SALES TAX - HOW DOES IT WORK FROM THE VENDOR POINT-OF-VIEW?

Please note that the guidance below is not a substitute for professional legal and/or tax advice. Any tax advice contained in the body of this e-mail is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

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Although Sales Taxes bear a minor resemblance to VAT tax, they function quite differently in practice. If your business relies on physically delivering goods, understanding the basics may impact your US operations in a significant way.

The main concept works as follows: 

• When a business has a “physical presence” in a particular state, it is required to add Sales Tax to the sales price of all goods that are physically delivered within that state to an “end-user”. Please note that 1) The delivery address is the determining factor – not the billing address and 2) an “end-user” is defined as any customer that is purchasing a product in order to use it for personal and/or business use (i.e. does not intend to re-sell it). The Sales Tax that is charged to customers then needs to be remitted to the state within which the product was delivered. This way, the business does the administrative work of the state by charging the tax on behalf of the state.

• When a business has a “physical presence” in a particular state, it is not required to add Sales Tax to the sales price of goods that are physically delivered outside that state. Rather, customers have the obligation to declare such purchases to the state wherein the goods were delivered. Individuals do so in their personal state tax returns while businesses do so by way of directly reporting to the state. The resulting taxes paid by customers are known as Use Tax, even though they correspond to the exact same amount as the Sales Tax that would have otherwise appeared on an invoice. One could thus argue that Sales Tax and Use Tax are synonymous.

Frequently Asked Questions include:

HOW IS PHYSICAL PRESENCE OF A BUSINESS DETERMINED?

That is simple. Ask yourself the following questions:

• In which states do my employees work?
• In which states do my business have fixed assets?
• In which states do my business have inventory?

Any state that is identified in the questions above is a state wherein your business has a “physical presence”.

 But what if your business only delivers a product into a state and installs that equipment ? What if your business has a sales person that travels into a state on a regular business to solicit sales ? What if your business has a sales booth at a trade convention in a particular state multiple times per year ? The answers to these types of questions can often lead to unanticipated physical presence in a state that can then lead to the need to file various different tax returns (income, employment, sales, etc.). 

HOW MUCH SALES/USE TAX SHOULD BE ADDED TO INVOICES?

Once you have determined that sales tax should be added to an invoice, the % tax rate to use can be tricky to identify. The state will generally have an overall state tax rate – some states have no sales tax. Unfortunately, once a state imposes sales taxes, cities and counties also often use that system to generate revenues. As a result, each zip code in such a state may require its own sales tax rate. Generally, each such state publishes the proper rates to assign to each zip code on their website. Staying current is critical since those rates vary from time to time (they almost always increase) and any taxes that were not invoiced must nonetheless be paid by the vendor.

WHAT HAPPENS IF MY BUSINESS HAS NO PHYSICAL PRESENCE IN THE US?

 If your business has no physical presence in the US, you need not concern yourself with charging sales taxes. The burden is entirely transferred to your customers who should, in theory, declare their purchases from you. However, take caution in quickly assuming that your business has no physical presence in the US if you have a close or related party relationship with one distributor in the US . 

IF MY BUSINESS HAS A PHYSICAL PRESENCE IN THE US, CAN I AVOID DEALING WITH SALES TAX BY RECORDING ALL SALES IN A BUSINESS OUTSIDE THE US?

This is a question that often arises when a US business is strictly established for the purpose of generating sales that will be administered outside the US.  Unfortunately, that is not a solution. Once a US presence is established, sales taxes must be administered, no matter how the underlying accounting is managed.  A better solution is to ensure that the physical presence of your business is restricted to states that do not require sales tax – for the time being.

ARE LABOR COSTS RELATED TO THE INSTALLATION OF SOLD EQUIPMENT SUBJECT 

TO SALES TAX?

Simply put, the answer is “No”. Only the price charged for items sold is subject to sales tax. 

Note that if your business charges for materials and fabrication labor separately, such a distinction should be viewed merely as a means of presenting differently the sales price of a physical good. Accordingly, fabrication labor is subject to sales tax.

WILL MY BUSINESS LOSE CUSTOMERS IF IT HAS TO SUDDENLY CHARGE SALES TAX 

TO EXISTING CUSTOMERS?

In theory, the answer is “No”. If subject to Sales Tax, your customers should either be paying Sales Tax as part of their vendor invoices or paying Use Tax directly to their state. If anything, administering Use Tax places a burden on your customers that they should gleefully avoid by paying Sales Tax instead.

However, it is worth noting that many customers may not be fulfilling their Use-Tax obligations. Accordingly, they might view your products as being more price-competitive when Sales-Tax does not appear on their invoices. Even if your customers are properly administering Use-Tax, purchasing agents may not understand that their accounting departments are having to work overtime to account for Use-Tax.  They may think they are saving money by avoiding Sales Taxes.

In conclusion, assigning Sales-Taxes to invoices should not affect your operations. If it does, it is most likely the result of a lack of understanding the system on the part of your customers.