Amazon/Overstock Gamble May Pay Off

Includes: AMZN, OSTK
by: Boaz Berkowitz

I was surprised to notice how silent Amazon (NASDAQ:AMZN) appeared to be vis-à-vis New York’s new tax law during the company's earnings call yesterday. Thomas Szkutak, Amazon’s Senior VP & CFO, brushed off questions regarding the tax issue as “too early to comment.” By contrast, in Overstock’s (NASDAQ:OSTK) latest Q2 2008 earnings call transcript, the company had much to say about the issue. What really caught my attention was when Jonathan Johnson, Overstock’s SVP, stated that the New York State Senate had voted to repeal New York’s most recent tax law which would put this whole mess behind us.

For those of you who weren’t aware, New York State passed a new law that went into effect on June 1, 2008. The law, dubbed “the Amazon tax,” requires all internet companies with affiliates in NY State to charge sales tax on shipments bound for New York. The State expects this to increase tax revenue by $50 million.

Why is this law a problem? Well, according to the Supreme Court’s 1992 ruling in Quill v. North Dakota, companies are obligated to charge sales tax only for states where they have a physical presence. That is why New Yorkers may have noticed that they need to pay sales tax when making an online purchase from sites like Best Buy (NYSE:BBY), Circuit City (NYSE:CC) or Barnes & Noble (NYSE:BKS), but not from sites like Amazon,, Overstock and others. The former group has a presence in virtually every state, while the latter set does not. Technically, New Yorkers were always supposed to pay sales tax on purchases from sites like Amazon to the government, but since the web stores weren’t forced to collect the tax, few actually paid.

New York State has found a way around this law by stipulating that New York based affiliates could be constituted as a “physical presence,” though until now, they have generally been interpreted as advertising vehicles. Affiliates get paid a commission for driving a customer to online stores. Websites like Amazon have thousands of such affiliates.

Why is this law important? It means that one of the major advantages that a company like Amazon had over a company like Barnes & Noble is that they did not have to charge sales tax to New Yorkers. This often resulted in a lower overall price. Now these companies do need to include tax and it remains to be seen if their more price sensitive customers may no longer be as loyal. I, for one, am not. And while a $1.00 sales tax on a book may not be enough to dissuade a customer from making a purchase, tax on a laptop, which could easily add over $100, might.

So how have companies responded? The harshest response came from Amazon and Overstock, which have independently filed lawsuits against New York State challenging the constitutionality of the new law (note: by filing independently, they are forcing New York to defend themselves against two lawsuits rather than one; a considerably more expensive undertaking). Meanwhile, most sites such as Amazon and have complied and as of June 1st, have been charging sales tax to many an unsuspecting New Yorker. An email to each of these companies inquiring as to why the sites now charge NY sales tax resulted in an almost identical response which can be summed up as: New York passed this law, if you have a problem with it, contact them. As a result, I am sure I was far from the only one who complained to the New York Legislature about this.

Overstock, followed by other online retailers were even more creative and decided to dump its 3,400 New York affiliates. Not only did this protect the company from having to charge sales tax in NY, but it sent a clear message to Albany: keep this law and you will hurt New York small business owners. As a result many sites like have started a grassroots effort to pressure New York to repeal the law.

There are a lot of online shoppers in New York, and while Amazon and Overstock complain that such a law is unconstitutional or too hard to implement, what it really comes down to is that 10% or more of their customer base is affected by this new law and may defect to the competition. This poses a major threat to these companies’ profitability which is already being affected by the economic downturn.

Why should those of you who do not live in New York care? If you ever want to ship an item to a friend or relative in NY, you’ll have to shell out a little extra for NY sales tax, one of the highest in the country. Even worse, if New York gets away with this law, other states may follow. California has already considered implementing an “iTunes tax” which would have charged tax on all music downloads, but the law was defeated in committee. At least for now.

So where do we stand at this point? It seems that Overstock and Amazon’s gamble may have paid off. Faced with angry customers, worried affiliates and looming lawsuits, New York State may be about to back down. The Senate voted unanimously on a bill to repeal the law and the bill has now been passed on to the Assembly for review. But there is a long way to go until the battle is over. Regardless of what happens, I will likely never see the $15.11 in sales tax I just paid to Amazon for my most recent order.

Disclosure: The author is Seeking Alpha's director of contributor relations, and owns stock in Amazon.