Tax Bite Imperils Amazon

Its richly valued shares could be at risk from an attempt to expand online sales taxes.
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Wall Street may be on board, but it's Washington, D.C., that could hold pitfalls for

Amazon.com

(AMZN) - Get Report

.

Shares of the Web retailer have soared 60% to $71.17 since it

announced a blowout quarter in April. But investors piling into the stock should be aware that the company -- and its stock -- could be facing new legislative headwinds.

A new piece of legislation seeks to have online retailers collect state sales taxes from certain customers. The companies have avoided paying these taxes until now, allowing them to pass along the discounts to their customers.

And while legislation to have online retailers collect these taxes isn't entirely new, recent events have boosted the chances that the bill becomes law this time around.

That could introduce an unexpected hitch for a retailing giant such as Amazon, which trades at a lofty valuation of 55.6 times forward 12-month earnings.

Google

(GOOG) - Get Report

shares, by comparison, trade at a P/E ratio of 26.5, while

Apple

(AAPL) - Get Report

trades at 29.7.

On May 22, Sen. Mike Enzi of Wyoming introduced new legislation that would make big e-commerce players like Amazon collect additional sales tax. Existing laws allow Web retailers to avoid paying taxes in states where they don't have a physical presence, even though they do business with residents of such states.

The value of the tax statute has not been lost on Amazon, which scaled back its distribution centers by nearly half since it was first founded.

But with record numbers of customers flocking to make purchases online, states are deprived of revenue they badly need to fund civic projects, argues Enzi. "Main Street retailers collect sales taxes, while many online and catalog retailers are exempt from collecting the same taxes," a press release outlining the bill said. "This is costing states and localities billions in lost revenue."

And while the revenue of online retailers such as Amazon grows fat, reasons for not paying state taxes are wearing thin. So far, Web retailers have successfully argued that the burden of having to account for the thousands of local tax statues is too cumbersome.

But in 2005, a group of 15 states banded together and enacted the Streamlined Sales and Use Tax Agreement, which created a simpler tax policy and made it less of a hassle for online retailers to collect taxes from customers in these states. The agreement also set the stage for Enzi's provision.

"Now that the agreement is in effect, the states are looking to Congress to enact legislation requiring remote sellers to collect the tax," says attorney Andrew Feiner of the New York law firm Andrews Kurth.

With Congress in Democratic control, and with states finally having banded together, the odds of a law being enacted may be greater now than ever.

"The consensus in the industry is that this is not a matter of if, but a matter of when," says Cowen analyst Jim Friedman.

And Amazon could have more at stake than any other retailer if the legislation passes.

The sheer volume of its sales -- Amazon had revenue of $11.5 billion in 2006 -- would make it more exposed to any new tax requirements than other companies.

Amazon also has gone to great lengths to keep this already large top line growing fast. And the company may absorb some of the cost rather than pass it off to customers entirely, says Paul Misener, Amazon's vice president of global public policy.

"We could share some of the costs because you can't pass them off entirely since there is the law of supply and demand," Misener says. "If prices go up, then demand goes down, and that would mean sales and revenue could go down."

But that could put pressure on Amazon's already thin profit margins. And the alternative -- raising prices for customers -- also could prove perilous by taking a toll on sales.

The legislation also could give the ever-expanding list of smaller sellers on the Internet an advantage over giants such as Amazon. Provisions in the bill exempt sellers with less than $5 million in sales the prior year from having to collect taxes, for example.

That means even a giant such as rival

eBay

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, which sees many small sellers list their products in its platform, could gain a relative advantage. "That's why we have said there should be a fair application of this collection requirement," says Misener. "If people are truly concerned about fire engines and schools at a local level, a company like eBay should not be able to hide behind these kinds of exceptions."

Still, Misener says that despite progress by participating states, tax laws remain too unwieldy, and he doesn't expect the bill to pass. And beyond any partisan considerations, the bill may be held in check because neither party would want to pass legislation that seems like a tax increase before the presidential election next year.

"It could be another five or six years before anything really happens," he says.

But for investors in a stock such as Amazon, which trades at six-year highs, the impending legislation should be enough to give pause.