CA Bill 178 – A lesson in not seeing the big picture

I was reading the backlog of news the other day and I stumbled on a surprisingly short-sighted bill which is equivalent to the Warriors signing Maggette in a panic move after Baron skipped town.

CA Bill 178 is authored by Assembly Members Nancy Skinner (D) and Charles Calderon (D). The bill adds this paragraph into the Revenue and Taxation Code:

(5) Any retailer entering into an agreement with a resident of this state under which the resident, for a commission or other consideration, directly or indirectly refers potential customers of tangible personal property, whether by a link or an Internet Web site or otherwise, to the retailer, if the cumulative gross receipts or sales price from sales by the retailer to customers in this state who are referred pursuant to these agreements is in excess of ten thousand dollars ($10,000) during the preceding four calendar quarterly periods. This paragraph shall not apply if the retailer can demonstrate that the resident with whom the retailer has an agreement did not engage in referrals in the state on behalf of the retailer that would satisfy the requirements of the commerce clause of the United States Constitution during the four quarterly periods in question.

After a quick skim, it looks like the state wants to apply sales tax to transactions made between online retailers and the local populace on the condition that the retailer has made more than $10,000 in sales in California in the past year. These retailers currently do not charge sales taxes in California because they do not have a physical presence in the state. That sounds reasonable, right? They do business here, we tax them. It’s the American way.

But, if you were to read the bill more carefully, you would see a major blunder on the part of Assembly members Skinner and Calderon. There is a loophole in the text which allows retailers to sell to California tax-free and those that get burned again are the residents of California.

To apply sales tax to a company’s sales, the company must have a physical presence in California. The bill targets affiliates based in California whose links help online retailers market their products. To bypass the bill, the retailer only has to drop these affiliates and continue to sell to California through out-of-state affiliates. In essence, the retailers only pay sales tax for the past year and no longer have to pay the years after. So, we take them to the cleaners for a year but we screw over thousands of affiliates in California forever.

After a bit of searching, we can see where Skinner and Calderon got the idea. New York enacted a similar bill to tax online retailers. After the bill passed, tax revenue streamed into their coffers to the tune of $40 million. Retailers got wind of this pitfall and immediately pulled the plug on their affiliate program in New York which angered the affiliates living in the state. The affiliates in turn look toward relocating outside of New York to keep their business afloat. So, not only will New York receive diminishing returns on their tax revenue, they also drove away small businesses from their state and lose out on their income tax. If I had a loser smiley icon, I would of used it right about here.

Skinner and Calderon probably looked at the $40 million generated by the passed bill in New York, took a gander at the current budget deficit in this state and with the whispered promises of local retailers incorrectly added 2 + 2 to get 5.

The bill creates the taxable physical presence of the retailer by gathering all the affiliates together and calling them an extension of the retailer, a nexus if you will. If you ever played Starcraft, the Protoss worker bee would teleport buildings to the current dimension through nexus portals. The idea is similar but not as awesome.

Once the nexus is created, the bill will look back four quarters (a year) to determine if the retailers made more than $10,000 in sales in California and collect back taxes on their earnings. Then the bill forces them to collect sales tax on their future sales. If I were a retailer and I saw this happening, I would immediately dump the affiliates based in California and work with ones out of state. At most, I would only be taxed for three more quarters then its smooth sailing from there.

So, I’ve been throwing out the word “affiliate” and you’re wondering to yourself, what exactly is an affiliate?

An affiliate is an online advertiser. As a potential affiliate, you sign up with a company to display links to their products on your website. If someone clicks the link, a cookie is set on their computer or on the server telling them the person came from your site. If that person purchases a product, then you receive a commission on the sale.

What makes affiliate marketing so attractive is that you don’t necessarily need a business degree to get involved. Students looking to pay off their loans, stay-at-home parents looking for a second income, retirees looking to increase their nest egg or even your 9-to-5 office worker looking to earn enough to pay for lunches in downtown San Francisco can do it. 😉 A little common sense and effort can get you up and running within a few months.

If you’re lucky, you can make it big like Techbargains based in San Francisco and BensBargains created by a student at Berkeley. Affiliate marketing is not just limited to small businesses; large businesses that have an online presence is also affected as well–, GameSpot, etc.

Unfortunately, CA Bill 178 would effectively end the dreams of all affiliates living in California.

We need only look at what happened in New York and what is happening in Hawaii after the passing of this type of legislature. Overstock dropped their affiliate program in New York to avoid paying the sales tax. Amazon is looking to do the same in Hawaii if a similar bill passes there. Many other companies looking to avoid the tax will most likely do so as well.

This is Nancy Skinner’s reasoning for proposing this bill:

This legislation will close the current loophole in California tax law which has allowed out-of-state companies to avoid collecting California sales and use tax. During this unprecedented fiscal crisis we cannot afford to lose sales tax revenue from out-of-state companies when our own local businesses are struggling to keep their doors open.

Hut Landon of the Northern California Independent Booksellers Association chimes in with:

This bill helps preserve businesses and jobs in our communities. Independent booksellers have been hammered by unfair tax competition from Amazon for over a decade. And as Amazon has expanded its retail reach, more and more locally-owned businesses are faced with unfair competition. We welcome this effort to level the playing field for all retailers.

As I explained earlier, Amazon can just drop their affiliates in California and compete with locally-owned businesses with the same unfair advantage as before. So, not only will we continue to lose local businesses and jobs, we will also lose a contingent of affiliate businesses as well.

Rather than crying foul, why aren’t these businesses looking to expand their consumer base by getting into the online marketplace? We do have this system of delivering goods across state lines called the “post office”. I believe if local mom & pop stores offer their products online, there is bound to be buyers. Browse through eBay and you can see that anything can be sold online. It’s not that hard to take a book, put it in a box and ship it to an address. This is not rocket science.

In fact, local businesses can sign up with an affiliate service like Commission Junction or Linkshare and leverage the affiliates to sell their products online for them.

A hearing for this bill be coming up on April 13, 2009 in Sacramento. Before that time, please contact your local representative and urge them to stand against the bill.

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