In the context of taxation and business, “nexus” is a term that refers to the sufficient physical presence of a business within a state, region, or jurisdiction that it can be considered to have a substantial enough connection to be taxable there.
Nexus is established when a business has direct or representational presence in a particular area. This can be triggered through a number of activities including, but not limited to:
- Owning or leasing property.
- Employing personnel in that area.
- Maintaining inventory in a warehouse.
- Delivery of merchandise in trucks owned by the company.
With the rise of e-commerce, the definition of what constitutes a nexus has been expanded in some jurisdictions to include certain online activities. In the United States, for example, the Supreme Court case South Dakota v. Wayfair, Inc. (2018) allowed states to charge tax on purchases made to individuals in their states from out-of-state sellers, even if the seller does not have a physical presence in the taxing state.
This is often referred to as “economic nexus,” meaning the seller’s revenue or transaction volume in the state exceeds a certain threshold. This is in contrast to “physical nexus,” which is based on physical presence.
The specifics of what constitutes a nexus can vary from one jurisdiction to another, so businesses often need to consult with tax professionals to understand their tax obligations in the locations where they operate.
Example of Nexus
Let’s consider a business that’s based in California but sells products to customers all across the United States through its e-commerce website.
Suppose this business uses a third-party logistics provider’s warehouse located in Texas to store its inventory and fulfill orders. In this case, the use of a warehouse in Texas can create a physical presence, or “nexus,” for the business in Texas, even though the business is headquartered in California. This means the business could be required to collect and remit sales tax on sales to customers in Texas.
Now, let’s add to this example. Suppose the business starts to sell a lot of products to customers in New York, despite having no physical presence in New York. If the amount of sales to New York customers exceeds a certain threshold (for example, $500,000 in sales or 100 separate transactions in a year), the business might establish an “economic nexus” in New York. Under the rules established by the South Dakota v. Wayfair, Inc. decision, this could mean the business has to collect and remit sales tax on its sales to customers in New York.
These are just simplified examples. In reality, the rules can be quite complex and can vary by state or country. For instance, not all states in the U.S. have adopted economic nexus laws. Also, what constitutes a significant physical presence can vary. That’s why it’s important for businesses to consult with tax professionals who are familiar with the tax laws in the places where they do business.