By  on June 11, 2008

NEW YORK — A New York state law that went into effect June 1 could signal the beginning of the end for the online retail tax exemption. Alternatively, it could greatly restrict the use of affiliate marketing, which has helped fuel the growth of social media sites and been particularly useful for bringing shoppers to online retailers that don't have physical stores.

Since the law took effect, online retailers Overstock, eLuxury and others have dropped thousands of New York-based bloggers and other online sites from their affiliate marketing programs to avoid having to charge New York residents sales tax.

The law requires out-of-state retailers to charge their New York customers sales tax if the retailers pay any New York-based Web sites commissions for directing sales to their site. Most online retailers have affiliate programs, which typically account for 9 percent of online sales, according to the E-tailing Group Inc. of Chicago.

If the law succeeds in bringing New York more revenue and is not struck down, other states are likely to pass similar laws, said Jerry Cerasale, senior vice president of government affairs for the Direct Marketing Association in Washington.

So far, out-of-state retailers have responded to the New York law in three ways, said an executive at a direct marketing company who requested anonymity. Some have removed New York affiliates from their program, some are collecting sales tax, and others are changing the terms and conditions of their contracts with affiliates, he said. Overstock cut 3,500 affiliates from its program, the firm said.

Overstock, eLuxury, and some smaller retailers have dropped SheFinds, said Michelle Madhok, SheFinds chief executive officer and founder. SheFinds is a shopping blog that has 300,000 unique visitors a month, 50,000 e-mail subscribers and three full-time staffers. About 30 percent of its revenue comes through affiliate sales.

"Now if they want to be on SheFinds, they'll have to buy an ad," she said. One retailer suggested in an e-mail that Madhok should register her business in another state. "I chose to register my business in New York City because I think this is a great city, but New York State is giving us a disadvantage," said Madhok,Meanwhile, Amazon has not dropped its New York affiliates but is instead charging New York customers sales tax. The company filed suit against the state of New York in April alleging the law is unconstitutional because Amazon does not "solicit" business in New York State.

"This is very expensive for marketers," said Cerasale of the DMA, whose members include online retailers. Even though the retailers don't pay the sales tax themselves, it costs them to collect and manage it.

E-tailers could respond by charging sales tax or by restricting their affiliate marketing programs to the states where they are physically located and already required to collect sales tax.

The law does not apply to advertisements that are paid based on traffic or click-through, such as Google AdSense.

The law could affect online magazines, blogs and other types of social media, such as social networking sites, bookmarking sites and search sites, which often participate in affiliate programs. Affiliate sites are any sites that get a cut from directing sales to an online retailer.

Affiliates typically operate independently of the retailers who pay them commissions through an automated online process. The commissions are generated when a Web surfer clicks through to a retail site and buys something.

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