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The following is Part 2 of 4 Part Series that will help answer some basic questions.
Nexus, Interstate Commerce, Destination vs. Origin Sourcing &
What is Nexus?
Nexus means a connection, tie or link. For tax purposes it is what connects us to the authority of a taxing jurisdiction. Just as organizations can have nexus for income, property or payroll taxes, it can also have an obligation for sales or use taxes we well. A bright line test of physical presence is required for nexus. Sellers may have the minimum contacts required by the Due Process Clause and yet lack the substantial nexus required by the Commerce Clause. Sufficient nexus is established when an out-of-state seller’s activities in a certain state become substantial, frequent or continuous. In that case, the seller is considered to be engaged in business in that state and is then required to register with the state and collect, report and remit applicable taxes.
Some common activities that may constitute nexus would be:
- Occupying, maintaining or using a place of business (real property) in a state. i.e., office branch, sales or sample rooms, warehouse or storage facility, or distribution house.
- Employees or agents in a state.
- Advertising, canvassing, hawking, peddling or soliciting in a state.
- Delivering by other than a common carrier or mail.
A vendor or seller is required to collect the tax from the customer if all four of the following circumstances exist:
- Vendor or seller sells taxable property to customers located in the state.
- The property is stored, used or consumed in the state.
- The vendor or seller has sufficient nexus with the state.
Interstate Commerce – An interstate commerce exemption provides that no taxation may be imposed by a state on sales made in commerce between a state and any other state, or between a state and any foreign county. The Federal government is the only agency that may tax such transactions.
The basic principles of the Interstate Commerce Exemption are:
- Formalities such as the form of billing or change in the method of transportation do not affect the continuity of transit.
- If a break in transit occurs, the property may come to rest within the state and be subject to the state’s taxing authority. If interstate movement has not begun, the fact that such movement is contemplated does not prevent a state from taxing the property.
- If Interstate movement has begun, it may remain immune from state taxation despite temporary interruptions due to the necessities of the journey or for the purpose of safety and convenience in the course of movement.
- When the property has come to rest within a state and is held there at the pleasure of the owner for disposal or use, it is deemed to be a part of the general mass of property within the state and thus is subject to the state’s taxing authority.
In order for a state to tax a transaction, the following 4 tests must be met:
- The transaction must have sufficient taxable nexus with the state.
- The tax cannot discriminate against interstate commerce or unfairly favor a local vendor by charging a lesser rate.
- The tax must be fairly apportioned. i.e., the property is taxed in proportion to its presence in the state or the activity of the taxpayer in the state.
- The tax fairly relates to the benefits received. i.e., the benefits the taxpayer receives from the state are commensurate with the tax proposed.
Destination vs. Origin Sourcing for Rate of Tax – A sale occurs with the transfer of possession or the passing of title.
- Title passes: (1) when agreed to by the buyer and seller under the contract, or (2) if the intention of both parties is not indicated in the contract, title will generally pass when: (i) the goods are placed in a deliverable condition, or (ii) if the contract requires the seller to deliver the goods to the buyer at a place designated by the buyer. Or, if the contract calls for the seller to pay transportation or shipping charges, title passes when the goods have been delivered to the buyer as agreed.
Generally, only the state in which the buyer takes possession or control has the right to sales tax on the shipment. A sales tax paid to the ship-from state is illegal and the buyer would still owe the tax to the ship-to state. Turning a shipment over to a common carrier for shipment does not constitute the buyer gaining control or possession, regardless of who called the common carrier (seller or buyer).
- Reciprocity – When permitted, states observing reciprocity allow a purchaser to offset any use tax due on a purchase by the amount of sales tax legally paid to another state with respect to the same property. The effect of reciprocity is that the higher of the two rates will be the effective rate for the transaction. Examples: (a) A purchase is made and sales tax is paid in an 8% state on property that is then placed in service in a 5% state – with reciprocity, no use tax is due; (b) A purchase is made and sales tax is paid in a 5% state on property that is then placed in service in an 8% state – with reciprocity, use tax of 3% is due.
Taxable Basis – Defined as the value upon which any applicable sales or use tax will be assessed. Although the sale price or gross proceeds of sale are usually the stated basis for determining sales and use taxes, components of the taxable basis can include items other than the stated selling price of the article of taxable tangible personal property.
Some items that may affect the basis:
- Bad Debts – All states provide a way for retailers to recover sales taxes previously remitted on accounts receivable that become uncollectible.
- Finance, Interest and Carrying Charges – These items are excluded from tax if separately stated. Typically a retailer’s charges to a consumer for the borrowing of money, not the sale of tangible personal property, are not included in the taxable basis. There are some states that have an exception to these general rules and include Connecticut, Hawaii, Michigan, Mississippi, New Mexico and Vermont.
- Trade-in Allowances – Generally states treat the value of the trade-in one of three ways:
(1) In some states, sales tax is applied to the full price of an item, with NO consideration given to the credit for a trade-in (California, District of Columbia, Michigan, Nevada, North Caroline and Oklahoma).
(2) In seven states, sales tax is generally applied to the full price of an item, with no consideration for trade-ins, except for specific transactions such as the trade in of motor vehicles or farm equipment (Alabama, Arkansas, Maine, Maryland, Massachusetts, Ohio and Rhode Island).
(3) In the remaining states, sales tax is applied only on the difference between the sales price and the credit given for a trade-in. Most states limit this to like-kind or same-kind property to be resold later at retail, at which time the trade-in will be subject to sales tax again (i.e., Illinois).
- Samples and Withdrawals from Stock – Samples and withdrawals from stock of resale merchandise are usually subject to use taxes, with the taxable basis being the cost (although some states tax the price at which the items would have sold at retail).
- Bulk Sales – Can be defined as the sale of all or a majority of the assets of a business or recognized unit of a business at one time to a single buyer. Many times a new buyer takes over the existing business or intends to use the assets in their business. For this reason, bulk sales of tangible personal property are often excluded from the states’ definition of “retail sale”. Inventory is usually treated as exempt from sale for resale, as well as furniture, fixtures or equipment as an occasional or casual sale.
- Occasional and Casual Sales – In almost all states, some exemption is given for sales or use taxes (or both) for property sold outside the ordinary course of a trade or business or by those not engaged in a business activity. Most states will require these exempt sales to be isolated, infrequent or non-recurring in nature.
- Gratuities – Voluntary tips or gratuities left by customers are not included in the taxable basis. Mandatory amounts added to customers’ checks by the retailer are generally taxable. An exception exists in many states if the mandatory charge is all given to the server and/or the retailer receives no benefit of the charge.
- Returned Goods – Goods returned to retailers for which a full credit or refund is given are not normally treated as taxable sales. (i) Retailers that accept returned goods normally refund to the consumer the sales tax originally paid by the consumer for the returned goods; (ii) a credit on the sales tax return covering the period of the return is usually given for the amount refunded or credited to the customer’s account, (iii) the goods returned are frequently put back into stock and taxed again when resold. Note: Restocking charges invalid this.
- Self-Produced Assets – Special tax issues arise when a manufacturer produces both property for sale and property to be used in its business. States vary in the computation of taxable basis for self-produced assets, but common ways of computing the basis are:
- Cost of the materials used in producing the asset.
- Cost of materials and labor.
- Full cost of production including material, labor and overhead.
- Fair market value or selling price of the finished asset.
- Selling price, if stock item; cost if asset produced is not regularly sold.
Portions of the information are from the Sales and Use Tax Workshop, and used with permission by Fred Pryor Seminars. All rights reserved.
Coming in the next and future Newsletters:
Part 3 – Warranties, Exemptions, Registration & Compliance
Part 4 – Streamlined Sales Tax Project
Look for these great articles and stay ahead of the curve! Contact a BRP professional to keep your business up to date and ready for success.
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