Israel-based companies at risk of US state taxes

Israeli companies need to examine the potential consequences of the US Sales Tax case (Wayfair) as states consider hunting for more tax dollars abroad

The Wayfair case, which was decided on June 21 and concerns state sales tax, sent shockwaves through the US tax system. It means US states will be able to collect sales taxes from out-of-state sellers, overturning a decades-old Supreme Court decision in Quill, which stated the opposite.

Although the case is specific to the US, there is little clarity over whether states could attempt to assert taxing rights over foreign-based companies. This is raising concern among big businesses that sell into the US or have US-based operations.

Multinational businesses that previously took the position that they did not have ‘nexus’ (a jurisdictional requirement to be subjected to a state’s tax) due to a lack of physical presence may no longer solely rely on such a position in jurisdictions that enact or have enacted laws similar to South Dakota’s.

At Weinstein & Co., we are trying to get the word out and in a theoretical sense are concerned about the ruling’s potential impact on foreign-based clients.

The difficulty, of course, for states attempting to collect taxes from remote foreign companies, is enforcement.  As countries including Australia, Japan, as well as EU member states, found out when introducing destination-based taxation for VAT or GST, it is difficult to force foreign companies to comply.

The US Federal Constitution allows states to pursue taxpayers in other states under the “full faith and credit” clause; however, the principle doesn’t really extend to foreign companies.

Nevertheless, Israeli companies, particularly affiliates or subsidiaries of Israeli companies that have a presence in the US, should be very concerned because states could use ‘affiliation’ concepts to seek recovery of the sales taxes that should have been collected and not paid.

Will foreign sellers benefit from tax treaty protection?

The physical presence requirement, which was the subject of the Wayfair case, is similar to the permanent establishment concept in most tax treaties. However, US tax treaties do not generally apply to state indirect taxes.

The US-Israel tax treaty (1995), for example, stipulates: “The existing taxes to which the Convention shall apply are: a) the income tax (including capital gains tax), the company tax, and the tax on gains from the sale of land under the land appreciation tax.”

However, it does not refer to US state sales tax, only referencing federal income taxes imposed by the Internal Revenue Code and excise taxes on insurance premiums.

Some states do have areas of legislation relating to sales into their borders from outside of the US however.

Washington, for an example, provides an exemption for items “in import or export commerce”. This generally includes items shipped from outside the US directly to retail consumers in Washington if the property remains in the stream of import until delivery to the customer.

Yet states without a specific carve-out for foreign sales can seek to apply their nexus standards to both domestic and foreign sellers that make sales to consumers in the state.

In the future, countries could seek to amend their tax treaties with the US to prevent states from claiming taxing rights over companies based within their borders. Particularly for countries that do not apply the destination principle for indirect tax purposes, this would be an effective way of preventing double taxation – if the US agreed to such changes.

We recommend consultation with our international tax experts in order to understand how this issue will affect your business — both in the US and in Israel.