by Eran Shif, senior director of transfer pricing at Avalara
Following ecommerce’s post-pandemic boom, online sales are continuing to take more and more spend share with 30% of all retail sales being made online in the peak of November 2022. If online retailers are to continue on this trajectory, they’ll need to look beyond their home borders in order to grow.
What benefits can online retailers unlock by selling internationally? If we take the US as an obvious example, expansion into this market is understandably attractive to significantly increase the possible pool of customers and help boost brand recognition in a market which doesn’t differ too much from the UKs.
Online retailers can increase their top and bottom-line by establishing a US company, even if it’s an empty company with no employees or an office. They can increase sales by channelling sales to a front US entity, as many American customers will tend to buy from a US company rather than a foreign one.
In addition to this, having a US bank account means being able to accept all types of US credit cards and other payment methods, a broader pool of resources to choose from, and the ability to reduce losses caused by volatile foreign exchange commissions.
However, with expansion comes greater tax compliance and responsibilities. Greater scrutiny on international groups’ tax arrangements comes off the back of a global outcry over multinationals moving profits to low-tax jurisdictions to minimise their bills – also known as transfer pricing. With increased transparency in modern tax administration, inappropriate profit shifting between subsidiaries and failure to declare and document transfer pricing arrangements accurately are sought out by tax authorities regularly.
With HMRC currently consulting on the requirement for large multinationals operating in the UK to produce a master file on transfer pricing agreements, cross-border tax complexity is only set to increase and impact smaller taxpayers as well. If online retailers are to expand internationally, they must adopt efficient and creative ways to reduce tax compliance costs.
If online retailers are to expand their presence internationally, the tax function must shoot up the boardroom priority list. It’s crucial for businesses to mitigate hefty revenue losses and risk of non-compliance with local tax guidelines.
When expanding internationally, retailers need to take into account a number of international tax issues:
- Which type of foreign entity they should establish (e.g., in the US a corporation, LLC, S corporation).
- Setting a supply chain and transfer pricing policy with respect to their intercompany transactions.
- Classifying the nature of their intercompany transaction to avoid withholding tax. Depending on the relevant tax treaty, royalties for use of technology may be subject to withholding tax while resale of software (including SaaS) may not.
- Filing annual tax returns in the foreign country, but also maintaining updated transfer pricing reports.
This can feel overwhelming and companies commonly charge tax incorrectly if they’re unfamiliar with the tax regulations in the industry and country they’re operating in. For example, there are over 13,000 sales and use tax jurisdictions in the US — many overlap significantly and have different tax rates.
In a single US transaction, a company might have to calculate and apply tax rates from state, county, and city regulations. This can be complicated and time consuming to manage.
US nexus laws are a great example of how complex liability can be. If you have a physical presence in a state, or if you sell more than a certain value of goods there, you’ll establish nexus and have to remit sales tax to the relevant authority. Although it might sound simple, the specific nexus rules for each state can become very complicated for businesses new to the US
If you’re a retailer which trades in digital services – for example, digital downloads or an online marketplace – the task in hand appears even more complex as digital tax law again varies considerably between different US states. EU rules on digital services VAT also differ depending on if the buyer is a business or a consumer. A business that primarily sells digital goods (e.g. a software company) must thoroughly research how their goods and services will be taxed in a region before they start trading into that region.
To get ahead of inevitable scrutiny, retailers should:
- Undergo in-depth preparation of transfer pricing reports to ensure the right portion of profit is allocated between the UK and the local US company, and update these reports on an annual basis.
- Automate transfer pricing processes to mitigate fall-out – Partnering with the right technology third-party who can provide a smart automated transfer pricing documentation tool and real-time counsel on changing OECD guidelines can help online retailers maintain their compliance.
- Redirect business costs. Using automation allows non-experts to also generate transfer pricing reports. Lengthy hours spent during transfer pricing audits can be redirected to allow online retailers to use their compliance budget on tax planning and growth-focused consulting rather than repetitive compliance tasks.
The gains to be made by trading beyond our small island are not in question and technological advances and a renewed focus on resilient supply chains have made it easier than ever for retailers to grasp the opportunities in front of them. And if transfer pricing is part of your expansion strategy, don’t let the issue of tax hold you back. Leaning on others can go a long way to lightening this administrative burden and accelerating growth.
Eran Shif, senior director of transfer pricing at Avalara