US Tax Patchwork Creates Confusing Snarl for Canadian Businesses

The Trump administration’s tariffs haven’t deterred savvy Canadian entrepreneurs from doing business in the US. Many Canadian companies have opted to sidestep current 35% duties by obtaining a certificate that covers 98% of cross-border exports. Others are considering forming US companies should tariffs become more aggressive.

While either of these choices may solve the tariffs problem, another potential economic trap lies in wait for Canadians doing business in the US—tax nexus.

US state taxation of Canadian companies revolves around nexus, the concept that a company can have sufficient connection to—or presence in—a state to give that state the constitutional right to impose a sales or income tax on that business.

It’s possible for a Canadian business to unknowingly create nexus in multiple states simply by using fulfillment centers or selling through online platforms. Each US state has its own tax rules and regulations, and many counties and cities add their own regulations and taxes, creating over 12,000 taxing jurisdictions. This bears little resemblance to Canada’s federally managed harmonized sales tax.

This means careful planning is a must.

Location of Inventory

Many Canadian companies have established inventory storage hubs within the US or work with US fulfillment centers, such as “Fulfillment by Amazon,” to store and drop-ship their products throughout the country.

Storage of inventory in a state can be deemed a physical presence in that state and trigger nexus (physical nexus). When enough goods are sold and shipped to another state, that can trigger nexus in the recipient state (economic nexus).

Although marketplace facilitator legislation, prompted by the 2018 US Supreme Court decision in South Dakota v. Wayfair, has placed the burden of state-by-state tax collection on the backs of facilitators such as Amazon.com Inc. and Etsy Inc., the necessary tax filings are still up to businesses who make the sales.

Dual Nexus Challenges

All but five states—Alaska, Delaware, Oregon, Montana, and New Hampshire—charge sales tax, and the tax rates vary.

Economic nexus can be triggered by the number of sales one has in a state, or the total dollar value of those sales. For example, New York nexus happens when one has $500,000 in sales and 100 sales, while nexus is triggered in New Jersey when one has $100,000 in sales or 100 sales. California nexus happens after $500,000 in sales regardless of the number of transactions.

Companies need to track their US sales state by state. If a business exceeds a nexus threshold, they’ll need to register with that state immediately to avoid noncompliance.

Exempt transactions, such as the sale of products to a company that intends to resell them, come with their own documentation obligations. The seller must keep a copy of the buyer’s resale certificate to withstand a sales tax audit.

Even if a company’s main base of operations is in Canada, if it has employees or property in a state, including an office or warehouse, it may incur sales tax obligations through physical nexus. Working through a third-party facilitator such as Amazon or Walmart Marketplace may also trigger nexus.

With the complications surrounding sales tax, it’s vital that Canadian firms:

• Know their inventory locations (facilitators provide reports that answer this)
• Check the nexus threshold in the states where they sell
• Register immediately upon reaching that state’s threshold
• Use tax automation platforms that manage multistate compliance

Other Tax Requirements

Canadian firms with physical nexus also may be obligated to file a state income tax return. Forty-four states impose a corporate income tax. Nevada, Ohio, Texas, and Washington levy a gross receipts tax instead, while Delaware, Oregon and Texas impose both. Only South Dakota and Wyoming have neither.

Each state has different rules to determine if a foreign company has enough of a presence to have established a fixed place of business or permanent establishment requiring a tax return.

For example, California expects a foreign company to file a tax return if they have achieved any one of the following:

• Sales: Exceed $735,019 or 25% of total sales
• Property: Own or lease real and tangible personal property in California with values exceeding $73,502 or 25% of total property values
• Payroll: Pay compensation in California exceeding $73,502 or 25% of total payroll

To file a state return, a Canadian company must register in that state and pay a franchise tax for the privilege of doing business there. And because most states base their tax return on a company’s federal tax return, a Canadian company most likely will need to file a federal tax return as well.

The Canada-US tax treaty guides such tax filings, preventing double-taxation and providing further direction to the tax obligor.

Canadian companies also face potential use tax filing requirements (triggered when a product is shipped from outside a state but used there) and property tax (triggered if the Canadian firm owns or rents real property, such as an office or warehouse). Property tax is levied on the real property itself as well as on the assets within that property.

Looking Ahead

Even though initial sales may not trigger a tax nexus in the US, Canadian companies should be prepared for growth and the tax responsibilities that come with it.

Staying on top of one’s sales and where they occur is critical, and it’s never too early to integrate an automated tax service into one’s sales platform.

And with all the tax complexities surrounding doing business in the US, obtaining the services of a knowledgeable tax professional might be the wisest decision of all.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Abraham Finberg is principal at AB Fin and has worked in the cannabis sector since 2009, counseling clients in all phases of business advisory and tax.

Simon Menkes supports accounting firms, their clients, and advisers through accounting and advisory services.

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