By Christopher Swope

First, states took on Big Tobacco. Then cities took on the gun makers. Could the dot-coms be next?

Sound far-fetched? Maybe not.

Sure, the legal logic behind an assault on Internet merchants would be different than with guns and butts. Buying stuff online poses no threat to public health in particular, though it has yet to be seen whether we’ll all go blind from staring at our computer screens.

The truth is, however, that a number of e-tailers are leaving themselves wide open to a legal attack. The issue, as ever, is sales taxes, and whether or not the dot-coms should be collecting them for the states.

On its face, this is a simple question. It has been generally presumed that the same rules which apply to the mail-order catalogue industry also apply to e-commerce. That is, a merchant must collect sales taxes for any states in which it has a “physical presence” such as a store, a warehouse or a sales force. This “nexus” rule was the essence of the U.S. Supreme Court’s finding in Quill v. North Dakota eight years ago, and a previous mail-order case from the 1960s.

Quill may still be the law of the land, but big retailers have been more limber than Gumby in stretching to get around it. Take the big national chain stores, which in recent years have been launching online versions of themselves. Wal-Mart, for example, has nearly 3,000 stores in all 50 states — nexus as far as the eye can see. But in January, Wal-Mart sliced off its Web site, Wal-Mart.com, as a separate company. As its own entity, Wal-Mart.com technically has nexus in, and therefore collects sales taxes for, only three states: California, Arkansas and Utah. Dozens of retailers have done essentially the same thing, including Kmart, Barnes & Noble, and Gateway, the computer maker.

These arrangements leave a very blurred line between the company with nexus everywhere and the one with nexus almost nowhere. In Wal-Mart’s case, a customer who buys a product tax-free from the Web site can return the same product at one of Wal-Mart’s stores down the street. The Web company has a separate management team, but its CEO reports to a board of directors that includes Wal-Mart’s top two executives. Wal-Mart’s partner in the Web venture, James Breyer, recently told the New York Times that Wal-Mart and Wal-Mart.com would work “seamlessly” together. In cases like this, it is legally unclear exactly how Quill applies — after all, it was written for the mail-order age — but a good case could be made that Wal-Mart.com indeed does have nexus wherever Wal-Mart does, and owes most of the states a tidy sum in sales tax.

Pure e-commerce sellers like Amazon.com aren’t out of the woods either. The only state Amazon has been collecting sales tax for is Washington State, where its corporate headquarters are. Like many e-tailers, however, Amazon has a wide-ranging “associates program.” In this marketing approach, Amazon has put its link on the Web sites of 430,000 partners, including other Internet merchants. Each time a customer clicks through one of these links to Amazon’s site and buys something, the partner gets a commission of as much as 15 percent. States could make a decent argument that Amazon’s associates are essentially acting as a sales force, and that Amazon has nexus wherever its associates do.

For their part, Web merchants are trying to stay above water in a hyper-competitive marketplace. But they also recognize that they are in a sticky situation, and have used the congressional e-commerce commission to try to wiggle out of it. The “business caucus” proposal that forms the basis of the report the commission presented to Congress Wednesday would change the definition of nexus so as to write some iffy Internet business practices into law. With elections looming this year, however, it is unlikely that Congress will address such a politically charged issue anytime soon.

The stakes are large. If the states were to succeed in challenging the dot-coms on these or other nexus grounds, it could yield a devastating blow. The e-tailers are potentially liable for all the back taxes they haven’t been collecting. In Amazon’s case, that would mean coughing up a sizable percentage of more than $2.4 billion in online sales it has made since 1995. To be sure, it’s not in the states’ interest to destroy e-commerce. But if this type of defiance continues, don’t be surprised if they go after their share.

Christopher Swope is a staff writer for Governing.

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