By Jim Ford, Managing Director, Sales & Use Tax Compliance, Global Tax Management
If you have been tracking US Sales and Tax over the last few years you may have heard about the Wayfair case and its impact on US sales and use tax. In order to understand Wayfair, we wanted to give a quick overview of U.S Sales and Use Tax and insight on some of the areas you’ll need to focus on when doing business in the U.S.
In Europe you are most familiar with VAT Taxes. Although both Sales and Use Tax and VAT Tax are both indirect taxes, the implementation of the two taxes is very different. We’ll discuss how Sales Tax is implemented and highlight some of the differences between U.S. Sales and Use and Traditional European VAT Tax.
What’s the Difference Between U.S. SUT and VAT?
The Value Added Tax is a form of indirect tax that is imposed at different stages of production on goods and services. Sales and Use (Often refer to collectively as “Sales Tax”) is only imposed on the end user of the goods or services. So unlike VAT Tax, we try to impose sales tax at the very last sale, the sale to the ultimate user of the goods and services. The idea is the tax is due at first “use” of the goods or services, not when it goes from one stage or production to the next.
Since sales tax is imposed only once, there is no concept of input tax credits, nor do we take credit for sales tax paid on items procured. Since conceptually, the end use should only pay the sales tax, items purchased that later became resold goods or materials, including raw material used in production of new goods are purchased tax exempt using either prescribed manufacturing exemptions in the state of production or via resale exemptions.
There is no federal sales and use tax in the United States. Although many proposals have been put forth over the years, no form of federal sales tax or VAT tax has ever taken hold in the US. Sales and Use Taxes are implemented at the state level in the U.S. Taxes can be imposed at multiple levels within the state (state, county, city and potentially defined taxing districts).
There are certain sales taxes that can be implemented below the state level in the US. If you do business in the states of Alabama, Colorado, Louisiana or Alaska or Puerto Rico; you may also be subject to city or county taxes that are administered by the local authority, not the state itself.
Since taxes are administered at a state level, tax rates and taxability of goods and services vary from state to state. Although there are some common themes, each state (and sometimes locality) has the right to impose tax on different goods or services depending on their adopted laws. There are still four states: Delaware, Montana, New Hampshire and Alaska that have no sales tax at the state level (AK and MT do have some taxes administered locally).
In the US states generally try to tax the sales of Tangible Personal Property and certain enumerated services. Exemptions for personal use goods, medical devices, prescription drugs, and professional services are common in the states, but rules vary state by state. In certain cases, in lieu of an exemption a reduced rate may exist for certain goods and services. Many states have broad based manufacturing exemptions that allow for the purchase of goods used in the manufacturing process at reduced or nil rates, but again the rules vary from state to state; so you must check locally before you assume an exemption exists.
Since sales taxes are administered state by state, we always have the question of where to charge the tax, ergo which locality’s rules apply to a sale. Generally, we use the “ship to” address as the situs for where to charge the tax. In order to determine whether a business is required to register and collect a jurisdiction’s tax, we used the “physical presence standard;” which was put into place via case law in the 1990’s. The predominate theory was that physical presence would be required to trigger nexus or taxable presence in a particular jurisdiction. So remote sales were not deemed sufficient to establish nexus and therefore not sufficient to compel a business to register and collect a jurisdiction’s sales tax.
This question of Nexus or taxable presence is what the fuss has been about the last few years. As internet sales became more dominant in the marketplace and sellers no longer had to meet with their customers face to face, more and more businesses were outside the requirements and therefore states revenues suffered. Brick and mortar stores were at a disadvantage and states began to look for new ways to implement requirements on remote sellers.
The Supreme court decision overturned Quill Corp. v. North Dakota (1992), which had held that the Commerce Clause of the US Constitution barred states from compelling retailers to collect sales or use taxes in connection with mail order or Internet sales made to their residents unless those retailers have a physical presence in the taxing state.
It’s all about Nexus
Economic nexus, marketplace nexus, reporting requirements, affiliate nexus, click thru nexus … These are all new terms we’ve added to the indirect tax lexicon over the last few years. The states have now moved towards a more “economic” based nexus model that attempts to identify those businesses gaining a benefit from the states’ markets and subsequently force them to collect and remit their state and local taxes.
As states’ sales tax revenues declined due to remote sales, they reacted with more aggressive enforcement and auditing of existing taxpayers and policy changes that sought to increase the taxable base. The concept of sales reporting and notification requirements was introduced in Colorado to potentially identify untaxed sales and compel the purchasers to self asses the use tax.
Seven states implemented reporting requirements before Wayfair. More states announced immediately after the decision that they would also enact reporting requirements. Reporting requirements don’t require businesses to officially register to collect the state sales tax; rather, they establish thresholds for annual reporting that would be required in lieu of collecting. Reports may have to be sent to customers indicating the total amount of tax-free purchases they made. Those same reports may also have to be sent to state taxing authorities.
After Wayfair, states that were on constitutionally shaky ground are now firmly justified and these requirements may have already been implemented. This is one of the first important areas to address post-Wayfair. Those responsible for sales tax collection and remittance should ask themselves:
- Does my business operate in one of the states that have already implemented reporting requirements?
- Are there more states enacting changes that take effect in the fourth quarter that I need to worry about?
- What type of data do I need to report to my customers and taxing authorities?
Reporting requirements could have a multitude of effects. Obviously, customers who have not been self-assessing use tax might take a second look at their purchases and their procedures knowing that their vendors are now required to report to taking authorities. Our clients are primarily large corporations, and we have seen some of these companies compel their vendors to collect the state’s tax. Don’t be surprised if some customers request that you charge sales tax going forward. It may be a requirement for their continued business.
Once a business has decided that it is going to collect these taxes, it needs to look at requirements to do business in the state. Registration is usually a simple process but may vary by state. A business has the option of registering centrally, but if it does so, it may be automatically registered for all states that participate in the program. Be prepared to provide some personal information for owners or officers. This seems simple enough, but the scrutiny over the security of personal data could make this a challenge.
When contemplating registration, businesses should consider what approach makes sense. Many of our clients are evaluating the possibility of registering everywhere versus rolling out registrations over time. Registration — if a company is not doing business in a state — can be outsourced. Otherwise it can easily consume in-house resources, considering the secretary of state registrations that may be required, individual sales tax registrations that must be completed, the litany of follow-up questionnaires and forms to validate, and ensuring that the business is not subject to the other state taxes. Businesses should also consider what to do about states with home rule reporting of local taxes. Most local sales and use taxes are collected at the state level, but there are more and more local taxing authorities popping up every year. Home rule jurisdictions require separate registrations for local taxes and may also require separate return filing.
If a business has only operated in a few states or has been based in a single state, it may need to consider how to calculate sales and use taxes for other states where registration is required. Just because a company is compelled to register does not mean it should collect the tax. Sales for resale, sales to exempt organizations, and sales of products or services that are generally not taxable will not change when these laws are sorted out — this is just a question of nexus. If a company determines it needs to collect the tax, and its products and customers are taxable in that state, it must decide how to apply these taxes to its invoices. The application of tax is a real-time exercise, and this is a project that involves a lot of stakeholders. Company employees will be dealing with accounts receivable, accounting, tax, and information technology, so consider that in the implementation plan. Any process that touches invoices will need to be thoroughly tested, so businesses should not take this exercise lightly. The following table shows three potential solutions.
Monthly Sales and Use Tax Compliance
Once a company is registered, it must file returns. Even if its sales will not be taxable, the business will still be required to file returns at the prescribed frequency. Sales taxes follow a monthly cycle and are trust fund taxes that must be remitted to the taxing authorities — generally in the month following the end of the tax period. However, there are less frequent filing requirements. Many states have quarterly reporting and others have annual and semiannual reporting options. Filing frequency is usually determined based on average tax liability or average gross sales — but this can vary by state. If businesses are unsure, they should estimate low when registering. States reevaluate frequencies each year, so once a fact pattern is established, the taxing authorities will notify the company if it needs to change.
Be prepared to make these filings and payments electronically, which is both a blessing and a curse. Thresholds for mandatory electronic payment are low in many states, and many states have eliminated paper returns and have no threshold for requiring electronic transmission of returns.
Because they will file 12 times a year, businesses should use automation when they can. General account reconciliations, payments, and return filing data preparation all must be done monthly. In the sales tax world, businesses are often dealing with large data files that can be unwieldy. They should build an end-to-end process that leverages automation whenever they can.
In the old paradigm, a distributor would only register where it had physical locations. Distributors are generally exempt from sales tax collection because their sales are for resale. Wayfair is not going to change that. If a company’s sales are for resale, it may be compelled to register, but not necessarily collect the state tax. It will, however, have documentation requirements under the new regime. The burden of collecting and maintaining exemption documentation is on the seller. Although it may not have a sales tax collection burden, if it is required to register, it must maintain exemption documentation to assure that during an audit, those sales are not deemed taxable and included in its assessment.
Businesses should consider automation in this area as well. The burden of collecting and validating certificates is not an easy one — it’s an ongoing process. New customers must be set up and documentation will need to be received and maintained. In addition, many states have mandated that certificates expire either annually or every two years, so this is a process that will require maintenance.
The other issue is that this task usually must be shared between two groups. Tax does not want to be involved in accounts receivable operations or setting up new customers — nor should it be. Here again is where automation can help, as the company may be able to develop a workflow that includes a tax review but does not hold up the process for new customers and invoicing.
When a business registers to collect sales and use taxes, there may be other implications to consider. Does the company distribute free goods or samples? Are there other items that, once registered, will create a use tax obligation? Are there promotional materials that are sent to states? Before registration, this may not have been an issue as the company did not have nexus. But if Wayfair requires registration, businesses should also consider some of these business activities that may have been in place for years. Are there business practices that, prior to any changes in state sales tax nexus rules, would have been cost neutral but now are cost creating? Companies must consider how these changes can affect business outside of just sales and purchasing.
Businesses should start considering the potential changes and their effects. Sales and use taxes are indirect taxes, that if passed on to customers minimize the impact to the bottom line. If a business doesn’t properly implement or consider these issues, it becomes liable during audit.
Other References from GTM on the Wayfair Topic:
How to Execute Post-Wayfair Tax Calculations
Navigating the Post-Wayfair World