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Foreign companies and state income tax nexus
In this edition of Inside Deloitte, the authors consider the various income tax nexus theories that state tax agencies may apply to companies located outside the United States, as well as other approaches that states may use to tax the income of a foreign company, including worldwide filing regimes, state tax haven laws, and other inclusionary rules for combined filing states.
State governments find themselves confronted with the realities of an economy that is more global and integrated. In that environment, reliable network connections often pose greater operational challenges than do international borders relative to the sale and delivery of services, intangibles, and digital products. Because of the internet, companies anywhere in the world can have a business presence in a state without ever setting foot inside the state’s borders.
The nature of the global economy can pose challenges for state governments as they seek to tax foreign companies that are engaged in a substantial amount of commerce with instate customers. Some states use doing business statutes and income-sourcing methods that were enacted decades ago when the US economy largely revolved around manufacturing, resource extraction, and more localized and in-person delivery of services. Those 20th-century taxing provisions did not contemplate a multinational business selling products and services through the internet. The perception that substantial tax revenue is lost through a state’s limited ability to tax foreign companies and that such businesses are not paying their fair share of taxes has become a rallying cry in many state capitols in recent years.1 Concerns at the state level with revenue loss are exacerbated by the anticipated slowdown in state tax revenue collections over the next several years.2
The first state income tax consideration when examining a particular business is whether nexus has been established in the state—that is, has the company engaged in sufficient business activity in the state to be subject to its taxing jurisdiction? Absent nexus, the state lacks the authority to tax the business. As a general matter, states often assert nexus as aggressively as possible, bound only by the requirements of the US Constitution.
The aggressive application of state nexus standards may surprise foreign companies that may be under the impression that the existence of a tax treaty between their home jurisdiction and the United States avoids state income tax.
As this article will describe, however, the states are generally not parties to US tax treaties. As a result, taxpayers that have structured their affairs to avoid creating a permanent establishment in the United States for federal income tax purposes may have nonetheless established a taxable nexus with various states and possibly incurred a state income tax liability.3 Taxable presence in the states can be created in a variety of ways, many of which differ markedly from the federal PE test. And notwithstanding nexus, a foreign company must also be aware of the rules in various states targeted at some types of foreign activity, including worldwide filing regimes, state tax haven laws, and other inclusionary rules for combined filing states.
This article will examine those various issues and how they apply to foreign companies, particularly those with substantial inbound transactions in the United States. While a company doing business in a particular state may be subject to that state’s taxing jurisdiction, a careful taxpayer that closely evaluates the various state provisions can potentially mitigate expensive missteps.
1 Robert Schroeder, ‘‘Americans’TopTax Complaint: Corporations ‘Don’t Pay Their Fair Share,’’’ MarketWatch.com (Mar. 20, 2015).
2 Lucy Dadayan and Donald J. Boyd, ‘‘Softening Third-Quarter Growth in StateTaxes,Weak Forecasts for Fiscal 2016 and 2017,’’ The Nelson A. Rockefeller Institute of Government, No. 102 (Mar. 2016).
3 Foreign companies doing business in the US may also create nexus with state and local taxing jurisdictions for sales and use tax purposes. Those taxes raise additional nexus considerations that are beyond the scope of this article.
If you have questions regarding this edition of Inside Deloitte, please contact:
Mike Porter, principal, Deloitte Tax LLP
Scott Schiefelbein, senior manager, Deloitte Tax LLP
J. Snowden Rives, manager, Deloitte Tax LLP
The authors thank Tom Cornett for his contributions to and review of this article.