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Amazon shoppers will squeeze through Calif. tax loophole

On Saturday, California residents get to pay tax at checkout on Amazon.com purchases. But hundreds of thousands of items will remain (apparently) tax-free.

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's agreement with Sacramento officials means that, starting Saturday, it will collect sales taxes on items that it sells to California residents.

But Amazon will continue to not collect taxes on hundreds of thousands of items that it lists for sale on its Web site, stores in its warehouses, and packages for quick shipment to California residents.

Those orders -- called "fulfilled" by Amazon -- amount to a tax loophole that has left Sacramento tax collectors a tad unhappy. California sales tax rates are among the highest in the country, topping out at 9.75 percent, meaning the apparent tax savings can add up quickly.

A representative of the State Board of Equalization, which collects California sales taxes, told CNET today that whether Amazon can be required to collect taxes on "fulfilled" orders is a tricky question. "It's difficult for us to comment on the way Amazon is set up within its family of companies (and) whether there there would be a consignment relation," the representative said.

Amazon says the law is clearly on its side. Spokesman Scott Stanzel said that for fulfillment sales, "sales tax collection depends on the tax obligations of the seller," not Amazon itself.

Roughly one-fifth to one-quarter of the items that Amazon offers to ship are "fulfilled by" products. It's a staggering selection, including everything from Calphalon non-stick pans, iced tea, stereo speakers, video games, and even the PetZoom Pet Park Indoor Pet Potty.

The State Board of Equalization's maybe-yes-maybe-no approach is a significant departure from its position yesterday, when a representative sent CNET a statement saying that Amazon would have to collect taxes on orders it fulfills. "Since Amazon is handling the merchandise and all aspects of the sale, the Board of Equalization would consider them the retailer, and Amazon would have to collect tax on the transaction," the initial statement said. Late last night, a few hours after CNET contacted Amazon for a response, the board responded with what it described as "updated" information.

For these orders it fulfills, Amazon acts as a warehouse that stores items on behalf of the seller for a daily fee. Amazon argues that it's acting as the transaction's middleman rather than the actual seller. (According to the board's guidelines, consignment sales are taxable, but broker sales, where the "owner maintains control of the item prior to the sale," are generally not.)

Amazon as warehouse
Amazon's we-won't-collect position isn't unique to California. It also doesn't collect taxes on "fulfilled by" items that it ships to customers in states such as New York -- though it will for items listed as "Ships from and sold by Amazon.com."

The exception is if the seller has a physical presence, also called nexus, in those states. In other words, Amazon would collect taxes for a Los Angeles-based photo retailer selling through its site to photographers in San Francisco.

Amazon declined to provide details about how many items it ships on behalf of third-party sellers, but its executives have promoted its Fulfillment by Amazon service as a significant growth opportunity. Its Web site says: "Fulfillment by Amazon is a powerful addition to your selling on the Amazon.com Web site. Buyers trust Amazon to pack, ship and service your orders as we do ours."

Amazon spent $2.7 billion on fulfillment for the first six months of 2012, compared to $1.8 billion during the same period a year earlier. "Over the last several years, we've gotten closer and closer to customers from a delivery speed standpoint and when we do that, it helps our retail offering, but it helps also our third-parties who are participating in fulfilled by Amazon," Thomas Szkutak, the company's chief financial officer, said during a January earnings call.

In September 2011, Amazon agreed to drop its opposition to California's plan to force taxes on online sales. That deal also lets it build in-state fulfillment centers closer to California customers; ones are under construction in San Bernardino and Patterson, in addition to lockers in the San Francisco Bay area where customers can pick up items.

The justification for Sacramento's push was 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, as previously mentioned, is called "nexus." And Amazon has pointed to analyses saying that, even with tax collection, it still offers better prices than traditional retailers.

There is some incongruity in what The Los Angeles Times described as the deluge of orders from Californians intent on placing orders before the Saturday deadline.

Online purchases from sites like Amazon and eBay may have seemed to arrive tax-free. 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.