Indirect tax as direct tax: An extended reach

Holding a credit cardWhile tax reform lowered corporate income tax rates, there is no parallel break for indirect taxes. On the contrary, indirect tax burdens, in the form of jurisdiction sales taxes, are generally increasing. This is because policy makers have taken a new tack to boost state and local revenues ─ shifting focus from profit and outcome to transaction and revenue. With the shift, indirect tax is taking much of the attention that tax and finance departments previously reserved for direct taxes.

The increased focus on indirect tax is attributable not only to the policy shift to transaction-based taxes, but also because of the global shift to an online retail market.  Like much of the global economy, indirect tax is moving beyond the physical and into the virtual. 

Wayfair gives a major boost to indirect tax In one fell swoop ─ the Supreme Court’s summer 2018 Wayfair decision ─ the door was opened for states to impose indirect tax requirements on foreign sellers that have no physical presence with the states. Physical presence is no longer the sole factor in determining sales tax obligations. As a result, indirect tax collections will likely climb. Payments from remote sellers across the country and globe are expected to amount to billions of dollars. 

Wayfair is the most significant indirect tax decision in a generation. Businesses need to review activities in order to comply with this far-reaching ruling, as well as with other extensions of indirect tax. 

Indirect tax is taking greater effect The following Q&A provides a better understanding of changes in indirect taxes and how they might affect your business. 

Q: What is the principal indirect tax?

A: Sales tax, with a corresponding use tax.
Sales tax is a tax on retail expenditures of an end user. A seller is required to collect tax on the sale of taxable goods or services and remit the tax to the appropriate tax authority. A taxable good or service purchased for resale isn’t customarily subject to sales tax. 

Historically, a seller without a physical presence or agent in the jurisdiction hasn’t been required to charge sales tax at the point of sale. Wayfair, however, allows but doesn’t oblige states to impose sales tax on remote sellers within certain parameters. To compensate for scenarios where indirect tax is rightfully due but the seller isn’t obligated to charge sales tax, jurisdictions generally impose a use tax, which isn’t dependent on where the goods or services were purchased. Use tax is commonly imposed on the purchaser, not the seller.

Q: Are there registration limits for indirect tax?

A: Yes, certain thresholds must be met.
The conventional standard of physical presence (i.e., having offices, warehouses, inventory, property, employees, or contractors in a state) still applies in most jurisdictions, so a foreign or remote seller with physical presence in a state will likely need to register and collect that state’s sales tax.  The new standards for registration that states are establishing post-Wayfair mostly relate to transaction volume.  In some states, sellers will not reach the registration threshold until they make $500,000 of sales to customers in a state.  For other states, sales of as little as $10,000 can trip the threshold.  There may be other limits in addition to the dollar value of the sales.  

Q: Do registration limits apply to non-established businesses?

A: Possibly, depending on the jurisdiction.  
While sales tax registration and collection requirements don’t distinguish between established and non-established businesses, the Wayfair decision is viewed as extending the reach of states to impose collection requirements on foreign sellers.  Although these requirements vary, the general rule is that almost any amount of physical contact is sufficient for nexus. A business with property or personnel ─ including an agent sent to the jurisdiction or an individual contracted for services ─ likely has physical contact sufficient to establish sales tax nexus. Nexus can also be established because of unconventional physical presence such as certain online e-business relationships, affiliate relationships and sales thresholds. 

Q: What is the overall documentation requirement? 

A: Retaining a complete record including exemptions.
Sales and use tax compliance has fairly strict documentation requirements in virtually all jurisdictions. Generally, baseline requirements are that businesses maintain a complete record of all transactions for several years, often a minimum of five. The standard expectation is that records include such documentation as invoices, bills of lading and gross receipts from sales.

In addition, taxpayers must retain all exemption documentation, which could include resale certificates or consumer exemption certificates. For example, when a business makes a tax-free sale to a wholesaler, the business must collect and retain a resale certificate. Otherwise, the buyer or seller could be held liable for the tax due on the transaction.

Q: Can sales and use tax incurred by overseas businesses be claimed if they aren’t registered in the United States?

A: No.
No taxpayer can reclaim tax that was properly levied. A business doesn’t need to be registered with a state or jurisdiction to incur sales and use tax obligations. If the business has established nexus for sales and use tax purposes, it could be subject to the jurisdiction’s taxing authority. 

Although foreign businesses do not have a means of reclaiming properly levied tax, states have several means of pursuing tax that was not properly collected and remitted.  In addition to seeking penalty and interest on tax owed, states may freeze accounts, put liens on payments, seize assets through jeopardy assessments, and even pursue criminal charges in extreme cases.  While identifying registration and collection requirements up front can be a complex task, defending against an audit can be equally complex, and often more costly. 

Indirect tax territory is broadening 

While tax policy in the US was already evolving to increase states’ reliance on indirect tax, the Wayfair decision supercharged states’ abilities to increase indirect tax collections. Keeping track of how jurisdiction-by-jurisdiction requirements will impact collections is now more complex and critical than at any previous time. 

As its reach is extended into taxation of transaction outcomes ─ and of both physical and virtual presence ─ indirect tax will continue to increase and transform into direct tax.

Rob ClarkRob Clarke
Principal, Tax Services
T +1 813 204 5153

No image availableAdam Raschke 
Senior Manager, Tax Services
T +1 813 204 5178