U.S. sales and use tax compliance for EU businesses

For European businesses wanting to scale globally, the U.S. is often the first country they set their sights on. Understanding the country's rules and regulations surrounding tax liability is vital, as there are fundamental differences between the EU's regulations.

The US sales and use tax regime is incredibly complex; every state has a different tax framework, with variations in regulation covering everything from tax liability and tax rates to exemption categories and reporting requirements. On top of this, local area tax jurisdictions also have powers over some aspects of taxation and can set different rules for their area.

Here we share some of the key points for European businesses, wanting to start selling across the pond.

U.S. sales and use tax: the principle of 'nexus' 

Sales tax nexus is the root of all sales and use tax liability in the U.S. and is the connection between a seller and a state. Historically, nexus required a business to have a 'substantial physical presence' in the state, such as an office or a warehouse. If businesses are making sales into a jurisdiction where they have no physical presence, there is no requirement to register for sales tax under physical nexus rules. 

However, a landmark court judgement in 2018 established that states can also apply 'economic nexus' to businesses. This is where a connection to the state is determined through the level of sales activity to customers within it. Economic nexus rules are being applied more frequently now, thanks to the growth of remote sellers capitalising on the opportunities offered by the growth in e-commerce.

How can businesses establish if they have physical or economic nexus or both?

Economic nexus is established by two factors:

1) sales revenue value and/or 2) number of transactions, which includes the renewal of a subscription (which counts as one transaction). There is no consistency between states as to the level of revenue or number of transactions at which nexus is created, the revenue figure required or the defined period for calculations for economic nexus to be created. Although, we are seeing a trend of state taxing jurisdictions eliminating the number of transactions threshold.

This is where complications arise. Some states use one measure to determine economic nexus, others use a combination.

As well as having a physical presence in a state, physical nexus can be created, sometimes unknowingly, by a broad range of activities, including employees crossing state lines on a regular basis with work. Each state has their own rules on this. It can also be created by working with third-party contractors in a state, when a seller's website installs cookies on a customer's device, exhibiting at trade shows and via online affiliate marketing, known as 'click­ through nexus'.

To understand which nexus(es) you have created, you must monitor sales activity by state and each state's legislative changes, as well as understand state-specific rules on sales revenue value.

How is U.S. sales and use tax applied by customer location determination?

A customer's location is determined by their five-digit ZIP code. When the product taxability code is added to this, it determines the transaction's sales and use tax.

For more accurate sales tax rates, 'ZI P+4' is used. This requires a much more granular level of detail of the address as well as validation of the details given by the U.S. Post Office's database and allows more precise identification of relevant state and city taxes.

What is excluded and exempt?

While states can apply at their discretion for tax exclusions, there are some goods and services which are exempt from US sales and use tax, primarily on how they are used in business.

These exemption certificates are applied for by a customer to the state in which the product or services will be delivered or used. It is a business's duty to review its completeness and validity and show due diligence in doing this.

There are two main types of certificates:

Use-based, such as resale exemption certificates, are the most common. With sales tax charged at point of sale, goods bought for resale are exempt to avoid double taxation.

Entity-based certificates are used by charities, churches and educational, political, trade and welfare organisations.

Most exemption certificates are state-specific. A multiple-jurisdiction form can be created for ease of tracking a company's state exemption numbers.

What are the challenges in reporting U.S. sales and use tax? 

Reporting U.S. sales and use tax is made more complex by each state having their own rules and regulations. Here are some of the top-level considerations:

• The detail of the information required on reports varies from state to state.
• Timing of returns can vary, typically they are due either monthly, quarterly, or annually. But some states have more unusual frequencies, including semi-annual or even occasional.
• Reporting for relevant tax jurisdictions, where sales and use tax is not a flat rate across a state, returns must provide the relevant detail for each local tax jurisdiction. Tax reports need to be broken down to show how the sales tax is apportioned to the relevant tax jurisdiction. This can include state, city, county and metropolitan areas.
• Tax exempt sales must also be reported effectively.