Canadian Online Business Take Note: Internet Tax Case

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“The world has changed dramatically in the last two decades… An entity may now have a profound impact upon a foreign jurisdiction solely through its virtual projection via the Internet.”

This statement from the New York Court of Appeals in the recent decision in Overstock v. New York Taxation and Finance (PDF) paved the way for an interesting conclusion on the taxing power of New York State - and by extension, the sales tax that may be applied to many online sales, including sales by Canadian online business into the US market.

Traditionally, a state’s taxing authority was based on “economic activities” by the seller, for example, through its employees or sales agents in that state. The question faced by the court in this case was whether click-through links on a “local website” (that is, a website owned by a local state owner) would qualify to establish “economic activities” in that state. For example, a link to Amazon from a local New York State website has the effect of driving sales to Amazon. The court decided that by compensating the local New York State website owner who has signed-on to an affiliate agreement, Amazon is deemed to have established an “in-state sales force”.  The site which hosts the link is paid a commission, flat fee or price-per-click, and this was considered enough to create a “substantial nexus” to the state. Passive advertisements, by contrast, would not by themselves create a substantial nexus.

It is not clear whether Overstock.com and Amazon will appeal the decision.

In other news, the U.S. Senate voted 74-20 to put The Marketplace Fairness Act of 2013 to a final vote, an Act which would allow states to collect online sales taxes. The OECD is also preparing guidelines on how to handle international value-added taxes, to deal with the current “uncertainty and risks of double taxation and unintended non-taxation”. The 2013 draft of the OECD Guidelines derives from the “neutrality” principle (the notion that value-added tax is a tax on final consumption that should be neutral for business), and the so-called “destination” principle (that tax should be paid in the jurisdiction of consumption).

In the meantime, Canadian online retailers selling into the US marketplace should consider reviewing their affiliate click-through agreements and assess sales-tax collection policies with tax advisors.

Related Reading: New York’s Highest Court Affirms Constitutionality of Click-Through Nexus