There are certain exceptions to the application or non-application of taxes on a transaction in the United States. What are these exceptions?

Retail sales of tangible personal property are generally taxable for U.S. sales and use tax purposes. However, even if a sale constitutes a retail sale, the transaction may be exempt for various reasons.

Exemptions vary from state to state and are, in some cases, based on criteria relating to the region’s economy. It is important to note that coordinating exemptions between several states can be complex due to variations in tax rules and taxation criteria.

Three situations where tax exemption is possible

Depending on the nature of the goods

In principle, there are three situations where tax is not applicable, the first being exemptions due to the nature of the goods. These transactions are not taxable per se and do not require any special documentation once it has been established that the object of the sale is a good or service that is not taxable.

For example, some states will not tax food products, while others will not tax medical products or certain types of clothing.

Depending on the buyer’s status

The second category includes exemptions linked to the buyer’s status. For example, churches, governments and certain charitable or educational organizations may be exempt from paying tax. In such cases, the seller must retain proof of its customer’s status under which the exemption applies.

It should be noted that some of these exemptions may be transferred to the exempt customer’s supplier. The rules vary from state to state.

Certain exemptions are based both on the buyer’s status and the nature of the transaction. In some cases, companies may benefit from temporary or specific exemptions for particular projects taking place in one or more States.

This could include exemptions for construction projects, temporary events or other specific activities that occur in one or more jurisdictions. For example, a company may obtain an exemption for a specific construction project or for a trade fair. Once the event is over, the exemption automatically expires.

Depending on the use of the good or service

Lastly, the third category includes various exemptions related to the buyer’s use of the property. These exemptions ensure that only the retail buyer, i.e., the consumer of the taxable good or service, will be liable to pay sales tax and that intermediaries will not have to pay additional taxes, which would result in double taxation.

For example, retailers will not pay tax on their stocks, but will pay tax on their counters and the goods used to promote them. The service provider will pay tax on its inputs, but will not have to charge tax on its services.

Most frequent exemptions

Exemption from sale for resale

By default, sales of tangible personal property are taxable. However, sales for resale are exempt in all states on the express condition that the supplier has the documentation justifying this exemption.

The resale exemption is the best-known retail sales tax exemption. Resale exemptions apply to goods acquired for resale in the same condition and may extend to goods used to become an integral part of a good to be resold. In general, if the property acquired for resale is ultimately used by the retailer, then the retailer will have to pay tax on that property.

Resale exemption certificates are used by resellers to purchase goods for resale without paying sales tax.

Some businesses are granted a direct payment permit by the State, which means that their suppliers do not have to charge them tax. These businesses will then have to pay the tax themselves when filing their tax returns for the period including when they consume or use taxable goods.

Exemption for manufacturing equipment

Manufacturing exemptions play an essential role in supporting the manufacturing sector by alleviating the tax burden associated with goods and services used in the process of manufacturing goods that will be resold.

In some cases, manufacturing exemptions may be partial rather than total. This means that specific goods or services will be taxable, but at a reduced rate. Rates and criteria may vary, adding to the complexity of the process.

Manufacturing exemptions are often linked to the specific use of goods and services in the manufacturing process. This means that in order to benefit from the exemption, the goods must be used directly in the production, processing or assembly stages. This exemption can cover both manufacturing equipment and components of the good that is produced and will be resold.

Goods that are not used directly and exclusively in the manufacturing process may not qualify for exemption. Determining when the manufacturing process begins and ends varies from state to state. These variations concern, for example, equipment used in research and development, packaging equipment, equipment used to move parts or goods during the process, and equipment linked to environmental or safety requirements.

Manufacturing exemptions can vary in terms of the parts and components used in manufacture. Sometimes, only parts and components that become an integral part of the final product benefit from the exemption, while parts used for the maintenance or repair of existing equipment are excluded.

Manufacturing exemptions often come with strict documentation requirements. Companies must be able to document that goods and services are used in accordance with the exemption criteria. This may include keeping accurate records, retaining invoices and receipts and preparing appropriate returns.

Exemptions for use in several states

Some states grant exemptions that apply to goods or services used in more than one jurisdiction. These exemptions generally apply to software in situations where, for example, an entity signs a contract with a software supplier for several licenses. The licenses are managed by the head office located in one state, but will be used by company employees in several states.

In such cases, some states allow the buyer (i.e., the head office) to provide a certificate of exemption for use in several states to its supplier so that the latter does not collect tax on the transaction; it will then be up to the buyer to pay the tax itself in the various states where the licenses will be used.

Documentation

Sellers who have an economic nexus in a state are responsible for collecting and remitting tax on its taxable supplies and, in the event of failure to do so, may have to pay the tax with penalties and interest. The burden of proof that the transaction is exempt, if applicable, therefore lies with the seller. If in doubt, sellers should generally collect the tax and buyers should request a refund from the tax authorities.

Each state has its own rules concerning exemption certificates and their renewal. Some jurisdictions require additional information when renewing, while others simply ask for confirmation that the information is still valid. It is essential to consult the local tax authorities for precise information on renewal requirements in each state, as validity periods vary from state to state.

It is important to regularly check the validity of the exemption certificates you hold. The rules are subject to change and it is possible that some states may require information to be updated or renewed. Additionally, changes in certain companies’ activities or structure may have an impact on their exemption eligibility.

Furthermore, it should be noted that some states do not allow sellers who are registered or required to be registered to simply receive a completed exemption certificate and rely on it to be relieved of their obligations if the sale is otherwise taxable. Indeed, these states will require sellers to be aware of the rules applicable in the state where they are doing business and to know whether the exemption actually applies depending on the particular goods being sold and the context. For example, some states may require sellers to pay tax on the supply of goods that are not subject to exemption, even if they have an exemption certificate duly completed and signed by the buyer.

When expanding into the US, it is important to understand the intricacies of the various exemptions and to ensure that you meet the eligibility criteria and documentation requirements. A thorough understanding of these limitations can help companies avoid costly mistakes and maximize tax benefits while maintaining full compliance with ever-changing regulations.

Changes to U.S. sales taxes can impact your business. Furthermore, the rules differ from state to state.

Quebec companies operating in the manufacturing, IT or distribution sector often have commercial ties with the U.S. Recent developments regarding U.S. sales tax laws can have a major impact on their operations–whether they have a physical presence in the U.S. or not.

Registration and fiscal obligations

In the U.S., sales taxes are mainly determined at the state level. Nearly all U.S. states have their own sales tax, with the only exceptions being New Hampshire, Oregon, Montana, Arkansas and Delaware (known as NOMAD).

In addition, states have authorized various local entities such as counties, cities, etc. to collect retail sales taxes. These local taxes are levied in the same way as state taxes, but increase the effective tax rate by a few percentage points. This means that the tax rates and rules vary greatly from state to state.

Physical or online presence?

When does a Canadian business selling in the U.S. need to worry about taxes? Traditionally, businesses that had a physical presence (e.g., a warehouse or subsidiary) in a particular state were required to collect and remit the applicable sales tax. However, e-commerce changed all this.

In the case of Wayfair v. South Dakota, in 2018 the U.S. Supreme Court ruled that states could require companies with no physical presence in the state to collect sales tax if they meet a certain sales or transactions threshold in the state. This paved the way for the concept of “economic nexus” in determining whether a business is required to collect sales tax in a given state.

Therefore, from now on Quebec businesses with online sales in the U.S. may be required to collect and remit sales taxes in a number of states due to their economic presence—even if they have no physical presence there. This means that cross-border tax compliance has become even more complex for a number of businesses.

It is also important to note that while the threshold is generally $100,000 in sales or more than 200 transactions per year¹, each state has its own rules and thresholds for collecting sales tax. Even if, at first glance, a business exceeds the economic nexus threshold it may not always need to register for the purpose of collecting sales tax in a given U.S. state. Certain types of businesses or transactions could be excluded in calculating the threshold, such as sales for resale (e.g., a wholesaler that sells to resellers) or the sale of manufacturing or farming equipment, which would actually be exempt. In addition, specific rules in one state could exclude other situations, particularly if the business operations in this state are considered to be occasional or isolated. States can have specific thresholds to determine what is considered to be “occasional”.

Most U.S. states also have “marketplace” rules whereby a business selling products via website—like Amazon or Best Buy—is required to collect and remit sales tax even though, legally speaking, online sales websites would generally be considered to act as agents for their clients to facilitate sales. It should be noted that sales tax rules in the U.S. governing sales websites are constantly changing and may vary from state to state as well as depending on the particular situation.

1Some states, such as New York and California, have a higher threshold ($500,000 per year) while several others have an annual threshold of $250,000.

Collecting and remitting U.S. sales taxes

Once a seller is registered or has a registration requirement, it must collect the applicable sales taxes from its customers and remit the amounts to the tax authorities.

If a seller fails to report sales, there is generally no statute of limitations period and states can demand payment for the amount of sales taxes beyond the normal three to four years².

It should be noted that the fact that a business is a registrant collecting sales tax does not increase the tax cost for its customers since they are required to self-assess and pay sales tax if the supplier has not collected the appropriate amount.

2Some states have a longer statute of limitations period. The rules vary from state to state.

How the U.S. sales tax system works

Unlike VAT systems, retail sales taxes generally apply only to tangible personal property—not to intangible assets or real property. Moreover, services are generally not subject to retail sales tax, with the exception of specifically identified services or those that are specifically related to tangible personal property.

It is important to note the treatment that applies depending on the type of assets sold.

1. Sales of tangible personal property

U.S. sales tax generally applies to sales of material goods such as merchandise and manufactured products. The applicable rules and rates vary depending on the state. Quebec businesses selling tangible personal property in the U.S. must take into account the tax rate that applies in each state and make sure that sales taxes are being properly calculated and collected.

2. Professional services

In most U.S. states, sales tax does not apply to professional services, such as advisory, accounting and IT services. However, there are some exceptions and these types of services are taxed in some jurisdictions. Exceptionally, some states tax most services other than those that have been specifically identified. Quebec businesses that provide professional services in the U.S. must check the rules in each state to determine whether sales tax applies.

3. Services relating to tangible personal property

Services relating to material goods, such as maintenance, repair or installation services, may be subject to sales tax in some states. The distinction between services and the sale of goods may sometimes be more subtle. Quebec businesses that provide services relating to tangible personal property need to assess the rules in each state to determine whether sales tax applies to their specific services.

A transaction may be exempt from sales tax for different reasons. Exemptions vary from state to state and, in some cases, are based on economic criteria in the region. For further information, please see our article on exemptions.

4. Software and data processing

U.S. states can treat software differently, regardless whether in physical or downloadable format. Some states consider software to constitute material goods to which sales tax applies, while for others software is a tax-exempt service.

Under the SaaS model, software as a service is delivered via the cloud. Customers access software via the Internet rather than installing it locally on their own device. The taxation of SaaS services varies from state to state. Some states consider SaaS services to be taxable and require sales tax to be collected, while for others SaaS is a non-taxable IT service. Determining where the SaaS services are being sold can also be a complex matter.

The PaaS model provides a platform allowing developers to create, host and deploy applications. The taxation of PaaS services can also vary. Some states consider PaaS services to be taxable since they involve use of an IT infrastructure. The PaaS model can also involve taxable services (e.g., hosting the application) in addition to non-taxable services (e.g., supplying development tools). These considerations, as well as the wide array of services that can be provided, including development, implementation, configuration and data migration, can make fiscal obligations more complex.

Data processing services are often taxable, although the definition of what constitutes a data processing service varies from state to state. Some U.S. states consider these services to be taxable and require sales tax to be collected, while others consider them to be non-taxable professional or IT services. It is extremely important to know the position taken by the particular state in order to determine whether the data processing services are subject to sales tax. Some states may have exemptions for professional or IT-related services. However, these exemptions may differ from state to state and vary according to the specific data processing services being provided.

Mastering the complexity of state rules

If you are developing the U.S. market in different states, you need to master the complexity of state tax rules. Since each state has its own taxation criteria and exemptions, tax compliance may be harder to achieve. It is important to act quickly and have good advisors.

Moreover, due to the complexity of U.S. tax rules, many businesses opt for automatic collection and remittance. Specialized software solutions can be helpful in ensuring that tax rates are calculated properly based on a customer’s location and generating accurate tax returns.

On September 21, 2023, the Department of Finance Canada tabled Bill C-56 proposing legislation to temporarily enhance the GST Rental Rebate for construction of specific rental housing. These measures will increase the GST Rental Rebate from 36% to 100%, and remove the phase-out thresholds for this type of housing.

Currently, for the construction of rental housing designated for long term rental, a partial rebate of 36% of the GST is provided for units valued at $350,000 or less. The rebate is on a sliding scale for homes valued between $350,000 and $450,000. The rebate does not apply to units valued at more than $450,000.

The Department proposes legislation amendments to increase the rebate rate from 36% to 100% for some rental housing. In addition, the phase-out thresholds will be removed. The rebate will apply to all rental housing, regardless of its value.

Public service bodies will also be able to access the increased rebate.