With the passage of the hotly debated state budget last night, New York legislators approved a bill that will require many online retailers to begin collecting sales taxes on purchases shipped to the state, even if they have no operations or employees working there.

New York Governor David Paterson is widely expected to sign the measure.

The so-called "Amazon tax" closes a loophole for Internet retailers who derive sales through affiliate programs in which Web site owners place a link to the merchant on their site and earn a commission on sales made from referrals. In lobbying for the bill, the industry group representing New York retailers had argued that the exemption from the sales-tax collection requirement gave out-of-state online retailers an unfair competitive advantage.

"This is a first step -- but a critical one -- in our ongoing battle to level the sales tax playing field between New York retailers and the out-of-state Internet giants that have, for years, capitalized on an unfair and unintended competitive advantage driven solely by tax policy," James Sherin, president CEO of the Retail Council New York, said in a statement reacting to the bill's passage.

Legal experts predict challenges by Web affiliates.

The controversial bill ends what for many New Yorkers had been tax-free online shopping, and experts predict that other states could follow suit with similar provisions. Consumers are required to report purchases they make online from out-of-state companies on their tax returns and remit a use tax, but many people are either unaware of that obligation or ignore it. Collecting those taxes from individuals has been an administrative impossibility.

New York expects the new requirement will generate about $50 million in revenue this fiscal year.

The debate over the bill, which former-Gov. Eliot Spitzer introduced in February, had drawn sharp criticism from Amazon and conservative tax policy analysts. It also rests in a murky legal area about the interstate tax responsibilities of online retailers.

Amazon did not immediately respond to a request for comment.

The Quill That Became Law

The tax was inspired in some ways by a 1992 ruling by the U.S. Supreme Court. In Quill v. North Dakota, the Court determined that out-of-state retailers cannot be required to collect sales tax on purchases sent to states where they did not have a physical presence. They argued that compelling merchants to adhere to the complexities of the state and local tax codes would place an unreasonable burden on interstate commerce.

With the new law, New York is taking an aggressive stance on the Quill ruling, claiming that a retailer such as Amazon holds a physical presence in the state because it derives sales through its affiliates who live there, explained Hugh Goodwin Jr., a state and local tax attorney and partner at the global firm DLA Piper.

As governors and legislators search for new sources of revenue, New York's move could become a model for other states, but Goodwin expects a legal challenge over whether Internet affiliates are enough to constitute physical presence within a state.

"Quill says what it says, and it says physical presence," Goodwin told InternetNews.com. "It is an aggressive posture by the states. The states have to expect that there's going to be some opposition to provisions that are coming really close to this definition. That's where the battleground is."

The law only applies to online retailers that collect at least $10,000 in annual revenue from affiliates who live in the state, but the requirement will be burdensome even for large companies, said Joe Henchman, tax counsel at the Tax Foundation, a tax-reform research group in Washington, D.C. There are more than 7,400 state and local tax codes in the United States, and retailers complain that complying with the nuances of each will entail considerable expense.

"States are becoming increasingly ambitious about collecting revenue from out-of-state companies," Henchman told InternetNews.com. While Shermin of the Retail Council praised the bill for levelling the playing field for online and traditional retailers, Henchman said it will have the opposite effect, and that a universal tax rate is the only fair solution.

"Brick-and-mortar retailers will have to keep track of just one tax law at a time, while online retailers will have to keep up with 7,400," he said. "A neutral tax system would have all retailers collect tax on one standard or the other."

There is an initiative to simplify the tax codes among states through national legislation, but critics charge that the Streamlined Sales Tax Project is mired in bureaucratic infighting among the member states, and that even if Congress passed legislation based on its recommendations, it the state and local tax codes would still be overly complex.

In its lobbying efforts, Amazon had professed support for the Streamlined project, of which New York is not a member.

Spitzer had introduced the idea in November in a memo from the Department of Tax and Finance, but rescinded it the same day as media outlets began reporting the controversial new policy.