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Upcoming Case Could Dramatically Affect State Sales Tax

Upcoming Case Could Dramatically Affect State Sales Tax

The U.S. Supreme Court will review sales tax nexus as part of an upcoming court case

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The review will consider whether a physical presence test is still necessary, or whether the U.S. may change the way it approaches imposing U.S. tax on online sales. South Dakota v. Wayfair Inc., which is expected to be heard in April, 2018, could result in a change to the sales tax obligations of companies making sales to the United States, as certain emerging state economic nexus rules could become enforceable, depending on the court's decision.

The U.S. Supreme Court finally agreed to review sales tax nexus in Wayfair following lobbying efforts from many states, many of which have imposed their own economic nexus rules. Although it's not yet clear what the court will ultimately rule, it is interesting to note that President Trump reportedly "feels strongly" that the United States should impose a sales tax on online sales.

Background
U.S. states generally impose sales tax on sales of goods that are sold into their state, while services are generally exempt. Historically, a state could not impose a sales tax on an out of state vendor unless that vendor had a physical presence in the state, as established in a 1992 U.S. court case, Quill v. North Dakota (504 U.S. 298 (1992)). Physical presence was generally established through things like equipment, land, or employees in the state, but could also include things like a customer leasing software that is downloaded to a customer in the state. Although each state had unique rules, all included the physical presence standard.

U.S. states implementing online rules
In recent years, U.S. states have started to implement rules around when an out-of-state retailer would owe sales tax in the state. These rules are based on the perception that brick and mortar retailers are at a disadvantage compared to online retailers, who do not have to collect and remit state sales tax, and that the states are losing out on taxes that might otherwise be collected. These state-imposed economic nexus rules demonstrate an emerging trend towards economic taxation instead of presence-based taxation and include:

  • Click-through nexus - Where an out-of-state vendor is referred by an in-state vendor's website and customers "click through" that in-state website to reach the vendor's products
  • Affiliate nexus - Where an out-of-state vendor partners with an in-state vendor for an integral part of their service, it creates nexus for the out-of-state vendor (e.g., a computer vendor partners with an in-state company to repair their computers on behalf of customers)
  • Economic nexus - Where an out-of-state vendor will be required to collect sales tax from in-state customers where they sell a certain amount into the state (e.g., an out-of-state vendor makes 100 sales to the state, or has over $200,000 from revenue in the state, though some states have economic threshold levels as low as $10,000 of sales)
  • Additional reporting - Certain states that cannot impose a tax on out-of-state retailers have imposed significant reporting on out-of-state vendors, including identifying customers who should be self-assessing taxes owed to the state that the retailer did not charge on their purchases.

Click-through nexus, affiliate nexus, and additional reporting are currently enforceable since they are extensions of physical presence. However, even though many states have legislated economic nexus rules, they have not been able to enforce them because of the precedent set by Quill. If the U.S. Supreme Court does overturn the decision in Quill, states would be able to enforce these rules, which will significantly impact the sales tax obligations of companies making sales to the United States, and open the door to the adoption of more economic nexus standards.

For more information, contact your KPMG adviser.

Information is current to March 20, 2018. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500
 

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