Circuit BoardOn December 2nd (ironically, Cyber Monday), the Supreme Court made headlines when it announced the denial of Amazon’s petition for certiorari appealing the New York Court of Appeal’s determination that the online shopping leader is obligated to pay New York Sales Tax.

As a rule, and consistent with due process requirements, a retailer is only obligated to pay state sales tax in the states in which the retailer has a “physical presence.”  Mere advertising or delivery of goods within a state is insufficient create physical presence within the state. For example, in Quill Corp. v. North Dakota, the Supreme Court emphasized that even where an out-of-state mail order shopping retailer delivers goods to a customer within a state, absent other substantial connections with the state, the retailer has not established physical presence within the state.  Furthermore, the Court emphasized the importance of a bright-line physical presence rule in determining state tax liabilities.

Twelve years after Quill, the retail shopping world has changed dramatically.  Today, online shopping has become one of the most popular avenues for consumers to purchase goods.  Through its popularity and convenience, online shopping has provided retailers with a tool to sell goods to out-of-state customers, without meeting the physical presence requirement for state sales taxation.  Thus, arguably, online shopping gives retailers an avenue to provide goods nationally without being subject to taxation on a national scale.

In response to this dilemma, some states, including New York, have passed laws to attempt to limit online retailers from circumventing state sales taxation in all cases.  For instance, New York’s law provides that an out-of-state retailer will be subject to New York Sales Tax where (1) the seller has a contract with a New York resident, (2) the New York resident refers customers to the retailer, and (3) the seller receives a minimum of $10,000 in sales from New York customers referred through the contractual relationship., the very popular online retailer, is incorporated outside the State of New York, and does not have any buildings or infrastructure located within the state, such as distribution centers.  Yet Amazon has entered into numerous contractual relationships with New York retailers and vendors through which Amazon pays the New York resident a commission on all sales made through the use of an link located on the resident’s website.  The contractual commission relationship between Amazon and its vendors enables Amazon to benefit from the encouragement and solicitation of New York customer sales, without owning or operating a business facility within the state.  Under New York Law, Amazon’s contracts subject it to state sales tax.

In 2008, Amazon challenged the New York law imposing state sales tax upon sales earned through commission relationships, asserting that it was unconstitutional and in opposition to the “physical presence” requirement.  The online retailer’s challenge was dismissed by the New York Supreme Court, and the dismissal was affirmed on appeal.  In its decision, the New York Supreme Court noted that though Amazon was correct in asserting that physical presence is a requirement for the imposition of state sales tax, Amazon had, through entering into commission contracts with New York residents, consciously solicited sales from New York customers, and created a physical presence within the state via its commission contracts with New York residents.

What is the takeaway?  The Supreme Court’s decision to leave the New York Court of Appeals decision stand does not mean all out-of-state companies selling into another jurisdiction are suddenly subject to sales tax in that jurisdiction. It appears that, for now, the physical presence requirement is still necessary for a state to impose sales tax in such situations.  Nonetheless, it appears that, depending upon individual state law, a state may be able to  impose sales and use taxes upon out-of-state retailers who have assumed a physical presence through commission based contractual relationships with in-state residents, vendors, or retailers.  Therefore, it is essential that companies and franchisors exercise diligence and caution when entering into contractual relationships with out-of-state vendors, especially ones that will result in the payment of regular commissions, because such relationships could result in new sales and use tax liabilities.