Revisiting Nexus Standards: Establishing U.S. Jurisdiction to Tax Cross-border Commerce

Benjamin Franklin said that the only sure things in life are death and taxes. But with the rise of online shopping, it’s become uncertain how taxes should work for international business. The U.S. tax system is trying to figure out new rules for taxing cross-border commerce in the modern world. People are questioning if old tax laws still make sense. When people from other countries make money in the United States, both the U.S. and their home country can tax that income. The U.S. has two ways of deciding who gets to tax the income: based on where the person lives or where the income was earned. For U.S. citizens and companies, they get taxed on all their income, no matter where it was earned. But for people from other countries, they usually only get taxed on the money they made in the U.S. if they have a business here. This is usually determined by tax treaties between the U.S. and other countries. The permanent establishment concept is when a foreign company has a fixed place of business in the United States, like a store, office, or factory. This concept helps determine if the foreign company should pay taxes in the U.S. or in their home country. It came about in the early 20th century when foreign businesses started entering the U.S. market, and it helps prevent double taxation of their profits. This concept is important for how taxes are handled in international business. The concept of permanent establishment was originally created for businesses with physical locations in the US. But now, with online commerce, foreign businesses can reach US customers without having a physical presence. This has led to debates about whether the concept of permanent establishment needs to be updated to include economic presence, not just physical presence. However, changing this standard may be unconstitutional under current laws. In the Quill case, the Supreme Court said that before a state can tax a business from another state, there needs to be a connection between the two states that makes the tax fair and reasonable. This is called due process nexus. It’s like saying the business has to have some kind of economic presence in the state. But there’s also another standard called commerce clause nexus, which requires an even stronger connection between the business and the state. The Court didn’t give a lot of details about what counts as a “substantial nexus,” but it’s clear that it’s more than just economic presence. So, both of these connections have to be met before a state can tax a business from another state. Several state court decisions have said it’s okay for states to tax companies based on their economic presence in the state, rather than physical presence. But these decisions aren’t very convincing, because they don’t have a strong basis in law. One case in particular, Geoffrey, Inc. v. South Carolina Tax Commission, said that a company’s economic presence was enough to justify the state taxing them. The problem is, the court didn’t have much legal support for this idea and cited older cases that didn’t really apply. So, the idea of taxing based on economic presence isn’t as clear-cut as some people think. In the KFC Corp. v. Iowa Department of Revenue case, the Iowa Supreme Court decided that KFC had to pay state taxes even though they didn’t have a physical presence in Iowa. They based their decision on some older court cases, but those cases were about different legal issues. The Iowa court also said that the U.S. Supreme Court only requires physical presence for sales and use taxes, not income taxes. But it’s actually because the U.S. Supreme Court has never had a case about income taxes without physical presence. So, the KFC case is still kind of unclear about whether physical presence is needed for income taxes. The OECD has guidelines for when a server can create a taxable presence in a country. While a website by itself doesn’t create a taxable presence, a server in a country can. This means foreign companies with servers in the US might have to pay taxes here. It’s important for these companies to understand and manage this risk. Basically, U.S. citizens and resident aliens have to pay taxes on all income, no matter where it comes from. Foreign individuals and corporations also have to pay taxes on income from the U.S. under certain circumstances. There’s a lot of debate about how to tax income from digital commerce and whether having a server in a different country counts as doing business there. The Supreme Court has made some decisions about whether states can require out-of-state businesses to collect sales tax. The Supreme Court has not taken on cases about taxes for companies operating in different states, saying it’s up to Congress to decide. Many companies have been involved in these cases. Some examples are Dairy Queen and KFC. There are also cases involving companies like Wrigley, Mobil, and Kraft General Foods. Overall, the Supreme Court has said that companies need to have a significant presence in a place to pay taxes there. The Tax Law Section is sharing information on behalf of its members to help improve the administration of justice and advance the science of jurisprudence. The section includes professionals like Brianne De Sellier and John Kelleher, who have studied accounting and taxation to provide expert advice in their field.

Source: https://www.floridabar.org/the-florida-bar-journal/revisiting-nexus-standards-establishing-u-s-jurisdiction-to-tax-cross-border-commerce/