Sales tax traps for e-retailers
In the U.S., sales and use taxation is governed by the 50 states and the District of Columbia. Companies making sales to customers in the U.S. are subject to sales tax regimes to the extent they have nexus with the relevant state. Nexus can be created either by having a physical presence (for example, payroll, property, including a building or inventory, or agents) or an economic presence in the state. In its landmark 2018 decision in South Dakota v. Wayfair, the U.S. Supreme Court (Court) overruled the long-standing principle that physical presence in a state was required for a remote seller to have sales tax compliance obligations in that state. The Court held that states may impose sales tax collection obligations on remote sellers whose sales exceed a monetary or transaction threshold (USD 100,000 or 200 separate transactions within the past or current year, respectively), without regard to physical presence of the business in the state. In the wake of the Wayfair decision, 43 U.S. states enacted economic nexus laws.
State sales tax exposure may arise even where an e-retailer does not have employees or office space in the U.S.. For example, an e-retailer can create physical presence nexus by placing its inventory in a third-party logistics (3PL) warehouse or through a marketplace facilitator fulfilment program (for example, Fulfilment by Amazon (FBA)). Even if the e-retailer does not own or lease the warehouse in which its inventory is stored, the e-retailer retains title to the inventory, and therefore holds property in the state where the inventory is stored. And as noted above, economic nexus can be triggered in a state based on the volume of sales or transactions conducted in the state.
Reporting requirements under marketplace facilitator laws
More than 40 U.S. states have marketplace facilitator laws that require facilitators to collect and remit sales tax on behalf of retailers selling through their platforms. However, there is a common misconception among e-retailers that marketplace facilitators always collected sales tax on their behalf.
E-retailers using a third-party fulfilment network likely established physical presence nexus in states before they had an economic nexus with the state. Further, in approximately 27 states, the marketplace facilitator laws have later effective dates than economic nexus laws. As a result, there may be a gap between the time an e-retailer first established nexus with a state and the time the marketplace facilitator collection requirements took effect. In many states, the e-retailers, not the marketplace facilitators, are ultimately responsible for the accuracy of the sales tax collection and reporting due to nexus created through a third-party fulfilment network and during the gap between effective dates.
U.S. states are auditing remote sellers more aggressively and asserting nexus on businesses that held inventory in the state (in other words, physical presence) during pre-Wayfair periods. States can obtain 3PL and other warehouse data through individual tax audits and they routinely monitor marketplace facilitator and 3PL organizations’ websites to determine which companies have utilized these services.
Further, if a company had nexus with a state, but never filed a sales tax return, the statute of limitations to audit the company’s sales taxes remains open. This allows taxing jurisdictions to issue notices of assessments up to the time when the company initially had nexus with the state.
Action steps for e-retailers
Given the nuances around nexus and sales tax collection, companies that sell to U.S. customers should be vigilant in determining whether they are responsible for any sales tax that was uncollected before marketplace facilitator laws were enacted, which shifted the responsibility to, or shared the responsibility with, a third-party platform.
E-retailers that have nexus with a state should quantify their historical exposures and consider mitigating historical liabilities through voluntary disclosure agreements (VDAs) before registering with the state for sales tax. Participation in VDAs generally reduces the lookback period to three to four years and provides for an abatement of penalties.
Although there are many opportunities for businesses to sell products to U.S. consumers through online marketplaces, e-retailers should be cognizant of the possibility that they may create nexus with a state and thus have compliance obligations. The lack of uniformity across the states that impose sales tax has the potential to give rise to significant challenges when discerning the what, where, and when of state taxation for e-retailers.