Foreign businesses operating in the U.S. face a variety of challenges, including knowing what their filing duties might be for income and sales tax.
By Judy Vorndran and Stacey Roberts
Complications of U.S. State and Local Tax
Many companies are now familiar with the Wayfair case given it is approaching its third birthday, but Wayfair is not the only nexus trigger for foreign companies selling to U.S. customers. Nexus is a legal concept that defines the base-level of activity necessary to allow state and local governments to tax businesses. Nexus and the U.S. Constitution’s Commerce and Due Process Clauses are the only inhibitions preventing U.S. States from imposing tax on everyone everywhere.
It is important to note that not all states follow U.S. tax treaties because states have their own sovereignty (they don’t have to listen to everything the U.S. federal government does, aka “Tax Mom and Dad”). This autonomy leads to a complicated web of tax laws and regulations as states raise revenue from their own tax base.
Unfortunately, states cannot rely solely on federal government subsidies. As a result, states impose a variety of taxes and fees: income/non-income, gross receipts, business and occupation, commerce, commercial activity or franchise type taxes, sales/use, property (real and personal), payroll, unclaimed property and excise taxes.
If your business is registered for a sales tax license, you are potentially subjecting yourself to other tax filings. Of most importance (in our opinion), is the potential for income taxes.
Once you create a sales tax license you are essentially telling the government that you are doing business in that state. This leads the state and local governments to query what other taxes they might be owed, prompting nexus questionnaires, notices, and jeopardy assessments if you ignore them.
As a result, foreign businesses selling in the U.S. will want to consider with their tax adviser the right entity structure. Although it might be simpler to just register the foreign entity for sales/use taxes, this could create additional filing obligations on that entity that were unanticipated when opening a sales tax account. This means that a foreign entity might be taxed both by the country of origin as well as the U.S., and multiple forms can be required by both the federal and states. With each entity potentially being taxed differently, a comprehensive entity structure becomes necessary to minimize tax duties.
Many companies that recently began selling and shipping to U.S. customers do not realize the importance of setting up an entity structure. Thus, companies unwittingly get sales tax licenses or register for payroll and pay the payroll on behalf of the foreign entities, which trip other filing obligations. Now different entities are paying different taxes, and forms must be filed in order for the foreign entity to be compliant within the US and within the states where sales tax registrations were procured.
In order to create a state return, a proforma or “as if” federal return must be created, as state income taxes piggyback on federal taxable income. States need a mocked up federal income tax return attached to the state returns, but the states frequently don’t provide a template. Businesses essentially have to create one.
In addition, exchange rates change country by country. GAAP is different from IFRS accounting, and there are other foreign/federal differences in how books and records are created. On top of sales and income taxes, foreign businesses can be obligated for property, payroll, and non-income based taxes that do not have treaty protections. All of these examples are compliance costs that foreign taxpayers may not be thinking about.
State-by-State Sales Tax Differences
Unfortunately, no two states are alike when it comes to taxes. There are a variety of different taxes that may or may not apply to your business.
Washington has an unusual tax structure unlike any other state in the nation known as the business and occupation tax (B&O), which is filed in conjunction with a sales tax return and based on receipts earned only in Washington. Nevada has a commerce tax which has different rates depending on the type of business and, just like with B&O, is only based on Nevada receipts. Neither of these Nevada or Washington taxes have anything to do with a federal tax return. Texas has a margin tax which now applies to both flow through entities and corporations, even though Texas does not have an individual income tax.
None of these three types of taxes are protected by treaties. The good news is that most of these types of taxes are at a simplified rate, and the tax calculation is relatively easy with the proper entity structure in place.
U.S. states and different European countries are similar in their diverse political, economic and tax structures. One key difference is that all state laws are in one common language, English, and there is only one U.S. Supreme Court, so researching the laws and tax cases should be an easier process. Unfortunately, that is about the only benefit because different states might interpret the same word differently.
Similar to Europe, each state has a unique history of industries and infrastructure that leads to wide discrepancies in old laws. Many of these laws are still in place despite new technology with some state income taxes originating well before the federal income tax was enacted in 1913. Given the difficulty of amending laws and the court cases that have developed in interpreting them, it is no easy feat to change a law.
While new laws are being introduced, some of these legacy laws remain, creating layers of tax law. U.S. States are always on the move in managing their unique tax base as affected by their economies.
While many states used to be more dependent on income taxes, the federal government gives entitlements like bonus depreciation, R&D credits and the like, which leads states to realize they are getting shorted on income tax. They come up with new taxes like the Nevada Commerce tax, which has only been in effect for seven years. New on the horizon is Maryland’s digital advertising tax. If successful, other states will likely consider adopting something similar.
Specifically pertaining to Wayfair, which was decided on June 21, 2018, 45 states plus DC have a Wayfair type law on their books with varying thresholds, enactment and enforcement dates. It takes a specialist to track these distinctions and apply the laws to each unique business operating or selling into that state. Now, with Wi-Fi and less employees showing up in an office, the physical location of hired talent is less scrutinized. This will increase their tax obligations across the world.
The point is there is not a one-size-fits-all taxing structure for foreign companies operating in the U.S. Looking at federal treaties is just the first step to tax compliance in the U.S., and setting up an entity structure with a tax professional can ease the process significantly.
For more guidance, reach out to the tax professionals at taxops.com.
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