Wayfair: Foreign-based companies at risk of US state taxes

South Dakota’s case against online merchant Wayfair will have a big impact on the US tax system

Foreign companies need to examine the potential consequences of the US Wayfair case as states consider hunting for more tax dollars abroad, say tax advisers.

The Wayfair case, which was released on June 21, sent shockwaves through the US tax system. It means US states will be able to collect sales taxes from out-of-state sellers, overturning a decades-old Supreme Court decision in Quill, which stated the opposite.

Although the case is specific to the US, there is little clarity over whether states could attempt to assert taxing rights over foreign-based companies. This is raising concern among big businesses that sell into the US or have US-based operations.

Baker McKenzie's David Pope, a state and local tax partner in the New York office, said he has received a "substantial" number of enquiries from non-US based clients on Wayfair's impact.

"Multinational businesses that previously took the position that they did not have 'nexus' (a jurisdictional requirement to be subjected to a state's tax) due to a lack of physical presence may no longer solely rely on such a position in jurisdictions that enact or have enacted laws similar to South Dakota's," he told International Tax Review.

Steve Wlodychak, EY's state and local tax policy leader, added that he is also worried about the ruling's potential impact on his foreign-based clients.

"I actually, personally haven't fielded many questions from foreign companies on the impact of the Wayfair ruling on state sales tax collection but I am trying to get the word out and in a theoretical sense they should be very, very concerned," he told ITR.

The difficulty, of course, for states attempting to collect taxes from remote foreign companies, is enforcement.

As countries including Australia, Japan, New Zealand, Norway, South Africa and South Korea, among others, as well as EU member states, found out when introducing destination-based taxation for VAT or GST, it is difficult to force foreign companies to comply.

The US Federal Constitution allows states to pursue taxpayers in other states under the "full faith and credit" clause, but Wlodychak said the principle doesn't really extend to foreign companies.

But Wlodychak warned that foreign companies, particularly affiliates of large multinationals that have a presence in the US, should be "very concerned" because "states could use 'affiliation' concepts to seek recovery of the sales taxes that should have been collected and not paid."

The physical presence requirement, which was the subject of the Wayfair case, is similar to the permanent establishment concept in most tax treaties. However, US tax treaties do not generally apply to state indirect taxes, confirmed two Big 4 advisers.

The US-Switzerland tax treaty (1996), for example, stipulates: "The existing taxes to which the Convention shall apply are: a) in Switzerland: the federal, cantonal and communal taxes on income (total income, earned income, income from property, business profits, etc.)."

However, it makes no reference to US state sales tax, only referencing federal income taxes imposed by the Internal Revenue Code and excise taxes on insurance premiums.

Some states do have areas of legislation relating to sales into their borders from outside of the US however.

Washington, for an example, provides an exemption for items "in import or export commerce". Kent Johnson, partner and national leader for indirect tax services in KPMG's state and local tax practice, said this "generally includes items shipped from outside the US directly to retail consumers in Washington if the property remains in the stream of import until delivery to the customer".

But Johnson expects that states without a specific carve-out for foreign sales will seek to apply their nexus standards to both domestic and foreign sellers that make sales to consumers in the state.

In the future, countries could seek to amend their tax treaties with the US to prevent states from claiming taxing rights over companies based within their borders. Particularly for countries that do not apply the destination principle for indirect tax purposes, this would be an effective way of preventing double taxation – if the US agreed to such changes.

"One suggestion – and I might be committing treason here in the US – is for foreign negotiators of tax treaties to seek to expand the 'permanent establishment' concept to state taxes too," said Wlodychak. However, this might go in the opposite direction of what the European Union member states are trying to do under the OECD BEPS proposals and the concept of 'place of presence' in the digital economy, he noted.