Try, Try Again ... Illinois Imposes a New and “Improved?” Affiliate Nexus Law

Effective January 1, 2015, out-of-state retailers are once again presumed to have sales tax nexus in Illinois if they satisfy the following criteria:

• the out-of-state retailer has a contract with a person in Illinois;
• under the contract, the person in Illinois refers potential customers to the retailer and the retailer pays to the person in Illinois a commission or other consideration based on the sale of tangible personal property by the retailer;
• the person in Illinois provides to the potential customers a promotional code or other mechanism that allows the retailer to trace the purchases made by these customers;
• the retailer made cumulative gross sales of $10,000 during the preceding four quarterly periods to customers referred by persons located in Illinois, regardless of the location of the customers.

As such, the referring activities can include an Internet link, a promotional code distributed by printed or broadcast media, or some other mechanism.  If all of these conditions are met, the retailer is presumed to be maintaining a place of business in Illinois and is required to register and to collect and remit Use Tax on all of its sales to Illinois customers. [Public Act 98-1089, 35 ILCS 105/2(1.1) and 35 ILCS 110/2(1.1)]  The presumption of nexus can be overcome if the out-of-state retailer can prove on audit that the referred customers had so little connection with Illinois that current U.S. Commerce Clause nexus standards prohibit imposing compliance obligations on the out-of-state retailer. [For a Summary of this legislation, See Illinois Department of Revenue Informational Bulletin FY 2015-07 (December 2014)]  Illinois now joins 24 other states that have enacted some form of “affiliate” or “click-through” nexus standard, as a means of capturing sales tax revenue on remote sales.

Illinois had previously enacted “click-through” nexus legislation in 2011, following New York’s lead by creating a rebuttable presumption that nexus existed for out-of-state retailers like Amazon that contracted with an Illinois resident to display a link on its website that had the ability to connect an Internet user to the out-of-state retailer’s website, when those referrals generated over $10,000 per year in sales.  However, Illinois’ “click-through” nexus standard was limited to Internet marketing or linking activity.  In October 2013, the Illinois Supreme Court held that the law imposed a discriminatory tax on electronic commerce by imposing a use tax collection obligation based only on Internet referrals but not on print or over-the-air broadcasting referrals.  The Illinois high court found that that state’s nexus law was “preempted” by the federal Internet Tax Freedom Act (ITFA), P.L. 105-277, and therefore unenforceable. With that finding, the court did not address the Commerce Clause challenge to the law. (See Performance Marketing Ass’n v. Hamer, No. 114496 (Ill. 10/18/13).)  Though the trial court had also rejected the law on U.S. Commerce Clause grounds, the Illinois high court did address this.  Of note, New York’s law, has survived constitutional scrutiny, and the U.S. Supreme Court has declined to review the case.  [See Overstock.com, Inc. v. New York State Dep’t of Tax. and Fin., 20 N.Y.3d 586 (N.Y. 2013)]  New York’s law provides that the referring activities can include other methods, in addition to website links.  At least four other states (Georgia, Kansas, Maine and Missouri) have “click-through” nexus standard that provide the referring activities can include other advertising or marketing methods, in addition to Internet links.

While Amazon began collecting Illinois sales tax, effective February 1, 2015, affiliate nexus laws do not solve the sales and use tax compliance problem that states have with remote sales. For one, while such laws have certainly generated additional revenue for states, remote sellers can simply close their affiliate programs with residents in a state that enacts a “click-through” nexus standard. This not only results in lost sales tax on remote sales, but also lost income tax for income generated by the resident affiliates that use such affiliate programs. Furthermore, business models will continue to change in response to such evolving nexus standards. Indeed, Amazon now collects sales tax in twenty-four (24) states, as it continues to grow its physical presence, regardless of such changing nexus standards. While Amazon had pulled its affiliate program out of Illinois in response to the previous Illinois “click-through” nexus law in 2011, Amazon is constructing a distribution facility in Illinois, set to open in 2017.

The Illinois “click-through” nexus law represents a disturbing trend in evolving nexus standards that create a presumption of nexus for all remote sellers that utilize any method of advertising or marketing – Internet, printed media, broadcast media - to reach potential customers. This trend can have implications not only for Internet retailers, but for all sellers, including the company in one state that advertises on billboards, radio, television or newspapers, and generate sales to customers located in another state. 

Meanwhile, the debate over a legislative fix to state tax nexus over remote sellers continues to intensify in Congress. Representative Goodlatte (VA) has issued a draft proposal of the Online Sales Simplification Act, designed to address states’ sales tax compliance obligations for remote sellers, while responding to the criticisms of many regarding the Senate’s Marketplace Fairness Act, which attempts to do the same. What is clear from both the House and Senate proposed solutions is that (1) more work remains to be done before a workable solution is achieved, and (2) a Federal resolution addressing the sales taxation of remote sales is something we are all likely to see in the next few years, if not this year.