Introduction: Sales Tax Collection – Obligations & Compliance
US Supreme Court Justice Kennedy has been in the news lately. The so called 'swing vote' of the United States Supreme Court has retired. Justice Kennedy has been responsible for some of the most pivotal precedents of the past 30 years. Before departing the Court, Justice Kennedy gave one last major precedent. The news may have been over shadowed by the announcement of his retirement, but the precedent did not slip past any good tax lawyer; Canadian tax lawyers included.
Kennedy's recent decision in South Dakota v. Wayfair, Inc, et al, has overturned a long standing rule that has in many ways contributed to the rise of online retail giant Amazon and the era of e-commerce. Prior to the release of South Dakota v Wayfair, Inc et al, it was generally understood that in order to be liable to collect and remit sales taxes back to the state governments for the jurisdiction in which the consumer is located when making the online purchase, a business would need to have a physical presence in that state.
Substantial Nexus: the physical presence requirement
This need for a physical presence in the state where the consumer is located stems from the case precedents being overturned by Justice Kennedy's decision, the most recent being Quill Corp v North Dakota, 504 U.S. 298 (1992). In the previous decisions, the Supreme Court had consistently held that a state legislature is able to regulate commerce only to the extent that it does not discriminate against interstate commerce nor impose undue burdens on interstate commerce. Although this has not changed in the new decision, what has changed is the facts of doing business across state lines.
When it comes to local sales taxes, interstate commerce is still required to pay its fair share. There is no discrimination or undue burden on out-of-state retailers where the taxes are imposed equally on all retail sales. The question in issue is not whether the tax can be imposed on the transactions but rather, who does the burden of collection fall on? The Court will uphold a State imposed obligation on out of state retailers to collect and remit tax where the tax applies to an activity with a substantial nexus with the taxing State. In the absence of a substantial nexus, the State government can look only to the consumers to collect and remit the appropriate sales tax.
Taxing the Changing Retail Landscape
All previous cases have held that a 'substantial nexus' necessarily includes a physical presence. All of those cases involved, mail-order retail or something of the like. Times have changed, as we have all born witness to, and the internet has dramatically changed the way consumers interact with retailers. Not only is it now possible to purchase from a retailer who has no physical presence in the state where the consumer is located, it is often the most affordable and convenient option.
Because of this, online retailers have been able to offer the same products for the same prices as the local retailers without carrying the same burden to collect and remit the local sales tax. This has created an unintended competitive advantage for online out-of-state retailers and an ample opportunity for tax evasion for consumers.
The decision by Justice Kennedy changes the interpretation of "substantial nexus". Such a nexus "is established when the taxpayer [collector] avails itself of the substantial privilege of carrying on business in that jurisdiction". It is important to note that Justice Kennedy made specific reference to virtual presence as part of the sufficient nexus that Wayfair Inc. had in this specific case. Kennedy's reasoning is that because online retailers have out-sourced the establishment of a physical presence in any jurisdiction to the consumers, who carry around smart phones at laptops, the regular place of interaction between merchant and purchaser exists within the state.
The federal and provincial sales tax arrangement here in Canada does have a similar circumstantial trigger for a business to be obliged to collect and remit a sales tax. The federal goods and services tax, the "GST" or HST in some provinces, is levied in all provinces and territories. To comply with the federal Excise Tax Act, a non-resident supplier of goods or services must register for a GST account where they have a permanent establishment or are considered to be carrying on a business in Canada. Those businesses are obliged to collect and remit the tax.
Several Provinces (British Columbia, Saskatchewan, Manitoba, and Quebec) maintain a separate sales tax system; other provinces have adopted a "harmonized" sales tax arrangement; the difference between the two is administrative in nature.
An important note on inter-provincial trade: for a Canadian business that does not have a permanent establishment in the province into which it is making a sale, if selling to an HST province the business must still collect HST at the appropriate rate for the province in which the customer is located.
The registration requirements for the federal GST account satisfy the requirements for the provincial sales taxes in those provinces which have adopted the HST, while the provinces that maintain separate systems have their own administrative requirements.
For the purposes of the Excise Tax Act, a permanent establishment in Canada is defined as:
a) A fixed place of business of the particular person, including
- A place of management, a branch, an office, a factory or a workshop, and
- A mine, an oil or gas well, a quarry, timberland or any other place of extraction of natural resources,
Though which the particular person makes supplies; or
b) A fixed place of business of another person (other than a broker, general commission agent or other independent agent acting in the ordinary course of business) who is acting in Canada on behalf of the particular person and through whom the particular person makes supplies in the ordinary course of business
This definition merely kicks the can down the road. The phrase "a fixed place of business[...] through which the particular person makes supplies" is not that much more illuminating that "permanent establishment".
Determining whether your business practice has a "fixed place of business" in Canada, or any particular province, is a question of fact. When assessing whether your business activity constitutes a fixed place of business, look to see how these characteristics manifest:
- Does your business presence take up space?
- Is there continuity and/ or permanency to the business activity?
- Does your business exercise a measure of control over the place of business?
Assuming there is a fixed place of business, the obligation to collect and remit tax is only imposed on that non-resident business if the supply of products or services is made through this place of business. This too is a factual consideration that requires a review of the characteristics that manifest in the activities of your business. The Canadian Revenue Agency (the "CRA") provides guidelines as to what factors shall be considered. The primary factors being:
- Whether there is authority at the place of business to enter into contracts or accept purchase orders.
- Whether there is tangible personal property that is being supplied is physically manufactured or produced at the place of business
- Where the business is providing services, whether the services is performed at the place of business; or
- Whether service, maintenance or repair of equipment provided by the non-resident business is performed at the place of business.
These primary factors are individually considered to be sufficient for finding as fact that the supply of goods or services is made through that fixed place of business. The CRA also provides for other factors that, taken in concert, could reach the same conclusion:
- Does the place of business receive orders?
- Does the place of business provide for storage or shipping of goods?
- Does the place of business provide for the general administration of customer accounts?
- Does the place of business provide for the advertisement of the products or services, or the solicitation of orders?
Many of these factors are targeted at a more traditional concept of commerce. Online retail businesses that want to sell into the provinces in Canada may soon face a new reality of obligations for collecting a remitting sales taxes. The significance of Justice Kennedy's decision in South Dakota v Wayfair, inc. may prompt Canadian provincial governments to bring about changes to their sales tax schemes as well.
Most notably, the province of Quebec recently announced a change to the QST (the provincially administered sales tax scheme). The so called "Netflix tax" now requires that businesses that are non-residents of Quebec must collect and remit sales taxes on intangible, digital services provided within the province. The decision of the Quebec government was in direct contrast to the decision of the federal government in the months prior.
Tax Tip: Sales Tax Collection is Changing - Seek Regular Consultation from a Tax Lawyer
If you are a business that is currently, or plans to engage in online retail and distribution to US consumers your tax realities are about to change significantly. The obligation to collect and remit sales taxes is now fair game to impose upon your business. While it will take time for the state legislatures across the United States to reform their sales tax laws, it should not take you and your business long to begin reviewing the tax planning and compliance strategies you have in place with an experienced Canadian tax lawyer. Create a plan of how those strategies may need to adapt as state legislatures respond to this case and remain informed of proposed changes at the state and provincial legislatures.