This post is by Emma Scotton, Director and Founder at independent ecommerce consultancy KnowGlobal.
Ecommerce is booming and businesses are increasingly fighting for a share of the lucrative global market by looking at ways to take their online business cross-border.
The US market makes for a particularly attractive option, with US consumers expected to spend $327 billion online in 2016. Moreover, the number of web shoppers in the US is expected to grow by 15% this year to 192 million and each shopper will be spending more on average, up 44% from 2012 to $1,738 per year.
What’s more for marketplace sellers is that global marketplaces are expected to own nearly 40% of the online retail market by 2020, providing a viable and rewarding route to new markets for businesses of all sizes.
In the rush to expand, however, merchants can overlook areas of international business that are unfamiliar. Ensuring you support international payments and have a logistics network capable of fulfilling orders is important, but with new opportunities come new complexities, particularly when meeting the challenge of sales tax compliance in the United States.
- What is sales tax?
- How does sales tax differ from Value Added Tax (VAT)?
- Just how complex is sales tax?
- What is the risk if you’re not compliant with sales tax regulations?
- What is nexus?
- How do you determine if you have nexus?
- What constitutes a “significant physical presence”?
- Nexus triggers
- Other sales tax rules
- Top points to consider before selling into the US
- Steps to successful market-entry in the US
What is sales tax?
As revenue from property taxes collapsed during the Great Depression in the 1930s, US states implemented transactional taxes on commodities. As an indirect tax (a tax levied on goods and services), sales tax requires the seller to collect funds from the consumer at the point of purchase.
Today, there are over 12,000 state, county and city jurisdictions in the US charging a sales tax. Forty-five states and the District of Columbia now impose a sales tax on retail sales and some services. The bulk of their revenue is now generated from sales taxes, not income taxes.
The five states that do not have a state-wide general sales tax are Alaska, Delaware, Montana, New Hampshire and Oregon, although Alaska and Montana do allow localities to charge local sales taxes.
How does sales tax differ from Value Added Tax (VAT)?
Businesses in Europe are used to dealing with transactional taxes in the form of VAT, but US sales tax is a different prospect entirely.
With over 12,000 taxing jurisdictions throughout the US, each empowered to alter rates and rules with little oversight, the complexity for companies trading in the US becomes mind-boggling. There are 100,000+ rules and boundary changes annually, so it’s easy to see why many companies require outside expertise to manage what initially seems like a straightforward process.
On which items do you charge sales tax? What rate of sales tax do you need to charge for different addresses on the same street? What is the difference between state, county, city and special taxes? Where do you need to file and remit sales tax? What records need to be kept in case of audit? How often do you file taxes and to which authority? And what on earth is nexus?
These are just some of the questions merchants will need to consider before either selling or planning to sell in the US. It’s a veritable minefield of legislation, regulation and complexity but if you get it right the rewards for your business could be sizeable.
Just how complex is sales tax?
Depending on the state in which your customer is based, different items may be taxed at different rates. In some states, for example, food is not taxed, while in others the same item may be classified differently. So far so good.
In New York, clothing and footwear costing less than $110 per item/pair is exempt from state sales tax, yet it is still subject to local sales tax in some jurisdictions. Local jurisdictions can change their tax policy towards clothing once a year, however, “most fabric, thread, yarn, buttons, snaps, hooks, zippers and similar items that become a physical component of clothing” or are used to repair it are exempt.
To be compliant, a retailer needs to know the correct classification of an item in each state to ensure it collects and remits the correct level of tax. Collecting too much in one state will make them uncompetitive, while not collecting enough increases their exposure to potential fines. Adding to the complexity, in some states the rates can vary by city, county, or even street. Two adjacent properties can have different tax rates.
What is the risk if you’re not compliant with sales tax regulations?
In an effort to safeguard tax revenues, each state conducts audits of businesses, which may result in penalties and interest. Businesses must keep records of sales in each US city, county and state in which they sell. California alone announced in August 2014 the hiring of 100 auditors, lawyers and specialists to help collect online sales tax.
As more businesses sell in the US, auditors are also turning to international sellers to ensure they do not have a competitive advantage over domestic retailers. The financial importance of collecting sales tax on a state cannot be underestimated. The more auditors assessing international businesses, the more revenue a state can make in penalties and unpaid tax.
With the average audit costing as much as €79,000 (US $100,000) you can’t afford to be complacent about compliance.
What is nexus?
The good news is international businesses selling in the US are not required to collect sales tax in a state unless they have “nexus”.
Nexus is defined as a connection or business presence in a state or jurisdiction. If you have nexus in a state, you need to collect and remit sales tax according to their regulations.
How do you determine if you have nexus?
On the face of it, for a marketplace seller, it sounds like you need not be concerned with Sales Tax. However, here comes the bad news. Activities leading to having nexus vary per state and can include activities such as opening offices, stores or franchises, storing items in warehouses or even attending meetings or tradeshows.
Determining nexus can be confusing if you are unprepared or do not fully understand the obligations. This will ultimately increase your business’ exposure during potential sales tax audits.
Once you have determined where nexus exists for your business, you are required to calculate, collect, report and remit that state’s sales tax. There are several scenarios where nexus can be applied to marketplace sellers giving you a “significant physical presence”, and these should also be considered before you start selling to US consumers.
What constitutes a “significant physical presence”?
Nexus rules are established by individual states and every state defines them uniquely.
Determining exactly how a rule applies to a business is critical. With more than 12,000 sales tax jurisdictions across North America, and with rates and boundaries constantly changing, staying on top of nexus responsibilities is a substantial drain on businesses, carrying no benefit to the bottom line.
Recently, in an effort to avoid losing taxes, many states have enacted Amazon laws, requiring more national and international online retailers to collect sales tax for the first time. These laws expanded definitions of nexus to include online-specific relationships such as affiliate and web advertising.
As a marketplace seller, you will need to consider closely the ways in which you manage your fulfillment as a number of scenarios here may trigger nexus.
The following scenarios are some of the more common situations in which marketplace sellers can trigger nexus.
Owning or leasing property or warehouses in the US
To better serve US consumers, and for cost-effective delivery, many marketplace sellers opt to store inventory in the US itself. Whether you decide to own or lease property in the US for this purpose, or you decide to rent or own storage or warehousing facilities, this will be considered a nexus-triggering activity. You will therefore be required to register, collect and remit Sales Tax for sales in the state in which your property, storage or warehouses are located.
Using a third party fulfillment provider with a presence in the US
Similarly, some marketplace sellers may decide to outsource elements of their supply-chain to a third-party, who will store and deliver goods to customers on their behalf. This method of fulfillment can prove cost-effective for businesses and enable you to get goods to your US customers much quicker. However, even if you outsource to a third party, and it is the third party who owns the warehouse and delivers your goods in the US, this can still trigger nexus.
Let’s take Fulfillment by Amazon (FBA) as an example. FBA helps sellers sell products internationally by giving you access to Amazon’s logistics network. If you ship your products to their fulfillment centers, they’ll store, pick, pack and ship it locally to your customers.
Whilst the definition of nexus varies slightly from state to state, all states where Amazon has warehouses (with the exception of Virginia) say the same thing, namely that this suffices for the creation of nexus. For example, Kansas regulations state that “stocking inventory in a Kansas warehouse or consignment” triggers nexus. Similarly, Washington regulations state that where “the goods are located in Washington at the time of sale and the goods are received by the customer or its agent in this state” nexus will be triggered.
Amazon won’t always notify you if they move your inventory to a new fulfillment centre. So a conservative approach is to register for Sales Tax in all the states where Amazon has a fulfillment centre to avoid getting caught out. It should also be noted that once you have nexus in a state you must collect tax on all sales into that state whether or not you ship them yourself or through a third party.
Many retailers and marketplace sellers utilize drop-shipping as a supply-chain management technique. In this scenario, the retailer does not keep the goods in stock but instead transfers customer orders and shipment details to either the manufacturer, another retailer or a wholesaler who then ships the goods directly to the customer. This triangular situation adds a layer of complexity when it comes to determining nexus.
If both you as the retailer and your drop-shipper are situated outside of the US, and thus have no nexus in the state of your US customer, it will be the customer who is subject to “use” tax.
But if your drop-shipper is located in, or has nexus in, the state in which the sale occurs, then the drop-shipper could be responsible for collecting sales tax. That said, the rules vary again across different states, and in certain circumstances use of an in-state drop-shipper by an out-of-state retailer is a nexus-creating relationship, and it will be the seller who will be responsible for collecting the sales tax. In other states de minimis thresholds apply, whereby nexus is triggered only once the retailer or the drop-shipper have shipped $50,000+ worth of goods.
With this degree of complexity, sellers must ensure they plan ahead. All members of the supply-chain must cooperate to determine nexus to avoid either double-charging for sales tax or not charging at all.
To safely navigate these challenging tax rules, businesses should understand their exposure as part of a nexus study. Making the nexus determination on your own is difficult, confusing and can lead to problems further down the road.
Other sales tax rules
This complexity doesn’t end at nexus! Sales tax compliance is full of complicated rules and nexus is just one aspect. Several other layers must also be considered in order to be fully compliant.
Some bizarre but very real sales tax laws:
- In New York, any bagel that has been sliced or prepared with toppings is subject to a sales tax. However, if it is sold whole and consumed outside of the store, it is untaxed.
- Alabama charges a 10-cent tax on any pack of cards that contains 54 or fewer cards in the deck. The seller must also pay $1 and an annual tax of $3.
- Pennsylvania taxes air – at least the air that comes out of a compressed air vending machine or vacuuming vending machine. Therefore, petrol stations must charge the tax when customers pump up their tyres. Also in Pennsylvania, state and US flags are not subject to tax, but if either is sold with “accessories” (i.e. a pole), the entire purchase becomes taxable.
- In New Jersey, naturally carbonated water is exempt, but artificially carbonated water is taxable.
- And finally… in Tennessee, the sale of a good is subject not only to the state sales tax of 7%, but the local sales tax on the first $1,600, plus an additional state sales tax of 2.75% on the second $1,600, all of which cannot exceed $3,200 – potentially subjecting a sale to a 9.75% sales tax rate.
Top points to consider before selling into the US
1. Keep up to date with each state’s tax requirements
Businesses need to keep up to speed on all the changes made by states and municipalities each year. These changes include rate increases/decreases as well as new sales taxes added to jurisdictions, and boundary changes.
2. Establish processes for water-tight record keeping
The best way to stay compliant is to keep up to date on filing sales tax returns and payments (quarterly or monthly, depending on the state’s requirements) and keep accurate and detailed sales records.
What records do businesses need to keep?
- Sales invoices
- Paid bills
- Purchase orders
- Register tapes
- Bank statements
- Cancelled cheques and similar original documents
- Depreciation schedules and other fixed asset records
- Documents supporting tax-exempt sales, such as resale and other exemption
- Freight bills indicating shipments to addresses across states
Keeping records and preparing and filing sales tax returns can be a major headache, particularly for small businesses. The good news is there are tools available that automate these processes, reduce this tedious and labour-intensive task, and save you money in the long run.
3. Understand your nexus requirements
As outlined above, nexus-triggering events can be complicated and vary across states and product types. The way in which you deliver the goods sold to US customers will have implications for your tax obligations. Using any third party, whether it’s a drop-shipper, carrier or warehouse can trigger nexus for your business, so consulting with experts will be critical.
4. Plan to use geo-location over ZIP codes
While the US Postal Service has established ZIP codes for mail delivery, tax jurisdictions do not generally follow ZIP codes. Going down to street level is essential to get it right. Businesses relying solely on ZIP code often find big discrepancies during audits.
In order to help businesses cope with these differences, providers of automated solutions continually research the physical boundaries of taxing jurisdictions nationwide. Without the use of geospatial technology, there is limited chance of accurately determining which jurisdiction applies to a transaction.
5. Set out your returns filing and remittance schedule
Each US state has its own set of rules and regulations for filing and remitting tax, which may differ from other states. In addition to state rules, cities and counties may impose and manage sales tax returns on their own.
Responsibility lies with businesses to not only determine if they have to file with specific cities and counties, but also to register of their own accord. Moreover, filing frequencies vary by jurisdiction so not all returns are due on the same day of the month. When dealing with multiple states and local jurisdictions, the number of due dates and filing schedules that must be managed can be daunting.
Filing methods can vary just as much, even within the same state or municipality. Some states now require sales tax returns to be filed electronically; others still require hard copy submission, while a few states offer online filing along with an electronic data interchange (EDI) option.
6. Collect and store all exemption certificates
Not everyone is required to pay sales tax. Depending on the rules in the taxing jurisdiction, certain businesses and individuals may be exempt. The vendor must collect and keep on file a valid exemption certificate for each business, organization or individual with an exemption.
It is also up to vendors to ensure that exemption certificates are valid for each sale transaction. This requires businesses to keep a copy of each exemption certificate and ensure that they are renewed when they expire.
7. Identify if the “Streamlined Sales & Use Tax Agreement” is right for you
Around half of the states have worked together on an agreement called the Streamlined Sales and Use Tax Agreement, designed to “simplify and modernize sales and use tax administration in order to substantially reduce the burden of tax compliance.” Signing up to SST requires only one form to register across all SST states. Once registered, businesses then have to file returns every month in all SST states.
For companies selling, or looking to sell in the US, or have affiliate relationships in a number of states, registering as an SST volunteer can save you a lot of time, effort and money. There is no cost for registration and if you qualify, filing is a free service across the SST states. SST volunteers have limited audit exposure (no negative audits are possible).
As of early 2015, SST Member States include:
- New Jersey
- North Carolina
- North Dakota
- Rhode Island
- South Dakota
- West Virginia
8. Plan for sales tax holidays
Further complicating the matter, dozens of states also declare sales tax holidays. Some states offer tax reprieves for products like school supplies for kids, while others give consumers a tax break on hurricane preparedness items, like plywood and nails. In states where hunting is a big business, tax holidays might be in place for firearms, ammunition and hunting supplies.
The holidays are varied and complicated, often taking place over specified dates and limiting the number of items that can be purchased tax-free.
In Virginia, for example, during the sales tax holiday for clothing and school supplies, many items are singled out as exempt. For clothing, this includes clerical vestments, choir and alter clothing, corsets, girdles, lingerie, purchased costumes, steel-toed shoes, suspenders, formal wear, etc. However, protective gloves, hard hats and helmets are taxable. School supplies that are exempt include calculators, binders, erasers, lunch boxes, highlighters, notebooks, paintbrushes, scissors, etc.
Keeping up to date with these tax holidays may seem burdensome, but could actually prove part of a rewarding marketing strategy and help you to take advantage of peak selling times.
Steps to successful market-entry in the US
International trade is a great way to grow your business, so don’t be put off by the complexities of sales tax. Expansion need not be daunting and provided you take the right steps, selling your products in American markets could be the boost your business needs.
- Work out where your business has nexus, so you know in which states you’ll need to register by declaring your business.
- Get your ID number by setting up an account with a state, and visit their local “.gov” website to determine the exact steps. Usually they will have you file a form and register.
- Once that is complete, you will have a unique code applied to your business and this code will show up along with your business name in all future sales tax filings.
- As soon as you have completed your paperwork, make sure to check that same regulatory department for up-to-date rates, tables, rules, and boundaries.
- Research the taxability of your items, making sure to apply thresholds and tax holidays if they apply in the state.
- Make sure that you only have to file one sales tax form in one state, as many states require remittance to local jurisdictions (which can number in the hundreds), as well as the state.
Alternatively, there are a number of solutions available to merchants to help automate and take the administrative burden out of US sales tax.
This post was by Emma Scotton, Director and Founder at independent ecommerce consultancy KnowGlobal.