Amazon.com (NAS: AMZN) is slowly losing its battle against taxes, or so it would have you think. The e-tailer waved the white flag on Friday after reaching another agreement, this time with the state of Texas, to collect sales tax starting on July 1. Not long ago, Amazon would stop at nothing to avoid taxing customers on their purchases. The Seattle-based company even shut down a warehouse in Irving, Texas, last year when the state demanded $269 million in unpaid taxes.
However, there is more to Amazon's tax evasion than meets the eye.
The great debate
According to a 1992 Supreme Court decision, Amazon and other Internet-based retailers are free from collecting taxes in states where they don't have warehouses or physical storefronts. While this may not have made a huge difference at the time, today an increasing number of people are shopping online. In fact, states will lose an estimated $23 billion in unpaid taxes this year.
When the law was passed, Amazon.com was but a twinkle in founder and CEO Jeff Bezos' eyes. But today, Amazon is the world's largest online retailer -- accounting for about 20% of all online retail sales. The company reported first-quarter earnings last week that crushed Wall Street's estimates, with sales climbing 34% to $13.2 billion in the period. That's up from sales of $9.86 billion in 2011. Meanwhile, earnings per share of $0.28 were ahead of analyst expectations for just $0.07 a share.
Clearly, Amazon knows how to generate sales. So why does the company insist on avoiding the taxman? Amazon's opposition to tax collection is part of its plan to offer the lowest prices possible. But this strategy is putting the heat on local brick-and-mortar businesses whose stores are being used for comparison-shopping. More and more customers are visiting physical stores like Target (NYS: TGT) and Best Buy (NYS: BBY) to interact with the products and often make purchases elsewhere online. Even retail juggernaut Wal-Mart (NYS: WMT) hasn't been immune to the effects. The convenience of buying online coupled with soft consumer spending the past few years resulted in retreating same-store sales.
An unfair advantage
With Amazon's speedy and frequently free shipping, it makes the sense for many consumers to shop this way. Best Buy's reluctance to address the problem of "showrooming" has left the company battered and bruised. At least Target took action: The bull's-eye retailer hopes to work with its vendors to offer exclusive items that can be purchased only in the chain's physical stores.
While this issue is still largely unresolved on a national level, Amazon is slowly letting go of its long-held hostility toward charging tax in states where it operates fulfillment centers.
On second thought
Under its new agreement with Texas, Amazon will begin collecting 6.25% sales tax on residents' online purchases beginning on July 1. The company also promised to create 2,500 new jobs in the Lone Star state and dedicate $200 million in capital investments. As a result of Amazon's newfound willingness to level the playing field, Texas will forgive the $269 million it says Amazon owes in back taxes.
I'm not sure this marks another round lost in a state-by-state fight against charging sales tax as much as it highlights a fundamental shift in Amazon's overall growth strategy. According to The Wall Street Journal, these new facilities will enable the company to speed up shipping times and reduce costs to its customers.
The Journal also indicates that a majority of Amazon's growth comes from its Prime service. Amazon Prime is the retailer's gateway drug. It entices customers to spend more (and more frequently) by offering free two-day shipping on an unlimited number of deliveries for just $79 a year. As a Prime member myself, I can attest to its addictive qualities. The program has been a drain on Amazon's income statement, but as the company builds new facilities and fulfillment centers across the country, it lowers the cost of operating Amazon Prime.
Texas now joins Kansas, Kentucky, New York, North Dakota, and Washington as the sixth state in which Amazon has agreed to collect sales tax. The company's new tax strategy will expand to include seven more states by 2016.
Your takeaway prize
As a customer, you may lose out on tax-free purchases in the future, but I think this does far more good for local economies. For investors, more distribution centers in more states will mean greater cost savings for Amazon as the online retailer benefits from economies of scale.
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At the time this article was published Fool contributor Tamara Rutter owns shares of Amazon.com and Target. Follow her on Twitter, where she uses the handle @TamaraRutter, for more Foolish insight and investing advice. The Motley Fool owns shares of Best Buy and Amazon.com. Motley Fool newsletter services have recommended buying shares of Amazon.com. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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