On June 21, 2018 the U.S. Supreme Court brought down its decision in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (hereinafter referred to as “Wayfair”) which dramatically changed and expanded the concept of “nexus” for determining whether a seller into a state is required to collect sales tax in that state.
Briefly, prior to Wayfair, case law supported the notion that in order for a business to be required to collect sales tax in a particular state it had to have a degree of physical presence in that state. This physical presence was often referred to as “nexus” with the state. No nexus in a state, no requirement to collect sales tax in that state no matter how many sales were made into that state or the dollar amount of such sales into that state. The leading case in this regard was Quill Corp. v. North Dakota, 112 S. Ct. 1904.
In the “old” economy this concept probably made sense as most business was conducted through brick and mortar storefronts. The explosion of internet commerce through companies like Amazon & Apple with billions of dollars of sales into states in which these companies have no physical presence left state and local governments wondering whether the old physical presence test was still appropriate.
The State of South Dakota believed that US business had outgrown the concept of physical nexus and in 2016 introduced legislation which would allow it to collect sales tax from out of state sellers for goods shipped into the state. The law introduced the concept of “economic nexus” and required South Dakota sales tax to be collected and remitted by out of state vendors with South Dakota sales of at least $100,000 or 200 sales transactions shipped into the state in a year.
Wayfair and two other large internet sellers challenged the law and were successful in both the Sixth Circuit (court of appeals) and South Dakota Supreme Court, both of which cited that they were bound to follow Quill until overturned by the Supreme Court. The Supreme Court agreed to hear the case in October 2017 and abrogated Quill in its decision released the following June. In its decision a 5-4 majority of the court ruled that the physical presence rule of Quill was “unsound and incorrect” and that “the internet’s prevalence and power have changed the dynamics of the national economy.”
Since Wayfair, 45 states plus the District of Columbia have either enacted sales tax economic nexus filing requirements or are in the process of adopting reporting requirements either legislatively or through administrative rule. This means that for a Canadian business that has no connection with the United States other than the location of some of its customers it may have to register for sales tax, collect and remit sales tax and file sale tax returns for each state in which it exceeds the threshold for economic nexus.
What about Income Tax?
When a Canadian company does business in the US, the threshold for US federal taxation of profits attributable to the US business is a permanent establishment located in the US. The term “permanent establishment” is defined in Article V of the Canada-United States Tax Convention (1980) (hereinafter referred to as the “US Treaty”). Generally the term “permanent establishment” means a fixed place of business through which the business of the Canadian company is wholly or partly carried on although there are provisions in Article V of the US Treaty that will give rise to a permanent establishment in situations in which there is no “fixed place of business”. No permanent establishment in the US, no US federal taxation of business profits of a Canadian company.
The individual states are not parties to the US Treaty and are not bound by its terms. Accordingly it has long been recognized that a Canadian company that is not subject to US federal income tax may, nevertheless, be subject to state income tax on income attributable to the state if the company has income tax nexus in that state. Prior to Wayfair, states generally had a “degree of physical connection” required in order to have income tax nexus in that state. Once state income tax nexus was reached, the state would use some method to apportion the income of the company to the state, often some combination of property, payroll and sales. The income to be apportioned would often be federal taxable income before or after application of tax treaties and then sometimes adjusted for differences under state tax law.
Following Wayfair, many states have enacted or proposed legislation that introduces an economic nexus concept in order to determine whether a business is potentially subject to state income or gross receipts tax. To date, 40 states plus the District of Columbia and New York City have proposed or enacted legislation that incorporates an economic nexus standard.
That said, Public Law 86-272 is a federal law that protects a business from being subject to state income tax for merely soliciting sales in a state. It applies only to sales of tangible personal property and taxes payable on net income. Accordingly it does not protect services income, sales of intangibles or taxes payable on gross receipts such as Washington’s Business and Occupation tax. Lastly, Public Law 86-272 protects interstate commerce only and commentators are mixed as to its protection afforded to a Canadian corporation making sales into a state as this is probably international commerce, although the point is not free from doubt.
In summary, it is recommended that a Canadian business with material sales into the United States review the local sales tax and income tax rules, particularly in the states with the highest sales activity, in light of the new economic nexus standard in order to protect itself from a surprise assessment of state and local taxes down the road.
Article written by:
Jeffrey A. Fortin, C.A., C.P.A. (IL, USA) – Partner, US Tax
Jeffrey can be contacted at 403-767-1503 or send us a note at firstname.lastname@example.org