Venable’s John F. Cooney on vs. New York State Department of Taxation and Finance

For the past three years, and the state of New York have been sparring over whether marketing affiliates based in New York constitute nexus for the online retailer, thus requiring the collection, tracking and reporting of sales and usage tax for affiliate-driven online purchases.

New York enacted the statute in 2008, upon which filed suit. In January 2009, New York’s trial court found in favor of the state, moving the case to the appellate level; the Appellate Court has been reviewing the case since September 2009.

With the likelihood of a decision coming back from New York’s Appellate Court in the near future, Target Marketing talked to John F. Cooney, a partner in the Washington, D.C., office of law firm Venable LLC. Cooney wrote an amicus brief on behalf of the Performance Marketing Alliance, supporting the trade group’s assertion that the New York law is unconstitutional. Here, he explains the legislation’s impact on the practice of affiliate marketing, the larger movement in the states to enact similar laws and the anticipated path this battle will take.

Target Marketing: What are the main ramifications of the New York statute on marketers that use affiliates for advertising?
John Cooney: The New York statute would require entities that are using affiliates to collect New York state use tax for every sale they generate that is generated through a New York website, which would basically be defined as a website operated by a company that is organized under New York law or an entity that happens to have its website physically located in New York.

For the largest enterprises, such as, there may be tens of thousands or even in excess of a 100,000 people who are affiliates who operate websites that bear banner advertisements or clickthrough advertisements [for their products and services]. … So it’s an obligation to collect information about what may be a large number of entities and then determine how many sales were made through them and then set aside the money for the use tax and send it in to the state.

TM: And what are the ramifications for the affiliates?
JC: For the affiliates, they should be keeping information about sales they generate, collecting sales tax information for the people with whom they deal. So there will be implications both from sort of a sales tax collection and payment side and also on the corporate tax side, because they’ll be required to report their revenues to the state.

TM: How many other states have passed similar laws?
JC: The first one was the New York state tax statute. Then Rhode Island was second … it passed that end of June, very early July of 2009. In that situation, because Rhode Island was a small state, Overstock and Amazon simply cut off all their affiliates in Rhode Island. It’s a small state, so there probably were only several hundred, but probably less than a thousand people that were adversely affected.

Since then, I think North Carolina has passed a similar statute, and there are [bills] that are being considered at various levels of the states’ legislative processes this year. I think Connecticut is probably the state that’s closest to adopting a new one. But these bills have been considered by various committees in the state legislatures, typically as part of the budget process. And the budget is one of the last things to be resolved before the legislature adjourns. So there are a lot under consideration, and if new ones are going to pass, they’ll probably pass at the end of June, as most state legislatures tend to go out of session [then].

Other states are looking at this [issue] very carefully. … So if the New York statute ultimately is upheld, I think we’ll see legislation like this in many other states. But I think, by and large, the states are tending to hold off because they understand that the constitutionality of this approach is likely to be resolved in the New York litigation. So the [states] that aren’t actively moving on it are studying it and monitoring the situation.

TM: Does a click on a banner ad constitute a sale?
JC: To my way of thinking, the clickthrough is no different than viewing an ad on TV and viewing an ad on a billboard, where you see something that you want to buy and say I want to contact them. In the old days, you dialed up their 800 number and you went to Lands’ End and you said, “I’d like to buy three of those shirts,” and they filled the order remotely and sent it to you. Under the Quill case, if that was the only contact that Lands’ End had with the state, then Lands’ End didn’t have to collect the use tax. And to me, it’s much the same thing that if you look at a banner ad and say I want to go to Amazon and explore, you know, court books that they have this week, you still have to click through then to something else.

And it can’t be constitutionally significant that in the Lands’ End model, you had to dial a 10-digit phone number to get there; with the banner ad on a website, all you have to do is click once. The individual has to take some kind of implementing step to go to the [company that’s] actually advertising the product and actually can make the sale. The affiliate is just like the publisher, like Time magazine, that carries an ad for Lands’ End, in the sense that they don’t offer the products themselves, they don’t handle the money, they’re not involved in the actual sale transaction, they’re not involved in fulfilling the order.

TM: What does a loss for Amazon mean to marketers?
JC: A loss for Amazon—and this issue is likely to be appealed to the U.S. Supreme Court at the end of the day, one way or another, simply because it is a significant issue—the net effect of this would be to chill very substantially, if not completely end, the ability of businesses to rely on the affiliate marketing model. It would certainly require major changes.

As I think of the affiliate model now, as we say in our brief, it solves John Wanamaker’s problem. Wanamaker was the first great marketer in the U.S., a hundred years ago, and used to say that half of all advertisements are wasted; the problem is you can’t tell which half it is. It’s a very difficult area in which to figure out which advertisements are leading to the completion of sales. And the way I conceived of the affiliate marketing model is that it solves Wanamaker’s dilemma, at least in the electronic commerce model, because it allows the merchandiser to determine exactly which advertisement generated which sale, and to compensate the publisher of the ad (the person who ran it) only for ads that are successful.

So it’s a fundamental change in the economics of advertising. And that’s allowed people to do two things. First, it’s allowed many publishers, many websites, to sign up to become advertisers (publishers of ads) and to receive revenues if they’re successful in generating sales. The process is automated, so hundreds of thousand of people can sign up in an automated manner and become a publisher of ads. And it’s also very cost effective for the [marketer] itself, because it’s only going to pay for ads that generated the sales; there’s no upfront investment cost. … Revenue streams are being generated that go to these websites, many of which are part-time jobs or small businesses and have been generating revenue that those people can use to enhance their website to display more information online that’s free to people who use the website—therefore benefit the public by providing income streams that help more information be posted online where the rest of us can access it.

So the effect of a tax that imposes a heavy upfront burden on the merchandisers, the Amazons of the world, will be that they won’t be able to have such a broad network. They’re going to have to think carefully about which [affiliates] they want to sign up and how many within a particular jurisdiction, because they will be taking on a substantial information generation burden and tax collection burden if they have affiliates in states that have this law.

TM: What is the likely trajectory of the Amazon case in New York?
JC: This is at the intermediate level of the New York Appellate Courts. It has not yet gone to their Court of Appeals, which would be the next step. And I’m certain that the case will get to the New York Court of Appeals one way or another. All that process probably will happen later in 2010 … and then when the New York Court of Appeals resolves the case, the losing party at that level would have the right to petition the U.S. Supreme Court to see if [it] wants to review it.

TM: Will this case go that far?
JC: It seems to me it will … [The Amazon case is] the first application of the electronic commerce model in a field that’s been a prolific source of Supreme Court cases over the years. And as electronic marketing continues to get a larger share of the total advertising dollars and total sales dollars, I’m sure that there will be state efforts to tax online marketers and it will be a prolific source of litigation for years to come, as people try to take established principles and figure out how they work in this new field