updated 6/13/2005 8:39:36 PM ET 2005-06-14T00:39:36

A little-noticed appellate court ruling against Borders Group Inc. sets a precedent that could enable California to force some major Internet retailers to start paying state sales tax for books, music and other goods sold online to state residents, analysts said Monday.

Whether California tax collectors use the precedent to go after not only Borders but Barnes & Noble Inc., Amazon.com and other online retailers remains to be seen. But independent booksellers and other "bricks-and-mortar" retailers have been cheering, saying the ruling should remove their Internet competition's unfair advantage.

"There are a lot of online retailers who are watching this intently," said Tom Dressler, a spokesman for the state Attorney General's office. "Clearly online retailing is growing so one would think the potential revenue problem is fairly substantial."

Businesses can avoid paying sales taxes to states where they have no physical presence, according to a 1992 U.S. Supreme Court ruling.

Borders Group Inc. says it has never collected sales tax for books and music sold over the Internet to California residents, even though the Ann Arbor, Mich.-based corporate parent operates 129 California stores under the Borders and Waldenbooks brands, as well as a 414,000-square-foot distribution center in the state.

Borders says it doesn't have to collect California sales taxes because its online division — since outsourced to Amazon.com — doesn't own or lease property in the state. None of the online division's employees or bank accounts are in California and all Internet orders were received and processed outside the state.

"We've done everything within the confines of the tax law. We have always believed that what they did was correct under the Constitution," said Borders lawyer Scott Brandman.

California's 1st District Court of Appeal rejected that argument, ruling on May 31 that the Borders' Web site and retail stores have been too intertwined to call themselves separate companies. The three-judge panel cited in-store advertising for the Web site, receipts that said "Visit us online at www.borders.com" and the ability of customers to return online merchandise at retail stores.

The judges also noted that the companies had board members in common and shared a similar logo.

"All the while, Borders and Online were involved in cross-promotional activities, promoting the Borders 'brand,'" Judge Maria P. Rivera wrote. "We conclude that the imposition of a use tax on Online during the entire disputed period does not violate the commerce clause of the United States Constitution."

Michael Mazerov, senior fellow at the liberal Center on Budget and Policy Priorities in Washington D.C., said the case "suggests that having somebody in the state conducting activities that facilitate your out-of-state sales creates your obligation to charge sales tax."

The decision could lead to similar rulings by the State Board of Equalization against Delaware-based Barnes and Noble and maybe even Washington-based Amazon.com, which handles online sales for Borders and other bricks-and-mortar affiliates, paying them a cut of the profits, said Lenny Goldberg, executive director of the California Tax Reform Association.

"Any business in California is going to have to collect from their online subsidiary," said Goldberg, who also lobbies for the Northern California Independent Bookseller's Association. "It certainly potentially allows the board to make a case that Amazon has agents and affiliates in California."

A state audit of more than $1.5 million in sales by Borders Online between April 1, 1998 and Sept. 30, 1999 found the company owed more than $167,000 in taxes. The company paid up, then asked for a refund. The board denied the request and Borders Online sued, losing in a lower court as well. Borders hasn't decided whether to appeal to the California Supreme Court.

Neither Dressler nor Anita Gore, a spokeswoman for the tax collection agency, would comment on what the state will do next.

States and local governments have lost $15.5 billion in sales tax revenues because of Internet sales, according to conservative estimates by researchers at the University of Tennessee. The loss is projected to increase to $21.5 billion by 2008 as e-commerce continues to grow.

Borders is also fighting online sales tax disputes in Nevada and Illinois, according to documents filed with the Securities and Exchange Commission, and has warned that profits might drop if it's forced to pay taxes on its past online sales. But the company said any adverse rulings won't affect its ability to pay its bills or undermine its financial strength. Borders earned $131.9 million on sales of $3.9 billion last year.

"The notion that these were separate companies was nothing more than a tax dodge," said Oren Teicher, chief operating officer for the American Booksellers Association, a Tarrytown, N.Y.-based nonprofit organization of independently owned bookstores. "We just think everyone ought to be treated the same."

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