MLM SALES ON THE INTERNET

By Jeffrey A. Babener
  2002

MLM Internet Sales Exploding

Unfortunately, although the typical internet marketer is immune from sales tax collection in the same fashion as mail order sellers, the same will probably not hold true for the MLM company that markets over the internet.

Sales of MLM products on the internet are exploding.  The reasons are many.  First, internet technology has enabled virtually all leading MLM/network marketing companies to take orders over the internet rather than by call centers.  For many companies, internet ordering dominates the ordering process and makes the buying experience much more convenient for distributors and customers.  Second, leading MLM companies provide replicating web templates for distributors to drive customers to the ordering section of web sites.  Third, in addition to existing MLM companies that allow for alternative ordering via the internet, many new MLM companies have appeared whose sole method of marketing is through the internet, often offering web shopping malls.  Will this paradigm change in ordering relieve MLM companies from obligations for sales tax collection in that the ordering process makes them more like a catalog mail order firm?  Unfortunately, although the typical internet marketer is immune from sales tax collection in the same fashion as mail order sellers, the same will probably not hold true for the MLM company that markets over the internet by utilizing networks of thousands of distributors in every state to drive customers to their internet sites.

 Wake-up Call for MLM Internet Malls

MLM distributors often express frustration that MLM companies collect sales and use tax on product purchases.  Because there is no "in store sale," networkers often think that they are immune just like mail order catalog and internet sellers.

Well, unfortunately the activity of distributors in each state deprives networkers of the immunity from sales and use tax.  In fact, at a recent industry meeting, James Richmond, Chief Administrator, Sales and Use Tax, for Amway, noted that Amway has collected and remitted such tax since 1971 and believes it has a moral and legal obligation to do so.

To the surprise of many, Richmond indicated that, since Quixtar, Amway's internet spinoff, is part of the Amway family of companies, it has a legal obligation to collect tax on internet sales as well.  This is a wake-up call for all the MLM internet virtual malls sprouting on the web.

Blame the Pharaohs.

Sales and use taxes are a source of great revenue for states and great headaches for MLM and direct selling companies.  Sales taxes are collected in the vast majority of states and tens of thousands of local cities and counties have similar taxes.

Commerce Clearing House, the publisher of many tax publications, reports that in Egypt the pharaohs placed a general tax on the sale of all commodities at the rate of 5% of sale price.  The Romans obviously thought this was a good idea and, after their conquest of Egypt, the rate rose to 10%.  For the next 2,000 years, to this day, bureaucrats have found sales tax a favorite revenue raiser.

Both MLM distributors and MLM companies are always asking:  Can states legally tax interstate sales?  Who is responsible for sales tax?  When should it be collected?  How should it be collected?  These questions are constantly put to MLM companies and their distributors.

They Call It "Nexus."

The right of a state to collect sales tax on interstate sales is restricted by the commerce clause in the United States Constitution, which prohibits states from unreasonably interfering with interstate commerce.  The U.S. Supreme Court has held that states cannot impose sales tax on companies whose sole business is a mail order business.  MLM companies are in a different category than mail order firms, however.  Multilevel marketing does involve interstate sales of products, but it also involves one‑on‑one personal contact with customers and substantial activity within most states.  MLM distributors or sales representatives are basically independent, commissioned local sales people who: (1) sell the product directly in the state; (2) procure sales orders for the company; (3) promote product within the state; (4) recruit other participants in the state to join the MLM program.  Therefore, MLM companies have sufficient activity to trigger a legal term called "nexus," i.e. "legal presence" for sales tax purposes.

Because of this activity, say state tax officials, MLM companies, unlike mail order companies, are probably liable for state sales and use taxes.  In a famous case decided by the Supreme Court in 1960, the court held liable a national company for sales of independent distributors in Florida.

Companies that do not seriously address the question of sales tax, may find themselves liable for some significant penalties.  In the event the company does not collect the tax, and the distributor does not collect and remit the tax, the company may find itself liable for the entire amount, plus interest, plus additional stiff penalties.  Companies which ignore the sales tax issue altogether are clearly headed for trouble. And it's not just tax on products, but equally applicable is sales tax on sales aids.

So - What To Do?

Prudent MLM companies follow one of two approaches when it comes to collection of sales tax.  Companies collect the sales tax based on the suggested retail price at the time of the sale of product to distributors.  Companies are likely justified in collecting sales tax on the wholesale price on that product which is actually personally consumed by distributors.  The company then remits the sales tax to the locality.  This approach has some distinct advantages.  First, the company removes the administrative burden from its distributors who are complying with local sales tax regulations.  Second, the company probably develops a better relationship with the state or locality because it has taken on the responsibility of seeing that taxes are paid.  For those companies that can afford it, there are computer services which provide detailed sales tax information on the thousands of taxing localities.

Some companies, on the other hand, are either not equipped to collect and remit sales tax, or they do not want to be in the business of collecting and remitting sales taxes.  These companies require distributors to obtain and furnish the company with a state sales tax I.D. number and to collect and remit the tax themselves for resales or personal use.  The companies that follow this approach should be very careful to verify that their distributors have obtained state sales tax I.D. numbers, and that their distributors are remitting appropriate sales taxes.

It's Tough Out There.

No question - this area is a big headache, not just for traditional MLM, but also for internet MLM.  Also, no question - this quagmire is best navigated by qualified lawyers and accountants.  If you are a distributor, have patience with your company.  If you are a company, have patience


Jeffrey A. Babener
Babener & Associates
121 SW Morrison, Suite 1020
Portland, OR 97204
Jeffrey A. Babener, the principal attorney in the Portland, Oregon law firm of Babener & Associates, represents many of the leading direct selling companies in the United States and abroad.

www.mlmlegal.com

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