State wins key court battle to collect sales taxes

State government's recent victory in its long-running battle to collect sales taxes from a global publisher of children's educational materials could bode well for its larger battle to collect taxes from online retailing giants.

Though the case against a subsidiary of New York City-based Scholastic Inc. well pre-dates the statute enacted last year to force Amazon, Overstock and other online mega-stores to collect and remit sales taxes, the state Supreme Court's ruling recognizes the basic principles behind that measure.

"It is relevant, clearly relevant to the whole discussion of out-of-state sellers," said Department of Revenue Services Commissioner Kevin B. Sullivan. "It is very helpful to the state's position."

Scholastic is well known for publishing a wide array of children's classroom magazines including Junior Scholastic and the Weekly Reader. According to case records, more than 14,000 teachers in Connecticut participate in Scholastic book and magazine programs.

In a unanimous ruling, the court held that even though Scholastic neither owns nor leases property here, it owes more than $3 million in sales taxes and penalties in connection with the materials ordered, paid for and distributed via regular mail to Connecticut classrooms.

"We conclude that the Connecticut school teachers who participate in the plaintiff's program may be considered its representatives," Justice Peter Zarella wrote for the court. "... Although individual teachers may decide not to participate in the program, those who participate distribute the plaintiff's catalogs, flyers, other forms and other materials to the children."

Connecticut law does not require that the teachers in this case, or any business representative, have a legal relationship with the retailer, Zarella added. The teachers' "principal function is to serve as the exclusive vehicle for selling the plaintiffs' products to their students," he wrote.

Scholastic Inc. spokesman Jeffrey Mathews said Thursday that "we're in the process of considering whether we'll appeal" the Connecticut ruling to the U.S. Supreme Court.

At issue is a loophole in states' tax rules opened by a 1992 decision by the nation's high court. It essentially held that states cannot force businesses to collect sales taxes unless they have a "nexus" or physical presence within that state.

And Sullivan hopes that just as the Connecticut court recognized Scholastic Books' presence here through the teachers it works with, a similar argument will be upheld when it comes to online retailers.

'Amazon's Law'

A common misconception among Connecticut consumers, lawmakers say, is that Internet transactions are exempt from sales tax. If retailers don't collect and remit the tax back to Revenue Services, consumers are supposed to report and pay it themselves through their annual state income tax filing.

But while the sales tax raised $3.3 billion last fiscal year, only about $10 million of that was paid through income tax filings.

A 2010 analysis by the Center on Budget and Policy Priorities, a nonprofit fiscal and public policy group based in Washington, D.C., estimated that states lose a total of $7 billion a year in sales tax revenue tied to online transactions.

Connecticut legislators took a controversial approach last spring, adopting a measure patterned after a 2008 New York statute that became known as "Amazon's Law."

Connecticut's solution hinges on sales affiliates, local companies that receive a small commission for redirecting customers to a retailer's website. Any firm with more than $2,000 in annual sales generated through its Connecticut affiliates effectively has a physical presence in the state, according to the statute, and therefore must collect and report sales tax.

Nearly 3,000 Connecticut firms affiliated with online retailers made $236 million last year from relationships with those and other online retailers, and paid about $7 million in state income taxes, according to the southern California-based Performance Marketing Association, which represents Amazon, other online giants such as Google, Yahoo and eBay, as well as a growing affiliate network.

Though Connecticut's version of Amazon's Law hasn't landed in court yet, several major retailers have disputed their obligation to collect sales taxes. Overstock, Amazon and other retailers cut ties with their affiliates here shortly after the rule was adopted last spring. The association estimated that nearly all companies here lost at least one affiliation with a major retailer over the past year.

Rebecca Madigan, the association's executive director, said Thursday that there is a growing recognition among online retailers, affiliates and most states, that the issue needs to be resolved in Congress with a uniform policy benefiting businesses, consumers and government.

"I think it is inevitable," she said, adding that she thinks a final compromise might be struck this year. "I don't think the (U.S.) Supreme Court is going to issue another ruling on this. ... Congress is going to have make this change."