Preparing for UK/US trade? There’s no one-size-fits-all approach to US sales tax
Larry Mellon, tax director in the Chief Tax Office at Vertex Inc., encourages businesses looking to trade across the pond to implement a US sales tax strategy to prepare for the complexities.
The global e-commerce market is expected to reach $6.5 trillion in 2023, with reports predicting online sales to increase year-on-year and its market share of total retail sales rising from 17.8% in 2020 to 23% in 2025. Unsurprisingly, the UK has also followed suit, with forecasts showing that total retail e-commerce revenue will rise to 42% within the next two years. Supporting this trend, research by Vertex also highlighted that increasingly more businesses are looking to take advantage of the e-commerce boom by entering into new geographical markets as part of their own growth ambitions.
Despite stiff competition for conducting cross-border trade to areas such as the Middle East and South America, one third of UK businesses believe that North America provides the most promise for export sales, according to Internet Retailing. This is evidenced by latest statistics published by the Department of International Trade which revealed that in 2022, UK exports to the US increased by 11% compared to 2021; making the US the UK’s largest trading partner. Despite no agreements yet on a UK-US free trade treaty, many businesses recognise the US as a hotspot for growth. But are they prepared to navigate one of the most complex indirect tax systems in the world?
What exactly is US sales tax?
In the UK, VAT is added to most products and services sold by a VAT registered business and is only levied at country level, whereas US sales tax is applied at state level and can differ between local jurisdictions. Each state sets its own sales tax rules, often taking different approaches. As a result, every state has a different tax framework, with variations in regulations covering everything from tax liability and tax rates through to exemption categories and reporting requirements. Additionally, local area tax jurisdictions also have authority over some aspects of taxations, implementing rules for their own district.
At the root of all sales tax liability is nexus. This is based on the principle that there needs to be a connection with the state to pay a sales tax. Historically, this connection relied on businesses having a ‘physical’ connection but many states have now extended its definition to include sellers of digital services. Since the landmark South Dakota vs Wayfair case in 2018, ‘economic’ nexus has also been established to help tax authorities collect revenue from remote sellers that previously had no requirement to register for sales tax under physical nexus rules.
Planning your US sales tax strategy
If you plan to sell products and services into multiple US states, what considerations should be made to make sure your day-to-day tax management is compliant?
It’s important to consider if your sales activities create physical nexus, economical nexus – or both. The law only requires you to fall into one category.
Remote sellers of physical and digital goods can find themselves having a physical nexus as this can be created by a broad range of activities. Whereas there are only two aspects used to determine economic nexus: sales revenue value and number of transactions (including renewal of subscriptions). To remain compliant, businesses need to make sure they are constantly monitoring sales on a state-by-state basis as there is no consistency on the level of revenue or number of transactions used to determine economic nexus.
Determine taxability of products
Product level taxability refers to the classification of products and services to ensure the correct tax rate is applied. Individual tax jurisdictions can exclude particular classes of goods or services or offer reduced tax rates. However, many states are finding it harder to define new technologies within their tax framework. Therefore, definitions can be vague, and each state (and local tax jurisdiction) can take a different approach making it difficult to understand if a product is liable or not.
Don’t forget about ‘use tax’!
Businesses who don’t have nexus within a state still have tax obligations thanks to a complementary tax called ‘use tax’. This is where tax has to be paid by the buyer in scenarios where the sellers do not collect tax.
A number of states have chosen to offer remote sellers the option of complying with strict tax notifications and reporting requirements rather than registering for sales tax, yet this can be an onerous task making voluntary sales tax registration a more attractive option.
Understand the implications of multi-state sales
Given the wide variety of rules and rapid rates of change, selling into multiple US states can mean your business is subject to a range of indirect tax challenges. You will need to know whether to apply destination or origin-based tax rules to your product or service, determine customer location at zip code level, and identify the tax exemptions and exclusions on goods and services within each state. The latter requires a tax exemption certificate from the customer.
Be mindful of reporting requirements
The process of reporting as well as the detail of information required varies state to state. Typically, this needs to contain everything from sales per tax rate at line-item level, to transaction details such as customer name, invoice number, and invoice date. It is also important to understand specific reporting requirements around the timing of returns, the relevant details needed by each local jurisdiction as well as any measures around exempt sales.
There is no one-size-fits-all approach when it comes to US sales tax compliance: every business is different, with its own unique requirements. Vertex can help ease complexities and support your business with its growth ambitions. Learn more here.
Get in touch with Vertex.