On June 21, 2018, the U.S. Supreme Court issued its decision in South Dakota v. Wayfair Inc., overturning the long-standing “physical presence” nexus standard established through Quill Corp. v. North Dakota. The result of the decision is that the states may impose sales and use tax collection and remittance responsibilities on remote sellers based solely on their economic presence in a state — even if the seller has no physical presence there. As of August, almost all the states that impose a statewide general sales tax have adopted some form of economic sales tax nexus through new statutes, regulations, or policy. Most of the states’ economic nexus thresholds are based on total sales or number of transactions into a state — for example, $100,000 in sales or 200 separate transactions in one year — although these standards vary among the states.
Importantly, this decision not only affects U.S. domestic entities, but also foreign entities making sales into the United States, and new collection, remittance, and reporting requirements may arise for inbound businesses that have not had such a responsibility in the past. Accordingly, all inbound businesses should evaluate the impact of Wayfair on their U.S. business activities. Below are five common misconceptions of how Wayfair may affect an inbound business.
Misconception: Wayfair does not apply to my inbound transactions because my country has tax treaty protection with the United States.
Reality: While some states may recognize treaty protections for income tax purposes, those protections do not extend to state and local sales and use taxes.
Forty-five states and the District of Columbia, as well as nearly 10,000 local jurisdictions, impose sales and use taxes. State and local tax nexus is often addressed in the context of analyzing what a company does and determining where in the United States the company could arguably have established sufficient contacts for it to be required to file returns. Simply stated, nexus describes the degree of business activity that must be present before a state taxing jurisdiction has the right to impose a tax.
For foreign businesses, sales tax nexus was historically a concern if the business established a physical presence in the United States through, for example, offices, warehouses, inventory, salespeople, or employees. In the post-Wayfair world, foreign-based remote sellers are no longer protected by the physical presence safe harbor.
U.S. state and local sales and use taxes, and often other state-imposed taxes, generally apply regardless of whether a federal tax treaty exists or a business has a permanent establishment in the United States. Foreign sellers may be subject to state and local sales and use tax registration, collection and remittance, and filing obligations based solely on the volume of sales or number of transactions made in the United States.
Misconception: My services business does not have to respond to Wayfair because the decision only applies to businesses selling tangible personal property.
Reality: Service providers may also be subject to a state and local sales and use tax compliance obligation.
After Wayfair, news and media seemed to suggest that the decision applied only to internet retailers selling televisions, furniture, or exercise equipment, but that’s far from the case. The Court’s decision affects all remote sellers, including businesses providing strictly services, such as business and professional services or cloud computing and other internet-related services.
Not all states treat services alike. Although most states impose a sales tax on the sale of tangible personal property and on specified enumerated services, at least seven states impose a sales tax on broad categories of services. If a service provider establishes sales tax nexus under a state’s economic presence thresholds, the provider will need to determine taxability in that state under its sales tax regime. Accordingly, if a business meets the economic nexus standards in a state, registration, filing, or other compliance obligations may be necessary, even if the business’s services are nontaxable in that state.
Additionally, inbound businesses may have difficulty properly sourcing the location of a transaction. Determining what state may tax a transaction may require analysis of conflicting and often overlapping sourcing rules, especially if a service is provided in one state but the benefit of the service is received in another state.
When multistate digital goods and services are involved, some states look at first use to determine sales and use tax obligations, while others look at a percentage of use or percentage of licenses in the state. Successfully navigating state and local sales and use tax sourcing provisions may not be as simple as using the invoice’s billing location. Planning, structuring, and communicating with your U.S. customers can help mitigate sales and use tax liability in multiple jurisdictions on the same transaction.
Misconception: My sales are exempt because they are resold or used in an exempt manner.
Reality: Distributors, wholesalers, resellers, and businesses making other exempt sales may still have a compliance obligation, even if no sales and use tax is due. State economic sales tax nexus provisions typically do not address whether the sales thresholds include nontaxable or exempt sales for purposes of determining whether a nexus
threshold has been exceeded. Some states have provided guidance confirming that resellers will not have to register, while sellers making other types of exempt sales may still need to register.
Until the states provide guidance on the inclusion of nontaxable sales, distributors, wholesalers, and sellers of generally exempt goods and services should consider collecting resale or exemption certificates on qualifying sales. Also, those businesses may have a registration and filing compliance requirement even if no sales tax is due on the transaction — potentially creating a complicated landscape of new administrative burdens and challenges for foreign tax departments.
Misconception: My business does not have any sales and use tax issues and therefore Wayfair does not affect any of my U.S. state and local tax obligations.
Reality: The Court’s analysis of state nexus under the commerce clause of the U.S. Constitution applies to all state taxes, including income, franchise, and gross receipts taxes.
Wayfair addressed whether a state can require an out-of-state seller to collect sales and use tax when the seller lacks a physical presence in that state. However, the Court’s analysis in determining whether a state tax nexus law is constitutional under the commerce clause applies to all state taxes. Under this new jurisprudence, states may begin to consider economic activity tests for non-sales and use tax nexus, like existing income tax factor-presence standards already adopted in several states.
In mid-2019 Hawaii became the first state to adopt an economic income tax nexus standard for businesses without a physical presence in the state, based on a sales and transaction threshold. The standard is identical to the state’s sales and use tax economic sales tax nexus standard.
It is anticipated that other states will follow Hawaii’s lead and adopt similar standards for income tax purposes. For example, the Texas comptroller has released proposed regulations establishing an economic threshold for the state’s franchise tax applicable to returns due on or after Jan. 1, 2020. Locally, Philadelphia adopted a $100,000 economic nexus threshold for the city’s business income and receipts tax, and San Francisco adopted a $500,000 sales threshold for several city taxes including the gross receipts tax — both effective in 2019.
Remote businesses should consider that P.L. 86-272 — the federal safe harbor prohibiting a state from imposing a net income tax on a seller’s business activity if it is limited to the solicitation of orders for sales of tangible personal property — may apply. Wayfair did not modify P.L. 86-272 protections.
Misconception: My inbound business will not be contacted by state and local taxing authorities, so I have no need to respond to Wayfair.
Reality: Now is the time to act.
The enforceability of economic sales tax nexus provisions on foreign businesses with no U.S. presence is an unsettled area of state and local nexus law.
There is a significant difference between a legal liability (technically exceeding a state’s threshold) and the enforceability of that liability (enforcing compliance). With Wayfair and subsequent adoption of economic nexus standards for sales tax purposes by most states, there is clearly a legal responsibility for remote sellers, wherever located, to collect and remit the sales tax due on sales to in-state customers, and, where they do not, there is a legal liability for the uncollected tax on the remote seller.
When the tax is not paid by the seller or the customer, there are potentially significant impacts for financial statement purposes, and there may be long-term consequences regarding the alienability of the entire business to U.S.-based or U.S.-present purchasers, future investment in the United States, and freedom of movement and investment of executives, board members, and owners in the United States. This is because the sales tax, as a trust tax, carries with it broad successor and personal liability powers.
Inbound businesses should consider having a conversation with their U.S. state and local tax advisers to determine what action, if any, should be taken in response to economic sales tax nexus. A foreign inbound business may consider the following steps as an example of how some businesses may want to address and prepare for these new nexus standards:
- Identify and quantify: Review and quantify where economic sales tax nexus has been established by considering the dollar amount and number of transactions made to each state, the effective dates of the nexus provisions, the taxability of the property or services sold, availability of exemptions, and the tax rates of each jurisdiction.
- Determine readiness: Evaluate processes and systems necessary to comply with U.S. state and local sales tax nexus provisions. Does the business have a technological solution or enterprise resource planning available to help automate the tax collection and remittance process?
- Choose an optimal path to compliance: Consider limiting exposure through tax planning and mitigation strategies, adopt reserves as necessary, and stay up to date on frequent changes in state nexus provisions.
Inbound businesses should avoid a wait-and-see approach to the new regime of state and local sales and use tax nexus provisions, as nearly every state adopted an economic sales tax nexus provision within the first year of the Wayfair decision.