International sellers using Amazon's FBA program should be aware of these U.S. tax implications.
Over the past several years, Amazon’s Fulfillment-by-Amazon (“FBA”) service has become an enormously popular business model for international merchants looking to sell products online to U.S. customers. Under the FBA model, Amazon sellers store their products in one of Amazon's dozens of fulfillment centers across the United States, which then pick, pack and ship products to customers, as well as provide customer service, including product returns.
Amazon FBA has become so popular that it has actually restricted new merchants from sending inventory to fulfillment centers during this year’s fourth quarter because of capacity concerns leading up to this year’s holiday season.
With every new business model that touches the U.S. market, there are a number of important tax issues that need be considered. The popularity of Amazon FBA has prompted both Amazon and its overseas merchants to try to fit the FBA model within the framework of the federal and state tax rules and regulations. The following are certain key U.S. federal and state tax considerations facing international merchants using Amazon’s FBA to sell products to U.S. customers.
Amazon FBA and State Taxation
From a state tax perspective, Amazon international sellers are potentially subject to two main methods of taxation – sales tax and income tax. The fundamental principle underlying a state’s right to tax transactions under both of these methods is “nexus,” which generally means the connection a taxpayer has to a particular state.
Just as state tax rates are determined on a state-by-state basis, so are the parameters of nexus. Some states focus on so-called “physical presence” (e.g., employees or property within the state), while others focus on so-called “economic presence” (e.g., a significant amount of sales within the state) or other factor methodologies. A layer of complexity is added by the fact that nexus is often defined differently for sales and income tax purposes. As a very general rule of thumb, states require a greater connection for income tax nexus than for sales tax nexus.
Most states generally take the position that third-party fulfillment centers do create sales tax nexus. As such, if a state has an Amazon FBA warehouse (more than two dozen states currently do), and your products are stored in such a warehouse, you’ll most likely be viewed as having nexus in that state and you’ll be required to register for a sales tax permit and collect and remit sales tax on sales to that state’s customers. Notable exceptions include Virginia and New York, which have specifically ruled that fulfillment centers do not create sales tax nexus in their respective states.
Managing sales tax obligations across many states can be challenging for international FBA sellers. To the taxpayer’s detriment, Amazon is known to be quite elusive about where it has fulfillment centers and where your particular product is stored at any one time. To Amazon’s credit, however, it does provide its online sellers with access to service providers and software that offer solutions that make sales tax compliance more manageable.
In recent years, states have become increasingly aggressive in trying to impose taxes on online sellers. Some states, for instance, have reframed their method of taxation from an income tax into a broader “gross receipts tax” for the purpose of capturing more taxpayers within their nexus net. These states argue that while they are constitutionally restricted from imposing income taxes on businesses whose only contact with the state is soliciting sales (under a law known as P.L. 86-272), they are technically not so restricted with respect to non-income-based taxation.
In a similar vein, in the international context, some have argued that constitutional protections against income taxation with respect to limited activities are meant to apply only in the context of interstate transactions and not in the case of international transactions.
In the case of third-party fulfillment centers, Bloomberg BNA’s recently published Multistate State Tax Report for 2015 is instructive. In the report, senior state tax officials were surveyed on a variety of gray areas of state income and sales taxation, including the issue of third-party fulfillment services. While the survey rightfully disclaims that the responses should not be viewed as official state positions, they can be seen as giving a good indication as to each state’s general approach to the issues discussed.
In the survey, state officials were asked specifically whether “unrelated third parties located in your state provid[ing] fulfillment services (i.e., fill product orders from corporate-owned inventory)” was a nexus-creating activity. Most state officials answered “yes,” and only a small minority (Oklahoma, Rhode Island and Vermont) answered “no.” The answers provided by the officials on this and other issues are indicative of the overall aggressive approach by most states in this and other controversial areas of state income taxation.
In the case of Amazon FBA, unfortunately, Amazon seems to provide little direction for its online sellers regarding issues of state and local income taxation, and instead, caveats on its website that state and local income taxation obligations are solely the responsibility of the independent sellers.
Due to the complexities and uncertainties surrounding the state income tax implications of utilizing Amazon FBA, international sellers are often left with a difficult choice between taking a more conservative, but costly, approach that generally assumes nexus creation or a more aggressive, but risky, approach that generally assumes a lack of nexus under the Amazon FBA business model. Clear and official guidance by state taxing authorities would certainly be of significant help to today’s many uncertain taxpayers situated in the U.S. and abroad.
Amazon FBA and Federal Taxation
Similar to state taxes, the extent to which the U.S. government can impose federal taxes on an international merchant depends greatly on the level of connectedness that the seller has to the U.S. Whereas “nexus” is the key principle in this regard in the area of state taxation, federal tax is triggered if the activities of a foreign seller in the U.S. rise to the level of a “U.S. trade or business” or “USTOB,” and the seller’s income is effectively connected to such U.S. trade or business.
In the case that a foreign seller is resident in a country that has an income tax treaty with the U.S. (which generally trumps U.S. domestic law), a foreign seller’s U.S. business profits may be exempt from U.S. taxation so long as they are not attributable to a “permanent establishment” or “PE” in the U.S. The PE threshold is generally considered to be more taxpayer friendly than the USTOB threshold.
The parameters of USTOB and PE have been the subject of decades of litigation in U.S. courts, which has at least led to the development of some judicial precedent in this area. More recently, in the international arena, the PE concept has been the main focus area of the recent so-called Base Erosion and Profit Shifting (BEPS) project of the Organisation for Economic Co-operation and Development (OECD), with a special emphasis on today’s digital economy.
At the risk of delving too deeply into a technical analysis, suffice it to say the Amazon FBA model may present USTOB or PE risks depending on the particular terms of an agreement between Amazon and the international seller. As a rule of thumb, the more an agreement represents an agency relationship, the greater the risk generally becomes.
Currently, Amazon requires foreign online sellers to simply provide a Form W-8BEN to demonstrate their non-U.S. tax residency and avoid U.S. federal withholding tax. Interestingly, the Form W-8BEN is appropriate in cases where the foreign payee does not have income effectively connected with a USTOB. Amazon is careful, however, to include in its Amazon FBA agreements a tax indemnity clause stating that the seller acknowledges that storing products in its fulfillment centers may create tax nexus in any country, state, province or other locality in which the seller’s products are stored. It also says that it is the seller’s responsibility to fulfill any resulting tax obligations.
As with state income tax, the tax characterization of the Amazon-to-seller relationship can have significant federal tax implications from both a substantive and reporting perspective. In an uncertain tax world, an international seller’s tax risk appetite will often be the guide to its ultimate approach.
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