A story titled Appeals court: Borders must pay Calif. tax on online sales may be the straw that breaks the camel’s back in the controversy over collecting sales tax on internet purchases. Businesses can avoid paying sales taxes to states where they have no physical presence, according to a 1992 U.S. Supreme Court ruling. Borders books online division has no physical presence in California and as such has decided not to charge tax in California.

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.

"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 in San Francisco 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.

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."

Whether this is an isolated incident focusing on Borders or this is an indication that states will be trying o get the rest of the $15.5 billion being lost each year is unclear. It seems that for now the states are going after the low hanging fruit, the companies with some indirect physical location in their state. We will see how this story unfolds over time.