Tax compliance crucial for online businesses selling into U.S.
By AdvocateDaily.com Staff
For Canadian-based entrepreneurs who sell goods or services into the U.S. market, tax must be paid to an applicable tax authority on income earned online — and to avoid the risk of double taxation, you must comply with both U.S. and Canadian tax laws and have the proper business structure within which you are operating, says Oakville-based U.S. tax attorney (NY, DC) Alexey Manasuev.
As Manasuev, principal of U.S. Tax IQ, tells AdvocateDaily.com, U.S. and cross-border tax issues can become complicated for entrepreneurs with businesses based on online platforms or those in the internet marketing and digital commerce spaces.
“Generally, if you are here in Canada, you have your online business, you have some sales, or you provide services, you may think — and sometimes reasonably so — that there should be no U.S. taxes owed. Oftentimes, this is not quite right. It all depends on your specific facts and circumstances. U.S. tax law is complex, and whether or not you are subject to U.S. tax depends on several factors.”
As a general proposition, says Manasuev, those businesses physically based outside of the United States who are providing services to U.S. based clientele are not subject to U.S. tax.
However, he adds, “In consideration of the Foreign Account Tax Compliance Act (FATCA) and the variety of enforcement initiatives in the U.S. to collect taxes when owed, some withholding agents or payors will withhold on payments made to Canadian service providers even though it is non-U.S. source income and as such, is not subject to withholding.”
For those who provide services online to U.S. clients, says Manasuev, the simplest way to avoid having income held at the source is to provide the withholding agent in the U.S. with Form W-8 BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals), or Form W-8 BEN-E, Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities), if the service provider is a partnership or corporation in Canada receiving payments from a U.S. client.
“These forms establish the foreign status of the person who is the beneficial owner of the income. It establishes the country of residence, and it also establishes the qualification for treaty benefits that allows the income recipient to either reduce or eliminate U.S. tax withholding based on different facts and circumstances and based on the type of income they receive,” says Manasuev.
“Providing the appropriate form allows the U.S. withholding agent, to the extent they know and follow the rules, to not withhold when it has to do with the provision of services, for example, and when the individual has not crossed the border to perform those services on U.S. soil,” he adds.
When it comes to smaller Canadian businesses selling products into the U.S., there are additional considerations around U.S. state income tax liability and filing requirements, as well as concerns around U.S. state sales tax.
As Manasuev notes, a 2018 U.S. Supreme Court ruling that South Dakota can impose sales tax on online purchases even if a business isn’t physically based in the state reversed a 25-year-old ruling that only applied sales tax if the seller had physical presence of property or employees in the state — which is referred to as ‘sales tax nexus.’
As a result, he says, more and more states are now following a dollar sales amount threshold approach as opposed to the previous rules around physical presence.
“There are states that are applying that lower threshold for having foreign taxpayers subject to U.S. state taxes. It is becoming much more complicated, and because there are so many states, you really have to look into any state where the Canadian entrepreneur, who is involved in online business, has inventory and sales," says Manasuev.
“Right now, if you have sales in different states or customers who buy products that you sell online from different states, you may be subject to U.S. state sales taxes, and U.S. state income taxes. Providers may now be subject to different state income tax filing requirements and state tax liability," he says.
In terms of how tax liability is determined, Manasuev says different states follow different rules.
“Some states still require physical presence. If you don’t cross the border and are not physically present in that state, you will be fine. In more and more cases, the sales threshold is imposed, and as long as you sell in that particular state and exceed certain threshold amounts, say US$250,000, you will then be subject to sales tax in that state.”
In some situations, Manasuev says, platforms such as Amazon, Shopify and others may automatically calculate applicable sales taxes for a particular state and collect them on behalf of an online retailer — but this isn’t always the case.
“In more and more cases, Amazon for example, depending on the arrangement, especially with smaller business owners, the provider does not want to take responsibility for collecting sales taxes. As a result, they leave it to the entrepreneur themselves to figure this out, and this can be a nightmare. Not only will the business owner now have to pay someone to figure out what their tax obligations are in a state in which they sell, which is not an easy exercise and is not cheap, but they also have to monitor their sales for each state and understand the applicable rules and thresholds for each state.”
If possible, says Manasuev, small online retailers should ensure that they can ‘activate’ state sales tax options on the e-commerce platforms they are using, which allows the entrepreneur to assess any state sales tax that may be owed. If they cannot use this option, he says, then they need to look into other ways of addressing it, by understanding how tax is collected, what the nexus threshold is in that particular state for sales tax purposes — and whether a physical presence or a sales threshold exists.
“If it is a sales threshold, then you need to track your sales to understand your tax obligations,” he explains.
Ideally, says Manasuev, entrepreneurs should discuss their situation with a qualified U.S. tax adviser from the start, in order to ensure they set up the proper business structure — whether as a sole proprietor, a Canadian corporation, or a U.S. subsidiary, for example.
“Structuring can involve many different sorts of forms — it can be a corporate structure, or a partnership can be involved. In all of those cases, people need to be aware that while structuring may be a long-term decision for a business, the decision to structure the business properly may need to be done ahead of time to be proactive and to ensure that in the future, your business, as it grows, is ready to do what you expect the business to do and to have your tax exposure managed effectively,” says Manasuev.
“I think talking to a qualified U.S. tax adviser before you do anything is helpful because you would have an idea of the options for structuring your business to meet your objectives, what the obstacles are and what the framework is that you are getting yourself into,” he says.
“On that basis, you may make a decision to operate only in Canada, or you may operate globally. Speaking to an adviser will make you aware of your options. You do not necessarily have to have a complicated structure in the beginning, but oftentimes it may help you understand future obstacles and help you better manage and understand future implications if you do it correctly from the outset,” he adds.