Navigating the complexities of sales tax is a critical task for businesses, especially when dealing with cross-border intercompany fees. These fee arrangements can be categorized in various ways, such as management fees, administrative fees, technology fees, support fees, etc. Such fees, charged by a non-U.S. parent or management company for providing administrative, financial and operational services to its U.S. subsidiaries or affiliates, can have various sales tax implications, especially when they involve the sharing, transferring or leasing of tangible personal property, including software and technology, or the sharing of employees where the U.S. subsidiary supervises and directs performance.
Intercompany transactions can be subject to sales tax, and unlike in income tax regimes, these transactions are not eliminated in combined or consolidated filings. If not identified and properly addressed, businesses may find that everyday expenses—such as back-office administration, management, employee payroll, internal equipment or inventory management—are subject to sales taxes. This article highlights sales tax considerations related to cross-border intercompany fees, explores the key issues and common challenges and provides best practice suggestions for audit preparedness to minimise potential exposures.
Services customarily rendered by attorneys, accountants and actuaries when acting within the scope of their professions are excluded from taxable management services. Marketing, investment, investment banking, insurance services and environmental consulting services are also generally excluded, including when the service provider is acting in the capacity of a member of the board of directors of the service recipient. There is a limited exemption for services rendered between parent companies and wholly owned subsidiaries related to the management of industrial, commercial or income-producing property, as well as flight instruction or chartering services by certified air carriers. However, for corporations engaged in the media business with their principal place of business in Connecticut, at least 80% ownership is required to qualify for this exemption.
Also in Connecticut, the sales price of taxable managed services excludes, if properly documented on the invoice, separately stated compensation, fringe benefits, workers' compensation and payroll taxes paid to employees performing such services. A failure to show separately stated details on the invoice will cause sales tax to be imposed on the single bundled fee.
By way of comparison, New Mexico imposes sales tax on most services but permits a deduction for a business entity’s receipts for administrative, managerial, accounting and customer services that it performs for an affiliate on a cost basis. It also permits the joint use or sharing of office machines and facilities on a cost basis. However, if the affiliate pays its parent on a cost-plus basis for these services, as may be required by the transfer pricing rules, such receipts cannot be deducted and are subject to tax. Other services, such as legal and human resource services, fall outside the scope of back-office support services and may be subject to sales tax. To qualify for the deduction, the parent company must have equity ownership in an affiliate that represents at least 50% of its total voting power or that has a value of at least 50% of its total equity.
In Hawaii, charges for legal, accounting, managerial and administrative services (including related overhead costs) furnished by one related entity to another, or interest on loans or advances to related entities, are not taxable. Related entities are generally entities related through 80% common ownership and at least 80% of the total voting power.
In contrast, South Dakota imposes tax on all services and does not offer any exemptions for services provided to related entities.
A non-U.S. parent may also provide its U.S. subsidiary with software it created or sub-license software it purchased. The intercompany sale or licensing of software may be subject to tax, depending on how the software is accessed. Approximately 35 states impose sales tax on electronically delivered software, such as an app downloaded onto a computer or phone, approximately half of the U.S. states impose sales tax on SaaS and around 12 states impose sales tax on data processing.
There are several available exemptions. The multiple points of use (MPU) exemption allows businesses to allocate tax based on the proportionate use of software across different jurisdictions. Available in Massachusetts, New York, Pennsylvania, Utah, Washington and the City of Chicago, among other jurisdictions, the MPU enables businesses to document that while the purchase of software licenses may occur in a taxable jurisdiction, the actual use of those licenses may take place in a different jurisdiction where the offering may not be subject to tax or is taxed at a lower rate.
Several states also provide for a sales tax exemption for data processing services provided to related group members. For instance, the District of Columbia exempts from sales tax data processing services that are provided by a member of an affiliated group of corporations to other corporate group members if the service rendered has not been purchased with a certificate of resale or exemption by the corporation that provides the service, is rendered for the purpose of expense allocation and is not for the profit of the corporation providing the service.
By the way of comparison, Texas, which imposes sales tax on data processing services, exempts from sales tax charges for taxable services if the seller and purchaser are affiliated entities that are members of an affiliated group under IRC section 1504. However, a seller of a taxable service or tangible personal property must pay sales or use tax on its purchase that the seller transfers to an affiliated group member. The seller may not claim a sale for resale exemption on the purchase.
Companies should carefully review their existing intercompany agreements to determine if, in addition to back-office support and professional services—which are typically not subject to tax in most states—the parent company is also licensing access to hardware or software for a single fee. Such bundling arrangements may make the entire fee subject to sales tax.
In states that impose tax on management services, such as Connecticut, it is possible to reduce sales tax by tracking and separately detailing taxable services, reimbursed costs and nontaxable services on the invoice. For companies aiming to minimize sales tax and avoid the applicability of bundling rules, it is imperative to maintain robust intercompany documentation. This includes issuing separately stated invoices for taxable business management services and nontaxable services (such as marketing or professional services) and separately stating the cost of employee benefits from service costs.
It is important to understand and document the ownership structure to claim exemptions from sales tax imposed on management services if the parent company wholly owns the subsidiary to which such services are provided as required in Connecticut, or if a lower ownership threshold will suffice (for instance, Hawaii).
Intercompany fees that include licenses to software, SaaS, information services and digital products among other nontaxable administrative or professional services may result in significant unintended liabilities due to the bundling rules. Thus, companies should understand the taxability of such electronic products and for contracting and invoicing purposes either have them listed on a separate invoice or separately state them on the invoice to avoid application of bundling rules that would make the entire fee subject to tax. The MPU exemption should be utilized if software products are purchased in one state, but used in another, which potentially may not impose sales tax on such products or imposes tax at a different and sometimes lower rate.
Sales tax that is due on intercompany fees, or a certain portion of intercompany fees (e.g., the use of software) should be collected and remitted to the state. As part of the compliance process, the non-U.S. parent entity will need to register with the state and collect and remit sales tax. Alternatively, if sales tax is not collected by the non-U.S. parent company, the U.S. subsidiary should self-assess and remit use tax to the appropriate jurisdiction.
Companies with extensive intercompany transactions across multiple states should consider the benefits of automating their processes and implementing an indirect tax engine. Such a system can track the taxability determinations and tax rates for over 12,000 taxing jurisdictions in the U.S. and simplify document retention for potential state and local audits.
Angela Acosta
Ilya Lipin
BDO in United States
Intercompany transactions can be subject to sales tax, and unlike in income tax regimes, these transactions are not eliminated in combined or consolidated filings. If not identified and properly addressed, businesses may find that everyday expenses—such as back-office administration, management, employee payroll, internal equipment or inventory management—are subject to sales taxes. This article highlights sales tax considerations related to cross-border intercompany fees, explores the key issues and common challenges and provides best practice suggestions for audit preparedness to minimise potential exposures.
Management services
Certain U.S. states impose sales tax on management services. In Connecticut, for instance, business analysis, business management, consulting services and human resource management services are subject to sales tax when they relate to a business's core activities, such as the sale of products or services, capital structure, budgeting or strategic planning. Human resource management services include activities such as the hiring, development, job-related training, compensation and management of personnel, employee relations, and the design and implementation (but not ongoing administration) of employee benefit plans.Services customarily rendered by attorneys, accountants and actuaries when acting within the scope of their professions are excluded from taxable management services. Marketing, investment, investment banking, insurance services and environmental consulting services are also generally excluded, including when the service provider is acting in the capacity of a member of the board of directors of the service recipient. There is a limited exemption for services rendered between parent companies and wholly owned subsidiaries related to the management of industrial, commercial or income-producing property, as well as flight instruction or chartering services by certified air carriers. However, for corporations engaged in the media business with their principal place of business in Connecticut, at least 80% ownership is required to qualify for this exemption.
Also in Connecticut, the sales price of taxable managed services excludes, if properly documented on the invoice, separately stated compensation, fringe benefits, workers' compensation and payroll taxes paid to employees performing such services. A failure to show separately stated details on the invoice will cause sales tax to be imposed on the single bundled fee.
By way of comparison, New Mexico imposes sales tax on most services but permits a deduction for a business entity’s receipts for administrative, managerial, accounting and customer services that it performs for an affiliate on a cost basis. It also permits the joint use or sharing of office machines and facilities on a cost basis. However, if the affiliate pays its parent on a cost-plus basis for these services, as may be required by the transfer pricing rules, such receipts cannot be deducted and are subject to tax. Other services, such as legal and human resource services, fall outside the scope of back-office support services and may be subject to sales tax. To qualify for the deduction, the parent company must have equity ownership in an affiliate that represents at least 50% of its total voting power or that has a value of at least 50% of its total equity.
In Hawaii, charges for legal, accounting, managerial and administrative services (including related overhead costs) furnished by one related entity to another, or interest on loans or advances to related entities, are not taxable. Related entities are generally entities related through 80% common ownership and at least 80% of the total voting power.
In contrast, South Dakota imposes tax on all services and does not offer any exemptions for services provided to related entities.
Technology services
U.S. subsidiaries often rely on a non-U.S. parent company’s technology, such as hardware and software, for its day-to-day operations. For IT security, financing or other business purposes, the parent company may purchase hardware such as computers, servers or other expensive hardware and lease it to the U.S. subsidiary in exchange for a monthly or annual fee. The leasing of tangible personal property is subject to tax unless a state-specific exemption applies. For instance, if sales tax is paid on an initial purchase, Minnesota exempts from sales tax tangible personal property not made in the normal course of the business of selling that kind of property and if the sale is between members of a controlled group as defined in the Internal Revenue Code (IRC) section 1563. Alabama also has an exemption for intercompany leases of tangible personal property where a subsidiary is wholly owned by the parent and any sales tax due, if applicable, was previously paid.A non-U.S. parent may also provide its U.S. subsidiary with software it created or sub-license software it purchased. The intercompany sale or licensing of software may be subject to tax, depending on how the software is accessed. Approximately 35 states impose sales tax on electronically delivered software, such as an app downloaded onto a computer or phone, approximately half of the U.S. states impose sales tax on SaaS and around 12 states impose sales tax on data processing.
There are several available exemptions. The multiple points of use (MPU) exemption allows businesses to allocate tax based on the proportionate use of software across different jurisdictions. Available in Massachusetts, New York, Pennsylvania, Utah, Washington and the City of Chicago, among other jurisdictions, the MPU enables businesses to document that while the purchase of software licenses may occur in a taxable jurisdiction, the actual use of those licenses may take place in a different jurisdiction where the offering may not be subject to tax or is taxed at a lower rate.
Several states also provide for a sales tax exemption for data processing services provided to related group members. For instance, the District of Columbia exempts from sales tax data processing services that are provided by a member of an affiliated group of corporations to other corporate group members if the service rendered has not been purchased with a certificate of resale or exemption by the corporation that provides the service, is rendered for the purpose of expense allocation and is not for the profit of the corporation providing the service.
By the way of comparison, Texas, which imposes sales tax on data processing services, exempts from sales tax charges for taxable services if the seller and purchaser are affiliated entities that are members of an affiliated group under IRC section 1504. However, a seller of a taxable service or tangible personal property must pay sales or use tax on its purchase that the seller transfers to an affiliated group member. The seller may not claim a sale for resale exemption on the purchase.
Companies should carefully review their existing intercompany agreements to determine if, in addition to back-office support and professional services—which are typically not subject to tax in most states—the parent company is also licensing access to hardware or software for a single fee. Such bundling arrangements may make the entire fee subject to sales tax.
Sharing of employees
A foreign parent company may lease its employees to a U.S. subsidiary on a temporary basis to assist with operations or fulfill specific expertise needs at the direction or supervision of the subsidiary. Such arrangements are often documented in intercompany agreements where a foreign parent receives payments for the subsidiary’s use of parent company’s employees without taking into account the sales tax implications. Several states, including Connecticut, New Mexico, Pennsylvania and South Dakota, impose sales tax on such leasing arrangements among separate but related legal entities. Pennsylvania recently issued administrative guidance indicating that sales tax can apply to such arrangements even with remote employees, with the result that there may be sales tax implications where an employee located outside Pennsylvania performs a service that is delivered or used within the state. Companies that rely on sharing employees should be aware of these potential unanticipated sales tax costs.Best practices
Sales tax should be considered during the planning and implementation of intercompany agreements and in transfer pricing discussions. Since each state, and sometimes locality in the “home rule” states such as Colorado, has its own rules on the taxability of products and services, it is essential to review each state where related entities have nexus for the potential application of sales tax to intercompany products and services covered by the fees. It is recommended to separate and analyse the taxability of each component of the fee. This will allow a determination of whether any particular product or service, when bundled together, can result in the entire transaction being subject to tax.In states that impose tax on management services, such as Connecticut, it is possible to reduce sales tax by tracking and separately detailing taxable services, reimbursed costs and nontaxable services on the invoice. For companies aiming to minimize sales tax and avoid the applicability of bundling rules, it is imperative to maintain robust intercompany documentation. This includes issuing separately stated invoices for taxable business management services and nontaxable services (such as marketing or professional services) and separately stating the cost of employee benefits from service costs.
It is important to understand and document the ownership structure to claim exemptions from sales tax imposed on management services if the parent company wholly owns the subsidiary to which such services are provided as required in Connecticut, or if a lower ownership threshold will suffice (for instance, Hawaii).
Intercompany fees that include licenses to software, SaaS, information services and digital products among other nontaxable administrative or professional services may result in significant unintended liabilities due to the bundling rules. Thus, companies should understand the taxability of such electronic products and for contracting and invoicing purposes either have them listed on a separate invoice or separately state them on the invoice to avoid application of bundling rules that would make the entire fee subject to tax. The MPU exemption should be utilized if software products are purchased in one state, but used in another, which potentially may not impose sales tax on such products or imposes tax at a different and sometimes lower rate.
Sales tax that is due on intercompany fees, or a certain portion of intercompany fees (e.g., the use of software) should be collected and remitted to the state. As part of the compliance process, the non-U.S. parent entity will need to register with the state and collect and remit sales tax. Alternatively, if sales tax is not collected by the non-U.S. parent company, the U.S. subsidiary should self-assess and remit use tax to the appropriate jurisdiction.
Companies with extensive intercompany transactions across multiple states should consider the benefits of automating their processes and implementing an indirect tax engine. Such a system can track the taxability determinations and tax rates for over 12,000 taxing jurisdictions in the U.S. and simplify document retention for potential state and local audits.
Angela Acosta
Ilya Lipin
BDO in United States