U.S. Taxation of Inbound International E-Commerce
The purpose of this article is to provide a brief and general overview of the tax implications for a foreign entity that sells its goods into the United States over the Internet. Due to the complexity of the rules in question, all readers are encouraged to consult with their U.S. tax advisors prior to entering the U.S. market.
Foreign taxpayers are only subject to U.S. federal income taxes with respect to their U.S. source income. Determining whether income is U.S. or foreign source is not always a simple matter. Additionally, income tax treaties often limit when the U.S. may subject the income of a foreign taxpayer to U.S. taxes. Therefore, it is important to determine whether the foreign taxpayer is a resident of a “Treaty Country” or not.
Treaty Country Residents
The business profits of a resident of a Treaty Country are only subject to federal income taxes if the taxpayer has a “Permanent Establishment” in the U.S. Although income tax treaties may have some variations from one another, a permanent establishment is generally defined as a fixed place of business through which business is conducted (such as an office, branch, place of management, factory, etc).
Generally speaking, a virtual presence in the U.S. via a website hosted on a foreign server should not be considered a permanent establishment. However, servers and other computer equipment located in the U.S. and owned or leased by a foreign enterprise may be treated as a permanent establishment unless the use of such equipment is limited to activities that are of a preparatory or auxiliary nature. Activities such as advertising, gathering market data and/or supplying information are generally considered activities of a preparatory or auxiliary nature. On the other hand, the use of any such equipment to accept orders for the sale of goods may be considered to exceed activities that are simply of a preparatory or auxiliary nature.
U.S. income tax treaties generally provide that the permanent establishment of an independent agent will not be attributed to its principal so long as the agent is acting in its ordinary course of business. Therefore, foreign enterprises will often consider entering into contracts with third-party hosting services if U.S.-based servers are needed or desired. The details of these third-party hosting arrangements must be carefully scrutinized.
The determination as to whether certain contacts, activities or property constitute a permanent establishment is extremely fact intensive. Therefore, it is important that a foreign entity engage a U.S. tax advisor to closely examine whether such foreign entity has a U.S. permanent establishment.
Additionally, as a side note, it should be noted that tax treaties do not generally prevent state and local governments from imposing taxes on a foreign enterprise’s activities. Therefore, if a foreign enterprise has any contacts with or to a particular state, the income tax implications of such contacts should be considered. Moreover, the availability of treaty protection does not relieve a foreign taxpayer from U.S. tax return filing obligations.
Non-Treaty Country Residents
In the absence of an applicable income tax treaty, a foreign taxpayer’s exposure to federal income taxes is based entirely upon the Internal Revenue Code. As noted above, only the U.S.-source income of a foreign taxpayer is subject to U.S. income tax.
The sourcing rules for a foreign taxpayer’s income from the sale of goods into the U.S. depend on whether or not the taxpayer has an office or fixed place of business in the U.S. In many ways, an office or fixed place of business is similar to a permanent establishment. Because the phrase “office or fixed place of business” is a term of art, it is important that taxpayers consult with their tax advisors to determine whether their U.S. contacts would be considered an office or fixed place of business.
If the taxpayer has an office or fixed place of business in the U.S., then any sales attributable to such office or fixed place of business would be subject to U.S. income tax.
On the other hand, if the taxpayer does not have an office or fixed place of business in the U.S., then the sales of inventory will be sourced to the place where title to the inventory passes. Subject to a tax-avoidance rule, the parties can generally elect where title passes in the sales contract. Therefore, a properly structured sales contract is essential to avoiding U.S. income taxes.
Again, the above discussion is only a general overview of the U.S. tax implications of entering the U.S. market. If you are considering expanding your business into the U.S. market, we invite you to contact Mr. Badyal by phone at 619-500-4540 or by email at firstname.lastname@example.org for a free initial consultation.
IRS CIRCULAR 230 NOTICE: To the extent that this message concerns tax matters, unless expressly stated otherwise, it is not intended to be used and cannot be used by the reader for the purpose of avoiding tax penalties that may be imposed by law. For more information about this notice, see http://www.irs.gov/pub/irs-utl/pcir230.pdf