By: Matthew Dyment, Aftab Jamil, Eric Fader and Steve Oldroyd, BDO USA, LLP
The impact of the U.S. Supreme Court’s decision in South Dakota v. Wayfair, now over a year since it was handed down, continues to reverberate throughout the business world. As the year wears on, it’s clear the decision carries implications for industries beyond retail and, indeed, for the very basic functions of any business with multi-state operations. Not understanding these implications can have significant financial consequences—failure to collect sales taxes on remote sales can result in significant tax assessments for the seller.
Management, with their tax advisor’s guidance, should be assessing potential sales and use tax exposures in light of Wayfair. Management should also consider how the Wayfair decision affects some less-obvious areas of their organizations. Managing the fallout from Wayfair requires a holistic view of how your business’ areas of operation intersect with sales taxes, as well as other state taxes, such as income or franchise taxes. In other words, it requires understanding your total tax liability.
Wayfair Sheds Light on Historical Noncompliance
In its June 21, 2018, decision, the U.S. Supreme Court replaced the physical presence nexus standard in favor of an economic one, thereby removing constitutional barriers to states’ lawful ability to collect sales and use taxes from out-of-state sellers. The Wayfair decision had a domino effect: States began adding or revising statutory language for remote sales/use tax collection, and several states introduced laws that automatically went into effect following the decision. As of the publication of this article, all but three states (Florida, Kansas and Missouri) have enacted an economic nexus rule, which makes collecting and remitting sales taxes a likely necessity: If you aren’t collecting sales tax, or aren’t collecting the proper amounts, you may be taking on significant financial risks.
In light of the Wayfair decision, it is appropriate for every management team to reassess its organization’s nexus, or connection, with each state where it ships or delivers sales. For many, this assessment may reveal a business already had state tax nexus, even before the Wayfair decision was issued, because they had an in-state physical presence. For example, software providers often offer onsite installation and training to accompany their product sales. If this is the case, the software seller most likely already had an in-state physical nexus because of the onsite installation service performed in the state. It is prudent for such sellers to quantify their historical exposures and consider mitigating historical liabilities through voluntary disclosure agreements (VDAs) before registering for sales taxes.
Wayfair Case Studies
If you are in the business of making retail sales of tangible property or taxable services, it is more likely than not that you will need to charge, collect and remit sales taxes. For businesses that have not been collecting sales/use taxes on their out-of-state transactions, their financial statements should reflect this liability and, if audited, there may be a significant cash outlay.
Case Study #1 – Physical Nexus with Inventory Held by Amazon
A small business was selling a popular holiday toy online. It would buy the toys in anticipation of its popularity, and contract with Amazon to fulfill online purchases. As such, Amazon was holding onto the business’ inventory in various states where Amazon operates. When one of the state’s Department of Revenue made an investigation of Amazon, Amazon disclosed to the state the names of the businesses storing items in its warehouses, which led to the discovery of this business. The company (unknowingly) had an in-state physical presence because Amazon held the company’s inventory in the state and, as such, was required to collect sales/use tax. Failure to charge, collect and remit sales taxes resulted in a tax liability with interest and penalty payments in the six-figure range. Without the resources to pay, the small business declared bankruptcy.
Case Study #2 – Economic Nexus of a Software as a Service (SaaS) Company
In another case, a SaaS company was collecting sales and use taxes only for sales made to in-state customers, even though it had customers located nationwide. When the organization’s owners decided to sell the entire business, the buyers discovered the company’s failure to collect taxes on remote sales during their due diligence process and determined that there would be a significant successor liability related to these uncollected taxes. Once the sales tax liability was discovered, the buyers sought a considerable purchase price reduction for the acquisition of the company. Ultimately, the parties agreed on a plan to remediate the exposure in non-filing states through participation in state Voluntary Disclosure Programs, including an escrow that would allow the buyer to resolve the unpaid sales tax issue occurring under the seller’s watch. The buyer then spent the next year working with its outside sales tax professionals to negotiate and finalize the terms of VDAs.
Compounding Complexity: Marketplace Facilitator Tax Laws
While Wayfair has obvious effects on the e-commerce sector, its impact also extends to the middlemen of retail sales transactions. As the year continues to unfold, unforeseen exposure for both retailers and these middlemen has the potential to have great impact as companies begin to understand their collection and reporting responsibilities.
New sales tax laws are now requiring marketplace facilitators — third-party entities that facilitate sales such as Amazon — to collect and remit sales and use taxes on behalf of retailers. These laws help to substantially reduce the number of remote sellers that state tax authorities may seek to audit. We expect nearly all states will enact marketplace facilitator tax laws in the near future.
By nature, marketplace facilitators don’t have intimate knowledge of the goods or services being sold as the retailers themselves. This lack of familiarity could result in a fair amount of under-collected sales tax if these sales are not properly accounted for or mapped to the correct taxability classification. Also, this under-collecting is compounded by the fact that there is lack of clarity around who should ultimately be responsible for the correct amount of sales taxes collected and reported to the taxing agencies, whether it’s the retailer or the company facilitating the sale.
It is imperative that companies keep a record of how each sale is taxed and who has collected and/or reported the sales tax. This enables transparency into potential liabilities, which, by extension, allows companies to prepare for the payment of such liabilities.
The complexities and far-reaching effects of the Wayfair decision cannot be understated. Sales and use tax exposure is just the tip of the iceberg. From tangible goods to services, and state income/franchise tax to financial reporting, Wayfair has unleashed a formidable amount of change to the most basic tax operations of your business.
If your company is in the business of making sales, you should be assessing how Wayfair compliance has altered your total tax liability. Contact us today for more information and guidance.