For a Canadian company doing business in the United States, nexus is the most talked-about issue from a US state tax perspective. Many companies fail to realize that a treaty-based exemption may provide protection from federal taxes, but generally not from state taxes. Ultimately, the issues are whether a company has nexus in a state and, if so, what can be done about it. Companies need to be constantly aware of potential state tax issues arising from nexus, but a variety of options are available to resolve multistate tax problems.

Not every company that engages in business activities in the United States falls within every state's tax jurisdiction. The US constitution generally limits a state's ability to impose tax obligations on an out-of-state company, based on the nexus concept. "Nexus" refers to the nature and frequency of contacts that an out-of-state company must establish in a state before it attracts taxation. The nexus requirement is constitutionally based, but it is also found in most states' tax laws.

Two recent rulings underscore how easily a Canco can create nexus in the United States. In a New York advisory opinion, a company headquartered in Washington state was absolved of any responsibility to collect New York sales taxes on sales of its promotional materials because it had no physical presence in New York. (See The Sourcing Business, TSB-A-06(14)S.) However, the state tax department also recognized that New York nexus was created by minimal activities such as the solicitation of business through employees (or independent contractors) or the delivery of products otherwise than by a common carrier. A large US retailer of books and music recently completed a long string of litigation in California courts involving so-called attributional nexus (Matter of Borders Online, Inc. v. State Board of Equalization, 129 Cal. App. 4th 1179; 29 Cal. Rptr. 3d 176 (1st Dist. 2005)). Attributional nexus can exist even if a taxpayer lacks physical presence in the taxing state: the activities of an agent or, more commonly, an affiliated entity within the state are attributed to the corporation located outside the state. In the Borders case, the California courts found that the state could impose a sales tax collection requirement on Borders Online--an out-of-state company that had no physical presence in California--because of its connection to its parent, Borders Inc., which maintained sufficient physical presence in California. Similar rulings have come out in New York, Tennessee, New Mexico, and other states in recent years. This issue often arises when a Canco sets up a US sub to handle all or some of its US operations. Under attributional nexus, a US sub's activities can be attributed to its Canadian parent, which then may have nexus for sales or corporate income tax purposes in several states.

Practically speaking, however, how likely is it that a particular state will raise nexus concerns? And assuming that the Canco is willing to comply, is there an efficient way to deal with the possibly overwhelming prospect of addressing all the issues that may arise in perhaps dozens of states, each with different tax rules? Unfortunately, US states have stepped up efforts to uncover non-compliant taxpayers. Some states have created "nexus squads" designed to find previously undetected taxpayers; many states cross-check federal tax filings; and--most importantly for Canadian companies--many states now have information-sharing arrangements with other states and federal agencies, including US Customs. For example, New York, Pennsylvania, and Michigan have information-sharing arrangements with US Customs offices, which have recently led directly to the initiation of state tax audits. It may be inevitable that any company that maintains somewhat regular contacts in the United States will fall within the nexus radar of many US states.

Depending on the facts, various approaches may be taken to resolve these multistate tax concerns. If the non-compliance period is brief, many companies consider prospective compliance only, which still leaves open the possibility of investigations and audits for prior periods. Other companies, particularly in the cross-border context, often consider the creation of a new, generally US, legal entity to handle all US operations prospectively. A new, untainted entity engages in the business activities and, it is hoped, avoids prior years' issues attached to the old Canco, but the strategy leaves the Canco still exposed to audits and investigations for prior years' taxes. If the prior years' liability is extremely significant, or if Canco's non-compliance spans more than just a few tax years, participation in state voluntary disclosure programs allows a taxpayer to come forward voluntarily and comply with a state's taxing provisions without fear of civil or criminal penalties or excessive lookback periods. Generally, states limit a taxpayer's back taxes to three years' taxes plus interest, and they limit any audits or investigations to the same three-year period. A program designed by the Multistate Tax Commission assists taxpayers with voluntary disclosures in several states. Under another multistate project, the Streamlined Sales Tax Project, many states offer amnesty to a taxpayer who is willing to participate prospectively. That amnesty is available only in participating states, and participation may create other issues for particular taxpayers, but it requires prospective compliance only and participants are absolved of all earlier years' sales tax responsibility.