Sales and Use Tax and Value Added Tax Pitfalls for E-Commerce Businesses
Sales and Use Tax and Value Added Tax Pitfalls for E-Commerce Businesses
COVID-19 has significantly disrupted the global economy, with e-commerce sales expected to reach more than $6.5 trillion by 2023. That’s more than double the $3.5 trillion spend from 2019. Given the continued growth of online sales, along with novel ways of trading via the internet, tax authorities in the U.S. and across the globe are taking steps to ensure e-commerce is appropriately taxed in their jurisdictions. One tax strategy that authorities have implemented is to impose sales/use tax and Value Added Tax (VAT) on online sales by deeming remote/non-resident vendors as having nexus in their certain jurisdictions.
When selling online to customers within the U.S. and internationally, e-commerce businesses should consider several sales/use tax and VAT issues:
Sales/Use Tax Implications for Non-U.S. and U.S. e-Commerce Businesses Selling to U.S. Customers
Sales and use taxation regimes are operated independently by each of the 50 states and the District of Columbia. Additionally, some states (such as Alabama, Alaska, Colorado and Louisiana) have local sales and use taxes that are administered by local municipalities and counties; these local-level taxes are governed by separate ordinances, they use their own tax forms and allow audits to be conducted by third-party contingency-fee firms.
A seller usually is responsible for charging sales tax at the time of the sale and remitting the tax to the state. A foreign company selling into the U.S. is subject to sales tax regimes to the extent the company has nexus with the state. Nexus can be established in a number of ways, including through a physical presence in or contact with the state (payroll, property, agents and inventory held under a “Fulfillment by Amazon” arrangement) or engaging in substantial sales that exceed economic thresholds, which some states introduced following the U.S. Supreme Court’s 2018 decision in the Wayfair case.
Digital goods and services
Approximately 25 states currently impose sales tax on digital goods and services. There are four general classifications that states use for taxing digital goods:
(1) Enumerated general products – Products delivered or accessed electronically (e.g., audio and audiovisual works, books, magazines, reports, photographs, greeting cards, etc.);
(2) Tangible personal property – Property that is seen, measured, touched or perceptible to the senses;
(3) Tangible functional equivalents – Products that are taxable when delivered in a physical form and, therefore, also taxable when delivered electronically (e.g., software, movies); and
(4) Services – Digital products classified as taxable services (e.g., cloud computing, software as a service, etc.).
If a digital product or service is subject to sales tax, the seller must determine how to source the sale of the digital product or service. The differing taxability and sourcing rules across states can create challenges whereby the same transaction may be legally taxed by two or more states. Sellers must perform a state-by-state analysis to determine the proper tax treatment of their digital products.
Online Sales of Goods in the U.S.
Any company with remote sales in the U.S., including a foreign company, must be mindful of economic nexus thresholds enacted by states post-Wayfair. Currently, 43 out of 45 states that impose a sales tax have economic nexus standards for sales and use tax, requiring remote sellers to register and remit sales tax if their activity exceeds a certain volume of sales (e.g., $100,000) and/or number of transactions (e.g., 200) generally measured within the past or current year. The complexity of compliance often depends on the company’s supply chain (i.e., direct sale to consumer (B2C) or wholesaler (B2B), type of purchaser (individual, business, government, nonprofit or other exempt entity), and whether the product is used in an exempt way by the purchaser (manufacturing, research and development, agricultural or pollution control)).
E-retailers likely established physical nexus prior to Wayfair for:
Having a remote workforce
Carrying out in person sales across state lines
Participating in trade shows
Storing inventory in warehouses or through the Fulfillment by Amazon program
Ignoring nexus rules can have unintended negative consequences, in particular, potentially disruptive sales tax exposures. E-retailers should quantify their historical exposures and consider mitigating historical liabilities by entering into a voluntary disclosure agreement with the relevant state(s) before registering for sales taxes.
Marketplace facilitator legislation, which has been enacted in more than 35 states, requires third-party entities, such as Amazon, to calculate, collect and remit sales tax on behalf of retailers that sell through the marketplace. Marketplace facilitators may not have as intimate knowledge of goods or services being sold as the retailers. This lack of familiarity may result in incorrect sales tax amounts being charged if the sales are not property accounted for or mapped to the correct taxability classification. The inability to collect the correct amount of tax is compounded by the fact that there is a lack of clarity around who should ultimately be responsible for the correct amount of sales tax collected and reported to the taxing agencies, whether it is the retailer or the company facilitating the sale. Marketplace facilitators also may not have the ability to determine whether an item was purchased by an exempt customer or have a mechanism in place to submit or collect exemption certificates. Companies should ensure that they maintain accurate records of how each sale is taxed and who has collected and/or reported the sales tax.
Compliance and Reporting
Although the U.S. Supreme Court anticipated that the Wayfair decision would not complicate the sales tax compliance function for many small and mid-sized businesses, the legislation and administrative guidance triggered by this decision had an opposite chilling effect. Today, 43 states have economic nexus for sales and use tax with varying safe harbor standards, compliance dates and tax rates ranging from 2.9% to over 12%. These state-level safe harbor provisions are in flux as states revise their gross revenue thresholds—some are increasing the threshold (e.g., California, New York and Oklahoma), others are decreasing it over time (Arizona), and other states are eliminating the transaction volume safe harbor (California, Iowa, Massachusetts, North Dakota and Washington) or introducing one (Ohio). States that do not levy a sales tax at the state level, such as Alaska, are permitting localities to enact Wayfair-like economic nexus laws.
If 43 separate tax rates seems daunting, consider 16,000, which is the ballpark number of state and local tax rates in effect at any time. Adding to this administrative nightmare, tax rates can change on a monthly basis, generating as many as 600 to 700 changes throughout the year. Companies across industries and of all sizes have to contend with the fallout resulting from Wayfair, but it has been particularly onerous for middle-market companies that often do not have internal processes, procedures and resources in place to address these challenges. For remote sellers that want to ensure they are in full compliance, there is justification for employing someone full-time to monitor administered sales and use tax laws. Many companies are resorting to automation to help manage sales taxes in multiple states.
VAT Implications for US-based e-Commerce Businesses Selling to Customers Overseas
Outside the U.S., companies that conduct business online must navigate VAT regimes that have been implemented in approximately 170 countries, many of which have implemented (or plan to implement) rules requiring remote vendors to register, collect and remit VAT. Similar to the U.S., with the exception of the European Union (at least conceptually), each VAT regime is implemented and operated independently. Therefore, companies carrying out business transactions online that have no control over where their customers are located are required to understand myriad definitions, approaches and interpretations to determine whether their business activities give rise to a VAT registration obligation (the VAT equivalent of nexus).
Digitalized Goods and Services: The sale of digitalized goods and services over the internet with minimal human interaction is generally considered electronically supplied services for VAT purposes. Almost 90 countries have introduced rules (or will soon do so) requiring nonresident vendors of electronically supplied services to register for, collect and remit VAT when providing electronically supplied services to customers that are established/resident in their jurisdiction. Many jurisdictions do not have a registration threshold, so a single transaction could trigger a VAT registration obligation. The failure of a U.S. business to proactively manage the VAT implications of its international activities could trigger VAT registration and reporting obligations in multiple countries as a result of providing electronically supplied services. Any business providing these services internationally should regularly perform a nexus study for VAT to identify where they are required to collect and remit VAT.
Online Sales of Goods from the United States (or Elsewhere): Historically, many countries allowed goods below a certain value to be imported without being subject to VAT. This enabled companies, such as Amazon and eBay, to ship goods across borders without collecting taxes. However, with the explosive growth of e-commerce and the perceived abuse of these relief measures, governments around the world, including Australia, New Zealand and Norway, have eliminated the VAT (or goods and sales tax) exemption for low value goods to increase tax revenues; similar rules will apply in the European Union and United Kingdom as from 2021). Vendors are now required to register for VAT and collect the tax at the point of sale. E-commerce businesses will need to continually review their international operations to ensure compliance.
Online marketplaces: With many e-commerce businesses trading via marketplace facilitators, it is often unclear which party is responsible for calculating, collecting and remitting VAT. Depending on the marketplace and country, the following may apply:
The marketplace calculates, collects and remits VAT;
The marketplace calculates and collects VAT, but the third-party seller is responsible for remitting and reporting VAT; or
The third-party seller is responsible for calculating, collecting and remitting VAT.
Where the third-party seller trades via multiple marketplaces, the situation can become very confusing. Since many countries impose joint and several liability for VAT on both the marketplace and third-party sellers, all third-party sellers should be carrying out their own reviews to ensure that the marketplace is correctly calculating, collecting and remitting VAT.
Compliance and Reporting: E-commerce activities create compliance and reporting obligations for businesses that can be challenging and burdensome. In addition to the requirement to file periodic VAT returns, e-commerce businesses must calculate VAT at the correct rate in the correct jurisdiction, which requires having processes in place to determine where consumption takes place. The rules vary by jurisdiction and often the billing address alone is insufficient. When assessing their VAT nexus footprint, businesses need to ensure they have identified and understand the place of consumption rules in each jurisdiction where they make sales.
Many tax authorities are prioritizing VAT compliance of e-commerce businesses and marketplaces. It is important for all e-commerce businesses selling internationally to comply with their VAT obligations in each jurisdiction where sales are made. Failure to comply with the VAT rules may have a significant financial impact if the business becomes liable for penalties, backdated payments, and, in extreme cases, criminal investigations and termination of seller accounts on marketplaces.
The continued shift toward the digital economy creates a wide range of tax implications that cut across both direct and indirect taxation. With the continued focus on the need to reform tax laws globally to adapt the rules to meet the challenges of the global economy (e.g. the OECD’s Pillar 1 and BEPS Action Plan projects), the taxation of the digital economy will come under increasing focus from tax authorities globally.
Considering many jurisdictions globally will be looking for additional sources of tax revenue to help cover the costs of COVID-19, it is likely that every tax jurisdiction will have a version of rules subjecting digital goods/e-commerce activities to taxation. This coupled with tax authorities taking more enforcement action will create additional burdens and risks for online businesses, due to having to interpret and comply with a multitude of different rules while also having to defend against sales/use tax and VAT demands.