Canada: Are You Selling To U.S. Customers? What The Wayfair Decision Means To Canadian Companies

The recent ruling of the Supreme Court of the United States in South Dakota v. Wayfair, Inc.,1 while receiving little coverage here in Canada, may have a substantial impact on how Canadian companies do business in the United States. In what may be a game changer for online retailers, the ruling has opened the door for individual states to enforce sales tax collection on sales shipped into their state, even where the seller has no physical presence. The Supreme Court overturned decades of judicial precedents and confirmed that physical nexus is no longer required for a state to enforce sales tax collection; rather, the concept of economic nexus should be considered as a reasonable basis.

Background

Historically, individual states in the U.S. have long had sales and use tax regimes. The two taxes work together: a seller who had physical nexus in the state was obligated to charge and remit sales tax to that state; a buyer who purchased from a seller who did not charge the state sales tax was expected to self-assess and remit a use tax in lieu thereof. The basis for the test of whether a seller had physical nexus comes from an earlier case, Quill Corp. v. North Dakota.2 In Quill, the Court had ruled that, under the "Commerce Clause," for a state to be able to enforce sales or use tax there was a bright-line physical presence requirement of the seller. Essentially, if a seller had no physical presence in an individual state, the state had no ability to enforce the collection of the state sales tax, and the onus was on the buyer to voluntarily self-assess and remit the use tax, if it applied.

South Dakota v. Wayfair Inc.

While that structure might have worked in 1992, individual states have long complained that potentially billions of dollars in state tax revenues have been lost due to the explosion of e-commerce (internet-based retailers) and the reality that buyers frequently do not self-assess the use tax component. Enter the state of South Dakota,3 which passed a new law in 2016 that required out-of-state sellers to collect and remit sales tax "as if the seller had a physical presence in the state." A volume-based test ($100,000 in goods or services, or 200 or more transactions) set a threshold sellers must meet for economic nexus. 

In the Wayfair case, the Supreme Court agreed that the physical presence rule from Quill was "unsound and incorrect," and that South Dakota's 2016 law (including the test for economic nexus for determining taxability) was reasonable.

The ruling has changed the tax landscape at the state level. To date, more than 39 states have enacted or will enact new laws with economic nexus threshold tests that are similar (although not identical) to South Dakota's. Some have instituted thresholds as low as $10,000 in sales,4 while others have thresholds as high as $500,000,5 and with varying thresholds for numbers of transactions. More states are expected to enact similar legislation in the coming months.

Wayfair may also have impact on more than just the state sales taxes. State corporate tax is determined on a state nexus basis, which also often requires a physical test. Tax professionals are watching closely to see if the sales tax concept of economic nexus over physical nexus will begin to appear in state corporate tax thresholds in the future.

Next steps for Canadian companies

For the Canadian company selling into the U.S., this structure creates a whole new level of risk that must be assessed. Consider the following mitigation steps:

  • Assess state activities
    All companies selling into the U.S. should thoroughly review activities on an individual state basis. The review should include an assessment of sales revenue and the number of transactions. A comparison of company activity with state thresholds will identify states where sales tax risks exist.
  • Analyze potential taxability of products and services
    Even where a company may have exceeded the economic nexus threshold in a particular state, the issue of whether sales tax should be charged is determined by the taxability of the individual product or service. An analysis of the products and services sold in the state will help to determine whether sales tax should be charged.
  • Develop internal systems to track state sales
    Going forward, the ability to track sales easily by state will become more important, particularly if state registrations are required. Developing and implementing reporting and tracking tools will be essential.
  • Develop sales tax compliance processes
    Companies selling heavily into the U.S. should assess whether current technology and personnel resources are sufficient to deal with the increased tracking and compliance requirements. Add-ons to current sales systems may be required to properly charge state sales taxes. Additional staff or third-party providers may be required to handle increasing compliance needs.
  • Develop a plan for keeping up to date on coming changes
    While many states have legislation already in force, several states have set enforcement dates sometime in the future, and some have not set enforcement dates at all. Those states that have not enacted new legislation in response to Wayfair are expected to do so in the coming months, and your Collins Barrow tax advisor can keep you up to date on state changes as they come into force.

Footnotes

1. Released June 21, 2018.

2. 2504 U.S. 2987 (1992).

3. Several states introduced similar laws in the same time frame. South Dakota's was the first to be challenged at the Supreme Court.

4. Pennsylvania and Oklahoma.

5. California, Massachusetts (transaction threshold applies also), Tennessee, Texas and Ohio. Enforcement dates of new laws differ from state to state.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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