Understanding the two sales tax sourcing rules is crucial in the effective management of your business’s sales tax compliance system.
“Sales tax sourcing” is the determination of which tax rate is applicable to a purchase, and to which taxing authority tax is owed. There are two types of sales tax sourcing rules that the states implement: destination and origin based.
Destination based Sourcing System
Most states adapt destination-based sourcing rules which consider the source of the transaction to be the destination at which the product will be used. In most cases, the product is used where it is delivered or shipped. Interstate transactions are taxed in jurisdictions where the property or services are delivered to the purchaser, user, or consumer. Sellers do not have to charge sales tax when the taxable property is to be received outside of the state unless they have a nexus with that state.
Destination based sourcing system can be very difficult to manage in the states with various local rates – retailers must state up-to-date with the ever-changing local rates.
Origin based Sourcing System
In origin-based states, the sales tax rate is determined based on the business location of the seller. An example of origin based-state is Ohio (others include Arizona, Mississippi, New Mexico, and Tennessee). Intrastate retail sales of tangible personal property or digital goods in Ohio are taxed based on the location where the vendor receives an order for the sale (assuming the vendor receives the order and the customer received the goods in Ohio). Interstate transactions are taxed based on the destination sourcing rules discussed above.
California is also generally considered to be an origin-based state. Sales tax is generally due at the place of sale of purchase, which is defined as the place where the property is physically located when the act constituting the sale or purchase takes place. If a retailer has more than one place of business in California, the tax rate is determined by where the principal negotiations are carried on. Additionally, those rules apply to the county and city sales tax allocation. However, district taxes follow destination-based rules of taxability.
Sales tax sourcing rules are commonly overlooked. When setting up your sales tax compliance process, make sure you identify the proper sourcing rules. If you make a mistake it could result in a significant audit assessment. For further information, please contact Chris Vignone or Ilona Sasiela.