New York’s highest court on March 28 upheld a New York law subjecting out-of-state internet retailers to New York sales tax collection requirements on the basis of their “affiliate” advertising programs.  Although the U.S. Supreme Court has held that a state cannot constitutionally require a retailer to collect sales taxes unless the retailer has a “physical presence” in the state, the New York Court of Appeals “deemed” that affiliate advertising on third-party New York residents’ websites “[e]ssentially . . . established an in-state sales force.”  But the court’s holding — which oddly appears to draw a constitutional line between flat-fee and commission-based advertising arrangements — is difficult to square with both Supreme Court doctrine and the realities of the online “affiliate” relationship.  In the end, the Supreme Court or Congress may have the final word on this issue.


The case,, Inc. v. New York State Department of Taxation and Finance, involved a tax law enacted by New York in 2008.  Under that law, an out-of-state internet retailer is presumed to be subject to New York’s sales tax collection requirements if a New York resident “refers potential customers, whether by a link on an internet website or otherwise” to the retailer in exchange for “a commission or other consideration,” and such referrals cumulatively result in at least $10,000 in annual gross receipts.  On its face, the broad language of the law would appear to cover all paid internet advertisements, but the New York Department of Taxation and Finance has applied the presumption to internet ads only where payment is based on the volume of completed sales generated by the link.

Internet retailers and were potentially subject to the law based on their “affiliate” programs.  Third-party websites could enroll in those affiliate programs and then would receive commissions for sales generated by any links they provided to Overstock or Amazon.

Overstock and Amazon challenged the constitutionality of New York’s law.  They cited the U.S. Supreme Court’s “dormant” Commerce Clause cases, which have held that the federal Constitution prohibits a state from collecting sales and use taxes from mail-order companies that lack a “physical presence” in the state, even if they advertise there.  The Supreme Court has also held that even a “small sales force” of independent contractors may be a sufficient physical presence — but the Court has since described that case as “the furthest constitutional reach to date of a State’s power to deputize an out-of-state retailer as its collection agent for a use tax.”

The Decision

Last week, the New York Court of Appeals went further, holding that Overstock and Amazon’s affiliated third-party websites were essentially an “in-state sales force,” thereby allowing New York to collect taxes from the out-of-state retailers.  But the court acknowledged that it would be unconstitutional for New York to subject out-of-state internet retailers to the tax collection requirements “if New York residents were merely engaged to post passive advertisements on their websites.”  According to the court, “The bottom line is that if a vendor is paying New York residents to actively solicit business in this State, there is no reason why that vendor should not shoulder the appropriate tax burden.”

It is not clear what the court could have meant by distinguishing “active” and “passive” advertising.  On the internet, both flat-fee advertisements and commission-based affiliate advertisements generally include links to the advertiser’s website and may appear as images or text, in-line or at the margins of a web page.  Websites might vocally encourage their visitors to patronize their advertising sponsors, regardless of whether those sponsors pay a flat fee or a commission.  In any event, these kinds of mushy factors should not matter when determining the reach of a state’s taxing authority, which the Supreme Court has measured by a bright-line rule for the express reason that the “bright-line, physical presence requirement” creates a “safe harbor” for vendors, “encourages settled expectations and, in doing so, fosters investment by businesses and individuals.”

Rather, the New York Court of Appeals seems to have based its ruling on the distinction between flat-fee and commission-based advertising arrangements.  But the mere payment structure for an advertisement has little bearing on the nature or extent of the relationship with the advertiser.  Why would the Constitution allow a state to subject an advertiser to sales taxes if it buys ads on third-party websites for $10,000 in commission fees, but prohibit a state from doing the same if that advertiser bought the exact same ads for $10,000 in flat fees?

In dissent, Judge Robert Smith pointed out the reality that “[t]he Overstock and Amazon links that appear on websites owned by New York proprietors serve essentially the same function as advertising that a more traditional out-of-state retailer might place in local newspapers.  The websites are not soliciting customers for Overstock and Amazon in the fashion of a local sales agent.”  According to Judge Smith, “To presume that every website that has an agreement under which it carries an Overstock or Amazon link is a sales agent for Overstock or Amazon would be to nullify the rule that advertising in in-state media is not the equivalent of physical presence.”


In the wake of this decision, internet retailers may be reluctant to enroll New York websites in their affiliate programs.  (Indeed, the court’s opinion observes that Overstock has suspended its affiliate program for those providing a New York address.)  More broadly, several states have followed New York’s lead by adopting similar laws.  If courts in those states follow the reasoning of the New York Court of Appeals and uphold those laws (for example, if the Illinois Supreme Court were to reverse a lower court decision striking down a similar law in Illinois), affiliate programs may become increasingly unattractive for some internet retailers — they might prefer to use solely flat-fee advertising arrangements to avoid having to collect sales taxes in states like New York.

This decision may also increase pressure for federal legislation to address the issue more comprehensively.  Related bills are already pending in Congress, and on March 22, the U.S. Senate held a non-binding “test vote” on the Marketplace Fairness Act, which would authorize states to require remote sellers to remit sales and use taxes.  The amendment to the Budget Resolution passed the Senate by a vote of 75 to 24, signaling that the Congress may be poised to act.

It should be noted, however, that even if Congress does not act, the New York Court of Appeals may not have the last word on the constitutionality of New York’s law.  Twenty years ago a state high court held that out-of-state mail-order companies could be subjected to state sales taxes on the basis of their in-state advertisements, but the U.S. Supreme Court reversed that decision on appeal.  The Supreme Court might intervene once more if it believes that New York has improperly burdened interstate commerce.

Dustin Cho contributed to this report.