New state and federal laws hold significant changes for Amazon FBA international sellers.
In our article last year on the taxation of Fulfillment by Amazon (FBA) international sellers, we covered some of the basic U.S. tax considerations associated with the popular FBA business model. We noted the general dearth of primary authorities providing direction to foreign sellers as to the federal and state tax consequences of fulfillment activities within the United States.
While specific guidance from the IRS remains wanting, several significant developments in 2018 should at least steer international sellers in a clearer direction.
Developments in state taxation
As a word of background, Amazon international sellers are potentially subject to two main methods of state 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.
Most states generally take the position that a third-party fulfillment center does, in fact, create sales tax nexus. As such, if a state has an Amazon FBA warehouse (many 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.
Until this year, sellers who did not have products stored in a warehouse in a particular state or any other physical presence in such state could rely on U.S. Supreme Court precedent, namely the 1992 Quill Corp. v. North Dakota decision, to provide protection from sales taxation in such state. This was based on the court's physical presence standard, which required physical presence, such as inventory or employees, in the state in order to create sales tax nexus.
In South Dakota v. Wayfair, Inc., a landmark case decided in June of this year, the Supreme Court decided in the state's favor and expressly overruled the long-standing physical presence test. The Wayfair decision gives states significantly more constitutional flexibility by allowing them to potentially impose sales tax on out-of-state sellers who merely sell to customers in the relevant state, even if they have no physical presence in such state. It remains to be seen how states react to the Wayfair case, but foreign sellers should expect to broaden legislation across states that further catches their activities in the sales tax net.
In this regard, some states have begun to require so-called "marketplace facilitators," like Amazon, to collect and remit sales taxes on behalf of their sellers. Amazon's website, in fact, currently has a page dedicated to educating sellers about the concept of marketplace facilitators. The page also follows the development of state legislation in this area, specifically listing Oklahoma, Pennsylvania and Washington as states with marketplace facilitator laws. Other states may follow suit, especially in light of the Supreme Court’s state-friendly Wayfair decision.
Developments in federal taxation
While state developments were broadcast loudly in the form of a Supreme Court decision and state legislative transformations, the federal development most relevant for Amazon FBA international sellers was somewhat inconspicuously tucked away in the Tax Cuts and Jobs Act, which was enacted into law at the tail end of 2017.
As a word of background, 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 United States. Whereas "nexus" is the key principle in this regard in the area of state taxation, federal tax is triggered (unless treaty protection is available) 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 "ECI" or income effectively connected to such U.S. trade or business.
The rules for determining whether income is ECI are quite complex and nuanced and subject to a number of exceptions. The main preliminary factor in determining whether income is ECI or not ECI is whether the income is from U.S. or foreign sources. The sourcing of inventory rules apply differently depending on whether the inventory is or is not manufactured by the foreign seller.
For products not manufactured by the foreign seller (i.e., manufactured by a third party outside the U.S.) – the so-called "title passage rule" applies. Under this rule, if title to the goods passes outside the U.S., income from the sale of such goods by a foreign seller is considered foreign source and therefore is not subject to U.S. federal income taxation. If title to the goods passes within the U.S., then income from the sale of such goods by a foreign seller is considered U.S. source and is therefore subject to U.S. federal taxation under domestic law. The Republican tax legislation seemingly did not change this aspect of the inbound tax rules.
For products manufactured (wholly or partially) by the foreign seller, however, the law changed significantly under the Tax Cuts and Jobs Act. Under the new law, which is effective beginning with the 2018 tax year, if goods are manufactured by the foreign seller outside the U.S., then the sale of such goods are considered foreign source and therefore not subject to U.S. federal taxation, even if they are sold within the United States (the "manufacturing exception"). This new provision should prove quite beneficial for online sellers who manufacture their own products. Regulatory guidance on the parameters of this new provision would provide further clarity in this area, but for now, the provision is a welcome development for online sellers.
Since the U.S. tax rules regarding Amazon FBA international sellers remain a moving target at both the federal and state level, it's important for foreign sellers to keep abreast of the latest developments in this area – subtle changes can mean significant federal tax implications from both a substantive and reporting perspective.