Editor: Mark Heroux, J.D.
The reach of indirect taxes is expanding. In these times of thriving e-commerce businesses, more and more countries are shifting the focus from direct taxes to indirect taxes and implementing such taxes as value-added tax (VAT), sales tax, and goods and services tax, affecting companies doing business across the globe. This discussion provides an update on the status of indirect taxes for e-commerce businesses, the expected changes to the European Union VAT and U.S. state and local sales tax, and the difficulties for businesses selling goods to consumers through their websites or platforms such as Amazon or eBay.
VAT in the EU
VAT is a consumption tax, taxing the value added to the goods and services sold in every transaction in the supply chain. The final consumer carries the burden of the VAT payment as the other parties in the supply chain, in principle, recover the VAT they paid. This leads to a benefit for tax authorities, as VAT generates revenue whenever a supply takes place, without considering factors such as salary or profit, as is done with income taxes. Apart from special cases, VAT imposes the same tax rate on everybody.
As e-commerce businesses are booming, the European Council has already adopted new VAT rules in relation to international trade and e-commerce, and more will apply as of July 1, 2021. These rules should create an equal market between EU and non-EU businesses, such as U.S. companies, and mitigate the risk of VAT fraud. These rules will have an immense effect on e-commerce supplies from countries outside the EU. Changes include:
- Abolishment of the VAT exemption for imports of small consignments with a value of up to €22 (approximately $25);
- Offering to businesses that supply goods from countries outside the EU to customers inside the EU the option to file only one VAT return for all their distance sales from countries outside the EU, for consignments with an intrinsic value of no more than €150 (approximately $170); and
- A special arrangement for levying VAT on importation, allowing certain businesses (i.e., mail or postal companies) to collect the import VAT from the person for whom the goods are destined.
Another change ensures that businesses will be responsible for paying the VAT due on e-commerce sales if they facilitate sales via electronic interfaces such as online marketplaces or platforms (e.g., Amazon or eBay). As these platforms are involved in substantial numbers of online sales all over the world, the impact will be significant. Subsequently, these platforms would like to mitigate their responsibilities where possible and may set new general terms and conditions that make it harder and more of an administrative burden to use them to make online sales.
Furthermore, keep in mind that platforms can (or even must) share much information with local EU tax authorities. Based on this information, local EU tax authorities can verify whether, for example, a U.S. business complies and pays VAT where required.
As mentioned, VAT is levied on every taxable supply and generates a lot of revenue for tax authorities. Therefore, one way or another, VAT will almost always affect a U.S. business trading within the EU, and tax authorities will do whatever it takes to collect this increasingly important source of revenue.
Indirect taxes in the US
A similar analysis applies to doing business in the United States. Foreign companies, like EU-established companies, may not have considered indirect taxes (e.g., sales tax and other non-income taxes) when contemplating doing business in the United States. Treaty protections between the United States and sovereign foreign nations allow foreign companies without permanent establishments to avoid taxation. However, not all states adopt these treaties. If a state adopts a treaty, it protects foreign taxpayers only from income taxation. Despite treaties, foreign taxpayers that establish nexus in states owe these indirect taxes. Note that nexus is not the same concept as permanent establishment.
On June 21, 2018, the U.S. Supreme Court ruled in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018), that states may impose sales tax collection responsibilities based on economic nexus. The ruling made it possible for states to impose sales tax registration, collection, and remittance requirements on remote retailers with no physical presence in a state, such as an e-commerce business established in the EU selling online goods to U.S. consumers. Prior to this ruling, taxpayers needed physical presence (e.g., employees, buildings, or inventory (this list is not all-inclusive)) to establish nexus.
Remote retailers can establish economic nexus in states by meeting dollar and/or transaction thresholds on products or services they sell into a state (e.g., $100,000 and 200 transactions). Since treaties do not apply to sales tax, foreign taxpayers can incur sales tax collection and filing requirements by meeting or exceeding these thresholds.
The U.S. sales tax system is unlike that of many foreign nations that impose a VAT. As mentioned earlier, VAT systems generally impose tax at each stage of the supply chain. The U.S. sales tax system imposes sales tax when products or services rest with an end user (i.e., the person consuming the product or service). Rather than imposing sales tax at each phase of the supply chain, states rely on statutorily enacted sales tax exemptions.
A variety of exemptions provide relief to parties within stages of the supply chain to ensure sales tax is paid only by end users. Forty-five states plus the District of Columbia impose sales tax and provide a resale exemption. Any company purchasing taxable goods or taxable services to resell to another party may purchase them exempt from sales tax by providing vendors a properly completed resale certificate. Certain states provide an exemption for manufacturers to purchase raw materials and other supplies without sales tax when these items are incorporated into finished goods. The manufacturing exemption may also extend to machinery and equipment. Additionally, select states provide exemptions to not-for-profit groups (i.e., Sec. 501(c)(3) exempt organizations) and state and local governments and agencies. Sellers must collect the exemption certificates from customers; otherwise, all sales are deemed taxable.
The U.S. sales tax regime differs from those of other nations by using this exemption approach rather than taxing each level of the supply chain as is done in a VAT system. Inbound companies should maximize their available exemptions to take full advantage of associated sales tax savings and planning opportunities.
The varying state and local tax rates in more than 11,000 jurisdictions across the United States add to the complexity of its sales tax structure. Sales taxes can include any combination of rates imposed by states, counties, cities, and other localities and special districts. Inbound entities starting business in the United States should consider the breadth of their operations across the country to account for variations in state and local sales tax rates. To ensure they use accurate rates in assessing sales tax to customers, inbound entities will need to analyze their state footprint to determine whether they should streamline the process with automated sales tax software.
In addition to sales tax, certain states impose non-income-based taxes. Non-income taxes are calculated on a measure other than net income (e.g., gross receipts, net worth). Some of the most common non-income taxes in the United States are Georgia's net worth tax, Ohio's commercial activity tax, Oregon's corporate activity tax, Texas's franchise tax, and Washington state's business and occupation tax. As stated previously, negotiated treaties only apply to federal and state income taxes (if adopted by the state). Inbound entities should be cognizant of all potential state taxes.
Preparation is key
EU VAT and state tax liabilities, when coupled with interest and penalties, can add up quickly and become material. Preparation is the key to ensuring businesses recognize and comply with their obligations as soon as their operations start.
Mark Heroux, J.D., is a tax principal and leader of the Tax Advocacy and Controversy Services practice at Baker Tilly US, LLP in Chicago.
For additional information about these items, contact Mr. Heroux at 312-729-8005 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Baker Tilly US, LLP.