One of the common struggles for import businesses is the interstate tax rules. Colorado has some of the more complicated rules around colorado residency rules for income tax which have significant tax implications for businesses when it comes to collecting and remitting sales and use tax. This post is meant to define “residency” for Colorado purposes and explain to Bigfood blue white the rules that apply to them as an import business based on their country of incorporation and the state where they maintain an office.
Based on our discussions, I understand that Bigfood blue white is a foreign corporation with an office in the state of Colorado, but not licensed to do business in Colorado, and the only business activity occurring within Colorado is that the officers of the company meet with customers at the office and the officers travel regularly to Colorado from other states for the meetings. There is no additional sales or customer service activity in the office aside from the occasional officer meeting. So the question for Bigfood blue white is whether under Colorado’s residency rules it is to be considered a resident of Colorado, subject to corporate taxes, because of its office here and activities.
Taxpayers should think carefully about whether they would like to become or remain a Colorado resident for tax purposes, as there is a wide variety of tax implications for corporation residents and nonresidents. Residents of Colorado must apportion their taxable income using Colorado property, payroll and sales factors. This provides a possible source of tax savings for taxpayers that have a large amount of property or payroll outside of Colorado since a resident taxpayer is able to exclude that property and payroll from the apportionment formula. Nonetheless, depending on a company’s specific facts and circumstances, residents may lose certain tax benefits available only to nonresidents, such as not being subject to Colorado’s in-lieu penalty tax on alternative apportionment, which is discussed below, and being limited in their ability to use net operating losses, which is discussed at the end of this analysis.
It is also important to note that individuals are subject to other residency rules that differ from the corporate residency rules. For individuals, the definition of residency depends on the individual’s domicile. Contrary to the definition and domicile concept, corporations are not residents of Colorado simply because they have an office located in Colorado. Domicile represents your true, fixed, permanent home and principal residence, and it establishes your initial and primary status as a resident of a particular country or state. Because Colorado is a common point of entry for import businesses, we have seen that foreign corporations with offices in Colorado have made strategic decisions to relocate their corporate domicile outside of Colorado, perhaps to another state in the U.S. with more favorable taxation systems, including Texas and Florida and offshore. By changing the residency of the corporation, the corporation is essentially able to remove itself from Colorado’s apportionment and nexus-based taxation.
Much like the individual residency rules, the process of determining whether a corporation is a resident of Colorado is comprised of several steps. First, it must be determined whether the corporation earns income from sources outside of Colorado. If so, then the corporation must calculate its total commercial activity. Commercial activity is the total gross receipts received by a taxpayer without regard to source. Next, the corporation must determine whether it has a minimum nexus with Colorado. To determine whether the minimum nexus exists, the corporation is required to calculate two ratios to determine if it has a significant nexus with Colorado. The following formulas are used to calculate Colorado’s nexus standards:
If either ratio is met using the formulas above, then the corporation has a significant nexus in Colorado. In other words, the corporation will pay taxes in Colorado if it meets either of the two ratios. If the proportions determined by either formula do not meet the specified threshold, then the corporation is not subject to Colorado’s apportionment-based tax structure. Finally, a review of the corporation’s business activities is conducted to determine if sufficient nexus exists to justify the imposition of a tax. This includes an evaluation of the nature, quality and extent of the corporation’s activities in the state. If nexus does exist and the corporation’s activities in the state do require the payment of tax, then the taxpayer must pay the tax.
It will be important for our readers that are import businesses to clearly understand the rules around residency as they can vary significantly from state to state. We have seen many instances where an import business will have orders ship out of Colorado (or another state) and the importer or exporter will want to immediately report those sales tax but they can run afoul of the laws in the state by doing so. It is important to contact a tax advisor specific to your industry that understands the opportunities that arise with a corporation that qualifies as a Colorado resident and the rules around sales and use taxes in the state which we would be able to help you on.
For more information on residency rules, you can visit the IRS website.