Annette Nellen
Court says no to affiliate nexus in Illinois

What is affiliate nexus, and why did it have a setback recently in Illinois?

June 14, 2012
by Annette Nellen, Esq., CPA

“Affiliate nexus” or “click-through nexus” laws represent efforts by some states to push the envelope on getting companies that sell to their residents to also collect sales tax from them. In April 2008, New York enacted the first such sales tax law. Subsequently, a few states, including Illinois, enacted similar legislation. Several more states have been unsuccessful in enacting similar legislation, while some states are still pursuing the approach.

Illinois’s statute did not use the same language as New York’s, even though the latter’s statute had survived a constitutional challenge in state courts. This mismatch led to the grant of summary judgment to the Performance Marketing Association Inc. (PMA) in May 2012 by the Illinois Circuit Court of Cook County.

This article describes the Illinois statute, its differences from affiliate nexus laws in other states, the court’s decision, and possible next steps. To gain an appreciation for this topic, following is an introduction to new advertising methods enabled by the internet and why they attract the attention of state governments.

The WWAW (worldwide advertising web)

The internet offers many new and efficient ways of doing business. The new approach at the heart of affiliate nexus statutes, as well as related litigation, is advertising. If your business decides to run an ad on television or in a print magazine, your charges are often based on an estimate of number of viewers or readers. Market uncertainty raises the risk that these ads may be costly in terms of cost per customer reached.

In contrast, the internet allows ads to be placed where the merchant pays only when some type of positive action takes place. For example, where a merchant has an ad on someone else’s website, possible bases for charging the merchant include each time someone:

  • Visits the webpage where the ad is located.
  • Clicks on the ad.
  • Clicks on the ad and buys something from the merchant.

Any of these possible bases presents a greater likelihood that the merchant will better use advertising dollars to gain product awareness, visitors to its website, or ideally, actual sales. Each of these types of arrangements exists today under the umbrella of “affiliate advertising” or “performance marketing.” The affiliate or publisher is the owner of the website, where the merchant’s ad or logo are placed per a contractual agreement. The arrangements, such as the matching of affiliates and merchants and the payment process, can be handled by third parties.

This new form of promotion creates revenue potential for all website owners. It has also led to new business opportunities for companies that facilitate the matching and interaction of the merchants and affiliates. In its complaint, the PMA stated that there were more than 200,000 online affiliates (including at least 9,000 in Illinois) and more than 5,000 advertisers using performance marketing arrangements (PMA original complaint filed in U.S. district court in June 2011, page 6, and complaint filed in state court in July 2011, page 7).

Illinois affiliate nexus statute

Illinois Public Act 96-1544 (3/10/11) made two changes to Illinois law on when a retailer or service provider would be subject to sales and use tax collection. Following is the text at issue in the PMA case (similar language was added for service providers):

1.1 Beginning July 1, 2011, a retailer having a contract with a person located in this State under which the person, for a commission or other consideration based upon the sale of tangible personal property by the retailer, directly or indirectly refers potential customers to the retailer by a link on the person’s Internet website. The provisions of this paragraph 1.1 shall apply only if the cumulative gross receipts from sales of tangible personal property by the retailer to customers who are referred to the retailer by all persons in this State under such contracts exceed $10,000 during the preceding 4 quarterly periods ending on the last day of March, June, September, and December. [35 Ill. Comp. Stat. 105/2(1.1)]

Other states

By May 2012, nine states had enacted affiliate nexus laws to attempt to get certain remote sellers to collect sales tax. Despite a common theory, the approaches have varied somewhat among these states. For example, seven of the states use a rebuttable presumption approach allowing the seller to avoid collection by showing there is no solicitation of sales in the state. Illinois’s statute did not include a rebuttable presumption.

Another difference for Illinois is that it only addresses affiliates with a “link on the person’s Internet website.” Other states have used broader language such as “by an Internet-based link or an Internet Web site, or otherwise.” (For more information on the similarities and differences, as well as links to the state affiliate nexus statutes, see the author’s Affiliate Nexus website.)

One similarity of the Illinois statute with other states is that it is a flawed solution to the state’s effort to collect sales tax from remote vendors. Not all remote vendors have affiliates, and those that do can cancel the contracts and no longer be subject to the legislation. Such actions have typically been taken by Amazon.com, Overstock, and other e-commerce vendors in response to new state laws (see, e.g., Dennis, “Amazon Cancels Affiliate Program With Illinois Residents After Governor Signs New Internet Sales Tax Into Law,” tellpeoria.com (March 10, 2011)). States must then continue to work for a federal solution (e.g., The Marketplace Fairness Act, S. 1832) and work to get their residents to self-assess use tax.

Illinois ruling of 2012

The ruling from the state court is brief with no detailed explanations. The court found paragraph 1.1 (see above) to be unenforceable because it failed to satisfy the substantial nexus requirement of the Commerce Clause of the U.S. Constitution. In addition, the court found that under the Supremacy Clause of the U.S. Constitution, the provision is preempted as a discriminatory state tax on e-commerce in violation of the Internet Tax Freedom Act, P.L. 105-277. The court also noted that “there is no just reason for delaying appeal on the merits, in light of the significant issues presented in this case.”

This case did not involve paragraph 1.2 added by the same legislation. It provides that a seller may have sales tax nexus if it has a contractual relationship with an in-state person selling similar items or services or using a similar name, trade name, or trademark. Cumulative gross receipts from such sales must exceed $10,000 in the four preceding quarters.

Looking forward

Several possible actions might alter the state of sales tax collection in the e-commerce space in Illinois and other states. These actions include:

  • The decision of the Illinois Supreme Court if the decision is appealed.
  • The Illinois Legislature could modify the statute by adding a rebuttable presumption to allow sellers to show that there is no solicitation in the state and by expanding the reach of the statute beyond internet advertising.
  • Litigation in any state might provide further guidance to help distinguish advertising and sales solicitation. Paying affiliates per click is more likely to be viewed as advertising than payment of a commission based on customer purchases after clicking through to the merchant’s website. As noted by a New York court regarding that state’s affiliate nexus rule, the compensation arrangement might lead affiliates to go beyond advertising to solicitation of sales (Amazon.com, LLC v. New York State Dep’t of Tax. and Fin., 81 A.D.3d 183 (N.Y. App. Div. 2010)).
  • Federal legislation to allow states to collect from remote sellers if certain simplifications are made to their sales tax rules. The current legislative proposals all include an exception for small sellers (defined differently in each bill). (See the author’s Affiliate Nexus website for details and links.)

Further information

For additional background on the affiliate nexus statutes, litigation, issues, and federal proposals to allow states to collect from remote sellers, see:

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Annette Nellen, Esq., CPA, is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, ABA and California State Bar. She chairs the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.