Last year, the State of New York kicked off what is now a legislative trend by requiring Internet retailers with affiliates residing in the state to collect New York sales tax. New York argued that those affiliates count as a physical presence, a claim hotly disputed by online retailers and marketplaces.

In May 2008, Overstock.com ended its relationship with over 3,400 of its New York affiliates and filed a lawsuit against the state, which is still pending along with a lawsuit brought by Amazon.com. And this week, Overstock.com and Amazon.com terminated relationships with affiliates in Hawaii, North Carolina and Rhode Island, states that have similar laws passed or pending.

It would seem that eBay, which has an affiliate program, is not obligated to collect state sales tax since it does not sell products itself. But the online marketplace has warned that such laws cause hardship on small businesses. In a statement issued yesterday, eBay said:

"While eBay recognizes the fiscal challenges facing many levels of government in this time of economic uncertainty, we are concerned that efforts to rewrite state and federal laws related to sales taxes on the Internet will unduly harm small business retailers and consumers. Simply put, there would be significant harm caused by imposing a new tax burden on small business retailers using the Internet, and on consumers looking to the Internet for values. eBay is working diligently with legislators in Sacramento to protect the needs of small businesses, entrepreneurs and consumers."

Whether affiliates who find their relationships with online retailers terminated would be motivated to promote eBay instead of other online marketplaces is uncertain, but if that were the case, eBay might actually benefit from those affiliates driving traffic to their website.

Other States Join New York
Overstock.com sent notices to all of its affiliate advertisers in California, Hawaii, North Carolina and Rhode Island informing them that the company was terminating their relationship owing to imminent passage of laws requiring Internet retailers to collect taxes if they have local affiliate advertisers. However, it reversed its decision to drop its California-based affiliates following intervention from Governor Arnold Schwarzenegger.

According to Overstock.com CEO Patrick Byrne, the governor told him he was going to "focus on balancing the budget via cost cutting, and not by jamming consumers and small businesses with new taxes."

Byrne also said in a statement this week that if states continue to pass such laws, "Sadly, the business of Internet advertising will be one more US-invented business that will migrate overseas."

Amazon.com also terminated relationships with affiliates in North Carolina, Rhode Island and Hawaii this week.