A Review of State and Local Taxes in a Cross-Border Environment

Tra­di­tion­al­ly, the U.S. econ­o­my revolved around local, in per­son ser­vices, man­u­fac­tur­ing and local resources. The tax­ing pro­vi­sions of many states con­tin­ue to reflect this out­dat­ed eco­nom­ic mod­el. More recent­ly, the glob­al econ­o­my has shift­ed dra­mat­i­cal­ly, across bor­ders to include busi­ness­es involved in e‑commerce, dig­i­tal prod­ucts and deliv­ery of ser­vices across state and inter­na­tion­al lines. This shift has had a dra­mat­ic impact on state and local economies that heav­i­ly relied on the rev­enue pro­vid­ed by com­pa­nies that were sit­u­at­ed with­in a state. Now, for­eign com­pa­nies are engaged in busi­ness­es, that local busi­ness­es used to pro­vide, and the state and local gov­ern­ments still want their piece of the tax pie.

There are var­i­ous con­sid­er­a­tions when inter­na­tion­al or for­eign com­pa­nies or indi­vid­u­als begin engag­ing in busi­ness with the Unit­ed States. One must rec­og­nize the dis­tinc­tion between Nexus and Per­ma­nent Estab­lish­ment (“PE”). Although a cor­po­ra­tion may be able to avoid a Per­ma­nent Estab­lish­ment in the U.S., thus poten­tial­ly avoid­ing fed­er­al tax, a for­eign com­pa­ny may in fact be sub­ject to state and local tax­es when their nexus with a par­tic­u­lar state is suf­fi­cient to be sub­ject to state and local tax in that juris­dic­tion. This is as result of the fact that state and local gov­ern­ments are not engaged in inter­na­tion­al tax treaties with for­eign gov­ern­ments, which gen­er­al­ly pro­vide a frame­work for tax­a­tion when a for­eign com­pa­ny seeks to trans­act busi­ness with­in the U.S. Com­pli­cat­ing mat­ters fur­ther is that state and local nexus rules and their appli­ca­tion vary from state to state. Thus, in prepar­ing to do busi­ness with­in the U.S., it is not only impor­tant to under­stand both the fed­er­al tax impli­ca­tions on a cor­po­ra­tion doing busi­ness in the U.S., but, also the state and local tax impli­ca­tions if you are plan­ning on trans­act­ing busi­ness in a state.

A PE can be defined as a fixed place of busi­ness through which an enter­prise is whol­ly or par­tial­ly car­ried on. A for­eign cor­po­ra­tion will be required to file fed­er­al income tax returns when it is engaged in a trade or busi­ness with­in the U.S. and will pay tax­es on the income that is effec­tive­ly con­nect­ed with the busi­ness in the U.S. The PE def­i­n­i­tion is reserved for coun­tries with a tax treaty with the U.S., result­ing in fed­er­al tax oblig­a­tions on the busi­ness. 

Con­verse­ly, nexus may be found when a for­eign com­pa­ny either has phys­i­cal or eco­nom­ic pres­ence with­in the state. Nexus is the thresh­old deter­mi­na­tion for busi­ness­es to be sub­ject to state and local tax­es with­in a state and as men­tioned, each state has dif­fer­ent cri­te­ria for nexus. The impor­tant fac­tor here is that although cer­tain fed­er­al­ly estab­lished income tax treaties may define PE dif­fer­ent­ly, thus lead­ing to cer­tain cor­po­ra­tions being exempt from fed­er­al tax­es, hav­ing nexus with a state may lead to the cor­po­ra­tion being taxed by the state and/or local author­i­ty in either case. 

Cer­tain in-state activ­i­ties will lead to a find­ing of nexus. Some of those activ­i­ties include: hav­ing employ­ees trav­el­ling in state to con­duct busi­ness activ­i­ties, hav­ing a cor­po­rate office with­in the state, hav­ing inven­to­ry with­in the state, own­ing a ware­house in the state, own­ing equip­ment in the state or hav­ing a part­ner­ship inter­est that is oper­at­ing a busi­ness with­in the state. In addi­tion to these phys­i­cal pres­ence fac­tors, cer­tain states have enact­ed laws that enti­tle them to tax based on an ‘eco­nom­ic pres­ence’ stan­dard. Eco­nom­ic pres­ence is gen­er­al­ly found when a com­pa­ny is gen­er­at­ing income from, roy­al­ties, trade­marks or licens­es with­in the state and/or they are active­ly solic­it­ing busi­ness with­in the state. 

Final­ly, some states have enact­ed laws that have adopt­ed a fac­tor-based eco­nom­ic pres­ence test approach to nexus. Sub­stan­tial nexus would be cre­at­ed in a state if any of the fol­low­ing min­i­mum thresh­olds are exceed­ed: US $50,000 of prop­er­ty, $50,000 of pay­roll, US $500,000 of sales or 25 per­cent of the company’s total prop­er­ty, pay­roll or sales are in the state. (This is based on the Mul­ti­state Tax Commission’s mod­el stan­dards. Each gov­ern­ing state enacts their laws inde­pen­dent­ly.) 

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Fur­ther­more, a com­pa­ny may have income tax nexus in a state through the pres­ence of agents or inde­pen­dents con­trac­tors per­form­ing on behalf of the com­pa­ny. This assess­ment of nexus does not require a for­mal rela­tion­ship, rather a facts and cir­cum­stances approach can be tak­en to eval­u­ate whether the busi­ness activ­i­ties con­duct­ed on behalf of the com­pa­ny result in nexus with the state suf­fi­cient for the state to impose tax­es on the com­pa­ny. 

Although you, your clients or com­pa­ny may take suf­fi­cient mea­sures to pro­tect against cre­at­ing nexus with a state, it may be unavoid­able if you wish to con­tin­ue the activ­i­ties that the busi­ness is engaged in. If nexus aris­es, steps must be tak­en to ensure tax com­pli­ance with all rel­e­vant tax author­i­ties. At a min­i­mum, an eval­u­a­tion must be made as to when nexus was estab­lished, or will be estab­lished with a state. Cer­tain states will require state income tax returns to be filed for any year in which nexus was estab­lished, where­as oth­ers may lim­it the amount of years they can require you to file late returns. As well, cer­tain states may have dif­fer­ent fil­ing require­ments, with some states per­mit­ting the com­pa­nies to file on a world­wide basis or a com­bined basis. Fur­ther­more, one must deter­mine if they will be sub­ject to, net worth or equi­ty based fran­chise tax­es, sales or use tax­es, pay­roll or employ­ment tax­es, city or local busi­ness or fran­chise tax, and state and local licens­ing fees. 

If you find your­self or your clients have missed these types of fil­ings, there are var­i­ous meth­ods of becom­ing com­pli­ant. Cer­tain states have statu­to­ry amnesty pro­grams that allow for tax fil­ers to file late returns and have penal­ties waived for either unre­port­ed or unremit­ted tax­es. Often, the inter­est on these penal­ties may also be waived. Be sure to speak with a qual­i­fied U.S. tax pro­fes­sion­al to assess any poten­tial state or local tax­es that you may owe or will owe if you intend on doing busi­ness in a par­tic­u­lar state, and to deter­mine how you can become com­pli­ant if you have failed to file or pay tax­es.

Very tru­ly yours, U.S. TAX IQ Team