally prohibited from requiring the retailer to collect the tax. If the consumer fails to remit the tax, the purchase completely escapes taxation. It is estimated that this gap in California's sales and use tax (SUT) system costs the state over $1.145 billion in revenues each year.<1> c) What Would this Bill Do? : As noted above, Revenue and Taxation Code (R&TC) 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 this statutory list certain "out-of-state" retailers that use California residents, often referred to as "affiliates," to promote business. This bill is modeled after the so-called "Amazon" legislation passed in New York. New York, and other states that have enacted similar bills, argue that if a remote vendor (like Amazon) uses an affiliate marketing program, the vendor's in-state activities satisfy Quill's -------------------------- <1> This total represents $795 million in use taxes uncollected from California consumers and $350 million in use taxes uncollected from businesses. AB 153 Page H physical presence requirements and thus create SUT nexus for the vendor. Specifically, this argument is based on the theory of "attributional" nexus, as established in Scripto, Inc. v. Carson (1960) 362 U.S. 207 and Tyler Pipe Indus. v. Washington State Dep't of Revenue (1987) 483 U.S. 232, which hold that if a retailer has in-state agents that sell on the retailer's behalf, the in-state agents may establish nexus on behalf of the out-of-state retailer. d) Arguments in Support : Proponents of the Amazon approach note that many out-of-state retailers use California residents to drive business, and take full advantage of California's consumer base, but refuse to collect California's use tax. <2> This, in turn, places these companies at a competitive advantage vis-à-vis California-based businesses, which must collect and remit sales tax. e) Arguments in Opposition : Opponents of the Amazon approach argue that such legislation would cause out-of-state retailers to terminate their affiliate relationships with California residents. This, they argue, would place the jobs of California affiliates at risk in an already troubled economic climate. In addition, critics argue that affiliates operate far differently from the sales force "actively engaged" on behalf of Scripto, Inc. Specifically, they note that the work of most affiliates is passive and that affiliates do not call on customers or directly solicit orders. f) What Type of Affiliate Behavior Creates Nexus under this Bill? : As noted above, this bill imposes a use tax collection obligation on any retailer that enters into an agreement under which a California affiliate, for a commission or other consideration, directly or indirectly refers potential customers to the retailer, whether by an Internet-based link, a website, or otherwise. This -------------------------- <2> Amazon, Inc. collects tax in only five states: Washington, North Dakota, Kentucky, Kansas, and New York. Indeed, it would seem that tax avoidance has been a longstanding priority for Amazon, Inc. founder Jeff Bezos, who originally considered citing his company on an Indian reservation near San Francisco for tax avoidance purposes. ("Sorry, Shoppers, but Why Can't Amazon Collect More Tax?," Randall Stross, New York Times, December 26, 2009). AB 153 Page I language would seem to cover a broad range of potential affiliate arrangements. On one end of the continuum, this language would seem to cover rather passive commission-based link referrals, where the affiliate does no more than refer potential consumers via a link on their Internet website. On the other end of the continuum, this language would also cover affiliates who engage in active solicitations (whether by e-mail or otherwise). It is unclear whether a reviewing court would find all of these affiliate activities sufficient to establish nexus for remote vendors. Efforts could be taken to more specifically describe the types of affiliate activities that would establish nexus in California. However, providing such statutory clarity might have the unintended consequence of prompting remote vendors to simply restructure their affiliate agreements to fall outside the law's ambit. That is to say, out-of-state companies would effectively be given a roadmap for restructuring their affiliate agreements. g) Would Remote Vendors Really Terminate their California Affiliates? : It should be noted that out-of-state retailers have followed through on their threats to terminate affiliate contracts in states that have adopted Amazon legislation. After New York's enactment of its "Amazon" law, both North Carolina and Rhode Island followed suit. As a result, online giant Overstock.com cancelled its affiliate program in all three states, while Amazon.com cancelled its affiliate programs in both North Carolina and Rhode Island. h) How Reliable are the Revenue Estimates for this Bill? : The state's likelihood of actually collecting BOE's "static" revenue estimate depends entirely on (1) Internet retailers' willingness to continue their in-state affiliate programs, and (2) out-of-state retailers' continued willingness to sell their products on platforms like eBay with the attendant responsibility for collecting use tax on all sales to California consumers. The BOE has received direct confirmation from Amazon that it will terminate its relationship with its 10,000 California affiliates if this bill is enacted. BOE estimates that Amazon currently comprises roughly 50% of the Internet sales of large firms that currently do not have nexus in California. Consequently, the static revenue estimates cited above, AB 153 Page J adjusted for Amazon's anticipated response, would drop to $114 million in FY 2011-12 and $234 million in FY 2012-13. If other firms were also to terminate their affiliate programs in response to this bill, the potential revenue gains would be further diminished. Additionally, the termination of affiliate programs would have an adverse impact on state employment, which would lead to lower income tax revenues. The amount of these potential reductions is unknown. i) Legal Challenges Remain Unresolved : In November 2010, a New York appellate court ruled for the state on certain challenges to that state's Amazon law under the Commerce Clause and the Due Process Clause. The court noted, however, that additional discovery was required at the trial court level to determine whether there was sufficient in-state activity to establish nexus under the Commerce Clause. j) Recent Legislative Efforts Focused on Increasing Use Tax Collections : In recent years, California has taken other steps to increase use tax compliance. Chief among these efforts are the mandatory use tax registration program and the permanent inclusion of a use tax line on the state's income tax returns. Each is discussed briefly below: i) Mandatory Use Tax Registration for Service Enterprises : In 2009, California enacted R&TC Section 6225 seeking to increase use tax compliance among California businesses that purchase TPP from out-of-state. Specifically, Section 6225 requires "qualified purchasers" to register with BOE for annual use tax reporting. A qualified purchaser is defined as a person that: (1) Receives at least $100,000 in gross receipts from business operations per calendar year; (2) Is not required to hold a seller's permit or certificate of registration for use tax; (3) Does not hold a use tax direct payment permit; and, (4) Is not otherwise registered with BOE to report AB 153 Page K use tax. The BOE estimates that this mandatory registration program will generate roughly $58.5 million in FY 2010-11 from a total of 556,012 registered accounts. ii) Permanent Inclusion of a Use Tax Line on Income Tax Returns : In 2010, Governor Schwarzenegger signed SB 858 (Committee on Budget and Fiscal Review) into law as part of the FY 2010-11 Budget Agreement. Among other things, SB 858 provided for the permanent inclusion of a use tax line on the state's income tax returns, thereby allowing income tax filers to fill-in the amount of use tax due on their returns. BOE staff estimated that this provision would increase General Fund collections by roughly $9.2 million annually. aa) What Does the Legislative Analyst's Office (LAO) Recommend? : At this Committee's February 28, 2011 oversight hearing on the issue, the LAO noted, "Given the significant interstate commerce issues arising from use tax compliance, Congress is the most likely - and probably the most appropriate - venue for seeking a solution on the issue of use tax compliance." bb) What is the Cost of Maintaining the Status Quo? : In August 2010, Prof. Richard A. Parker of San Diego State University issued a report reviewing the impact of California's current use tax collection laws on economic activity, commercial real estate values, jobs and payroll in California. Among other things, Prof. Parker noted the following findings: i) California-based retail businesses are losing $4.1 billion annually in sales to exclusively online retailers. These losses are projected to grow to $7.7 billion in 2015 and $14.3 billion in 2020; ii) Goldman Sachs estimates that online shopping will increase from 4.4% of all retail sales to 17.1% of all retail sales and that since 2000, internet sales have more than tripled; and, iii) 18,300 full-time equivalent jobs are currently lost as a result of out-of-state online sales. This number is AB 153 Page L projected to grow to 34,100 in 2015 and 63,400 in 2020. REGISTERED SUPPORT / OPPOSITION : Support Al Davis Furniture All About Books American Federation of State, County and Municipal Employees Art Allis Supply Company Asian Pacific Islander American Public Affairs Association Auto Enhancement Avid Reader in Davis B. Alive Vitamins and Natural Foods Barnes & Noble Bells Books Betlach Desert Jewels Birkenstock Midtown Black Business Association of Los Angeles Book Passage Books Inc. Book Tree Bookshop Santa Cruz Boys Trains and Things Bowlers Corner California Association of College Stores California Business Properties Association California Conference Board of the Amalgamated Transit Union California Democratic Party Region 8 Director Candice Easter California Federation of Teachers California Labor Federation California Nurses Association California Professional Firefighters California Retailers Association California School employees Association California State Association of Counties California Teachers Association Carpet and Flooring Depot Central California Hispanic Chamber of Commerce Chain Reaction Bicycles Christopher's Books City of Kerman City Lights Booksellers & Publishers City of Berkeley City of Mendota AB 153 Page M College Textbooks Copenhagen Interiors Cuffs Boutique Diesel, A Bookstore Eastwind Books Eclipse Jewelry Electronic Recyclers International Engineers and Scientists of California Enhancery Jewelers Eso Won Bookstore Feldman's Books Felicia Strati Boutique Fig Garden Bookstore Fresno Area Hispanic Chamber of Commerce Fresno City Council Member- Oliver Baines III Fresno Metro Black Chamber of Commerce Garlic City Books Geneva Jewelry Habitat Books Harley-Davidson of Fresno Heroes Comics Inland Empire African American Chamber of Commerce International Longshore & Warehouse Union Janna's Needle Art Kaleidoscope, The Parent Teacher Store Kelly's on Fifth Keplers Books & Magazines Kitchen Design Expo Kline Music La Vive Jewelry Latin Business Association LiveGreene Los Angeles Area Chamber of Commerce Lou Rodman's Barstools & dining Mendocino Book Company Meridian Computer Midtown Business Association Miracle Mile Chamber of Commerce MJ Doyle Jewelers Moe's Books Morgan's Village Flooring Mrs. Dalloway's Nina's Books Nisei Farmers League North County Vacuum & Appliance AB 153 Page N Northern CA Independent Booksellers Association Pandora's Book Inc. Palo Alto Bicycles Peninsula Window Fashions Gallery Phono Select Records Placer County Deputy Sheriff's Association Professional & Technical Engineers, Local 21 Redwood Trading Post Rice Republic Rick's Furniture & Antiques Roy's Trains & Things Russian Hill Books Sacramento County Probation Association San Francisco Small Business Networks Sara TV Inc. Seabreeze Books & Charts Service Employees International Union, Local 1000 Shady Lane Skalet Family Jewelers Inc. Slack Shoppe Small Business California Small Business Network-San Francisco Sport Chalet Styleyes Suter-Wallauch-Corbett & Associates Swanbergs on J Target The Booksmith The Cotton Club The Good Life Café The Great Frame Up The Home Depot The Reading Bug Torreon Importing Tres Chic Boutique Tuscany Home Furnishing Unitedstate - Clothing and Music Store UNITE HERE! United Food and Commercial works Union, Western States Council Valley Industry and Commerce Association Vonda's at Villaggio Walmart 1 individual Opposition AB 153 Page O California Taxpayers Association Direct Marketers Association Howard Jarvis Taxpayers Association Performance Marketing Association Tech America Senator George Runner (Retired), Member, Board of Equalization Analysis Prepared by : M. David Ruff / REV. & TAX. / (916) 319-2098