The American market represents a dynamic growth opportunity for many foreign companies. For those with minimal physical presence within the United States, it may come as a surprise that significant tax compliance responsibilities can result from sales and distribution activities within various states. With many states and localities moving toward a bright-line economic approach to nexus (i.e. taxable presence) in the past few years, there has been a further increase in traps for the unwary.
State Corporate Income Taxes
For federal income tax purposes, non-U.S. companies can rely on any existing income tax treaties between the U.S. and the resident country to reduce or eliminate U.S. income tax liabilities. These federal treaties do not apply at the state level, however. Although a few states may choose to incorporate the terms of a tax treaty by reference, most have traditionally enforced a physical presence standard for nexus, looking primarily to property or payroll employed within their jurisdiction.
Enacted by Congress in 1959, Public Law 86-272 provides a specific carve-out for interstate solicitation of sales from nexus-creating activities. P.L. 86-272 applies exclusively to sales of tangible personal property; activities like solicitation for services, installation activities and licensing of intangibles are not protected. P.L. 86-272 protection is extended to non-U.S. companies by some, but not all, states. More recently, some state and local jurisdictions have moved to a bright-line economic threshold to determine income tax nexus. For example, California and Massachusetts both assert jurisdiction to tax when sales in the state total to $500,000 or more. Keep in mind that even though a state may incorporate a bright-line nexus standard, it cannot disregard P.L. 86-272 protection for income tax when the only activities creating the sales are the solicitation of tangible personal property.
Shift to Gross Receipts Taxes
In search of steady revenue sources, several states have enacted taxes based on gross receipts as a replacement or in addition to corporate income taxes. The Ohio Commercial Activity Tax, Washington Business and Occupation Tax and Oregon Corporate Activity Tax are examples. The Texas Franchise Tax, based on gross margin, is a variation on this concept. None of these taxes are subject to the limitations of P.L. 86-272 and most include a bright-line threshold for nexus. Non-U.S. companies should be especially aware of the level of economic activity in these states.
Net Worth and Franchise Taxes
Net worth taxes, also known as a franchise tax or capital stock tax, are based on a corporation’s equity or net worth apportioned to the applicable state. Net worth taxes may be imposed on companies with minimal activity in a jurisdiction. For example, the presence of a salesperson in the state could give rise to a franchise tax liability.
Sales and Use Tax after Wayfair
The U.S. Supreme Court upended state and local sales tax collection practices with its 2018 South Dakota v. Wayfair decision, which removed the physical presence roadblock to collection of state sales and use tax from remote sellers. While the Wayfair decision provided that physical presence in a state creates a sales and use tax reporting requirement, it limited states to asserting nexus only when a substantial level exists. In the Wayfair case, South Dakota used a threshold of $100,000 of sales into the state or 200 transactions to create economic nexus and trigger a sales tax filing requirement.
Most states have followed this lead and enacted similar statutes that create a bright-line sales threshold and, in some cases, a threshold based on number of transactions. It is important to understand that the sales threshold in the majority of states is based on gross sales, so even wholesalers who do not have a sales tax collection requirement will now have reporting requirements. Companies must now implement new sales tax processes, such as collecting exemption certificates for sales into states where they did not historically file, to document sales tax exemption for these transactions and avoid a levy from the state. Wayfair’s impact on sales and use tax matters started with domestic companies, but states will be casting a wider net to include foreign businesses, as well.
RKL’s International Tax Practice is ready to help non-U.S. companies assess economic nexus and state and local tax reporting requirements. Contact us via the form at the bottom of this page for assistance.