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GST, PST, HST, and QST—most Canadian businesses are familiar with these terms, as they have to navigate Canadian sales tax in their everyday operations. But what about US sales tax? Realistically, for the many private Canadian businesses that sell to US customers, US sales tax may not even be on the radar. Historically, this has not been a matter of significant concern; now, however, given recent legislative changes and the significant economic impact of COVID-19, many Canadian businesses could find themselves deep within a maze of US sales tax.
How Wayfair changed the game
The US sales tax system is significantly more complicated than its Canadian equivalent. According to the Tax Foundation (an independent tax policy not-for-profit organization in the United States), the US has more than 11,000 sales tax jurisdictions, each with its own set of rates, rules, and regulations.1 For example, Seattle, Washington, imposes one of the country’s highest combined local and state sales tax rates, while Portland, Oregon, imposes no sales tax at all2—an important distinction for Canadian businesses selling to markets along the West Coast.
In the past, it was commonly understood that US state sales tax should not apply to Canadian businesses selling into the US as long as these businesses had no “physical nexus” in the state. Generally speaking, having a physical nexus in a state means having a physical presence there, whether this means having employees, a fixed place of business, or fixed assets in the state.
This is no longer the case. On June 21, 2018, the United States Supreme Court ruled in South Dakota v. Wayfair, Inc. (Wayfair)3,4 that South Dakota can require businesses that have more than 200 annual transactions with in-state customers or aggregate in-state sales of US$100,000 to collect and remit state sales tax even if they do not have a physical nexus in the state.5 And since this floodgate was opened, more than 40 states have enacted similar laws whereby remote sellers could be liable to collect and remit state sales tax. These rules—generally referred to as “economic nexus”—look to the level of economic activity that a business has in a given state, and this activity is typically measured according to an annual gross sales threshold and/or the number of transactions made in a year.6
The introduction of economic nexus could create a significant administrative burden for Canadian businesses that sell into the US, particularly if sales are made to customers in more than one state. These Canadian businesses may be required to collect and remit sales tax in multiple states, and may be required to file multiple state sales tax returns.
Is it enough for Canadian businesses to know about economic nexus?
Although the 2018 court decision made numerous headlines, economic nexus is not the only cause for concern, as there are other types of nexus rules that could trigger sales tax obligations for Canadian businesses. Although these rules predate the Wayfair case, many Canadian businesses may not be aware of their existence, because the rules have been largely neglected and state enforcement has been lacking. Now, however, as some states face significant budget deficits due to COVID-19, we expect state tax audits to become more frequent and more aggressive.
When a business is subject to a US sales tax audit, the auditor will review all types of nexus, not just physical and economic nexus. Two other common types are affiliate/agency nexus and click-through nexus.
Affiliate/agency nexus is generally triggered when a remote seller has an affiliate/agent7 operating in a given state who sells the same or a substantially similar line of products there or who provides services, helps advertise, and/or facilitates sales to in-state customers on the remote seller’s behalf.
For example, if a remote seller sells computer hardware to a customer in a particular state, and the remote seller has a contract with a third party in the same state to install this hardware, affiliate/agency nexus could be triggered.
Click-through nexus is generally triggered when a remote seller sells into a state and the sales are referred by an in-state sales agent who is compensated via commissions. For example, remote sellers that list on Amazon could trigger click-through nexus on sales made into a state where Amazon has sales tax nexus and receives a fee for referrals.
Are wholesalers affected?
In general, sales made to distributors/resellers in the US are generally exempt (generally referred to as the “resale exemption”), as the sales tax should be collected from the final consumer. A distributor/reseller will generally provide a resale certificate to wholesalers that contains information on why they qualify for the resale exemption in their state. Before the Wayfair case, if the remote wholesaler didn’t have physical nexus in the state, they were not required to collect the resale certificates, because they generally weren’t required to register and file state sales tax returns.
Here again, the Wayfair case changed everything. Now, if a Canadian wholesaler has economic nexus in a state, they must collect resale certificates from each in-state customer, notwithstanding the fact that the Canadian business has no physical presence there. Additionally, in order to avoid penalties and interest, the Canadian wholesaler must do its due diligence to determine whether the resale certificates are valid. Further, even in cases where remote wholesalers do not have to collect and remit sales tax to a given state, they may still be required to register and file sales tax returns there, even if all of their sales are made to distributors/resellers that have provided valid resale certificates. This adds yet another layer of complexity and administrative burden for Canadian businesses selling into the US.
Although state revenues seem to have fared better than originally anticipated,8 states are likely still looking for ways to raise funds, which could include aggressively issuing sales tax audits and assessment notices to remote sellers to ensure that they’re collecting the appropriate state sales tax.
For Canadian businesses selling to US customers, navigating the complex US state sales tax maze requires a map—one with clear guidance on the various types of sales tax nexus and how they’re triggered, resale certificates, and sales tax compliance. Determining the implications of US state sales tax may not be a remote seller’s favourite activity, but there’s no point delaying the inevitable—it could have a substantial impact on the bottom line.
Jason Yip is an international tax manager with the Vancouver office of PwC Canada. He works with clients on Canadian and international tax matters, with a focus on Canada-US tax planning.
Jenny Li is a US CPA licensed by the California Board of Accountancy. She is an international tax partner with the Vancouver office of PwC Canada, where she specializes in cross-border taxation. Jenny has extensive experience advising Canadian businesses that are expanding globally and foreign businesses that are entering the Canadian market. She holds a master’s in business taxation from the University of Southern California.
- Jared Walczak and Dominic Pino, “Sales Tax Rates in Major Cities, Midyear 2019,” August 14, 2019, taxfoundation.org.
- South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018).
- AICPA, “South Dakota v. Wayfair,” aicpa.org.
- For example, the economic nexus threshold for Washington State is US$100,000 in annual gross retail sales. (From Oct 1, 2018, to Dec 31, 2019, Washington also used the number of transactions as a threshold, such that a business could trigger economic nexus if it had 200 or more transactions with taxpayers in Washington. This threshold was subsequently removed.)
- In some states, “affiliate/agent” applies to arm’s-length parties as well as related parties.
- Jared Walczak, “New Census Data Shows States Beat Revenue Expectations in FY 2020,” September 18, 2020, taxfoundation.org.