Amazon Ends Affiliate Relationships in California

In a major development for the largest online retailer in the U.S., Amazon is cutting off advertising affiliates in California over dislike of a new state rule forcing online retailers to collect sales tax in the state.

Seattle-based Amazon (NASDAQ: AMZN) said in an email sent to California-based affiliates Wednesday it would cut ties with affiliates residing in the state if the law became effective. Later Wednesday, California Gov. Jerry Brown signed the law into effect as part of a larger state budget. California is ailing financially, facing a budget deficit amid revenue shortfalls. The move by California to collect sales tax on items sold by online retailers and shipped into the state is an effort to curb loss of revenue when goods are sold by companies like Amazon and shipped into the state.

Amazon will continue shipping products into the state purchased by California residents from the company's own warehouse, but it apparently has cut off ties with affiliate merchants who sell products through Amazon, paying the company a distributor fee for the listing and transaction.

California's new rule requires online retailers to collect California sales taxes if they have in-state affiliates, so Amazon is protecting its core business by simply cutting its California affiliate retailers off, so it can continue selling goods into the state without paying sales tax. Typically Amazon affiliates pay fees varying from 4 percent to 15 percent of the total sale price, so the move by Amazon to stop working with affiliates in California is substantial.

Overstock also ended its relationship with California affiliates based upon the new rule. Neither Amazon nor Overstock would disclose to the Associated Press how many affiliates they worked with in the state before severing the relationships. California aims to generate $200 in revenue from the new law.

This is a major development for Amazon, which is facing similar threats for other states.

Since Amazon became an online retail force over the past decade and a half, the company has been protected by a 1992 U.S. Supreme Court ruling (Quill Corporation v. North Dakota) prohibiting a state from forcing businesses to collect sales tax unless they have a brick and mortar presence in the state. That's why for so many years buyers of luxury jewelry and clothing have bought products in one state while traveling, having them shipped back home if that store did not have a location in their hometown.

Technically speaking, taxpayers in many states are supposed to pay the tax to their respective government for purchases but few rarely do. In the case of books, or other retail items sold by Amazon, the money is small on an individual basis. But Amazon has revenue of nearly $40 billion. Even though the company is global, the largest segment of its business comes in the United States. Spread across the 50 states, the potential sales tax involving states is significant.

Dollars states lost before the online retail boom in the Internet age were minimal compared to what states claim they are losing now to online companies, Amazon in particular. Complicating matters even more for Amazon has been the fact that the company's legislative battle against the issue must be fought across 50 different states with different legislative personalities.

Only Tennessee, where Amazon is investing millions to build multiple distribution centers, is the legislature working actively on behalf of the company's interests. Amazon also collects sales tax in five states, including New York, Kansas, Kentucky, and Washington where it has physical locations. The leaves more than 40 states on the hostile or near hostile list and many, including California, have been aggressively targeting the affiliate partner e-commerce sites Amazon works with, pushing the company to threaten actually ending those relationships in hostile states.

Amazon CEO Jeff Bezos understands how difficult it will be for Amazon to get uniform action to its satisfaction across all 50 states so he's pushing for federal legislation to fix the problem. But that's easier said than done considering states for each elected member of Congress will likely pressure officials to keep their concerns a priority since most are facing difficult budget constraints.

Some estimates suggest, and Amazon has acknowledged that the problem, if not resolved favorable to Amazon across the country, could cost the e-retailer hundreds of millions in sales -- costing the company a long-held advantage it has had against brick and mortar retailers by effectively being able to discount products by the sales tax reduction from the start.

The issue is nothing new for the company, or its investors, and it certainly hasn't harmed the stock as the share price remains near its 52-week high trading at a price-to-earnings ratio of 82. But if the company doesn't resolve the sales tax issue favorably, investors jumping in at current prices may not get the same rewards that has come to those who invested over the past year when Amazon stock has made a mighty run.