Tax: A Critical Element of E-Commerce Business Success

by Chris Livingston and David Deputy

Taxing low value cross-border goods or services and doing so at the location of the consumer have elevated the tax risk profile of millions of e-commerce retailers.

E-commerce is dominating the retail industry as the fastest growing sales channel. In fact, in 2018, e-commerce sales represented more than half of all retail sales growth and there’s no sign of this trend slowing down. In 2019, $3.4 trillion of the $80 trillion global GDP will come from e-commerce. The ease of expansion and reach into new markets and the convenience it offers customers are among the driving factors contributing to the success of online retailing. 

However, as the highly popular e-commerce market becomes more competitive to draw and retain customers, customer expectations of retailers are climbing too—threatening the vitality of businesses if they fail to deliver top quality and seamless services. Fickle customers put a premium on user experience in both the B2B and B2C space. But at the same time, entering new markets comes with serious compliance implications that, if overlooked can lead to e-commerce business failures. 

Compliance challenges are compounded by the fact that many e-commerce businesses sell internationally, which comes with a myriad of different regulations they may encounter. Historically, compliance has involved customs, as well as health and safety regulations. However, recent changes have brought tax to the forefront, with countries like Australia requiring value added taxes (VAT) be paid even on small value cross-border sales. Dozens of other countries are imposing thresholds for sales on which taxes are due—a trend also seen in the U.S. at the state level. Vendor location and footprint no longer drive taxation, as global agreements are in place to use the residence of the consumer as the jurisdiction with the right to tax e-commerce. 

These two changes—taxing low value cross-border goods or services and doing so at the location of the consumer—have elevated the tax risk profile of millions of e-commerce retailers.

Transaction tax has become an unavoidable element of retail. Sellers who fail to properly manage U.S. sales tax and international VAT risk not only audits and hefty penalties that can impact cash flow, but also put their customer satisfaction in jeopardy. After all, customers expect tax to be calculated accurately and in real-time during order completion. Therefore, the inability to manage transaction tax can be deadly for a retail or e-commerce business. Further, some jurisdictions have threatened to send tax bills directly to consumers when e-commerce businesses fail to comply.

This perfect storm in the U.S. and abroad simultaneously means that, when it comes to sales tax, online retailers big and small are often faced with a regulatory nightmare. Governments aren’t taking pause in enacting or changing regulations to allow businesses time to adjust, either. According to an annual report tracking sales tax statistics, there have been an average of 221 new sales taxes, 367 sales tax changes, and 588 new and changed sales tax rates per year in the U.S. alone over the last decade. The U.S. sales tax landscape has become even more complex for remote sellers as states have been reacting to the 2018 Supreme Court ruling in South Dakota vs. Wayfair, which gave states the authority to impose sales tax on out-of-state transactions if certain economic nexus thresholds are met. Globally, the OECD has been leading an initiative around taxation of the digital economy; while not yet finalized, many countries have already begun enacting laws for remote collection of transaction taxes by nonresident sellers.

If tax law changes and remote collection were not enough, there’s also the challenge of differential taxation, which varies by product or service. From a tax perspective, not all products—even similar ones—are treated equally. Expanding into new offerings can quickly multiply the complexities of tax management, as rules vary both across jurisdictions and product types. For example, a piece of apparel categorized as a luxury item is taxed differently than one identified as essential clothing. 

Retailers face additional complications such as sales tax holidays. Most states hold sales tax holidays annually, but exempt or discounted items may change from year to year. Some jurisdictions could decide to not participate or have different rates, which complicates the sales, exemptions and returns processes. 

With the daunting complexities outlined above, and as tax authorities turn to transaction tax audits to close revenue gaps, retailers need to use automation to ease the burden and reduce the risk associated with noncompliance. An end-to-end sales tax solution can support retailers through the entire process—from collection through reporting. With technology, retailers ensure the right forms are filed with up-to-date rates and product tax codes for each jurisdiction. In addition, tax is validated for each ship-to address and all paperwork is in one place in case of an audit—which makes the otherwise painful process, easier. An automated solution can be especially helpful for retailers on the smaller side that have fewer resources to quickly adjust to changing laws. Omni-channel e-retailers that let technology handle tax management and create centralized sales databases can gain valuable insights that inform critical business functions, enabling them to grow with confidence.

To survive in the hypercompetitive e-commerce environment, retailers need the capability to manage tax and improve user experience. Otherwise, they are exposing themselves to costly noncompliance risk and miss out on an opportunity for increased efficiency and profitability. 

Chris Livingston is Director of Operations and Product at Vertex, Inc. David Deputy is Director of Strategic Development and Emerging Markets at Vertex, Inc.