In the United States, sales tax is the equivalent of the UK VAT system. There are important differences in the two regimes, most notably that sales tax is imposed by state governments on retail purchases of goods or services that are not exempt from taxation, whereas VAT is a type of consumption tax assessed on goods at each stage in the production process as they move through it to their final sale to consumers.
As noted above, the United States is characterized by its decentralized system of government. States, counties, cities, towns, and smaller localities independently decide how to raise the revenue needed to fund the services they provide. Such a regionalized system presents significant compliance challenges for businesses seeking to establish a national presence. States containing over 15,000 taxing jurisdictions levy their own sales taxes, set the rates, and determine what will and will not be taxed. As a result, such businesses face a complex structure of sales and use taxes. These are constantly changing as state and local lawmakers look for ways to increase revenue to meet their growing obligations. The advent of e-commerce has revolutionized the retail landscape. A niche business can now generate sales nationally via their websites and web-based marketing strategies.
Traditional nexus definition
Sales tax nexus defines the level of connection between a taxing jurisdiction such as a state and an entity such as a business. Until this connection is established, the taxing jurisdiction cannot impose its sales taxes. Nexus determination is primarily controlled by the US Constitution, in which the Due Process Clause requires a definite link or minimal connection between a state and the entity it wants to tax, and the Commerce Clause requires substantial presence. This traditionally requires a physical presence such as an office and/or an employee.
E-commerce business has made it relatively easy for customers to make purchases without paying sales tax. In addition, the payment of use taxes associated with most of these purchases is often overlooked by the purchaser. Landmark cases brought against e-commerce giants, such as Amazon, dramatically extended the reach of the state beyond its traditional borders. Initially, such a company was only required to collect sales tax in its home state. It is now getting much more difficult to avoid sales tax when shopping online. The broadening definition of physical presence has triggered an extended obligation to collect local sales tax (nexus). In addition, the huge growth of state online sales tax laws, known as “Amazon Laws”, often impose sales tax on retailers generating sales through in-state affiliates.
Wayfair – economic presence overrides physical presence.
In June of 2019, the United States Supreme Court ruled in South Dakota v. Wayfair that states can impose a sales tax collection obligation on out of state businesses that do not have a physical presence in that state. This landmark decision overturned precedent that has been in place for over fifty years which had required that a business have physical presence in a state before that state could force the collection of sales taxes.
Currently forty-two states have enacted legislation, rules, or regulations to adopt economic presence nexus requiring remote sellers to collect sales tax if they meet certain sales and transaction levels.
The sales tax landscape is changing constantly, and different states take different positions. It is advisable to discuss with a tax professional when you start doing business in the US to develop a reasonable approach to this complex topic.