Yesterday morning I sat in the Daley Center and listened as Cook County Circuit Judge Robert Lopez Cepero struck down Illinois' internet affiliate tax law and, in so doing, handed victory to thousands of internet entrepreneurs across the state. While the outcome of the case will rest ultimately with the Illinois Supreme Court, today's ruling is an important step in thwarting the barrage of oppressive taxes that are driving jobs out of Illinois and diminishing the state's revenue.
The law, effective July 1, 2011, targeted retailers who had contracts with businesses in Illinois that posted links on their websites to the retailers' websites. The law compelled those retailers to charge a use tax on Illinois' consumers for any products purchased after a consumer was "linked through" to the retailer's site from an Illinois affiliate.
When the General Assembly hastily passed the law, it was sold as a revenue generator but the Performance Marketing Association, the plaintiff in the case, reports that many of the state's estimated 9,000 Illinois-based online affiliates have either closed their doors or moved to neighboring states that are friendlier to economic freedom. Illinois-based online affiliates generated as much as $744 million last year and paid $22 million in state income taxes.
Judge Lopez Cepero ruled the law unconstitutional on two grounds: 1) it violated the Commerce Clause of the United States Constitution, which limits what entities a state can tax; and 2) it conflicted with the federal Internet Tax Freedom Act, which prohibits states from directly targeting and taxing internet commerce.
Regarding the Commerce Clause, Judge Lopez Cepero said that the state failed to establish that the retailers maintained the requisite "nexus" or connection to Illinois commerce necessary to tax out-of-state retailers. Traditionally, in order for Illinois to exercise its taxing power over a foreign company that company must have some physical presence within the state, whether it be an office, a factory or even salesmen who pitch the company's products directly to residents of Illinois.
An advertisement on an Illinois-based website does not create a significant enough presence for the state to tax the company doing the advertising. That ad on a webpage simply does not mean that the company maintains a place of business in Illinois such that it must register with the Department of Revenue and charge customers a use tax. For more analysis of the “nexus” issue, read this article by the Illinois Policy Institute’s chief economist, Dr. Lawrence J. McQuillan.
The Illinois law was also fatally flawed in that it attempted to tax internet commerce. This directly conflicts with the federal Internet Tax Freedom Act, which prohibits states from imposing a discriminatory tax on electronic commerce. Because the Illinois affiliate tax law imposed an obligation to collect Illinois use taxes on retailers who completed sales transactions through internet-based advertising, rather than other forms of advertising, it violated the federal statute that prohibits such discriminatory taxes against internet commerce. Judge Lopez Cepero ruled that this internet tax "moratorium" applied here, and therefore the Illinois law must be struck down.
The Illinois Department of Revenue has 30 days to appeal to the Illinois Supreme Court. While a final determination could be months away, today’s ruling is a victory for economic freedom in Illinois.