Avoiding the US Sales Tax Trap
UK and European companies that do business in the US or set up US operations are frequently puzzled by US sales and use taxes. Sales and use taxes are transactions taxes that are imposed on ultimate customers at a state and local level. The amounts and rules vary from state to state and locality to locality.
Sales and use taxes are not like European value added tax (VAT). VAT is a tax imposed on each level of a transactional chain but then recoverable in many circumstances except by the ultimate retail customer.
Sales and use taxes, in contrast, are imposed only at the ultimate point of sale, although intermediate parties in the chain may find themselves paying sales tax if they are unable to establish their right to exemption. A seller is required to collect sales/use tax from a customer in a relevant state and remit it to the state and local tax authorities if: (a) the customer is not exempt; and (b) the seller has sufficient nexus to that state that the seller is subject to the collection obligation.
Nexus is a physical connection to the state or locality, and can result from having an office in the state, employees or independent contractors in the state, inventory in, or drop shipping from, the state, an agent or affiliate in the state, or potentially even temporary business activities in the state, like participation in a trade show in excess of a certain number of allowed days.
If the seller is not required to collect sales/use tax or fails to do so, the customer is required to pay an equal amount of use tax to the state or locality. Compliance by larger corporate customers with their use tax obligations is generally pretty good; compliance by individual customers is poor, and compliance by smaller business customers may be unreliable.
Sales and use taxes typically are imposed on goods (tangible personal property) and not on most services, although this is not always the case. However, some states, including New York, treat software as a service (SaaS) as standardized (not customized) software, and consequently subject sales of SaaS services to sales and use taxes.
What does this mean for UK and European companies:
This is a compliance nightmare, but it can be managed. Get early advice from tax advisors who are knowledgeable in this area on a 50 state basis.
Require your customers to agree to pay use taxes and provide you with documentary evidence. This won’t relieve the company of its own liability to collect and remit (so the company could still be subject to penalties and interest), but the taxing authority should not be entitled to receive double payment if your customer has, in fact, paid the appropriate “use” tax.
Many states impose responsible person liability based on an individual’s “willful failure” to comply with that state’s sales and use tax laws. Thus, notwithstanding the limited liability provided by operating through a corporation, officers and directors may have personal liability for unpaid sales tax, penalties and interest if they willfully fail to collect, or remit, sales and use tax.
Robert P. Mollen Robert P. Mollen is a US-qualified corporate partner who has been resident in Fried Frank’s London office since 1991. Bob regularly advises technology companies, including early stage companies, in connection with their establishment and expansion of US operations, US commercial agreements and joint ventures, and securing of US investment by venture capital firms and others. Bob also works with VC firms with respect to US challenges faced by their portfolio companies, and with the UK and US governments in their efforts to help UK based companies succeed in the US. Bob can be reached at Robert.email@example.com
This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice. Please refer to your advisors for specific advice.