Linda Buquet of 5staraffiliateprograms.com gave me the latest heads up on the business side of this issue and has been providing Excellent Comprehensive Coverage on the New York Sales Tax Issue. Thanks, Linda.
Dozier Internet Law has been dealing with the new tax law that takes effect June 1 in New York. It is obviously a very complicated situation. I have some thoughts at a high level in terms of strategy and tactics in managing this risk pro-actively. I have worked as a lobbyist on three tax bills, two at the state level and one at the federal level, and encouraged the US Senate in testimony in 1998 to use private technology applications. So, I have assisted with the drafting of (and drafted) tax related legislation going back into the 1980s and used to represent the Commonwealth of Virginia and over a dozen local governments in governmental and municipal tax collection litigation.
First, you should not rely upon the possibility that this law will be declared unconstitutional. Amazon's judge may decide the statute is unconstitutional as applied to Amazon and those very similarly situated, but find that the statute is otherwise constitutional and enforceable. Dozier Internet Law may or may not be filing a lawsuit before the June 1 date, but there is no guarantee there will be an injunction ordered prohibiting its enforcement before then. So, while fighting this out in the courts is inevitable, obviously you need to make some decisions. Here is some guidance:
1) Don't sit by hoping that the Amazon case will lead to a quick injunction that will save the day. It might, and it might not. Whatever the decision, it is likely to be appealed, and if two or three years from now the statute is upheld by a final appellate court, your business will likely be on the hook! Don't be fooled by the fact that the Amazon case was filed in the "Supreme Court" in New York. That is a trial court...steps removed from the ultimate appellate court that will likely have to deal with any decision. The odds of settlement in such a high stakes, politically impactive dispute are usually low.
2) Don't just jump to the conclusion that you need to cut off all of your affiliates in New York by June 1. This is a business decision and you need to weigh risk against rewards. This net risk assessment needs to take into consideration a legal analysis of liability.
3) Know your exposure. The fact that your company may have tax liability does not mean that you have any risk at all! Consider adding a specific indemnification agreement into your affiliate agreements and making some credit worthiness decisions. And don't limit it to your New York affiliates...you really don't know where they are, after all! Clarification: Let me explain this in more detail. If you, as a merchant, decide to only permit non-NY affiliates, you will be relying of necessity on certain representations, particularly geographic location. If these representations are incorrect, and liability attaches because of the misrepresentations, then you should have contractual terms requiring an affiliate to reimburse you for the tax liability, and when dealing with either big affiliates or the "grey area" situations you may be well advised to make sure that the affiliate marketer is in the financial position to meet its obligations under such a contract term.
4) Consider establishing a "hold back" for affiliate commissions more than enough to cover any tax liability. This obviously becomes tricky in the sense that you don't want to retain commissions clearly owed to non-New York affiliates, so also establish a reliable method for evaluating who is, and who is not, subject to the New York law, although this will never be foolproof. Clarification: Merchant financial models don't take into consideration an unanticipated liability like retroactive tax liability. Some may consider, instead of relying upon contract representations and warranties from an affiliate, a more definitive and lower risk approach. If it makes financial sense, and subject to negotiations, another option is to establish the escrow account. There have been comments about the tax liability not being the affiliate marketer's responsibility. Of course, there may be a shifting of responsibility in a contract breach situation, and most importantly if a merchant is now faced with having to take some months to implement the necessary processes and technology to be able to charge the customer sales tax, merchants have other options such as this approach to keep the affiliate program going in the interim.
5) Amend your affiliate contract to allow for the creation of the liability reserve (like a tax escrow in a mortgage) to cover your sales tax liability until you can start charging. You likely can't give an affiliate personally identifiable information, and the affiliate contract is the perfect vehicle to reach an agreement on how this will be handled. Clarification: Personally identifiable information includes state of residence, particularly if the merchant has already agreed it will not be shared by contract in its privacy policy. Consequently, merchants must be careful to craft a solution that will not disclose state of residence in the accounting process with affiliates until its privacy policy can be amended.
6) Amend your privacy policies to allow for certain personally identifiable information (New York addresses) to be communicated to your affiliates. This may, or may not, be applied retroactively, and if not then you will need to segregate data. Clarification: This addresses accounting processes. Otherwise, affiliates will be unable to have any meaningful confirmation or validation of New York state customer transactions that may have a direct financial impact on them.
7) Google got a carve out...yes, that is my guess from reviewing the latest comments from the Department of Taxation in New York. It looks to me like there is language that removes their adsense program (for the most part) from coverage. If you cannot win at the legislature, carry your battle to the executive branch! The tax guidance interpreting the law has very likely come under the influence of the influential. Figure out a way to get your business treated well behind the scenes of all of this. It looks to me like Google did.
8) Begin to organize and be willing to finance litigation challenging the constitutionality of the law. Understand that if New York is successful, other states will follow. There has never been a "tax holiday" on Internet purchases. Consumers have to report their purchases and pay taxes. The issue here is the requirement for the merchant to charge and remit. If the industry is to prevail, it must organize and bring overwhelming force down on the New York situation.
9) Establish a special interest group. I was a founder and the National Legislative Chairman for a major national bar association in the 1990s. It can be done. Our impetus was also threatening legislation, but it now has grown into a dynamic and powerful legislative, educational and business association. The many, many small and mid-size affiliate marketers and related business interests need to come together to be heard early on in the process (unless you have leverage and resources like Google and can deal with things on your own!).
10) My last piece of advice is probably the most critical. We have entered a landscape littered with mines and minefields. Every business affected will likely have a lot in common, and alot not in common, with each other. You should deal with this situation as a unique problem to your organization first and foremost. There are many tactics available to consider. One is litigation, one is accommodation and negotiation with the tax department attorneys and Attorney General to try and get a carve out for your business, one is termination of business relationships, one is going the political influence route, one is shifting the burden and liability to affiliates, one is turning to Congress for pre-emptive relief, and...well, I could go on and on. Just work through this situation in a quality way with the right team.
Oh, and for affiliates out there in New York...just about everything I have said also applies to you. The industry realizes that you are losing your businesses because of this law. The reality, of course, is that affiliate marketers and the like from all across the country (except New York!) will now target New York consumers, and New York will lose an entire segment of small businesses throughout the state and control over compliance with New York laws. I expect that the next state to try this will also ignore the law of unintended consequences, and the same thing will happen...until there are only a couple of "tax haven" states where all of the affiliate marketers are located!
So, the final message is for the State of New York: If the momentum continues, New York affiliate marketers will be shut down entirely. You should have anticipated this consequence. No, you will not increase your tax base significantly. But you have added to your unemployment rates. We need to work together to save the many New York businesses going under.
Additional Comment May 24, 2008: We represent and have represented affiliate marketers, merchants, ad networks, search engines, and just about every other category of company or business involved in affiliate marketing, it seems. Affiliate marketers have no apparent immediate solution to this situation except to hope that merchants don't cut them off if they have a New York presence or merchants don't suspend their affiliate programs and only allow "blue chips" with strong balance sheets to continue. My suggestions are that the merchants don't jump to the conclusion that they should immediately cut off New York affiliates, and that there are many options available to merchants other than the "death penalty" for its entire affiliate program due to uncertainty about geographic location and presence. This is not a blog entry that is pro-merchant, pro-affiliate, pro-ad network, or pro-ad agency. And it is not anti-merchant, anti-affiliate, anti-network, or anti-ad agency...my comments are my personal views on the overall situation without regard to the various interest groups involved...but I must confess that all of my comments are "pro-smart decisions" and "anti-jumping the gun"!
Comments