E-Commerce Tax Laws

It is common knowledge that online businesses can reach customers across the country--and around the world--without opening a physical storefront. However, selling through a website, mobile application, online marketplace, or software platform does not exempt a business from ordinary tax laws. E-commerce companies may encounter sales and use tax obligations, economic-nexus rules, marketplace-facilitator requirements, income and franchise taxes, and international VAT or GST requirements.

The applicable rules may depend on where the business operates, where its customers are located, where inventory or computer equipment is maintained, and whether products are sold directly or through a third-party marketplace. Businesses should evaluate these issues as part of their broader legal and operational planning.

California does not provide a general tax exemption simply because a transaction takes place over the Internet. Sales of tangible personal property through a website are generally treated in the same manner as sales made at a physical store, by telephone, or through a mail-order business.

California distinguishes between sales tax and use tax. Sales tax generally applies to taxable retail sales occurring within California. Use tax generally applies when merchandise is purchased outside California for storage, use, or consumption within the state. Although use tax is imposed on the purchaser, a retailer that is considered engaged in business in California may be required to collect and remit it.

Online businesses must therefore determine whether a transaction involves taxable tangible personal property, where the sale is considered to occur, where the product is delivered, and whether a particular exemption or exclusion applies.

Historically, states generally could not require an out-of-state seller to collect sales tax unless the seller maintained a physical presence in the state. In South Dakota v. Wayfair, Inc., the United States Supreme Court rejected that physical-presence requirement.

The Court did not create a uniform national sales threshold or automatically impose tax-collection duties on every online business. Instead, the decision permitted states to enforce laws based on a seller's economic connection with the state, subject to constitutional limitations. As a result, a business may establish "economic nexus" through its volume of sales into a state even when it has no office, storefront, or employees there.

Economic-nexus thresholds, measurement periods, exemptions, and filing requirements differ among jurisdictions. Some states consider gross sales, while others focus on taxable sales or particular types of products. Businesses operating across state lines should monitor their sales by jurisdiction and avoid relying on a single nationwide standard.

An out-of-state retailer may establish economic nexus with California when its total combined sales of tangible personal property for delivery into California, together with the sales of related persons, exceed $500,000 during the current or preceding calendar year.

Sales facilitated through online marketplaces generally count when determining whether the retailer has crossed this threshold, even when the marketplace is responsible for collecting and remitting the tax on the facilitated transaction. Businesses should distinguish between sales considered for nexus calculations and sales for which the business itself is responsible for collecting tax.

Economic nexus is not the only basis for California tax obligations. Physical activities can create nexus even when the business does not satisfy the $500,000 economic threshold. Relevant contacts may include maintaining inventory, leasing property, operating a warehouse, using a computer server, or having representatives perform certain business activities in California.

Many online businesses sell through marketplaces that connect sellers and purchasers, process payments, list products, or provide fulfillment services. California's Marketplace Facilitator Act generally treats a qualifying marketplace facilitator as the retailer responsible for collecting, reporting, and paying sales or use tax on taxable retail sales of tangible merchandise facilitated through its marketplace.

This rule can reduce the individual seller's collection responsibilities, but it does not necessarily eliminate every obligation. A marketplace seller may still need to:

• Account for sales made through its own website or application;
• Determine whether marketplace sales count toward an economic-nexus threshold;
• Maintain records showing that the marketplace facilitator was responsible for the tax;
• Report facilitated sales when required; and
• Address resale certificates, drop shipments, returns, refunds, or product-specific fees.

Businesses should also distinguish between a true marketplace and a company that merely provides website hosting, shopping-cart software, or payment-processing technology. A merchant operating its own online store cannot assume that its technology provider is legally responsible for collecting and remitting tax.

The tax treatment of digital products and services varies considerably between states. Potentially affected transactions include electronically downloaded software, mobile applications, streaming services, digital publications, online courses, subscriptions, cloud services, and software-as-a-service arrangements.

California generally focuses its sales and use tax on transfers of tangible personal property. A purely electronic transfer may be treated differently from software or digital content delivered on physical media. However, the analysis may become more complicated when a transaction includes equipment, storage media, printed materials, installation, customization, technical support, or other bundled components.

Other states may classify remotely accessed software, digital entertainment, data-processing services, or electronically delivered products as taxable. Businesses should avoid applying California's treatment automatically to customers in other jurisdictions.

Contracts, invoices, and checkout systems should accurately describe what the customer is purchasing. Poorly defined bundles can make it difficult to determine whether taxable and nontaxable elements should be treated separately.

A business may create a physical presence in a state through inventory stored at a warehouse or fulfillment center. This can occur even when the company does not own the facility. Businesses using third-party logistics providers or marketplace fulfillment programs should identify where their inventory is stored and whether it is moved between states.

Drop-shipping arrangements can present additional issues because the customer purchases from one retailer while another supplier delivers the product. The parties' locations, registration status, and resale documentation may determine who is responsible for collecting and paying tax.

Written agreements with marketplaces, suppliers, fulfillment companies, and logistics providers should address recordkeeping, tax collection, indemnification, and the allocation of compliance responsibilities. Contractual allocation does not necessarily eliminate statutory liability to a government agency, but it may establish rights and remedies between the contracting parties.

Sales and use tax is only one part of e-commerce taxation. An online business may also be subject to federal and state income taxes, California franchise taxes, gross-receipts taxes, or local business-license taxes.

Income-tax nexus does not always follow the same standards as sales-tax nexus. Employees working remotely, contractors performing in-state activities, property located in another jurisdiction, or substantial revenue from customers in a state may affect filing obligations. The sourcing and apportionment of revenue from services, subscriptions, and intangible property can also require a separate analysis.

These issues should be reviewed with a qualified accountant or tax professional. Legal counsel may assist with entity structure, contractual provisions, regulatory interpretation, and disputes involving the business's online operations.

Businesses selling to customers outside the United States may encounter value-added tax, goods and services tax, customs duties, and import requirements. Obligations can depend on the customer's location, whether the customer is a consumer or another business, the type of product, the method of delivery, and whether a marketplace collects the applicable tax.

Digital products and electronically supplied services may be subject to place-of-consumption rules in certain jurisdictions. Because international thresholds and registration requirements vary, a business should obtain jurisdiction-specific advice before expanding into foreign markets.

Online businesses can reduce compliance problems by periodically reviewing their commercial operations. Useful measures may include:

• Tracking sales and inventory by state;
• Separating marketplace transactions from direct sales;
• Evaluating physical and economic nexus;
• Classifying products and services accurately;
• Maintaining resale and exemption certificates;
• Reviewing marketplace and fulfillment agreements;
• Keeping records concerning tax collection and remittance; and
• Coordinating legal advice with qualified tax and accounting professionals.

E-commerce tax issues often intersect with business formation, contracts, platform relationships, consumer disclosures, and dispute resolution. Our law firm assists clients with the legal aspects of Internet and e-commerce operations, including business agreements, marketplace relationships, technology transactions, regulatory risk, and disputes arising from online commercial activities.