How the U.S. sales tax rules apply to foreign (non-U.S.) companies that sell to customers in the United States can be complex and confusing! For some foreign sellers, the U.S. transaction based sales tax is very different from the consumption based model followed in many countries. Additionally, some foreign sellers may not realize that 45 of the 50 U.S. states, and the District of Columbia, impose their own state sales tax. Foreign sellers may also be surprised to find out that the definitions, rules and rates are not the same in all of the states or that many local governments, such as the individual cities within the states, can also impose a sales tax.
But for many foreign sellers – in particular those that are familiar with international tax concepts and U.S. federal tax treaty protection – it may come as an even bigger surprise to discover that in general, the U.S. states do not recognize tax treaties that have been entered into between the United States and a foreign country (bi-lateral tax treaties).
That’s right! Because U.S. states are not a “party to” bi-lateral tax treaties, even if a foreign seller is not subject to U.S. Federal income tax, the foreign seller could be subject to the sales tax laws of the various U.S. state and local governments.
So, in my post today, I will start off with a discussion of a very important tax treaty concept – the Permanent Establishment (“PE”). The definition of a PE is significant, in particular because there are certain activities or functions that a foreign seller can have in the U.S. which will not create a PE (“acceptable” activities) and will protect the foreign seller from U.S. federal income taxation.
However, these very same activities are the types of activities that could require a foreign seller to have to comply with the sales tax laws of the state where those “acceptable” activities occur. And so, I will also explain why even “acceptable”activities can create a sufficient connection or “nexus” for U.S. sales tax purposes. (Note, that when I use the term “foreign seller” I am referring to any type of foreign entity – a corporation, partnership or other type of legal entity – that is incorporated or formed in a country other than the United States and which makes sales to U.S. customers.)
What is a Permanent Establishment?
One reason countries enter into bi-lateral tax treaties is to reduce the double taxation that can occur when the same income is taxed by both countries. For instance, a foreign seller from a country that has entered into a bi-lateral treaty with the United States and that engages in business activity in the U.S., will not be subject to U.S. Federal income taxation unless the company has established a PE in the U.S. Even though each bi-lateral treaty is unique (the U.S. has tax treaties with about 65 countries), practically all treaties follow the same definition of a PE found in Article 5 of the Organization of Economic Cooperation and Development ("OECD") Model Treaty Convention.*
In general, a PE is defined as a “fixed place of business” through which a foreign entity's U.S. business is wholly or partially carried on. Examples of a fixed place of business include a place of management, and/or a branch, office, factory, workshop or place where natural resources are mined or extracted. Employees or dependent agents who regularly exercise their authority to enter into contracts in the U.S. that are binding on the foreign entity also create a PE. Even though having "fixed place of business" would generally create a PE, there are several activities that a foreign entity can engage in that will not create a PE. Some of these activities include:
- Renting or leasing a facility solely for storing, displaying or delivering the foreign entity's inventory;
- Maintaining the foreign entity's inventory for the purpose of storage, display or delivery;
- Maintaining the foreign entity's inventory solely for the purpose of processing by another enterprise;
- Maintaining a fixed place of business solely for the purpose of purchasing goods or collecting information for the taxpayer;
- Maintaining a fixed place of business solely for the purposes of carrying on any other preparatory or auxiliary activity;
- Carrying on business though a broker, general commission agent, or any other independent agent, provided the person is acting in the ordinary course of their business as an independent agent.
“Acceptable” PE Activities and Sales Tax Nexus
Early in my post, I mentioned that states are not "parties to" or "bound by" bi-lateral tax treaties. This means that even if a foreign seller engages in an activity that does not create a PE (and does not subject the foreign seller to U.S. Federal income taxation) these same activities can subject a foreign seller to a state’s sales tax laws.
In the U.S. we use a term called “nexus”, which means a “connection or tie”. When we say that a business has “nexus” to a particular state, this essentially means that the out-of state (or out-of-country) business has a sufficient connection to a state to allow that state to subject the business to the state’s tax requirements. For sales tax, the requirements that an out-of-state (or out-of-country) business can be subject to include being legally required to collect sales tax on sales to customers in the “nexus” state.
Explaining the concept of nexus and how nexus affects foreign sellers is another complex topic – and one that I plan on devoting an entire post to in the future. There is also a very significant development occurring in the U.S. right now, which involves the potential enactment of a Federal proposal called the Marketplace Fairness Act. If this proposal becomes final law, it could have a huge impact on foreign sellers. I plan to cover this topic in a future post as well.
However, for this post, foreign sellers should know that having a physical presence, such as owing or leasing warehouse space, or maintaining inventory in a state will create a sufficient connection for sales tax nexus to apply. Actually, every activity listed above as “acceptable” for avoiding a PE, is one that would create sales tax nexus in practically every state. Incidentally, many state sales tax laws specifically say that “maintaining, occupying, or using, through a subsidiary or agent, an office, place or distribution, sales or sample room, warehouse, or storage point” in their state creates nexus.
Another activity that many state sales tax laws say creates nexus is engaging independent contractors who act in an agency capacity. So while an independent agent might not create a PE for a foreign seller, an independent agent will most likely create sales tax nexus in any state in which they represent the seller even if they are not working exclusively for the foreign seller.
The U.S. sales tax rules are complex even for U.S. based companies – and can be even more confusing for foreign sellers. The fact that states are not a “party to” a bi-lateral tax treaty entered into by the U.S. government may be surprising to some foreign sellers who have assumed that avoiding a PE means that they will also avoid state sales tax requirements. But the very activities that are "acceptable" and will avoid a PE, like keeping inventory in a state, or using independent agents, are activities that will require a foreign seller to register and collect sales tax on sales to U.S. customers in the nexus states. And while some foreign sellers may believe that the states will not become aware of their U.S. selling activity, states are becoming more aggressive about identifying “non-compliant” foreign sellers, such as by looking at customs information on shipments. Yes, a bi-lateral tax treaty does not protect a foreign seller from the U.S. sales tax rules!
If you’re a foreign seller (in any industry) who wants to get a better understanding of the U.S. sales tax laws and how they apply to foreign sellers, then I invite you to follow my “Sales Tax for Foreign Sellers” posts here at SalesTaxSupport.com. And if you have certain topics that you would like to learn more about, or if you have a question or comment, please leave me a message in the comment section below.
*Note: In 2006, the United States Treasury Department reissued its U.S. Model Income Tax Treaty, which is a starting point (from the U.S. perspective) for negotiating an income tax treaty with a foreign country. The definition of a PE in the OECD Model Treaty Convention and the 2006 U.S. Model Income Tax Treaty are almost identical.
Other recent “U.S. Sales Tax for Foreign Sellers” posts by Sylvia F. Dion, CPA:
- Wayfair & Economic Nexus for Foreign Sellers: Key Sales Tax Questions
- U.S. Sales Taxes: Filing Frequency for International Sellers
- 7 Key Points Foreign Sellers Should Know about U.S. State Taxes
- Do International Sellers Registering for Sales Tax Need a U.S. EIN?
- International Sellers and U.S. Sales Tax Registration: 3 Key Issues