Amazon’s Fulfillment-by-Amazon (“FBA”) is an enormously popular business model for foreign (non-US) sellers looking to sell products to U.S. customers. Under the FBA model, Amazon sellers store their products in one of Amazon’s dozens of fulfillment centers across the United States, which then pick, pack, and ship products to customers, and provide customer service as well.
With every business venture that touches the U.S. market, there are a number of U.S. tax issues that need be considered for foreign sellers. In this blog, we analyze these issues for Amazon international sellers in two contexts – one where the foreign seller resides in a treaty country (i.e., a country that has an income tax treaty with the United States), and one where the foreign seller resides in a non-treaty country.
Amazon FBA – How it Works
Amazon offers a variety of services that cater to the various needs of merchants. In describing how Amazon FBA works, we describe the typical arrangement and pay particular attention to the aspects of these services that are relevant for analyzing the U.S. federal income tax considerations. Our description of the FBA process does not encompass all service models offered by Amazon. If a service model used by a seller differs from what is described below, the U.S. federal tax implications may differ significantly as well.
The process begins with a foreign seller (individual or company) who is looking to sell products in the U.S. market. The products may or may not have been manufactured by the foreign seller.
The foreign seller opens an account online with Amazon, which requires the seller to take a “tax interview.” Based on the answers given in the interview, Amazon determines the tax residence of the seller. Amazon requires a foreign seller to fill out and submit an IRS Form W-8BEN (Certificate of Foreign Status) or W-8BEN-E in the case of a foreign entity. The Form W-8BEN serves as documentary evidence to Amazon that the seller is tax resident in a foreign country.
U.S. sellers, in contrast, are required to fill out and submit a Form W-9. Amazon also submits a Form 1099-K for U.S. sellers who have more than a certain amount in unadjusted gross sales and a certain amount in transactions in a calendar year. This is normally not done for foreign sellers.
Once the seller account is opened, the foreign seller lists his products on Amazon.com. The seller sets his own price for the products. The listing does not yet go “live” on the website.
The foreign seller then prepares his inventory according to Amazon’s instructions and ships the items, at his own cost (including customs and duties), to Amazon, which then stores the items in one or more if its warehouses across the country.
The risk of loss and damage remains with the seller during the shipping process. The risk of loss and damage then lies with Amazon while the products are in storage. Title to the products at no time passes to Amazon. Legal ownership remains with the seller until an item is purchased and shipped to the customer.
Once stored, the foreign seller’s product is advertised on Amazon.com, where the seller is identified alongside the product. Amazon fulfills customer orders placed on Amazon.com (or fulfillment requests that are submitted for sales not on Amazon). It picks the seller’s products from inventory, packs them for delivery, and ships the products to customers from its network of fulfillment centers.
Amazon ships customer orders and provides tracking information for customers. It also invoices customers for their orders and manages customer inquiries, refunds and returns.
Sellers are charged a small monthly fee, a fulfillment fee per unit, and a storage fee per cubic foot (the rates of which can increase depending on the size and type of product). Sales revenues less these fees are paid by Amazon to the seller on a monthly basis. U.S. federal taxes are not withheld on payments by Amazon to foreign sellers.
Sellers can request at any time for Amazon to return unsold products or dispose of them. Amazon can also return products to foreign sellers at any time and for any reason.
Amazon FBA and Federal Tax Considerations
- Economic Relationship – Distributor versus Agent
In analyzing the U.S. federal income tax considerations associated with Amazon FBA, it is important first to examine the relationship between Amazon and the foreign seller.
On this issue, some commentators and practitioners have suggested that Amazon FBA substantively represents a buy-sell model, which would be a favorable view for foreign sellers from a tax perspective, because this would mitigate the foreign sellers’ activities within the U.S. to a certain degree. They argue that the seller has no relationship with the customer, doesn’t advertise to the customer, and doesn’t invoice the customer, so in substance, Amazon is the seller vis-à-vis the customer (and it is the buyer vis-à-vis the foreign seller).
Other commentators and practitioners, in contrast, believe that Amazon FBA should viewed as an agency relationship. First, Amazon clearly identifies the seller as such when advertising products online. Second, as a legal matter, title to products never transfers to Amazon – rather the sale is legally consummated between the consumer and foreign seller. Further, while unsold and returned items are handled by Amazon, they are ultimately returned to the foreign seller if not resold. These aspects evidence an agency relationship, under which the foreign seller acts as the principal and Amazon provides services on its behalf within the United States.
- Agency Status – Dependent versus Independent
In taking the approach that Amazon does in fact act as the agent of the foreign seller within the U.S., it must then be determined whether Amazon should be characterized as a “dependent” or “independent” agent of the seller.
Using the U.S. Treasury Department’s Technical Explanation to the U.S Model Treaty as a guide, an argument can be made that Amazon is better characterized as an independent agent.
The Technical Explanation to the Model Treaty provides three conditions for establishing independence: (1) The agent must be legally independent of the enterprise; (2) The agent must be economically independent of the enterprise; and (3) The agent must be acting in the ordinary course of its business in carrying out activities on behalf of the enterprise.
First, it seems that Amazon is legally independent of its sellers. Sellers do not own controlling interests in Amazon and there is otherwise no legal affiliation. Further, Amazon is not subject to sellers’ instructions regarding the conduct of its operations or subject to control by sellers. In fact, the opposite is true to a large degree. A foreign seller must adhere to a number of Amazon’s policies in order to participate in Amazon FBA.
Second, it seems that Amazon is economically independent of its sellers. It does not act exclusively or nearly exclusively for any single seller. On the contrary - it is estimated that hundreds of thousands of foreign sellers currently use Amazon FBA. In terms of cross-border business, Amazon FBA currently involves sellers in more than 100 countries sending orders to nearly 200 countries.
Further, in terms of business risk, it shares at least some of the risk of loss with its sellers. While it charges sellers a commission for each product stored and fulfilled, it also provides customer service and return processing, free shipping in certain instances, and must pay for warehouse costs and insurance. In this regard, Amazon has told investors that its fulfillment expenses exceed US$ 1 billion per month. Thus, if sellers’ products are not sold and Amazon FBA proves unsuccessful, Amazon would presumably risk a loss to a certain extent. In terms of legal risk, risk of loss or damage also belongs to Amazon while products are stored in its warehouses. These aspects further evidence the economic independence of Amazon under the Amazon FBA model.
Third, it seems that Amazon acts in the ordinary course of its business in providing FBA services to foreign sellers. Amazon FBA is an enormous and continuously growing business arm of Amazon’s overall concern. Providing an FBA service to a foreign seller is clearly an act in the ordinary course of such business.
Amazon FBA in the Non-Treaty Context
Assuming that Amazon is treated as an independent agent of the foreign seller, then the tax fallout should be further considered.
There are some U.S. court decisions which at least indicate that there is a risk that the regular and continuous activities of even a non-exclusive independent agent in the United States can be imputed to a foreign principal, resulting in a trade or business of the principal within the United States.
If a foreign seller would be found to have a U.S. trade or business by virtue of Amazon’s activities within the U.S., the tax and reporting implications would depend on whether the seller resides in a treaty country or not.
In the non-treaty context, income from the sale of products manufactured by the foreign seller outside the U.S. should presumably be considered foreign source and not subject to U.S. taxation in accordance with the new provisions promulgated under the Trump Tax Reform.
However, income from the sale of products not manufactured by the foreign seller should be considered U.S. source income under the title passage rule. This is because the foreign seller still owns the products while they are housed in Amazon’s U.S. warehouses, thus title to products passes to customers within the United States.
Such U.S. source income should be considered attracted to and actually derived from the deemed U.S. trade or business of the foreign principal and should therefore be considered effectively connected income (ECI) that is subject to U.S. federal income tax as well as, potentially, a so-called “branch profits tax” if the seller is a foreign corporation.
The seller would also be required to file a U.S. federal income tax return to report the effectively connected income. Failure to file and/or pay U.S. taxes can result in severe tax penalties.
We note, in this regard, that once a foreign seller has a U.S. trade or business, all of the taxpayer’s U.S. source active income is automatically considered to be effectively connected income to the U.S. trade or business for U.S. federal income tax purposes, even income from activities wholly unrelated to the U.S. trade or business (the “residual force of attraction” rule). This can be a trap for the unwary who cannot rely on the beneficial provisions of a U.S. income tax treaty.
Amazon FBA in the Treaty Context
In the treaty context, U.S. tax liability essentially comes down to whether the foreign seller is generating income that is attributable to a so-called “permanent establishment” in the U.S. In this regard, the activities of an independent agent normally do not create a so-called “permanent establishment” in the United States under the provisions of the U.S. Model Tax Treaty and conforming U.S. bilateral tax treaties. Further, the warehousing of products in the United States does not itself create a U.S. permanent establishment. Thus, it arguably follows that under treaty law, the activities of Amazon within the United States should not create a permanent establishment of the foreign seller within the United States.
If this is the case, then the foreign seller should not be subject to U.S. federal income taxation, even if the income from the seller’s activities are U.S. source (e.g., title to the inventory passes in the U.S.). However, the seller should be required to file a U.S. federal income tax return in order to report the utilization of the tax treaty. The taxpayer’s treaty position must be reported on IRS Form 8833 (Treaty-Based Return Position Disclosure).
As mentioned above, failure to timely file the income tax return and Form 8833 can have significant adverse consequences. Failure to timely file the return can prevent the taxpayer from preserving deductions and certain credits if the income is found to be taxable. Failure to timely file the Form 8833 can result in a $1,000 penalty for an individual taxpayer and a $10,000 penalty for a corporate taxpayer. It does not, however, preclude the taxpayer from making the treaty claim.
Organizational Structuring for Amazon FBA
In setting up a mode of operations within the United States, foreign sellers use a variety of organizational structures. It’s important for sellers to appreciate that certain structures can have adverse implications. Common structures include:
- Foreign individual is the seller:
This is the simplest structure from a U.S. federal income tax perspective. In this case, there should be no additional tax or reporting issues that are implicated other than those discussed above.
Foreign entity is the seller:
This also represents a relatively simple structure from a U.S. federal tax perspective. Assuming tax is not due then there should be no additional tax or reporting issues that are implicated other than those discussed previously.
It should be noted, however, that if the foreign entity is a corporation and is found, for the sake of argument, to have taxable ECI (by virtue of Amazon’s involvement), it could be subject to a “branch profits tax” in addition to federal income tax. The branch profits tax does not apply to non-corporate sellers, including individuals.
The branch profits tax is designed to subject the income earned by foreign corporations operating in the U.S. to two levels of tax like income earned and distributed by U.S. corporations. Under the branch profits regime, income is taxed at the U.S. corporate rate when it is earned (21 percent), and an additional 30 percent branch profits tax is imposed (the rate can be reduced by a treaty) when the income is deemed repatriated to the foreign parent corporation.
- Single-member US LLC is the seller:
From a substantive tax perspective, there is some ambiguity as to whether this structure presents additional adverse tax implications. An argument can be made that the structure is not problematic because under the entity classification rules as set out in Treasury regulations, a U.S. LLC is treated by default as a disregarded entity from its owner if it has a single owner. As such, from a substantive tax perspective, the U.S. single-member LLC does not exist, and therefore its activities are considered to be the activities of its foreign owner. This position, however, is hardly free from doubt, both under domestic and treaty law.
Either way, this structure does have an additional reporting implication. A foreign owner of a U.S. disregarded entity such as a U.S. LLC must file an annual informational return - IRS Form 5472 (Information Return of a 25% Foreign-Owned US Corporation). The owner must also keep records sufficient to establish the accuracy of the return.
- Multi-member US LLC is the seller:
From a federal income tax perspective under the entity classification rules, a multi-member U.S. LLC is not treated as a disregarded entity, but rather as a partnership (unless it elects to be treated as a corporation). Unlike a disregarded entity, a partnership is a “person” for tax purposes. Further, under the Internal Revenue Code and case law, a U.S. trade or business or PE of a partnership is imputed to its foreign partners.
Thus, even if Amazon FBA would not otherwise trigger adverse implications, this structure could result in taxable ECI in the hands of its foreign partners, even those resident in a treaty country. For this reason, from a tax perspective, foreign sellers may want to consider an alternative organizational structure.