Amazon's Third-Quarter Profit Down 73%, Stocks Drop
Amazon's Third-Quarter Profit Down 73%, Stocks Drop

A new law is making its way through the Illinois capital building that would raise prices of Internet purchases. Like similar laws in other states, this hints at the changes that could face digital media as well as physical media sold online.

The Illinois House of Representatives passed an Internet tax law on Thursday, the latest in a series of attempts across the country to create more parity between brick-and-mortar and online retailers -- and raise tax revenues. If signed into law, the Main Street Fairness Act will collect a 6.25% sales tax if the retailer has affiliates in Illinois. The law would effectively raise prices of Amazon's CDs and digital music for Illinois residents.

But this new law would not create a new tax but would require companies to collect taxes on their sales. About a dozen states currently tax digital goods. However, in states that are not home to the Internet retailers' main place of operations, it is up to the customer to remit the taxes to the state.

Calling the new law "unconstitutional and counterproductive," Amazon has told its Illinois affiliates that it is ending the affiliate program on April 15.

Other states have also targeted Internet sales by going after affiliates, who are paid marketing and referral fees. In 2008, New York passed its "Amazon law" that requires out-of-state retailers who generate $10,000 or more in revenue through in-state affiliates to collect sales tax. North Carolina and Rhode Island also have Amazon laws, and lawmakers in a handful of other states have introduced them. Similar laws were passed but vetoed California and Hawaii.

States have used the existence of affiliates to pass Internet tax laws because the law says a company can only be taxed in the state where it has a physical presence. Definitions vary, but a company typically needs to have a corporate headquarters and resident employees. Thus, Amazon would argue it owes state tax in Washington but not, say, Texas.

But some states are trying to change what constitutes a physical presence. In Texas, Amazon is fighting a large tax bill the state contends it is owed because the company operates distribution centers there. The company contends the distribution center is actually owned by a Kentucky-based subsidiary.

Could these laws impact purely digital music companies in addition to broader Internet retailers like Amazon? It certainly does seem possible. Two factors driving other Internet tax legislation apply to digital music. First, many digital music companies have either affiliates or operations in multiple states. Second, states across the country are likely to be desperate for tax revenue in the coming years.