Amazon.com (Nasdaq: AMZN ) isn't used to being twisted until it cries out "uncle" and much less "Uncle Sam."
However, an interesting battle is shaping up in New York, where the leading online retailer is locked in legal fisticuffs with the state's attempt to begin collecting state sales taxes from purchases originating within the state.
Amazon is bound by the current online taxation rules that dictate adding sales taxes on orders from states where it has a physical presence. In Amazon's case, that includes its Washington base, as well as Kansas, Kentucky, and North Dakota, where it has distribution centers for items sold directly from the company.
Amazon's third-party partners have different turfs. Target (NYSE: TGT ) orders are subject to sales tax in every state but Vermont. A smaller merchant has to automatically charge sales tax only when an order is being shipped within its home state.
So why is New York angling for a tax bite? Well, the state is arguing that the Amazon Associates program -- where website publishers of all sizes can collect commissions by promoting Amazon wares through their sites -- makes Amazon liable to collect the taxes on its behalf because those affiliates live in New York.
This has nothing to do with the rarely enforced use-tax rules. Amazon is now on the hook to begin collecting sales taxes on orders made from state residents, even if the orders didn't originate from one of the Amazon Associates partner websites.
It may not seem like much, but it adds up. Online retailers are subject to tight margins and the need to subsidize shipping to close sales. The difference between selling the same suit for $100 as opposed to $108 can mean a lost sale in a dot-com environment where price comparison shopping sites are plentiful and the competition is just a click away.
The sales tax dilemma is one of the reasons why cynics have debunked the persistent rumors of Amazon buying Netflix (Nasdaq: NFLX ) , where the DVD rental specialist has a distribution center in the heart of the most populated states.
Then again, Amazon has shown its ability to shape its different subsidiaries. For instance, the company's Amazon Digital Services division automatically tacks on sales charges only to orders coming out of Washington and North Dakota. Physical distribution centers in Kansas and Kentucky for the home company don't get in the way of the company's online fulfillment arm.
This doesn't mean that Amazon is still interested in Netflix, even if the sales tax overhang can be overcome -- or even if other states jump on the New York bandwagon to make that argument moot. Amazon's interests have moved toward the digital delivery of books, music, and movies.
Yes, Netflix has a successful online streaming interface these days, but that is certainly not a good enough reason to eye Netflix again. Besides, these rumors pick up in intensity only when Netflix is hitting new lows. Despite last month's poorly received quarterly report, Netflix is holding up quite well in this market.
So much at stake
It isn't easy to make it in e-tail, even with the sales tax break. Bluefly (Nasdaq: BFLY ) and drugstore.com (Nasdaq: DSCM ) are trading in the low single digits. RedEnvelope filed for bankruptcy last month. Overstock (Nasdaq: OSTK ) has done well in narrowing its deficits, but it's still posting losses.
With states mired in budgetary crunches, it's only logical for state governments to turn to low-hanging fruit in the form of online retailers who have skimped on collecting sales taxes.
Will Amazon win? Will New York win? If the state prevails, will Amazon simply prohibit New Yorkers from joining the Amazon Associates program, or is this part of a bigger trend where online retail is about to lose its sales tax advantage?
The plot thickens, as does the gamut of implications.
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Longtime Fool contributor Rick Munarriz respects the tax man and Amazon.com, so he won't take sides. He does own shares in Netflix. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.