Treasury Issues Final Regulations on Withholding with Respect to Interests in Partnerships Engaged in a U.S. Trade or Business

Summary

On October 7, 2020, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) issued an early version of final regulations that provide guidance related to the withholding of tax and information reporting with respect to certain dispositions of interests in partnerships engaged in a trade or business within the United States. The final regulations affect certain foreign persons that recognize gain or loss from the sale or exchange of an interest in a partnership that is engaged in a trade or business within the United States, and persons that acquire those interests. The final regulations also affect partnerships that, directly or indirectly, have foreign persons as partners.
 

Background

On April 2, 2018, Treasury released Notice 2018-29, which provided temporary guidance and announced an intent to issue proposed regulations under Internal Revenue Code Section 1446(f) with respect to the sale, exchange, or disposition of certain interests in non-publicly traded partnerships (non-PTPs). On May 13, 2019, Treasury published proposed regulations (REG-105476-18) primarily under Section 1446(f) relating to the withholding of tax and information reporting in the Federal Register (84 FR 21198). The proposed regulations implemented Section 1446(f) by providing guidance related to the withholding of tax and information reporting with respect to certain dispositions by a foreign person of an interest in a partnership that is engaged in a trade or business within the United States. In general, the proposed regulations provided rules that apply to transfers of interests in non-PTP interests and transfers of publicly traded partnership (PTP) interests. For a summary discussion of the proposed regulations, see our May 2019 tax alert.
 

Final Regulations Modify Withholding Exceptions and More

The final regulations retain the basic approach and structure of the proposed regulations with certain revisions.[1] Some of the key revisions are summarized below.[2]
 
The final regulations retain the general rule in proposed Treasury Regulation §1.1446(f)-2(a) that requires withholding on the transfer of a partnership interest unless an exception or adjustment to withholding applies. However, in response to comments, the final regulations add a rule in §1.1446(f)-5(b) that provides that any person required to withhold under Section 1446(f) is not liable for failure to withhold, or any interest, penalties, or additions to tax, if it establishes to the satisfaction of the Commissioner that the transferor had no gain under Section 864(c)(8) subject to tax on the transfer. Accordingly, while the general scope of the withholding obligation under §1.1446(f)-2(a) is retained in the final regulations, the consequences for failing to comply with the obligation are modified when the transferor had no gain under Section 864(c)(8) subject to tax on the transfer. As this rule applies for all purposes of Section 1446(f), it also modifies the consequences for a partnership that fails to comply with its withholding obligation under §1.1446(f)-3 or a broker that fails to comply with its withholding obligation under §1.1446(f)-4 on the transfer of a PTP interest. The final regulations also add an exception to withholding if the partnership certifies to the transferee that it is not engaged in a trade or business within the United States. The same exception is added for a PTP that is not engaged in a trade or business within the United States.
 
The final regulations modify the rule in proposed §1.1446(f)-2(b)(3), which provided an exception to withholding if the transferee relies on a certification from the transferor that states that the transfer of the partnership interest would not result in any realized gain, including ordinary income arising from the application of Section 751 and §1.751-1 (No Gain Exception). The final regulations provide that a transferor may rely on a certification from the partnership stating that, as of the determination date (as determined under the rules of §1.1446(f)-1(c)(4)), the transfer of the partnership interest would not result in any ordinary income arising from the application of Section 751 and §1.751-1.[3] This certification, in turn, is attached to, and forms part of, the general certification provided by the transferor to the transferee as part of the No Gain Exception.
 
Proposed §1.1446(f)-2(b)(4) provided an exception to withholding if the transferee relies on a certification from the partnership stating that if the partnership sold all of its assets at fair market value on the determination date, the amount of net effectively connected gain resulting from the deemed sale would be less than 10% of the total net gain from the deemed sale (the EC Gain Exception). The EC Gain Exception also applied to a partnership that is a transferee because it makes a distribution, in which case the partnership can rely on its books and records as of the determination date to determine if the EC Gain Exception applies. The final regulations modify the EC Gain Exception in §1.1446(f)- 2(b)(4)(i)(A)(2), which provides, in relevant part, that a transferee may rely on a certification from the partnership that states that if the partnership sold all of its assets at fair market value on the determination date in the manner described in §1.864(c)(8)-1(c), the transferor’s distributive share of net effectively connected gain from the partnership would be either zero or less than 10% of the transferor’s distributive share of the total net gain from the partnership. Accordingly, this modification applies to situations in which the transferor would not have a distributive share of net effectively connected gain (including by reason of having a distributive share of net effectively connected loss). Additionally, the final regulations retain the rules provided in proposed §1.1446(f)-2(b)(4)(i)(A) and (B) to allow partnerships to make the relevant determination at the partnership level as of the determination date, without regard to the transferor’s distributive share of net effectively connected gain.[4] For this purpose, however, the final regulations simplify the partnership-level exception to withholding by combining proposed §1.1446(f)-2(b)(4)(i)(A) and (B) into a single rule; this simplification is intended to be non-substantive.
 
In the preamble, Treasury states that a transfer of an interest in a partnership that is not engaged in a trade or business in the United States is not subject to Section 864(c)(8) and, therefore, should be excepted from withholding under Section 1446(f). Accordingly, §1.1446(f)-2(b)(4)(i)(B) provides that the transferee may rely on a certification from the partnership stating that the partnership was not engaged in a trade or business within the United States at any time during the taxable year of the partnership through the date of transfer (that is, the partnership was not a partnership engaged in a trade or business within the United States at any time during the period beginning on the first day of the partnership’s taxable year in which the transfer occurs and ending on the close of the date of transfer). For partnerships engaged in a trade or business in the United States that hold U.S. real property interests, deemed sale gain attributable to U.S. real property interests continues to be treated as effectively connected gain for purposes of the 10% prong of the EC Gain Exception provided in §1.1446(f)-2(b)(4)(i)(A). For partnerships that are described in §1.1445-11T(d)(1), see §1.1446(f)-1(d).
 
The final regulations also modify the exception to withholding under §1.1446(f)-2(b)(5). Under the exception in the final regulations (the ECI Exception), a transferor may qualify if its distributive share of gross effectively connected income from the partnership for each taxable year within the look-back period was less than $1 million and less than 10% of the transferor’s total distributive share of gross income from the partnership for that year, with both amounts reflected on a Schedule K-1 (Form 1065) (or other statement furnished to the partner) received from the partnership for each year. Because the ECI Exception looks to the transferor’s share of effectively connected income (as reported on a Schedule K-1 or other statement furnished to the partner), rather than its allocable share of ECTI, a transferor that is not allocated any effectively connected income or loss in any relevant year can still use the exception even if it has not received a Form 8805 for that year. The rule provided in proposed §1.1446(f)-2(b)(5)(iv) is modified to state that a transferor cannot provide the certification required for the ECI Exception if the transferor did not have a distributive share of gross income from the partnership in each of the relevant years. §1.1446(f)-2(b)(5)(iii). Therefore, a transferor will generally be able to use the ECI Exception even if it is allocated a distributive share of net loss from the partnership for the relevant taxable year.
 
Treasury notes in the preamble that it plans to revise the instructions to Forms W-8BEN and W-8BEN-E to describe the information required to be provided for making a treaty claim for purposes of Section 1446(f), including a treaty claim made with respect to a transfer of a PTP interest. To make the rules regarding claims for treaty benefits more administrable, the final regulations allow a transferor to use the applicable withholding certificate as the certification for making a claim for benefits under an income tax treaty.
 
The final regulations modify proposed §1.1446(f)-2(c)(2)(iv) to allow for a reduction of the amount realized when a transferor that is a foreign partnership has a direct or indirect partner that is not subject to tax on gain from a transfer pursuant to an applicable U.S. income tax treaty. Specifically, this modification provides that a treaty-eligible partner is not a presumed foreign taxable person for purposes of determining the modified amount realized under §1.1446(f)-2(c)(2)(iv). A foreign partnership that provides a certification of modified amount realized must include, in addition to the Form W-8IMY and a withholding statement, the certification of treaty benefits (on a Form W-8BEN or Form W-8BEN-E) from each direct or indirect partner that is not a presumed foreign taxable person.[5] Similar changes are made to the modified amount realized procedure for transfers of PTP interests.[6]
 
The final regulations modify the proposed regulations to allow transferors that are foreign trusts to use the maximum tax liability procedure in §1.1446(f)-2(c)(4) to reduce the amount to withhold. Similar to the approach taken with respect to foreign partnerships, these rules treat the foreign trust as a nonresident alien individual for purposes of computing its maximum tax liability under §1.1446(f)-2(c)(4).
 
In the preamble, Treasury states that it plans to amend the instructions to Forms 8804, 8805 and 8813 to provide that to obtain a credit against its Section 1446(a) liability, a foreign partnership withheld upon under Section 1446(f) on the sale of its non-PTP interest must attach to its Form 8804, Annual Return for Partnership Withholding Tax (Section 1446), a stamped copy of Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests.
 
The final regulations provide guidance for foreign trusts or estates that are withheld upon under Section 1446(f). Specifically, §1.1446(f)-2(e)(2)(ii) provides that a foreign trust or estate may claim a credit for an amount withheld under Section 1446(f) in accordance with §1.1462-1. Thus, the trust or estate may claim a credit to the extent it is ultimately liable for tax on the gain under Section 864(c)(8). Similar guidance is provided for foreign trusts or estates claiming credit for amounts withheld on transfers of PTP interests.[7]
 
Under the final regulations, a foreign grantor trust may provide to the transferee a Form W-8IMY, a withholding statement that provides the percentage of the amount realized allocable to each grantor or owner of the trust, and any applicable certification for each grantor or owner. A domestic grantor trust that has a foreign grantor or other owner may provide a similar statement in lieu of Form W-8IMY. The allowance described in this paragraph may also be applied in the context of a grantor or other owner of a grantor trust transferring a PTP interest.
 
The final regulations include a rule that allows a partnership to determine that it does not have a withholding obligation under §1.1446(f)-3 if it already possesses a Form W-9, Request for Taxpayer Identification Number and Certification, for the transferor that meets the requirements provided in §1.1446(f)-2(b)(2) to establish non-foreign status, even if the transferee does not provide a certification of withholding to the partnership under §1.1446(f)-2(d)(2).[8] Consistent with the general rules for partnerships that rely on information in their books and records, a partnership may not apply this rule when it knows, or has reason to know, that the Form W-9 that it possesses is incorrect or unreliable.
 
The final regulations remove the requirement in the proposed regulations that a PTP withhold on a transferee under §1.1446(f)-3 and instead add provisions imposing liability for underwithholding under Section 1461 on the partnership that issued the qualified notice.[9]
 
The final regulations allow a transferee to directly claim and obtain a refund for the excess amount withheld under §1.1446(f)-3. Specifically, the final regulations modify §1.1446(f)-3, in relevant part, to provide that a transferee may obtain a refund of the excess amount if it has made payments in excess of the tax that is properly due by the transferee for the tax period. Accordingly, under the final regulations, the partnership is not permitted to claim a refund on behalf of the transferee for the excess amount withheld under §1.1446(f)-3.
 
The final regulations also clarify that the excess amount withheld under §1.1446(f)-3 is the amount of tax and interest withheld under §1.1446(f)-3 that exceeds the transferee’s withholding tax liability under §1.1446(f)-2 and any interest owed by the transferee with respect to such liability.[10] This rule retains the general approach in the proposed regulations that computes the excess amount as the difference between the amount withheld under §1.1446(f)-3 and the transferee’s withholding tax liability under §1.1446(f)-2, but clarifies that both amounts are computed by including interest, and a refund may be claimed only to the extent that the excess amount produces an overpayment. To coordinate a partnership’s obligation to withhold with the transferee’s withholding liability, the final regulations modify §1.1446(f)-2(d)(2) to provide that a transferee’s withholding tax liability under §1.1446(f)-2 is not satisfied if a partnership knows or has reason to know that a certification relied on by the transferee to reduce or eliminate withholding is incorrect or unreliable.
 
The final regulations clarify that a related person is treated as liable for tax under Section 1461 to the same extent to which the transferee is liable under §1.1446(f)-2.
 
The final regulations also include additional guidance for withholding on the transfer of a PTP interest by a foreign person. In terms of the scope of the withholding obligation, the final regulations include rules related to (1) the qualified intermediary (QI) agreement, (2) transfers of PTP interests that are cleared and settled at a clearing organization, (3) documentation of non-foreign status of broker, (4) QIs assuming Section 1446(f) withholding responsibility, (5) QIs not assuming Section 1446(f) withholding responsibility, (6) withholding under Section 1446(f) on payments to non-qualified intermediaries, (7) brokers determination of prior broker withholding under Section 1446(f), and (8) the withholding date for sales of PTP Interests.
 
In addition, the final regulations make certain modifications to the exceptions to the withholding requirement that applies to a broker paying an amount realized from the transfer of a PTP interest, including exceptions that apply to distributions by PTPs and exceptions dependent on certifications obtained from transferors. Certain modifications were made to the ECI exception, which provides relief from withholding for transferors that certify on a Form W-8ECI that the transferor is a dealer in securities (as defined in Section 475(c)(1)) and that any gain from the transfer of a PTP interest is effectively connected with the conduct of a trade or business within the United States without regard to Section 864(c)(8),[11] and to the 10% exception, which provides that a broker may rely on a qualified notice stating that if the PTP sold all of its assets at fair market value in the manner described in §1.864(c)(8)-1(c), the amount of net gain that would have been effectively connected with the conduct of a trade or business within the United States would be less than 10% of the total net gain, or no gain would have been effectively connected with the conduct of a trade or business in the United States, or the partnership was not engaged in a trade or business within the United States at any time during the taxable year of the partnership through the PTP designated date.[12]
 
The final regulations include guidance with respect to determining the amount to withhold on a transfer of a PTP interest by a foreign person with additional guidance on the modified amount realized for transfers by foreign partnerships along with rules on determining the amount realized with respect to distributions. The final regulations also include additional guidance for reporting with respect to transfers of PTP interest on Form 1042-S.
 
The final regulations also include additional guidance with respect to the Section 1446 regulations relating to distributions by PTPs. The final regulations include a requirement for a PTP to provide a qualified notice to any registered holder that is a nominee for a distribution.
 
The proposed regulations added a default withholding rule (the default withholding rule) for cases in which a qualified notice fails to provide sufficient detail for a nominee to determine the amounts subject to withholding on a PTP distribution (a deficient qualified notice). Under this rule, to the extent that a deficient qualified notice fails to specify the type of income from which a distribution is made, the nominee must withhold at the highest rate specified in Section 11(b) or 881 for a partner that is a foreign corporation, or the highest rate specified in Section 1 or 871 for a foreign partner that is not a corporation.[13] The final regulations clarify that a lower treaty rate is not considered for purposes of determining the amount to withhold under the default withholding rule. In addition, the final regulations add language to clarify that a nominee must apply the default withholding rule when a PTP fails to issue a qualified notice for a distribution under §1.1446-4(b)(4) of the final regulations. Also, the final regulations add that if a nominee cannot determine the status of a partner as a corporation, for purposes of the default withholding rule the nominee is required to use the higher of the following rates: (1) the rate of withholding applicable to a foreign person that is a corporation, and (2) the rate of withholding applicable to a foreign person that is not a corporation.
 
To address cases in which a distribution by a PTP is paid through multiple nominees that might each be required to withhold under proposed §1.1446-4(d), the final regulations add an exception to withholding for a nominee paying the distribution to a QI or U.S. branch that is also a nominee for the distribution.
 
For additional details and guidance not discussed in this summary along with applicability dates to the final regulations, see the final regulations.
 


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[1] The final regulations also include certain conforming changes to regulations under Sections 1445 and 1446 to reflect the rate changes made by Section 13001(b)(3)(A)-(D) of the Tax Cuts and Jobs Act (TCJA) and the due date changes made by Section 2006 of the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (the Surface Transportation Act), Public Law No. 114-41 (2015). Although the changes to these regulations are applicable based on the date of publication of this document in the Federal Register, the same result applies before that date as of the relevant effective dates of the TCJA and the Surface Transportation Act.
[2] Certain modifications were also made with respect to the reporting requirements for foreign transferors and partnerships with foreign transferors in the Section 864 final regulations. See §1.864(c)(8)-2(b)(2)(ii) and §1.864(c)(8)-1(d)(2).
[3] See §1.1446(f)-2(b)(3)(ii).
[4] See §1.1446(f)-2(b)(4)(i)(A)(1).
[5] See §1.1446(f)-2(c)(2)(iv)(C).
[6] See §1.1446(f)-4(c)(2)(ii).
[7] See §1.1446(f)-4(e)(2)(ii).
[8] See §1.1446(f)-3(a)(1).
[9] See §1.1446(f)-4(b)(3)(i) and (c)(2)(iii).
[10] See §1.1446(f)-3(e)(2).
[11] See §1.1446(f)-4(b)(6).
[12] See proposed §1.1446(f)-4(b)(3).
[13] See proposed §1.1446-4(d).

California: New Law Clarifies Water’s-Edge Election for Certain Unitary Foreign Affiliates

A bill (Assembly Bill No. 3372 (A.B. 3372)) signed by the California governor on September 29, 2020 contains provisions that prevent the unintended cancellation of certain water’s-edge elections due to a change in California’s definition of “doing business.” The new law provides that an otherwise valid water’s-edge election will not be terminated if a unitary foreign affiliate becomes subject to California income or franchise tax solely because it meets the definition of doing business in the state. A.B. 3372 essentially codifies administrative guidance issued by the California Franchise Tax Board (FTB).
 
The new law applies to water’s-edge elections made for tax years beginning on or after January 1, 2021.
 

Details

History of California’s Water’s-Edge Election

For over 30 years, California has permitted a unitary group of corporations to make a statutory election as to whether their income for franchise tax purposes is determined on a worldwide basis or a water’s-edge basis. A unitary combined reporting group can make a water’s-edge election only if each member of the group that is subject to tax in California makes the election at the same time. Therefore, a member that chooses not to make the water’s-edge election but that subsequently becomes subject to California nexus could terminate the election for the group, with the result that the group would revert back to worldwide reporting.
 
In 2011, California expanded the definition of doing business under Rev. & Tax Code Section 23101 to include sub-Section (b), which creates a “factor presence” nexus standard. This subsection provides that an entity is considered to be “doing business” in California if its total sales in the state exceed $500,000. The sales (and property and payroll) threshold is inflation-adjusted and is currently set at $601,067 for the 2019 tax year. As a result, some foreign affiliate corporations that were not subject to California taxation at the time the group made the water’s-edge election became subject to tax in the state because they exceeded the new factor presence nexus standard.
 
To temporarily address this issue, the FTB issued several notices (FTB Notice 2016-02, FTB Notice 2017-04 and FTB Notice 2019-02) indicating that a water’s-edge election will not be terminated when a unitary foreign affiliate becomes taxable in California only because of the expanded doing business statute. However, unless legislation was enacted, taxpayers would have had to rely on periodic administrative guidance without any certainty that the FTB would continue to allow this treatment in future tax years.
 

New Legislation Updates the Water’s-Edge Election

A.B. 3372 addresses this water’s-edge election issue. For taxable years beginning after December 31, 2020, foreign affiliates that were members of a unitary combined group at the time a valid water’s-edge election was made, but that were not subject to California tax at that time will not terminate the group’s water’s-edge election if they subsequently become “taxpayer-members” in California under Section 23101(b) simply because they are doing business in the state. The foreign affiliate corporation will be deemed to have elected with the other members of the unitary combined reporting group.
 

 


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World Wide Tax News – October 2020, Issue 56

BDO’s World Wide Tax News summarizes recent tax developments of international interest across the world. Highlighted this month is the United Kingdom’s COVID-19 related implications for Corporate Criminal Offences legislation, along with the Global Tax Outlook 2020, and the BDO Rethink Transfer Pricing webinar series.

Other highlights include:

 

Sales and Use Tax and Value Added Tax Pitfalls for E-Commerce Businesses

COVID-19 has significantly disrupted the global economy, with e-commerce sales expected to reach more than $6.5 trillion by 2023. That’s more than double the $3.5 trillion spend from 2019. Given the continued growth of online sales, along with novel ways of trading via the internet, tax authorities in the U.S. and across the globe are taking steps to ensure e-commerce is appropriately taxed in their jurisdictions. One tax strategy that authorities have implemented is to impose sales/use tax and Value Added Tax (VAT) on online sales by deeming remote/non-resident vendors as having nexus in their certain jurisdictions.

When selling online to customers within the U.S. and internationally, e-commerce businesses should consider several sales/use tax and VAT issues:

Sales/Use Tax Implications for Non-U.S. and U.S. e-Commerce Businesses Selling to U.S. Customers

Sales and use taxation regimes are operated independently by each of the 50 states and the District of Columbia. Additionally, some states (such as Alabama, Alaska, Colorado and Louisiana) have local sales and use taxes that are administered by local municipalities and counties; these local-level taxes are governed by separate ordinances, they use their own tax forms and allow audits to be conducted by third-party contingency-fee firms.

A seller usually is responsible for charging sales tax at the time of the sale and remitting the tax to the state. A foreign company selling into the U.S. is subject to sales tax regimes to the extent the company has nexus with the state. Nexus can be established in a number of ways, including through a physical presence in or contact with the state (payroll, property, agents and inventory held under a “Fulfillment by Amazon” arrangement) or engaging in substantial sales that exceed economic thresholds, which some states introduced following the U.S. Supreme Court’s 2018 decision in the Wayfair case.
 

Digital goods and services

Approximately 25 states currently impose sales tax on digital goods and services. There are four general classifications that states use for taxing digital goods:
(1) Enumerated general products – Products delivered or accessed electronically (e.g., audio and audiovisual works, books, magazines, reports, photographs, greeting cards, etc.);
(2) Tangible personal property – Property that is seen, measured, touched or perceptible to the senses;
(3) Tangible functional equivalents – Products that are taxable when delivered in a physical form and, therefore, also taxable when delivered electronically (e.g., software, movies); and
(4) Services – Digital products classified as taxable services (e.g., cloud computing, software as a service, etc.).
If a digital product or service is subject to sales tax, the seller must determine how to source the sale of the digital product or service. The differing taxability and sourcing rules across states can create challenges whereby the same transaction may be legally taxed by two or more states. Sellers must perform a state-by-state analysis to determine the proper tax treatment of their digital products.
 

Online Sales of Goods in the U.S.

Any company with remote sales in the U.S., including a foreign company, must be mindful of economic nexus thresholds enacted by states post-Wayfair. Currently, 43 out of 45 states that impose a sales tax have economic nexus standards for sales and use tax, requiring remote sellers to register and remit sales tax if their activity exceeds a certain volume of sales (e.g., $100,000) and/or number of transactions (e.g., 200) generally measured within the past or current year. The complexity of compliance often depends on the company’s supply chain (i.e., direct sale to consumer (B2C) or wholesaler (B2B), type of purchaser (individual, business, government, nonprofit or other exempt entity), and whether the product is used in an exempt way by the purchaser (manufacturing, research and  development, agricultural or pollution control)).

E-retailers likely established physical nexus prior to Wayfair for:

  • Having a remote workforce

  • Carrying out in person sales across state lines

  • Participating in trade shows

  • Storing inventory in warehouses or through the Fulfillment by Amazon program

Ignoring nexus rules can have unintended negative consequences, in particular, potentially disruptive sales tax exposures. E-retailers should quantify their historical exposures and consider mitigating historical liabilities by entering into a voluntary disclosure agreement with the relevant state(s) before registering for sales taxes.  

Online Marketplaces

Marketplace facilitator legislation, which has been enacted in more than 35 states, requires third-party entities, such as Amazon, to calculate, collect and remit sales tax on behalf of retailers that sell through the marketplace. Marketplace facilitators may not have as intimate knowledge of goods or services being sold as the retailers. This lack of familiarity may result in incorrect sales tax amounts being charged if the sales are not property accounted for or mapped to the correct taxability classification. The inability to collect the correct amount of tax is compounded by the fact that there is a lack of clarity around who should ultimately be responsible for the correct amount of sales tax collected and reported to the taxing agencies, whether it is the retailer or the company facilitating the sale. Marketplace facilitators also may not have the ability to determine whether an item was purchased by an exempt customer or have a mechanism in place to submit or collect exemption certificates. Companies should ensure that they maintain accurate records of how each sale is taxed and who has collected and/or reported the sales tax.

Compliance and Reporting

Although the U.S. Supreme Court anticipated that the Wayfair decision would not complicate the sales tax compliance function for many small and mid-sized businesses, the legislation and administrative guidance triggered by this decision had an opposite chilling effect. Today, 43 states have economic nexus for sales and use tax with varying safe harbor standards, compliance dates and tax rates ranging from 2.9% to over 12%. These state-level safe harbor provisions are in flux as states revise their gross revenue thresholds—some are increasing the threshold (e.g., California, New York and Oklahoma), others are decreasing it over time (Arizona), and other states are eliminating the transaction volume safe harbor (California, Iowa, Massachusetts, North Dakota and Washington) or introducing one (Ohio). States that do not levy a sales tax at the state level, such as Alaska, are permitting localities to enact Wayfair-like economic nexus laws.

If 43 separate tax rates seems daunting, consider 16,000, which is the ballpark number of state and local tax rates in effect at any time. Adding to this administrative nightmare, tax rates can change on a monthly basis, generating as many as 600 to 700 changes throughout the year. Companies across industries and of all sizes have to contend with the fallout resulting from Wayfair, but it has been particularly onerous for middle-market companies that often do not have internal processes, procedures and resources in place to address these challenges. For remote sellers that want to ensure they are in full compliance, there is justification for employing someone full-time to monitor administered sales and use tax laws. Many companies are resorting to automation to help manage sales taxes in multiple states.

VAT Implications for US-based e-Commerce Businesses Selling to Customers Overseas

Outside the U.S., companies that conduct business online must navigate VAT regimes that have been implemented in approximately 170 countries, many of which have implemented (or plan to implement) rules requiring remote vendors to register, collect and remit VAT. Similar to the U.S., with the exception of the European Union (at least conceptually), each VAT regime is implemented and operated independently. Therefore, companies carrying out business transactions online that have no control over where their customers are located are required to understand myriad definitions, approaches and interpretations to determine whether their business activities give rise to a VAT registration obligation (the VAT equivalent of nexus).

Digitalized Goods and Services: The sale of digitalized goods and services over the internet with minimal human interaction is generally considered electronically supplied services for VAT purposes. Almost 90 countries have introduced rules (or will soon do so) requiring nonresident vendors of electronically supplied services to register for, collect and remit VAT when providing electronically supplied services to customers that are established/resident in their jurisdiction. Many jurisdictions do not have a registration threshold, so a single transaction could trigger a VAT registration obligation. The failure of a U.S. business to proactively manage the VAT implications of its international activities could trigger VAT registration and reporting obligations in multiple countries as a result of providing electronically supplied services. Any business providing these services internationally should regularly perform a nexus study for VAT to identify where they are required to collect and remit VAT.
 
Online Sales of Goods from the United States (or Elsewhere): Historically, many countries allowed goods below a certain value to be imported without being subject to VAT. This enabled companies, such as Amazon and eBay, to ship goods across borders without collecting taxes. However, with the explosive growth of e-commerce and the perceived abuse of these relief measures, governments around the world, including Australia, New Zealand and Norway, have eliminated the VAT (or goods and sales tax) exemption for low value goods to increase tax revenues; similar rules will apply in the European Union and United Kingdom as from 2021). Vendors are now required to register for VAT and collect the tax at the point of sale. E-commerce businesses will need to continually review their international operations to ensure compliance.
 
Online marketplaces: With many e-commerce businesses trading via marketplace facilitators, it is often unclear which party is responsible for calculating, collecting and remitting VAT. Depending on the marketplace and country, the following may apply:

  • The marketplace calculates, collects and remits VAT;

  • The marketplace calculates and collects VAT, but the third-party seller is responsible for remitting and reporting VAT; or

  • The third-party seller is responsible for calculating, collecting and remitting VAT.

Where the third-party seller trades via multiple marketplaces, the situation can become very confusing. Since many countries impose joint and several liability for VAT on both the marketplace and third-party sellers, all third-party sellers should be carrying out their own reviews to ensure that the marketplace is correctly calculating, collecting and remitting VAT.
 
Compliance and Reporting: E-commerce activities create compliance and reporting obligations for businesses that can be challenging and burdensome. In addition to the requirement to file periodic VAT returns, e-commerce businesses must calculate VAT at the correct rate in the correct jurisdiction, which requires having processes in place to determine where consumption takes place. The rules vary by jurisdiction and often the billing address alone is insufficient. When assessing their VAT nexus footprint, businesses need to ensure they have identified and understand the place of consumption rules in each jurisdiction where they make sales.

Many tax authorities are prioritizing VAT compliance of e-commerce businesses and marketplaces. It is important for all e-commerce businesses selling internationally to comply with their VAT obligations in each jurisdiction where sales are made. Failure to comply with the VAT rules may have a significant financial impact if the business becomes liable for penalties, backdated payments, and, in extreme cases, criminal investigations and termination of seller accounts on marketplaces.
 

Conclusion

The continued shift toward the digital economy creates a wide range of tax implications that cut across both direct and indirect taxation. With the continued focus on the need to reform tax laws globally to adapt the rules to meet the challenges of the global economy (e.g. the OECD’s Pillar 1 and BEPS Action Plan projects), the taxation of the digital economy will come under increasing focus from tax authorities globally.

Considering many jurisdictions globally will be looking for additional sources of tax revenue to help cover the costs of COVID-19, it is likely that every tax jurisdiction will have a version of rules subjecting digital goods/e-commerce activities to taxation. This coupled with tax authorities taking more enforcement action will create additional burdens and risks for online businesses, due to having to interpret and comply with a multitude of different rules while also having to defend against sales/use tax and VAT demands.
 


CONTACTS

Asia Pacific – Rethink-Transfer Pricing perspectives from around the world: navigating through crisis complexities

As individuals and businesses cope with the converging effects of COVID-19 and its economic fallout, they must also rethink their strategies to prepare for and adapt to new global tax challenges. BDO’s transfer pricing webinar series will highlight timely updates with interactive discussions from our global transfer pricing leaders. 

Discussion topics include:

  • Practical solutions to transfer pricing issues resulting from COVID-19

  • Transfer pricing implications of the proposed guidance issued by OECD on Taxing the Digital Economy Pillars 1 and 2

  • The impact of increased global supply chain restructuring on transfer pricing policies