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California targets Kindle lab in Amazon tax spat

New law says the presence of Amazon.com subsidiaries A9 and Lab126 in California is sufficient reason to levy sales taxes on shipments into the Golden State.

Declan McCullagh Former Senior Writer
Declan McCullagh is the chief political correspondent for CNET. You can e-mail him or follow him on Twitter as declanm. Declan previously was a reporter for Time and the Washington bureau chief for Wired and wrote the Taking Liberties section and Other People's Money column for CBS News' Web site.
Declan McCullagh
4 min read

Amazon.com said today that it's reluctantly severing ties with affiliates in California, a move that it hopes will let it continue shipping products to state residents without collecting sales taxes.

But a little-noticed clause in the legislation that Gov. Jerry Brown, a Democrat, signed into law today gives California tax collectors a second, albeit legally untested, cudgel to use against the Seattle-based company. The law takes effect immediately.

Cupertino, Calif.-based Lab126 is an Amazon subsidiary that designed the Kindle.
Cupertino, Calif.-based Lab126 is an Amazon subsidiary that designed the Kindle. Screenshot by Declan McCullagh/CNET

The measure says that any retailer who "through a subsidiary" has any "place of business" in California must collect sales taxes. And--surprise!--Amazon has two subsidiaries in California: A9, in Palo Alto, which works on search technology, and Cupertino-based Lab126, which designed the Kindle and is rumored to be working on much more.

That was hardly an accident of drafting on the part of the legislation's author, California State Assembly majority leader Charles Calderon, a Democrat. A formal analysis prepared by the Assembly's tax committee mentions Amazon no fewer than 28 times. It's the only company singled out by name.

Because "Amazon.com LLC... has other California-based members that perform various services in this state," the parent company can be "required to collect California use tax on their taxable sales to California consumers," the analysis says. Amazon, which did not comment to CNET, is still not collecting sales taxes for California-bound shipments.

The only problem for enthusiastic politicians and tax collectors is that the new law might not be entirely, well, legal.

In 1994, a California appeals court rejected state tax collectors' arguments when they tried a similar approach. The case involved a Colorado-based company, Current, which sold greeting cards, gift wrapping paper, and so on through the mail. It had no contacts with California.

Current's parent company, Deluxe Corp., did do business in California. The state Board of Equalization, operating under the theory that the finer points of corporate structure weren't that relevant, levied $344,088 in taxes on Current.

The appeals court tossed out that argument, saying that courts in Pennsylvania, Illinois, and Connecticut had considered similar cases and had all ruled against the tax collectors. Those decisions were "persuasive," a three-judge panel unanimously ruled, and Current and Deluxe "did not have integrated operations or management" and were "separate and distinct corporate entities."

A law that bites back?
In Amazon's case, A9 has a separate management team, headed by ex-AltaVista hand Bill Stasior, and a separate identity (its Palo Alto offices sport the A9.com logo, not Amazon's). Lab126 also has a distinct identity--a sign that Amazon has good lawyers--that's separate from its parent company.

California's legislation would actually harm the state, not help it, says Steve DelBianco, head of the NetChoice trade association, which counts AOL, eBay, Oracle, and Yahoo as members.

If it survived constitutional challenges, DelBianco says, "it would be a real problem for California businesses." That's because, he says, non-California investment funds won't want to invest in a California start-up business if that instantly creates a taxable relationship for all its the other non-California subsidiaries.

"This erects a barrier to California start-ups obtaining investment capital from out-of-state investors," he says.

The justification for the law is a reprise of arguments that state tax collectors, encouraged by companies like Wal-Mart and Best Buy, have made for at least a decade: they claim that Amazon, Overstock.com, Blue Nile, and other online retailers that don't collect taxes are unreasonably depriving states of revenue and that they enjoy an unfair competitive advantage over local retailers that must collect taxes.

On the other hand, a 1992 Supreme Court ruling says that, in general, retailers can't be forced to collect sales tax on out-of-state shipments unless they have offices in those states. The concept is called "nexus."

One approach is for tax collectors to target an affiliate program, which gives partners small fees for referrals. New York, North Carolina, and Rhode Island have enacted laws saying that if a retailer runs an affiliate program with referral payments, that's enough to trigger tax collection requirements. Amazon has sued New York and the lawsuit is pending.

California seems to be the first state, however, to enact a law placing corporate subsidiaries in its tax crosshairs. (The original bill, AB155, was glued onto ABX 28 1X, which Brown signed.)

"These laws threaten to hamstring the online marketing space at a time when outside investments in businesses are at levels not seen since 1999 before the tech bubble burst," wrote Lisa Picarille, a board member of the Performance Marketing Association. "Fueling the investment fever are high-profile IPOs such as LinkedIn along with Facebook and Groupon announcing they are preparing for mammoth IPOs as well."

To be sure, online purchases from sites like Amazon and eBay may seem to arrive in a a pleasant state of untaxation. But the law in California and other states actually requires shoppers to pay their own state's sales tax rate--the concept is called a "use tax"--and voluntarily cough up the exact amount owed each year at tax time. Few do.

An analysis of the subsidiary section of the new law prepared by the Assembly appropriations committee estimates it would bring in $83 million a year. It cautions, though, that the estimate "assumes that Amazon or other companies do not change their corporate structure or discontinue their use of in-state companies, or otherwise change behavior."

The analysis also includes this warning, which is likely to prove prescient if Amazon is forced to litigate: "The state would likely face significant litigation expenses owing to the legal uncertainty surrounding the bill's approach."