Introduction:
A nexus is a relationship or a bond between two or more entities. In tax law, it is a relationship between a taxing authority, such as a state, and a corporation. A nexus must exist before a taxing authority can impose a tax on an entity and requires that there be a significant connection between jurisdiction and industry.[1]
The word “nexus” is used in tax law to describe a situation in which a company has a tax presence in a specific country. The nexus is essentially a link between the taxing authority and the individual that must collect or pay the tax.
Two U.S. clauses. The constitution is the root of the tax nexus:
- The due process clause, which includes a link.
- The commerce clause, which “requires substantial presence”.
A nexus can also be used to define the amount and extent of commercial activity that must be present before a state can tax the income or revenue of an individual within its jurisdiction. The taxpayer must pay and collect sales taxes in that country if there is a nexus there and pay income tax on the income generated there.[2]
States can require a vendor to collect sales or to levy taxes only if the activities of that vendor create a relation or a minimum connection with the state. If this connection is created, the vendor is subsequently obliged to collect the appropriate tax from the purchaser and remit the tax to the State.
Cloud computing vendors must consider the location of the server to assess the possibility of a nexus. Placing a server in a state usually generates a physical presence within that state, which results in a nexus. Other nexus-creating practises include employing; physically soliciting sales; and conducting various installation, customization, or training activities in the state.
States also adopted legislation that aims to expand ties to vendors without the traditional in-state physical presence of staff, officers, independent contractors or property. These laws are based on click-through, affiliate, related-party, and controlled-group-nexus hypotheses. Cloud computing vendors should adhere to the traditional physical presence and alternative nexus bases when deciding if they have sales tax obligations to a specific state.
Some states may define SaaS transactions as taxable sales of tangible personal property, often by identifying them as licences or sales of pre-written computer software. Thus, selling SaaS to an out-of-state customer, where a vendor grants a software licence, can be interpreted as implying that the vendor is considered to own tangible property in the state where the customer is located.[3]
Types of Nexuses in Online Sales
States have come up with a variety of ways to create a nexus for online transactions.
- The click-through link is a direct link between the buyer and the seller. This may occur then a state-owned company is paying a fee for referring sales to an out-of-state vendor, such as via a website connection.[4]
- An affiliate nexus includes affiliates that are independent entities that sell to other firms. The Amazon Associates programme is a prime example of this. An affiliate is not an employee or even an independent contractor, but is actively involved in a corporation, and states have used this connection to collect sales taxes. This form of nexus also involves a referral commission to be paid by the affiliate.
- The economic nexus is the best way to assess the nexus of sales tax. It’s just sales. A company may have an economic nexus in a state if it sells above a certain sum or threshold. Idaho has set a minimum of $100,000 in annual revenue for the creation of a sales tax nexus.[5]
Taxation of the SaaS
After deciding the nexus, sellers and buyers must answer the potentially daunting issue of whether SaaS is subject to sales and tax.
States narrowly view their sales-and-use-tax laws as applicable to SaaS transactions and either (1) specifically state that SaaS receipts are taxable services; (2) regard the sale of SaaS as taxable electronic distribution or constructive possession of pre-written software (i.e. tangible personal property); or (3) consider SaaS to be within the scope of a specific taxable service.
In those countries where the facilities are not taxable or expressly specified, the analysis is whether the SaaS transaction constitutes the acquisition of tangible personal property. Some States may treat SaaS as a taxable acquisition of tangible personal property, while other States may consider it a service that does not make sales taxable unless explicitly specified. Besides, particular consideration should be paid to states that do not tax or exclude information services, as SaaS transactions may also be listed as such.[6]
States are following a contradictory approach to providing guidelines, leaving taxpayers burdened by dissecting administrative regulations or interpretive guidance that also lacks clarity. Finally, it is important to remember that some States further differentiate between service agreements and licencing agreements when determining taxability, frequently characterising a transaction based solely on the mark (form over substance) used to describe the type of agreement entered into.
Sourcing
Determining the status of the transaction is the final step in concluding whether the transaction is subject to sales or tax. Rigorous research is necessary to decide where the sale is considered to have taken place, which State authority is responsible for the transaction and, as a result, which State may have jurisdiction to compel the collection of sales taxes.[7]
States typically use destination sourcing and produce revenues at the location where the purchaser earns the value. Generally, the seller uses the details in his possession at the time of the sale to determine the state of the transaction. However, where digital goods or electronically distributed services are involved, problems arise if there are variations between the billing address and the actual location of the SaaS user base. Finally, it is important to know the position of the intended users in order to decide precisely if a transaction should be carried out in a single state, or even in multiple states. The seller should ask the purchaser for this detail.
Scrutinize Transactions to avoid costly missteps
Investments in software and information technology cover some of the largest costs that a company may incur in a given year. The risk of miscalculation of sales or tax on the purchase or selling of SaaS carries a substantial risk of liability that may materially affect the bottom line of a company. SaaS vendors who fail to collect sales tax in a state with which they have a nexus face substantial valuations, fines, and interest.[8]
In view of the fact that many states continue to postpone dated legislation and informal letter rulings as guidelines on the taxability of SaaS transactions, taxpayers must proceed with extreme caution when deciding whether the sales or usage tax is due. Lack of conformity between States further compounds and an atmosphere of misunderstanding and uncertainty. Taxpayers need to be vigilant when engaged in SaaS transactions and pay special attention to the tax treatment of SaaS by nexus and states. Finally, investment in SaaS may greatly enhance the capabilities and competitiveness of a business; a slight misstep in terms of sales and tax utilisation can undermine the returns made by such investment.
Conclusion
Companies must have a nexus in a state before they are obliged to pay income tax or to raise sales taxes there. Nexus means that the corporation has an active presence in the tax jurisdiction. The relationship for sales tax purposes has traditionally required a company to have a physical presence in that country, but the advent of the Internet has led States to view online companies more closely and to their non-payment of sales taxes.
The numerous States that paid sales taxes scrambled to lay down laws and procedures that would enable the collection of sales taxes for online sales. In order to avoid hurting smaller retailers, many states have set a minimum number of transactions or annual revenue amounts below which no sales tax is paid for online transactions.
References:
[1] Lackner, J. R. (2007). The Evolution and Future of Substantial Nexus in State Taxation of Corporate Income. BCL Rev., 48, 1387.
[2] Stombock, M. A. (2007). Economic Nexus and Nonresident Corporate Taxpayers: How Far Will It Go. Tax Law., 61, 1225.
[3] Heide, J. B., & John, G. (1988). The role of dependence balancing in safeguarding transaction-specific assets in conventional channels. Journal of marketing, 52(1), 20-35.
[4] Rosenbach, J. S. (2019). Ding Dong Quill Is Dead: How South Dakota v. Wayfair Alters the Substantial Nexus Test under Complete Auto. Denv. L. Rev., 97, 261.
[5] Hoti, A. M. (1995). Finishing what Quill started: the transactional nexus test for state use tax collection. Alb. L. Rev., 59, 1449.
[6] Schafer, C. J. (2001). Federal legislation regarding taxation of Internet sales transactions. Berk. Tech. LJ, 16, 415.
[7] Lackner, J. R. (2007). The Evolution and Future of Substantial Nexus in State Taxation of Corporate Income. BCL Rev., 48, 1387.
[8] Swain, J. A. (2003). State Sales and Use Tax Jurisdiction: An Economic Nexus Standard for the Twenty-First Century. Ga. L. Rev., 38, 343.
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