I think we can all acknowledge that the growth in e-commerce spending has been staggering, especially in the past 12 to 18 months considering the coronavirus pandemic. According to Digital Commerce 360, online sales accounted for only 5.1% of total retail sales in 20071. Fast forward 13 years and e-commerce sales as a percentage of total retail sales in 2020 is 21.3% – over a fourfold increase. To see what the impact of the pandemic was in terms of e-commerce spending, 2019 e-commerce sales as a percentage of total retail sales was 15.8%2. In other words, in a one-year span, e-commerce spending increased 34.8%, likely due exclusively to the fact that consumers were told to stay home due to the coronavirus.
As a result of this significant increase in online spending, there are more e-commerce only retailers than ever. Furthermore, the online sellers that are participating in programs such as Amazon’s FBA program are having more of their inventory spread all over the country. In Amazon’s case, it keeps building fulfillment centers and directing its sellers’ inventory into these centers, oftentimes in 25 or more states. So why does this matter, especially with respect to sales tax? When I’ve asked that question to various companies recently, the response has been something along the lines of, “Why does it matter? [insert name of marketplace] is billing and collecting the sales tax on those sales anyway in almost every state.” It matters for at least two reasons, and it all comes back to good ol’ fashioned physical presence-based nexus.
Remember that? It seems like forever ago when anyone in the sales and use tax world had any sort of discussion around physical presence and nexus. Long before the Wayfair decision in 2018, the law of the land was that a seller had to have some sort of physical connection to a state in order for that state to be able to require it to collect and remit sales tax. These physical presence nexus rules still exist, they’ve just been supplemented now with the Wayfair-driven nexus laws, namely economic and marketplace facilitator. The latter of these is the basis for the response to my question that I mentioned earlier. The companies I was discussing this with were essentially saying that since [insert name of marketplace] is the marketplace facilitator, the sales tax obligation is the facilitator’s. In other words, it did not impact them. There are at least two reasons why this is not accurate, or at minimum, shortsighted.
One reason why this is not accurate or is shortsighted is based on your company’s historical activity before the Wayfair decision. What if you began your online business in 2015 and shortly thereafter signed up to be part of Amazon’s FBA program? Amazon began directing your inventory to its fulfillment centers all over the country, but the issue is that you still own that inventory, not Amazon. As a result of the aforementioned good ‘ol fashioned physical presence-based nexus laws, your business had sales tax nexus in almost every one of those states to which your inventory was directed3. So from the time your inventory was directed to those fulfillment centers until the states enacted their marketplace facilitator laws – and assuming the business wasn’t registered for sales taxes in those states – you have sales tax exposure.
The question becomes how you know where your inventory is located. At least in Amazon’s case, you can find out with the Inventory Event Detail report in your Seller Central account. This report shows all the movement of your inventory and to which fulfillment center it goes. You will need to look up the address for the code name used to determine what state it is in (e.g., the CMH3 fulfillment center is in Ohio). I’ve had two different client situations recently where we pulled this information. The inventory was going to 29 states in one and 30 in the other. A word of caution – in my experience, the Inventory Event Detail report will only show activity for the past 18 months. A good rule of thumb is to download and save these for each calendar year on an annual basis.
Beyond the high risk of sales tax exposure for periods prior to the enactment of the marketplace facilitator laws, the other reason why it’s inaccurate or shortsighted to ignore where your e-commerce inventory is located is the high likelihood of other online sales channels within the company. For example, I’ve worked with numerous online retailers who not only sold through Amazon or some other marketplace, but the company also had its own online store, typically powered through Shopify or someone similar. There will be two factors at issue here. First, though the marketplace will presumably be collecting and remitting sales tax on the sales it makes on your behalf in the marketplace facilitator states, having your inventory in the various fulfillment centers around the country creates sales tax nexus for your other non-marketplace sales channels. Second, one must also consider whether a state’s economic nexus laws are inclusive or exclusive of sales made by your marketplace facilitator(s). Approximately 18 states exclude marketplace sales from their economic nexus threshold calculations, while approximately 25 include the marketplace sales in their calculations4. In other words, in these 25 states, one must consider the marketplace sales activity (dollars and transaction count, where applicable) plus the dollars and transaction count for its own online sales channel(s). As a result, it becomes more likely that economic nexus thresholds will be exceeded and create sales tax registration and collection/filing requirements in more states.
Whether a company’s e-commerce inventory has only created prior exposure within the marketplace activity itself or whether it is tainting a company’s other online sales channels, there is a common consequence that must be considered. If you have a relatively near-term exit strategy for this burgeoning e-commerce business, then things just became more complicated. Anyone that is looking to buy a retail business with a significant e-commerce element better ensure that they conduct the proper due diligence with respect to the sales tax profile of the seller. I had a situation recently where I was engaged by a long-time client of mine to conduct the sales tax piece of the overall due diligence related to a potential acquisition – an asset deal – of a strictly online retailer. The seller’s business was conducted 100% via Amazon, primarily through the FBA structure. The seller started its business post-2010 and became very successful. On the sales tax side, the seller was only registered in its home state the entire time. During the due diligence, the seller said that “Amazon takes care of all of the sales tax in the other states.” While that’s true as of the effective date of all the marketplace facilitator laws, it is most definitely not true prior to that. Amazon would only bill and collect tax in those states in which the seller indicated it should in the seller’s tax setup. Based on a review of the Inventory Event Detail reports, the seller had inventory located in more than 25 different states, not including its home state. All of their sales were general tangible personal property, so the exposure was enough to potentially sink the deal by itself. Even taking into account potential voluntary disclosures, it only reduced the estimated exposure (tax only – not including penalty or interest) by 35%-40%, primarily due to the fact that the voluntary disclosure lookback periods in many states are four years.
As you might expect in this situation, to continue with the acquisition, very well documented indemnifications and a rather large escrow are in order. Even in an asset deal, many states have successor liability laws on their books related to sales taxes. One other comment worth noting here. During the process of exploring the voluntary disclosure options in this due diligence, we discovered one very overly aggressive state (Arizona) that verbally said that they would base their lookback period on the marketplace facilitator law effective date, not the date the voluntary disclosure request is submitted. While this was communicated verbally by a representative in the state’s voluntary disclosure division and isn’t in writing anywhere, it certainly, is cause for concern.
For several years now, all anyone has been talking about are the Wayfair decision and the new economic nexus and marketplace facilitator laws. However, physical presence still matters when it comes to the inventory locations of online retailers. It’s important to determine where your inventory is located. Armed with that information, you can make better decisions about where your company should and should not be registered for sales taxes. This can not only mitigate any prior sales tax exposure that might exist but can also help position your company for a much cleaner sales tax bill of health in any potential due diligence down the road.
Note: On March 2, 2021, the Online Merchants Guild filed suit in the Middle District of Pennsylvania against Pennsylvania’s Department of Revenue (“DOR”), seeking clarification of Wayfair protections. Essentially, the OMG is alleging it is unconstitutional that the DOR can assert that an online retailer has sales/income tax nexus with the state simply by having inventory in a third-party fulfillment center. The OMG maintains that since the marketplace facilitator controls the movement of that inventory into the state, that should not create nexus for the online retailer, which would presumably taint other sales channels that the retailer has.
By: Brian Hollingsworth, CPA
3 New York is one state that says owning inventory located in a third-party fulfillment center does not, in and of itself, create nexus. NY Consol. Laws, Sec. 1101(b)(8)(v).
4 As of the date of this article, Florida, Kansas, and Missouri have no marketplace facilitator or any economic nexus laws (Kansas’ law has no thresholds, thus no “included” or “excluded” considerations), so any discussion of “inclusive” or “exclusive” in these three states is irrelevant.