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 USD 6.5 trillion by 2023. That’s more than double the USD 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 striving to ensure e-commerce is appropriately taxed in their jurisdictions. One tax strategy 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, there are several sales/use tax and VAT issues e-commerce businesses should consider.
Sales/Use Tax implications for non-U.S. and U.S. e-commerce businesses selling to U.S. customers
Sales and use taxation is operated independently by each of the 50 states and the District of Columbia. Additionally, some local sales and use taxes are administered by local municipalities and counties with their own ordinances, separate tax forms, and audits that may be conducted by third-party contingency-fee firms. States that have locally administered general sales and use taxes include Alabama, Alaska, Colorado, and Louisiana. Sales tax is usually the responsibility of the seller to charge at the time of the sale and remit to the state. Foreign companies selling into the U.S. are subject to sales tax regimes to the extent there is nexus with the state, which can be established, among other ways, through a physical contact with the state (payroll, property, agents, and inventory held under the Fulfillment by Amazon arrangement) or substantial sales exceeding economic thresholds enacted in light of the Wayfair decision.
Digital goods and services
Approximately 25 states currently impose sales tax on digital goods and services. There are four general classifications states employ in taxation of digital goods:
- Enumerated general products – Products delivered or accessed electronically (for example, audio works, audiovisual works, books, magazines, reports, photographs and greeting cards, and so on)
- Tangible personal property – Property that is seen, measured, touched, or perceptible to the senses
- Tangible functional equivalents – Products that are taxable when delivered in a physical form and therefore also taxable when delivered electronically (for example, software, movies)
- Services – Digital product classified as taxable services (for example, cloud computing, software as a service)
If a digital product or service is subject to sales tax, sellers need to determine how to source the sale of that digital good or service. The varying 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. today, including foreign companies, 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 is above a certain volume of sales (for example, USD 100,000) and/or transactions (for example, 200) generally measured within the past or current year. The complexity of compliance, as noted further below, often depends on the company’s supply chain (in other words, 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:
- Remote workforce
- Sales across state lines in person
- Tradeshow participation
- Inventory held in warehouses or through the Fulfillment by Amazon program
Years of nexus neglect can lead to disruptive sales tax exposures. It is prudent for retailers to quantify their historical exposures and consider mitigating historical liabilities through voluntary disclosure agreements (VDAs) before registering for sales taxes.
Marketplace facilitator laws, enacted in more than 35 states, require third-party entities, such as Amazon, to collect and remit sales tax on behalf of retailers selling 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 charged if the sales are not property accounted for or mapped to the correct taxability classification. Inability to collect the correct amount of tax is compounded by the fact that there is lack of clarity around who should ultimately be responsible for the correct amount of sales taxes collected and reported to the taxing agencies, whether it’s the retailer or the company facilitating the sale. Additionally, marketplace facilitators may not have the ability to determine whether an item was purchased by an exempt customer or have a mechanism to submit or collect exemption certificates. Thus, it is imperative that companies maintain accurate records of how each sale is taxed and who has collected and/or reported the sales tax.
Compliance and reporting
While it was anticipated by the U.S. Supreme Court 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 ruling 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 varying 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 (for example, California, New York, and Oklahoma), others are decreasing it over time (Arizona), and other states are removing the transaction volume safe harbor (California, Iowa, Massachusetts, North Dakota, and Washington) or implementing one (Ohio). States without sales tax on the state level, such as Alaska, are permitting localities to enact Wayfair-like economic nexus laws.
If 43 separate tax rates sound like a lot, consider 16,000—that’s 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 existing internal processes, procedures, and resources in place to address these challenges. For remote sellers that want to be in full compliance, there is justification to employ someone full-time to monitor administered sales and use tax laws. Many companies are focusing on automation to help manage sales taxes in multiple states.
VAT implications for US-based e-commerce businesses selling to customers overseas
Digitalised Goods and Services: The sale of digitalised goods and services over the internet with minimal human interaction are electronically supplied services for VAT purposes. Almost 90 countries have implemented rules (or will soon do so) requiring non-resident 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. Where a U.S. business has not proactively managed the VAT implications of their international activities, they could trigger VAT registration and reporting obligations in multiple countries as a result of providing electronically supplied services. Any business providing electronically supplied 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 U.S. (or Elsewhere): Historically, many countries allowed goods below a certain value to be imported without being subject to VAT. This enabled many companies like Amazon and eBay to ship goods across borders without collecting taxes. However, with the growth of e-commerce and the perceived abuse of these relief measures, governments around the world, including Australia, New Zealand, and Norway, have terminated exemptions for low value goods in order to increase tax revenues. Vendors are now required to VAT-register and collect VAT at the point of sale. With such measures being implemented in the UK and the EU in 2021, 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, there is often confusion as to which party is responsible for 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 the 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 get very confusing. Considering many countries make both the marketplace and third-party sellers jointly and severally liable for all VAT liabilities, all third-party sellers should be carrying out their own reviews to ensure the marketplace is correctly calculating, collecting, and remitting VAT.
Compliance and reporting: E-commerce creates 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—this 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 carry out 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.