Taxes and Amazon. All that international FBA sellers must know!
The Fulfillment-By-Amazon turned out to be a striking opportunity for nonresident individuals and companies. So what it takes to transform your small business into an Amazon extravaganza? A great place to find answers is the Fulfilled-By-Amazon information page. It comes with a bunch of useful information, such as a start-up guide, labeling and packaging instructions, fees, terms, case studies, and more. Still, the information about your U.S. tax obligations is obscure. This article aims to provide clear guidance on the key elements that nonresident individuals and non-US businesses must consider before conquering the U.S. market through an FBA agreement.
Planning, planning, and...planning!
Do you know what an Australian, Chinese, Slovakian and Indian FBA sellers have in common? The answer is the lack of an on-time strategy and planning. It is more than easy to register a company in Wyoming, Delaware or Nevada. All you need to do is find a registered agent, pick a name, pay the registration fee and whoa! Your company is born! If this approach encompasses all your strategy and planning, then you are in trouble. Soon you will find yourself in the middle of a minefield of franchise taxes, federal taxes, state taxes, local taxes, sales taxes, accounting issues, bank account problems to mention just a few. So before you even think about an FBA business in the United States, start working on your business strategy, tax planning, budgets, and projections!
Once you have a business plan in mind, realistic budget, and projections in place, it is time to consider the structure of the US entity. All states offer a variety of structures ranging from disregarded entities and partnerships to limited liability companies and corporations. Each one has benefits and drawbacks that deserve consideration. For instance, there is a difference when it comes to tax rates, deductibility of losses and expenses, capitalization, flexibility, liability, or ease to operate. Therefore, we strongly recommend you to hire a Certified Public Accountant or financial consultant to do the math for you. Do not ever, register a company before a fact-based analysis of the most appropriate entity for your business model! Recall that your goal is maximizing profits in a long run, rather than cost savings in a short-term.
Federal Income Tax
There is a direct correlation between your company structure and the prospective tax liability. Keep in mind that disregarded entities, partnerships, and LLCs are fiscally transparent, and the income of the entity flows thru and is taxed only once in the hands of the owner. On the contrary, a corporation is classified as an entity separate from its owners and is subject to tax at a company level. If dividends are distributed out of earnings and profits of a corporation a dividend withholding tax applies and a double taxation occurs.
To illustrate the federal tax effect on net income, refer to the following simplified comparison between an LLC treated as a disregarded entity and a corporation. Assume that a nonresident individual owns the LLC and the Corporation, and there is no tax treaty between the United States and the owner's home country. Further, this comparison is not a universal solution; do not act upon it before a consultation with a competent tax consultant!
This example comes as a reminder that every cent invested in on-time planning is repaid numerous times from tax savings alone!
State & Local Income Taxes
Apart from federal taxes, most states and some counties and cities apply an additional income tax on entities organized in the state or jurisdiction. The state and local income taxes vary significantly from one jurisdiction to another ranging from zero to over 9%. Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming have no state income tax on individuals. Tennessee and New Hampshire adopted a limited state income tax on interest and dividends received by individuals.
Only South Dakota and Wyoming have no state income or gross receipts tax on corporations. Delaware imposes a corporate and gross receipts taxes only on companies that are actively conducting business within the state. All other states apply corporate income tax, a gross receipts tax, or both on income earned by corporations registered in the state. Consequently, Delaware, South Dakota, and Wyoming are the obvious choice to organize your entity concerning state tax optimization.
Unarguably sales and use taxes are a primary concern for all FBA sellers. Similar to GST and VAT in other countries, the sales and use taxes are indirect taxes applied on consumers of goods and services within the United States. Unlike the GST and VAT, the sales and use tax rates are not uniform across all states. Instead, each state, municipality, county and even cities have an absolute discretion on whether to introduce sales and use taxes. This power to lay taxes created more than 12,000 sales tax jurisdictions with various rules, rates, and exemptions. And this number grows year after year!
Expectedly the states that do not lay income taxes adopted high state and local tax rates in return. Tennessee is leading the way with 9.46% combined sales tax rate! On the other side, three states have no sales taxes at all - Oregon, Delaware, and New Hampshire. Montana and Alaska do not have a state-wide sales tax regime, but some local jurisdictions within their borders lay sales taxes. So, how to cope with this diversity?
The answer is called a "substantial nexus" study. FBA merchants are required to collect sales taxes only if the products are subject to sales tax, and the merchant has nexus in the particular state where the goods are sold. In the dark ages before Google, Facebook, Amazon, and eBay, the determination of nexus was relatively straightforward. At that time most states considered a nexus exists if only you have employees, assets, investors or owners in that particular state. The expansion of the e-commerce changed the concept to include more on-line sales relationships. For instance, many states consider a web and affiliate advertising, hosted data centers, SaaS, subscription billing, consumer use notification, and even click-through sales as sufficient to establish nexus.
As most international FBA sellers do not have employees or a physical office in the United States, the key nexus driver remains the ownership of company assets in a particular state. When you ship inventory on consignment to Amazon, you most likely create nexus with the state where your inventory is stored. The fact that Amazon controls the warehouse does not negate nexus. On the contrary, Amazon is assumed to be your agent in that particular state. Consequently, it is vital to find out where your inventory is stored. Once you know the location of your inventory, you may do a simple nexus study for each separate location.
Start the nexus study by checking whether there is a sales tax in this particular state. If the answer is no, then your job is done. If Yes, determine the most likely volume of sales to consumers in this state for the next six months or so. How do you do that? Well, go back to the second paragraph and read the budgets and projections section again. When done, weight your product mix on data about age, population, gender, lifestyle or other sales drivers that influence the demand and the supply of a particular product in a particular state.
For instance, if the Amazon's warehouse is located in Alaska and you sell sun lotion and mosquito repellent would you expect a boom in the demand from residents of this state? Does it make a difference if the warehouse is located in Louisiana for example? If you've made accurate projections and you know the sales drivers for your product mix, you won't face significant problems obtaining realistic data about the expected sales volume. If you do not know what drives the demand for your products up and down, then I guess it is about time to place your marketing manager on unemployment benefits.
Finally, you must determine the average combined sales tax rate in the state. You may use sales tax software or browse the website of the State Department of Taxation for up-to-date information. The average combined sales tax rate will help you set a level of materiality that fits the size of your business, taking into consideration the expected volume of transactions. For example, assume that you sell a product for $5.00 apiece. Your operating profit is 25% of the sales price or $1.25 apiece. You expect that the volume of sales in the nexus state will reach about 10,000 pieces for a total of $50,000.00. Thus, your profit will be $12,500.00. The average sales tax rate on this particular product, in this state, is 1% of the selling price or mere $500.00 for all 10,000 products. Is the $500.00 sales tax material for your business? Nope, it is immaterial! This $500.00 sales tax bill will not turn your business upside down. Even if you fail to collect the sales taxes, and you are later on "asked" to pay them out of your pocket, you will still end up with a $12,000.00 profit. What if the sales tax rate is 8%? What if your profit margin is just 3%? Well, you better start collecting sales taxes, right?
Sales Tax Matrix
Once the nexus study is complete, it is time to make a major decision. When start collecting sales taxes? By law, once you establish nexus in a given state, you are required to start collecting sales tax on purchases from customers located within this state so long as your goods are not exempt from tax. However, it is often impractical or even impossible to obtain a business registration and sales tax permit within such a short notice. Therefore, we have come up with a decision-making matrix that is based entirely on the volume of sales and materiality levels.
- High sales and high materiality. If you expect a large volume of sales and the amount of tax is material, it would be wiser to register for sales tax before your first sale.
- Low sales and low materiality. Do not register at all if you expect weak sales and the amount of sales tax is immaterial.
- High sales and low materiality. Start the sales tax registration as soon as sales grow to a volume that is no longer light.
- Low sales and high materiality. Start the sales tax registration as soon as materiality increases to a level that it is no longer immaterial.
Sales Tax Registration
The sales tax registration process varies among the jurisdictions. Most certainly it will involve a business registration with the state, followed by a sales tax permit application. Some states require a surety bond or a security deposit if the expected sales taxes exceed a statutory threshold. Because of the diversified procedures, you must refer to the relevant State Department of Taxation for precise information.
US Bank Account
Yes, it is likely that you will need a US bank account to pay federal, state, and sales tax liabilities. However, do not assume that once you start a US business, you will automatically qualify for a checking account. The Patriot Act of 2001 scrutinized the KYC and AML procedures that apply to foreign individuals, including nonresident owners of a US business. So the question "How to open a US bank account if I do not live in the USA?" is a practical one. And our answer is always the same. It is not a mission impossible. Still, your options are limited. For instance, if you have a renowned and profitable business, some international banks with branches all over the world might be willing to assist you. If not, you may appoint a US citizen as an executive or director of your business. Of course, a decision like this comes at a price. If it does not work for you, then you must visit a US bank in person to open a business account. When you do so, make sure you fairly disclose that your business will be managed from outside the United States. Otherwise, one day you might end up with a US bank account you have no access to.
Another common question is "Can I overcharge my foreign company for goods and services so that we pay no taxes in the USA?" And the answer is Yes if you are ready to pay the transfer pricing penalty. The transfer pricing is a provision in Section 482 of the Internal Revenue Code that requires relates parties to move goods, services, and intellectual property to one another at a price that would be fair and just as if the parties were independent. Related parties are members of the same controlled group of companies, such as parent-subsidiary or brother-sister corporations, including companies controlled by the same individual or group of persons.
Consequently, you need to prepare a transfer-pricing study and keep contemporaneous documentation should you wish to engage in intracompany transactions. The documentation must clearly reflect the computation of the fair transfer price taking into consideration the assets owned, risks assumed, and functions performed by each separate company. Otherwise, you face a transfer pricing penalty of 20% or 40% of the tax underpayment depending on the size of the adjustment.
The decision to become an FBA merchant requires a comprehensive analysis of your business, including detailed budgets and projections. If you are not ready to spend time on making the right decisions, then be prepared to spend your money on compensating the wrong one! Every dollar you invest in structuring and tax planning will be rewarded. At last, but not least, remember that there is no one-size-fits-all solution, so get a tax professional before the tax collector gets you!