Cross-border: Canadian companies can have sales tax obligations in U.S. states

The international border between the United States and Canada is an obvious barrier that complicates commerce.

But thanks to the United States-Mexico-Canada Agreement (USMCA), and its predecessor, the North American Free Trade Agreement (NAFTA), customs and duties at the Canada-U.S. border aren’t horribly complex, said Matt Earish, the Toronto-based senior director for Customs at Avalara.

In fact, it’s the borders between the U.S. states that create the biggest compliance challenges for Canadian companies:

• There are more than 13,000 sales and use tax jurisdictions within the United States.
• U.S. law allows those jurisdictions to collect sales tax on transactions taking place within their boundaries, even if the selling company doesn’t have a physical presence there.
• Each state — and in some cases, individual cities and local governments — sets its own registration, reporting, tax collection, and remittance standards that remote sellers must meet.

The U.S. economy is huge, and successful Canadian businesses will want to capture as much of that market as they can. But doing so requires compliance with a host of state and local laws that are very much different from those found in Canada.

The United States and Canada are each other’s largest trading partners.

In recognition of that, the two countries have done a lot to reduce the paperwork required to move goods across the border.  

There are health and safety restrictions. All products sold in the United States must meet standards set by agencies like the U.S. Food and Drug Administration. That means imported goods must meet the same standards set by U.S. regulators for U.S.-made goods. At the border, U.S. Customs and Border Protection agents enforce those regulations.

Products manufactured in Canada can cross the border duty-free — as long as the importer has a certificate to prove the product is made in Canada.

Products manufactured in another country that are transshipped through Canada into the United States are generally subject to import duties. That means the importing company must complete a formal customs entry form and pay duty on the items.

However, small businesses making occasional shipments may be exempt. That’s because the United States in 2015 set a de minimis standard on imports that exempts transactions of less than US$800 a day from import duties.

For small businesses in Canada, meeting U.S. Customs requirements isn’t onerous, said Earish: “As long as your goods qualify for de minimis, aren’t regulated by one of the 40 participating government agencies, and you have the appropriate invoice for import, then the border can be a simplified process.”

While the United States doesn’t have a federal equivalent to Canada’s GST (goods and services tax), there are broad similarities between U.S. sales taxes and the PST (provincial sales tax) in Canada. Both are indirect taxes on the sales of goods and services that are collected by businesses and remitted to the relevant government authorities.

But the specifics of how they’re levied are different, and the combination of thousands of state and local U.S. sales taxes makes compliance more complex.

For starters, 45 of the 50 states on the U.S. side of the border collect sales tax. So do the District of Columbia, the commonwealth of Puerto Rico, and the territory of Guam.

Five states — Alaska, Delaware, Montana, Oregon, and New Hampshire — do not collect a general sales tax. Neither do the territories of the U.S. Virgin Islands in the Caribbean and the Northern Mariana Islands in the Pacific. (Alaska does allow local governments to collect sales taxes. We’ll discuss that more later.)

For most of the time Canada and the United States have shared a border, U.S. sales tax didn’t apply to most merchants on the Canadian side.

Not too long ago, a merchant only was responsible for collecting sales taxes and remitting them if they had physical nexus within a U.S. taxing jurisdiction. That meant, generally, that if your company had a brick-and-mortar presence — a store or a warehouse — within a state or city that levied sales taxes, your company was responsible for collecting taxes on the sales there and remitting them to the proper authorities. Having employees or inventory in a state could also establish physical nexus. Otherwise, sales tax generally didn’t apply.

Fairly straightforward, eh?

That all changed in 2018, with a U.S. Supreme Court ruling in a case involving the state of South Dakota and online retailer Wayfair. In that case, the high court ruled a company created a connection to a state — an economic nexus — based on the volume of business they did within that state.

Now, whether you’re required to collect sales taxes within a state depends on whether you have economic nexus there, and that’s based on the amount of business you’re doing, sort of the way Canadian law now requires nonresident sellers to collect GST/HST.

The difference is: Each state gets to set its own rules for what level of sales triggers the tax collection requirement, or for when a company needs to register to do business within a state, even if they aren’t required to collect taxes.

So in New York, an out-of-state merchant isn’t required to start collecting sales tax until they’ve recorded more than $500,000 in online sales and 100 transactions. New York doesn’t count sales of services toward this total — unless it’s SaaS.

But elsewhere along the border, Michigan sets the limit at either $100,000 in sales or 200 transactions, and it includes sales of both goods and services in the calculation. Out west in Washington state, once you’ve made $100,000 in sales of goods and/or services, you’re required to start collecting tax, no matter how many transactions.

Each state has different rules and timelines for when businesses are required to register to do business within their boundaries, as well.

Remember what we said about Alaska? While Alaska doesn’t collect sales taxes at the state level, it does allow local jurisdictions the option of levying them. As a result, Anchorage and Fairbanks don’t collect a sales tax, but Juneau collects at a rate of 5% and some jurisdictions levy up to 7.85%. Some of those Alaska cities specifically levy taxes on remote sellers.

(Additionally, some Alaska jurisdictions, including Nome, have sales tax rates that vary seasonally.)

Many, but not all, of the 45 states that do have sales taxes allow cities and counties to set their own tax rates or levy local taxes in addition to a basic state tax.

That means in Michigan, sellers collect a statewide 6% sales tax with no local add-ons. But south of Vancouver, in Washington state, the combination of a 6.5% statewide tax with the various local sales taxes can lead to combined rates as high as 10.6% (as of the third quarter of 2022).  

Also, many states allow for the creation of special-purpose taxing districts that can set their own tax rates. Missouri, for example, has more than 2,000 such districts, some with overlapping boundaries. Louisiana requires remote sellers to register with each parish a seller does business in, and each parish can have multiple jurisdictions that levy their own local tax.  

Colorado has more than 600 state-administered locations for sales tax collection, each with its unique combination of local taxes. Additionally, more than 70 Colorado jurisdictions (including the city of Denver) have home-rule status, which allows them to administer and enforce their own local tax laws, including performing their own audits.

In a number of states, total sales tax rates can vary based on which side of the street a transaction occurs.

Adding to the complexity: Different states tax similar items in different ways.

Take, for example, that American staple: the noble burrito. In New York, burritos are always taxed; in California, it depends on whether the burrito is sold hot or cold; and in Massachusetts, a number of factors come into play including whether it’s sold from a vending machine and – on college campuses – whether it’s purchased by a student or someone else.

Similar state-to-state variations exist for everything from software and other digital goods to feminine hygiene products. Many states – but not all -- also exempt groceries from sales tax, which could affect online sellers of goods like Canadian maple syrup.

And the laws around taxation of services also vary from state to state.

Once a Canadian company has collected the correct amount of tax, it will also need to determine how, when, and how often to remit to the tax authorities in the states where it has nexus. Due dates — say it with me now — vary from state to state.

Market research firm Potentiate found in 2020 that 79% of U.S. businesses (but only 46% of small businesses) were familiar with the concept of economic nexus.

Given that, it wouldn’t be surprising to find Canadian businesses that don’t understand the crucial U.S. tax compliance concept. To learn more about it, check out Know Your Nexus.