How Transfer Pricing Can Minimize State Nexus for Consumer Goods Companies

Expanding into e-commerce or DTC sales can create unexpected state tax nexus. Learn how transfer pricing policies can help companies reduce multi-state tax exposure.

Consumer Goods Company Avoids State Nexus with Proper Transfer Pricing Policy

Company Fact Pattern

The company designs, manufactures, and distributes a range of consumer products. As it expanded into direct-to-consumer ecommerce, the business faced potential state tax nexus exposure, raising the question of whether a transfer pricing structure could mitigate the risk. Historically operating on a B2B model, it sold to the U.S. market through a handful of third-party wholesalers across ten states.

Based on the popularity of its product line, the company recently launched a parallel direct-to-consumer (DTC) channel via a new company-operated e-commerce store.  While the DTC revenue remains modest, demand has been strong, with retail customers across all 50 states.

The DTC business built within the existing wholesale operation using the same personnel, with the addition of a small e-commerce team.

The State Tax Nexus Problem

The legacy B2B business had never had sales in the State of Washington.  With the launch of direct-to-consumer internet sales, the State of Washington argued that the company had established state tax nexus, potentially exposing the entire wholesale operation to multi-state tax obligations, not only for the relatively minor DTC business, but for the much larger wholesale operation. The question became: how could this exposure be avoided in other states?

Transfer Pricing Solution

While the company maintained that the web-based business was separate, it functionally operated as an integrated part of the larger enterprise, rather than as a distinct operation working at arm’s length.

The solution

• Creating a Separate DTC Entity
  • A separate legal entity was created to house the DTC business, and the e-commerce team was relocated to this new entity.
• Arm’s Length Pricing Between Entities
  • The new entity purchased inventory from the legacy entity and resold directly to consumers, with an arm’s length return benchmarked for online sales.
• Operational Support and Service Fees
  • The legacy entity continued to provide back-office and logistics support, in exchange for an arm’s-length service fee.

Going forward, with a truly separate business operating at arm’s length from the legacy operation, the DTC entity can avoid pulling the much larger legacy B2B business into the tax net of states where it would otherwise have no nexus.

Why This Structure Reduces State Nexus Risk

When ecommerce operations are integrated within an existing entity, states may argue that online sales create economic nexus for the entire business. Establishing a separate legal entity with properly documented transfer pricing policies can help isolate activities and reduce the likelihood that DTC sales will pull unrelated wholesale operations into additional state tax jurisdictions. Beyond setting appropriate transfer pricing, other important state and local considerations must also be addressed.

Contact Us

Navigating state nexus and transfer pricing can be complex. If your business is expanding into new sales channels, our team can help you get ahead of potential exposure before it becomes a problem. Connect with our state and local tax team here or with our transfer pricing team here.