VAT, GST and Sales Tax in United States

Summary

The United States does not impose a national-level sales or value-added tax. Instead, sales taxes and complementary use taxes are imposed and administered at the state (subnational) and local (substate) levels. Currently, 45 of the 50 US states, the District of Columbia and Puerto Rico impose some form of sales and use tax. (See chapter on Puerto Rico.) Only Alaska, Delaware, Montana, New Hampshire and Oregon do not impose such taxes. Taking into account both the state-level and local-level aspects of sales and use taxes, approximately 10,000 taxing jurisdictions exist in the United States.

The laws, rules and procedures with respect to sales and use taxes are not uniform among these jurisdictions, and issues such as tax-base calculation, taxability of specific items and tax rates vary considerably among the jurisdictions. Sales and use taxes are generally imposed on transactions involving the sale of tan­gible personal property. However, several states also tax certain specified services and digital property (for example, electroni­cally delivered software).

Tax rates

Sales and use tax rates vary among the states. For each state that imposes a sales and use tax, one uniform rate is imposed at the state level. However, several states impose a lower rate on certain items, such as food, clothing, selected services and medicine, instead of exempting such items outright. Excluding additional local sales and use taxes, state-level sales and use tax rates range from 2.9% (Colorado) to 7.5% (California).

Local rates, if authorized within a state, may vary significantly. In addition, a single situs within a state may lie within several different local taxing jurisdictions. For example, sales made in one store may be subject to city, county and district taxes, in addition to the state-level tax, while sales made from a different store may be subject only to a county tax, in addition to the state-level tax. As a result, it is possible that two identical transactions within the same state may be taxed at substantially different rates based solely on the local sourcing of the transaction. In certain states, local rates can exceed 4% and constitute a greater portion of the total sales tax due than the state-level rate.

Not all states authorize the imposition of local sales and use taxes. Others require rate uniformity across the state or minimum local rates, e.g., California.

Imposition of tax

Sales taxes are transaction-based taxes imposed on intrastate retail transactions (sales made between a buyer and seller located within the same state) and are calculated as a percentage of the receipts derived from the transaction. The legal incidence of state sales tax laws may be on the buyer (“consumer” taxes) or on the seller (“vendor” or “privilege” taxes). However, regardless of the form of the tax, the consumer generally will bear the actual cost of the tax, while the vendor will bear the compliance cost.

Use taxes, which complement sales taxes, are imposed on the use, storage or consumption in a state of property or taxable services that have not been subjected to a sales tax. Essentially, use taxes are designed to prevent the avoidance of sales taxes on interstate retail transactions (sales made between a buyer and seller located in different states) by taxing goods and service procured in one state but intended for use or enjoyment in another state. To the extent that sales tax is paid in one state on such interstate transac­tions, a credit is allowed against any use tax that is ultimately owed.

Jurisdiction to tax

The key issue with respect to sales and use taxation is jurisdiction to tax, or “nexus.” This concept deals with the power of one state to compel a seller to collect and remit the sales or use tax due on a transaction. Under current US law, nexus exists only if the seller has some physical presence within the taxing state (either by itself or through an agent or affiliate that is “establishing and maintaining” an in-state market for the seller) and if such pres­ence is more than de minimis.

Direct physical presence, even if unrelated to a seller’s sales activity, creates a collection obligation. Physical presence may be deemed to exist based on the ownership of real or tangible per­sonal property, the in-state presence of employees, the temporary storage of inventory or any other entry into the state by the seller or its employees (for example, delivery of goods sold in the seller’s own vehicles). Physical presence may also be attributed to a seller based on activities conducted by third-parties in the state on the seller’s behalf. Essentially, if an agent or affiliate of a seller that does not have nexus with a state enters the state and conducts activities on the seller’s behalf that serve to “establish and maintain a market” for the seller’s goods (for example, solic­iting sales, providing repair or installation services or providing training services), the seller may be deemed to be physically present in the state and be subject to the state’s sales and use tax jurisdiction.

If a seller has nexus with a state for sales and use tax purposes, the seller is generally required to register in that state for sales and use tax purposes, and the seller is required to collect and remit sales and use taxes due on its taxable transactions with customers in the state. The seller is also required to file monthly sales and use tax returns and remit all taxes collected. Failure to comply with the specific state requirement may result in the seller becoming liable for any tax due on a transaction, plus penalties and interest.

Since 2000, the US Congress routinely has considered legislation that would eliminate the physical presence nexus standard for remote sellers (sellers that sell and ship goods to customers from points outside of the customer’s state and that lack physical pres­ence in the customer’s state). However, none of these measures has progressed to a stage where passage seemed likely. As of late 2015, one proposal is pending before both houses of Congress that would allow eligible states to require all vendors except those qualifying as “small sellers” to collect and remit sales and use taxes on remote sales into the state without regard to the loca­tion of the vendor. The proposal would empower a state to require such collection by remote vendors either by: (1) being a member of the Streamlined Sales Tax Agreement, a multi-state compact designed to make state sales and use tax laws more uniform; or (2) adopting and implementing specified simplification mea­sures.

Given the uncertainty as to the advancement of the proposed legislation, taxpayers should expect the individual states to con­tinue to pass laws expanding their sales and use tax jurisdiction (both from an affiliate nexus and direct activity standpoint), subject to federal constitutional limitations. Since 2008, more than 25 states have enacted or considered laws that would expand the scope of “establishing and maintaining a market” to include activities such as the following:

  • Referring customers to a remote seller through a link on an internet website
  • Having a similar trade name, selling similar goods or services and being part of a controlled group together with a remote seller
  • Being part of a commonly controlled group that includes an in-state warehouse or distribution center that serves a remote seller

In addition, a number of states have enacted or considered legis­lation that would require remote sellers to notify customers, or the relevant state revenue agency, of their use tax liability. However, given that such requirements are of questionable con­stitutionality, their adoption at the state level has been limited.

Retail sales

State sales and use taxes apply to receipts from taxable property and services sold and purchased at retail. A “retail sale” generally is defined as the transfer of title and possession of property from the seller to the ultimate consumer in exchange for consideration. Wholesale sales (discussed below), also referred to as “sales for resale,” are exempt from sales and use tax in all states that impose a sales and use tax scheme. However, Hawaii imposes a 0.5% wholesale sales tax rate on resale transactions.

Taxation of services that are ancillary to the sale of taxable tan­gible personal property, such as delivery and installation, varies among the states. Most states have explicit statutory or regulatory provisions dealing with the treatment of such services. In many cases, such treatment is determined based on the state’s specific definition of “receipts” for sales and use tax purposes.

Retail sales involving three parties (retailer, buyer and supplier), in which title to the property sold passes from the retailer directly to the buyer, but possession is transferred from a third-party sup­plier directly to the buyer, are classified as “drop ship” transac­tions. In a drop ship transaction, the retailer is generally responsible for sales and use tax collection. However, if the retailer does not have nexus with the buyer’s state, a supplier with nexus in the state may be held liable for sales and use tax collec­tion on the transaction. Alternatively, states may attempt to assert nexus over the out-of-state retailer under a “flash title” theory (that is, by asserting that the retailer takes title to the property for an instant while the property is within the state and, accord­ingly, has physical presence) or assess use tax liability directly against the buyer.

Leases are treated as taxable retail sales in most states. The tax generally applies separately to each lease payment. However, certain states, such as Illinois and New Jersey, require lessors of tangible personal property to pay the sales tax in full on acquisi­tion and before any subsequent lease or rental. In these states, tax is not charged on the subsequent lease.

Lease transactions that are deemed to constitute “financed sales” (arrangements under which total lease payments approximate the sales price, with the lessor having the option to purchase the leased item for a nominal price at the end of the lease term) are generally treated as straight sales in most states. If a lease is reclassified as a financed sale, tax is due in full at the time of inception.

Sales and use taxes are imposed on receipts derived from taxable retail sales transactions. In most states, taxable receipts may be reduced by the value of any goods traded in by the purchaser as part of the transaction and by any coupons, rebates, or discounts issued by the vendor.

What is taxable

State sales and use taxes generally apply to sales of tangible per­sonal property, which is defined in most states as personal property that can be seen, touched, measured and weighed, or is otherwise perceptible to the senses. In general, services are not broadly subject to sales and use taxes. However, several states tax spe­cifically enumerated services. Such taxation is not uniform across the states.

Real property (land, buildings and fixtures) is not considered to be tangible personal property, and the sale or lease of real prop­erty is not subject to sales and use taxation, except in certain limited circumstances in Arizona, Florida, and New York City.

Intangible personal property, such as securities and intellectual property, are not subject to sales and use taxation. However, cer­tain intangible “digital equivalents” of tangible personal property may be subject to tax, depending on the specific state’s laws. For example, items such as music downloaded from the internet and canned (non-custom) computer software that is delivered elec­tronically may be considered to be tangible personal property in several states and are subject to tax. Similarly, depending upon the jurisdictions involved, cloud-based software (SaaS) may be classified as taxable tangible personal property, nontaxable intan­gible property or a service.

Many states classify utilities, such as natural gas and electricity, as taxable tangible personal property. In such states, sales of these utilities may be subject to sales and use tax in addition to any applicable utility transmission fees or excise taxes.

Situs of sales

Where a sale is deemed to take place is crucial in determining which jurisdiction’s tax laws and rates apply. For intrastate sales (that is, sales that occur entirely within a single state), the situs of the sale determines which local sales and use taxes are imposed in addition to the state-level tax and which locality receives the revenue. For interstate transactions, the situs of the sale deter­mines which state’s laws control and which state is entitled to the tax revenue.

In general, sales are sourced based on the nature of the transac­tion. For example, if a sale occurs at a fixed location, such as an over-the-counter sale at a store, the sale is sourced to that loca­tion. For intrastate remote sales that involve a buyer and seller (and possibly the goods sold) at separate locations, the transac­tion may be sourced to where the goods are received by the buyer, where the order is accepted by the seller or from where the goods are shipped.

For interstate remote sales, tax generally is imposed at the desti­nation (that is, where the goods are received by the buyer), regardless of where title passes to the ultimate customer. In such cases, use tax, rather than sales tax, is due, and it must be col­lected and remitted by the seller if the seller has nexus with the destination state. To the extent that the seller lacks nexus with the destination state, the purchaser must self-assess and pay use tax to the state.

Sourcing for intrastate sales, which is important for determining application of local sales and use tax, varies among the states. Most states apply local taxes on a destination basis, which means that local sales and use taxes at the customer location will apply. Others apply local taxes on an origin basis, which means that local sales and use taxes at the vendor or shipper location will apply.

Tax exemptions

Exemptions from state sales and use taxes are largely driven by policy and may be based on federal or state law. Exemptions based on federal law include taxes imposed on Indian tribes and reservation lands, and sales made to the federal government.

State and local level exemptions vary by jurisdiction, but may be grouped into the following four distinct categories:

  • Entity-based
  • Property-based
  • Use-based
  • Transaction-based

Like other aspects of state and local taxation, the availability and operation of sales and use tax exemptions and the procedures for claiming the exemptions vary among the states.

Entity-based exemptions. Sales made to entities that qualify for exemption in a state (for example, religious or charitable organi­zations and state and federal governmental agencies) are not subject to tax. Issues may arise with respect to contractors per­forming work for or on behalf of such exempt entities. In general, contractors must pay tax on items purchased in fulfilling a con­tract with an exempt entity. However, tax is generally not due if the contractor is acting as an agent for the entity in procuring items for the entity’s own use.

Property-based exemptions. Many states deem certain specific items to be exempt from tax as a matter of policy. For example, several states do not tax food, clothing or medicine, or they pro­vide for a reduced rate on such items. Certain states set thresholds for such items. For example, Massachusetts exempts clothing purchases up to USD175 per item.

Use-based exemptions. Items that otherwise are subject to the tax may be exempt based on their actual use by the purchaser. Most notably, items used in manufacturing, research and development and pollution control typically are eligible for exemption. In addition, many states provide specific exemptions for enumerat­ed items purchased and used in designated enterprise and eco­nomic development zones in the state.

Transaction-based exemptions. The most common sales and use tax exemptions are based on the type of transaction involved. In the retail context, the “sale for resale” or “wholesale sale” exemp­tion is most often claimed. The “occasional sale” exemption, also referred to as the “casual sale” or “isolated sale” exemption, typically applies in the context of business restructurings.

Sales for resale. To avoid multiple taxation, most states that impose a sales and use tax regime provide an exemption for wholesale sales. To claim this exemption, the purchaser must purchase the taxable items with the intention of reselling or leas­ing the items at retail. Any subsequent use by the purchaser of the items purchased under a resale exemption results in use tax becoming due. However, the seller is not required to collect such tax unless it knew at the time of sale that the purchaser intended to use the items.

Occasional sales. Sales that are rare or nonrecurring, such as the sale of the operating assets of a business division, qualify for exemption in most states. The theory underlying this exemption is that the sales tax is meant to apply to retail transactions only, and one-time sales are not sufficiently systematic to indicate that the seller is in the business of engaging in such transactions. In states that do not provide specific exemptions for business reorganizations (for example, incorporations, mergers and spin-offs), the occasional sale exemption may apply to limit the application of sales and use taxes to transfers of assets.

Temporary storage. Several states allow an exemption for prop­erty that is not used in the state, but is stored temporarily in the state and is intended for ultimate shipment outside of the state. This exemption typically applies to items fabricated or produced in a state and to items purchased and warehoused in a state but intended for ultimate transport outside of the United States.

Claiming exemptions. The process for claiming any of the exemp­tions described above varies depending on the type of exemption claimed and the state or states involved. In most instances, to claim an exemption, purchasers must provide the seller with a valid exemption certificate or statement in the form prescribed by law. In a number of states, the parties to the transaction must be registered for sales and use tax purposes in order to validly claim the exemption.

If the seller takes an exemption certificate in good faith (that is, the seller does not know of any reason why the exemption does not apply), the seller is relieved of any tax-collection requirement with respect to the transaction. “Good faith” standards are not uni form among the states. If a seller does not accept such cer­tificate and if the seller is otherwise required to collect tax but does not do so, the seller may be personally liable for any tax due on the transaction. In several states, a seller making an exempt sale must be registered for purposes of that state’s sales and use tax to be able to accept an exemption certificate from a pur­chaser in good faith. This requirement may present a challenge for non-US-based sellers making sales for resale, or sales under some other exemption, because registration often requires that the seller first obtain a federal employer identification number. In recent years, several states have dramatically increased their scrutiny of the exemption certification process.

Local (substate)-level sales and use taxes

Local sales and use taxes are authorized in 37 states. In most instances, the local sales and use tax base mirrors the state-level sales and use tax base. However, rates may differ significantly among the localities within a particular state. As indicated in Section B, a single address within a state may fall within multiple local taxing jurisdictions.

In most states, local sales and use taxes are administered at the state level. However, in a limited number of states, such as Louisiana, such taxes are administered by the locality imposing the tax, and separate registrations and filings may be required. Sellers that have nexus with a state are generally considered to have nexus with every locality within that state, regardless of whether they maintain any physical presence within a locality.

Registration, filing and compliance issues

Sellers that have nexus with a state (see Section D) must register with the state taxing agency for sales and use tax purposes. Registered sellers must collect and remit sales and use tax on all taxable transactions and maintain exemption certificates received from their customers. Sales and use tax returns are due on a monthly or quarterly basis, depending on the specific state’s laws. Sellers that do not make any taxable sales for a given period may be relieved from filing regular returns, or they may be required to file “zero” returns indicating that no taxable sales occurred.

Penalties

All states impose penalties for failure to file returns and pay taxes as required by law. Penalty rates vary among the states. With respect to cases not involving fraud, the penalties range from 5% to 25% of the tax due. In cases involving the failure to file or pay as a result of fraud, penalties can exceed USD50,000 and result in imprisonment for any officers deemed responsible for the will­ful failure.

Similarly, all states impose interest on tax determined to be due that was not paid. In general, interest is assessed from the due date for any tax determined to be payable until the date of pay­ment. The interest rate charged varies among the states. In gen­eral, interest rates vary from 1% to more than 14%. Some states determine their interest rates based on the prime rate, plus some additional percentage. Other states set rates legislatively. Rates set legislatively change less frequently, while those tied to the prime rate generally change quarterly, semiannually or annually, depending on market conditions.