Potential Fallout Seen from Online-Tax Ruling

A California appeals court ruling clearing the way for tax collectors in that state to pursue sales taxes from online sales from out-of-state merchants could have wide-ranging impacts for the e-commerce industry.

For now, observers say it’s too soon to tell how important the ruling, which the First District Court of Appeals in San Francisco issued late last month, will be for Web merchants of all sizes.

The case, known as Borders Online v. the State Board of Equalization, dealt specifically with sales from Borders to California residents during 1998 and 1999. Those sales totaled about US$1.5 million.

‘Sufficient Presence in State’

At the time, the e-commerce site offered buyers the option of returning items bought online to any Borders store. The issue in the appeal brought by Borders was whether the online entity, which was separately incorporated, had “sufficient presence in the state to justifying the imposition of the tax collection burden.”

Borders later removed the in-store return offer from its site, but continued to take such returns and to advertise the shopping site in its stores. Later still the bookseller turned over the operation of its online store to

Borders paid the tax bill — some $167,000 — for 1998 and 1999, but then applied for a refund. The denial of that request led to the legal actions that resulted in the appeals court ruling. The ruling could result in additional tax liabilities stretching to 2001, when Borders struck the outsourcing deal with Amazon.

Borders declined to comment on the decision and on whether it would take the case to the next review level, the California Supreme Court.

Impact Unclear

The ruling was being hailed by traditional booksellers, who have argued that a lack of sales tax levied on Borders’ and other Web sites gave them an unfair competitive advantage. It also was being watched closely by major e-tailers who could face much larger tax bills if California, and other states, choose to pursue them.

It’s not clear whether that will happen, however, though the ruling could greatly expand the definition of what it means to have a physical presence in a state. That’s been the measuring stick for determining if sales taxes must be paid since a U.S. Supreme Court ruling that predates the rise of e-commerce.

The implications, for instance, could be significant for an e-tailer such as Amazon, which manages online sales for a number of brick-and-mortar merchants and could be seen as having a presence in a number of states as a result.

Analysts say that by itself, such a ruling is unlikely to prompt a short-term reconsideration of a streamlined, national online sales tax, though such a proposal resurfaces every so often, with heavy lobbying from traditional retailers who have lost sales to online rivals and from states that are eager to reclaim lost sales tax revenue as they struggle to balance budgets.

Bigger Struggle

The question of how best to handle sales taxes online remains an open one. For years, the argument against such a national tax has been that putting it in place would be detrimental to the nascent online retail industry.

However, with Web-based retail growing at a double-digit rate for several years in a row and now making up more than 5 percent of all sales in some categories, that argument grows less persuasive each day.

In addition to a disparity between online and offline merchants, there is also inconsistency among Web retailers themselves, with multi-channel retailers that also operate brick-and-mortar stores already actively collecting sales taxes in states where that is required.

Most analysts believe an online sales tax would likely not be much of a drag on online sales growth, but would impact merchants, with smaller e-tailers struggling the most to comply.

“Consumers wouldn’t stop buying, but the impact of complying with these types of regulations on a mom-and-pop e-tailer would be significant,” Forrester Research analyst Carrie Johnson told the E-Commerce Times.

Technology-Constitutional Junction

As proof, Johnson noted that many multi-channel retailers, including Wal-Mart and others, began voluntarily collecting online sales tax more than two years ago. Despite that development, e-commerce continues to expand dramatically.

The ruling also fits into a larger context in which regulators and courts in states and at the national level struggle to figure out how border-less e-commerce fits into existing regulatory frameworks. Last month, for instance, the U.S. Supreme Court issued a key ruling that could change the way states regulate the online sale of wine.

As the judges in the Borders case put it: “We face with increasing frequency issues at the junction of Internet technology and constitutional principles. This is another such case.”

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