eCommerce Sales Taxes: Determine Your Liability
Nexus – What Is It?
Nexus is defined as a “connection” or “link.” In the world of lawyers, accountants and auditors, a nexus is an effective connection of a person or a company to a state so that the state has the ‘right’ to enforce its laws, and more importantly, its tax rules, against that entity. Without that point of authority, the state enforcers (the courts and the police) will not have the power to enforce the state rules.
Traditionally, the connection has been interpreted to indicate a form of a physical presence within the state. As freedom of movement has increased, and with it the ability to conduct business across state lines, it has become increasing difficult to define the term “physical presence”. Over the years, the judiciary has commonly held that the entity does not have to actually reside in the state. Rather, regular activity within the state will suffice to expose the entity to the legal requirements of the hosting state. But what if an entity never formally enters the state? Consider independent and unaffiliated sales representatives that roam the state and sell products, or use a warehouse to distribute the products? Courts will still interpret such activity as having a presence in the state.
Moreover, what happens if the company really has no presence, yet, consumers routinely purchase products from the company. This is an example of split principles. Some states will say that the company really has no presence in the state, had no control over the fact that its products ended there, and therefore should not be penalized and should not be subject to the rules of that state. This follows the principle that to create jurisdiction, the company must have an actual presence in the state. This principal is known as a “source” system. Another principle states that even though the companies were not proactive in getting their products into the state, they are benefiting from the fact that their products are being delivered and used in that state, and therefore they should be subject to the rules of the state. This is known as “destination” based nexus, whereby nexus is created by the place of delivery.
Unfortunately, different states follow either of these principles, and inconsistent definitions are the norm. It is very easy to see how this can lead to conflict. For example, what happens when a company located in a “source” state sends a product to a “destination” state? Where does the tax liability accrue? What tax rate is applicable? Depending upon the state, different items are taxed under different categories and at different rates.
Streamlined Sales Tax Project
The Streamlined Sales Tax Project (“SSTP”), streamlinedsalestax.org, is attempting to address this issue by creating a uniform rule of “destination” based nexus. In other words, part of implementing the SSTP would require “source” based states to change their rules to become “destination” based states. This is probably the single stickiest item for adoption of the SSTP: Many states have strong, local industries and are reluctant to make this change because it would effectively mean loss of tax revenue.
Should Retailers Fear a Customer Backlash?
There are several studies that show that charging taxes do not result in more abandoned shopping carts. There are many reasons for this, which are beyond the scope of this article, but the bottom line is that there shouldn’t be much backlash. Of course, there could always be that one consumer who is looking to raise a complaint. Retailers can explain their compliance efforts as efforts to comply with what the retailer believes to be its legal obligations, as a courtesy to its customer base (where they might have the reporting and payment obligation) as well as what the retailer believes to be their obligation to do on their own. Dell or Amazon did not seem to suffer any consumer backlash when they started to collect sales taxes. Consumers recognize that this is a legal obligation, and do not tend to raise a fuss when retailers are complying with these obligations.
What Should Retailers Do To Address Nexus?
Do Not Relocate. Retailers, especially small and mid-size ones, should not devote too much effort in relocating their business to be better positioned to address nexus issues. These are such complex issues that you might be doing more harm than good.
Implement Back-End Solutions. Any action that the retailer can should be on the back-end of the business. In other words, business owners need to take steps to assure that they are complying with the laws of the correct jurisdiction. Audits are triggered, and fines are imposed, even in situations of honest mistakes, such as where a retailer did collect the taxes, but paid them to the wrong state. The auditors of the aggrieved state-taxing agency do not take this into consideration when imposing the audit, or in imposing the fine. They might only factor the good faith mistake in their decision to choose between prosecuting the retailer on criminal tax evasion charges, or merely imposing interest, fine and a subsequent probation period where the retailer is closely scrutinized.
“Next Generation” Tax Solutions – Determine Nexus in Real Time
The retailer needs to implement tools that will assure compliance with the different rules. Unfortunately, this means being aware that there could be exposure even in places where the retailer is not aware that they have exposure. Similar to the function of a Certified Service Provider (“CSP”), under the SSTP, a good “next generation” tax solution integrated into the shopping cart of the retailer will have the ability to collect information that is unique to the transaction (including location of the retailer and where the product is being shipped to), process the data and conclude what is the governing jurisdiction, and calculate the correct tax. All this should be done in real time in order to be effective.
“Next Generation” Solution – File the Report
The duties of the CSP and “next generation” provider should stop with the tax calculation. The duties should also include the compiling of all relevant transactional information and filing the tax return on behalf of the retailer in the correct jurisdiction. It is critical that the solution have the ability to operate across all states and jurisdictions. A solution that knows and implements rules from a limited number of states is not one that a business owner wants to use in this era of borderless commercial activity. As a business owner, you are not limited in where you are selling and shipping your product.
Assistance to the Retailer
In short, the issue of nexus is extremely complex and is not necessarily addressed by a simple “you are obligated to file only in the state you have a physical location”. A good “next generation” solution will link into the retailer’s shopping cart to provide accurate tax calculations on each and every transaction, regardless of which state the transaction falls within. It should also enable the retailer to authorize filing tax returns in any state it believes they are required to file. If the retailer elects to register and file in other states – the “next generation” solution will provide such expanded filing capabilities as well. If the retailers starts with only one state, and later expands to other states – the solution should accommodate that as well.