Taxpayer appellants Amazon.com and Overstock.com, both online retailers who sell their products solely through the Internet, failed to demonstrate that a statutory provision that requires out-of-state Internet retailers with no physical presence in New York to collect New York sales and use taxes is facially unconstitutional under either the Commerce Clause or the Due Process Clause. The statute at issue created a rebuttable presumption that a retailer solicits business in New York if any in-state entity is compensated for directly or indirectly referring customers to the retailer, whether by a link on an Internet website or otherwise, and the cumulative gross receipts from these and other New York affiliate referrals exceed $10,000. The taxpayers both offered programs through which third parties (affiliates), who are compensated on a commission basis, agreed to place links on their own websites that directed users to the taxpayers’ websites.
Commerce Clause Analysis
The taxpayers alleged that the statute is unconstitutional on its face because it violates the Commerce Clause by subjecting online retailers, without a physical presence in the state, to New York sales and compensating use taxes. The court held that although there is some dispute as to the appropriate standard to apply when evaluating a facial challenge under the Commerce Clause (i.e., whether the court must determine that there is no set of circumstances under which the statute would be valid or apply the stricter test of determining whether the statute has a plainly legitimate sweep), the statute is constitutional on its face under either standard. A state tax that impacts the Commerce Clause will be upheld when the tax:
- is applied to an activity with a substantial nexus with the taxing state;
- is fairly apportioned;
- does not discriminate against interstate commerce; and
- is fairly related to the services provided by the state.
The parties agreed the only prong at issue was whether the statute satisfies the substantial nexus test.
Taking precedent into consideration, the court noted that although an in-state physical presence is necessary, it does not need to be substantial, but it must be demonstrably more than the slightest presence. The presence requirement is satisfied if economic activities are performed in New York by the seller’s employees or on its behalf. The Legislature had attached significance to the physical presence of a resident website owner when it enacted the statute. In so doing, the Legislature recognized that many websites are geared toward predominantly local audiences, so that the physical presence of the website owner becomes relevant to Commerce Clause analysis. Essentially, through these types of affiliation agreements, a vendor is deemed to have established an in-state sales force. As such, the New York Court of Appeals ruled that the statute plainly satisfies the substantial nexus requirement. Active, in-state solicitation that produces a significant amount of revenue qualifies as demonstrably more than a slightest presence. If a vendor is paying New York residents to actively solicit business in the state, there is no reason why that vendor should not shoulder the appropriate tax burden.
The court also observed that vendors are not required to pay these taxes out-of-pocket, but are instead collecting taxes that are unquestionably due, which are exceedingly difficult to collect from individual purchasers, and as to which there is no risk of multiple taxation.
Due Process Clause Analysis
Physical presence is not required in order to satisfy due process. Instead, due process analysis focuses on whether a party has purposefully directed its activities toward the forum state and whether it is reasonable, based on the extent of a party’s contacts with that state and the benefits derived from that access, to require it to collect taxes for that state. An entity that is engaged in continuous and widespread solicitation of business within a state has fair warning that its activity may subject it to the jurisdiction of a foreign sovereign, even in the absence of physical presence. The court held that a "brigade" of affiliated websites compensated by commission constitutes such solicitation.
The taxpayers claimed that the statute violates the Due Process Clause by creating an irrational and irrebuttable presumption of solicitation of business within the state. They argued that in order for the presumption to be constitutionally valid, there must be a rational connection between the facts proven and the fact presumed, and a fair opportunity for the opposing party to make a defense. The court noted, however, that the residents are compensated for referrals that result in purchases, and at least some of those residents will actively solicit other New Yorkers in order to increase their referrals and, as a result, their compensation. The court found it rational to presume that, given the direct correlation between referrals and compensation, it is likely that residents will seek to increase their referrals by soliciting customers, and that it is not unreasonable to presume that affiliated website owners residing in New York State will reach out to their New York friends, relatives, and other local individuals in order to accomplish this purpose.
The taxpayers also argued that the presumption is irrebuttable because it will be extremely difficult, if not impossible, to prove that none of their New York affiliates is soliciting customers on the retailers’ behalf. The New York Department of Taxation and Finance, however, has provided a method (contractual prohibition and annual certification) through which the retailers will be deemed to have rebutted the presumption. Although obtaining the necessary information may impose a burden on the retailers, inconvenience does not render the presumption irrebuttable. In addition, while not determinative, the court noted that the presumption places the burden on the retailers to provide information about the activities of their own affiliates, information that the department would have significant difficulty uncovering on its own.
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