B2B online sellers and buyers have a new road to travel in the world of tax reporting responsibility—and knowing which transactions are taxable and which are exempt.
Tread carefully, tax experts say. Now that the U.S. Supreme Court has struck down a company’s physical presence as a legal grounds for requiring sales tax collection, there’s much to be clarified regarding what triggers sales tax responsibility.
Sales tax liability can hinge on things as fuzzy as whether a laptop computer is used on a factory floor solely for the buyer’s own purposes—which would be subject to sales tax—and to what degree it’s used to fabricate products sold to customers—which likely would be exempt. Other gray areas arise over such topics as sales of cloud computing products and services, various forms of digital products like videos that downloaded or streamed, and whether a seller has widely distributed apps and software cookies.
“It will be an interesting transition time, for sure,” says Rebecca Newton-Clarke, senior editor at Checkpoint Catalyst, a tax law information service in the Tax & Accounting unit of Thomson Reuters. Companies will need to take a close look at their categories of product sales, their customers’ tax exemption status and the assorted tax rules of the states in which they have sales, she and others say.
The lasting results of the high court’s decision in South Dakota v. Wayfair are far from clear for online and mail-order catalog business-to-business sellers and their customers, experts say. While the court removed physical presence as a means to require sales tax responsibility, it replaced it with “significant economic nexus”—which can vary widely among states and in many cases is yet to be clarified. With tax laws and regulations varying widely, both sellers and buyers need to clarify how sales tax rates apply to particular business uses, and which customers, and which types of transactions, are exempt.
“What we will likely see is more enforcement of exemptions,” says Stephen Kranz, a tax specialist and partner at the Washington, D.C., law firm of McDermott Will & Emery LLP.
Sellers that until now haven’t bothered with sales tax collection and remittance in states where they had no physical presence, or physical “nexus” in legal jargon—such as a distribution center or sales office—may not have bothered to check whether their customers in those states had tax-exemption certificates, Kranz says. Now they should, he adds. “It would be a good use of time to evaluate where a company is registered and able to meet exemption certificate requirements,” he says.
A few of the areas requiring extra attention:
- Online marketplaces. More states—most recently Connecticut—are considering marketplace operators, as opposed to just the third-party sellers, as being liable for processing sales tax on marketplace transactions, Newton-Clarke says.
- Factory floors. If a company sells laptops, for instance, to a manufacturer for use on a factory production floor, sales tax may kick in if the laptop user is not directly involved in the production process. If the laptop is used to facilitate production of products sold to the manufacturer’s customers, the transaction would likely be exempt.
- Cloud computing. While some states tax cloud computing services and others don’t, the difference can depend how each state determines whether a company is paying for cloud data storage or cloud computing services for its own direct use or on behalf of its customers. “It’s a very unsettled area of the law,” Newton-Clarke says. She notes that some states charge sales tax on cloud data storage, but not on cloud computing. Other states, including Connecticut, charge sales tax on cloud computing but at relatively low rates, which can attract more cloud services business, she adds.
- Digital products. Many states treat digital products like audiobooks and videos separately from cloud computing, in some cases charging sales tax on audiobook and video downloads but not on streaming services, Newton-Clarke says.
- “Sleeper” laws, such as for apps and cookies. As states clarify their “economic nexus” laws and regulations, some are relying on long-running laws or regulations that have been in effect for many years. Massachusetts, for example, has a long-running rule that requires online sellers to collect sales tax because of the nexus tied to the software apps and cookies they have installed on customers’ computers and mobile devices. Iowa also refers to software apps and cookies in its economic nexus law. “A lot states have ‘sleeper’ laws,” Newton-Clarke says.
Several software vendors provide software tools designed to help sellers manage the slew of sales tax rates throughout the United States, including exemption certificates. They include Avalara, CCH, Oracle NetSuite, Savos, Thomson Reuters, and Vertex.
Packages of these tools typically enable companies selling products to research and confirm tax rates and requirements for particular product categories shipped to particular ZIP codes in each state, and configure a software tool designed to automatically apply the correct tax rate, if any, and tax exemptions to each line item in a customer’s invoice. Both the seller and buyer then have electronic records of the tax charged for each product in sales transactions, including records of any tax exemptions, that can be used in tax audits.
Thomson Reuters, for example, provides a OneSource software application for calculating taxes nationwide that starts at about $7,000 per year, based on the number of sales transactions, the company says. Deploying the software and also integrating it with a company’s own financial management technology starts at about $18,000.
Such software is designed to help buyers as well as sellers ensure that the correct amount of sales tax, if any, was applied to each invoice, says Adam Shaffner, senior product manager at Thomson Reuters for OneSource. “It validates if sellers charged the correct tax to customers, so they don’t overpay or underpay,” he says.
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