When administering sales and use tax from the corporate perspective there are inherent problems within the process that create inefficiencies and errors. These inefficiencies and errors can cause over and/or under payments of tax. Like corporate America, the revenue departments of the various states have also been forced to change the way they do business. Not a day goes by that we are not told about the fiscal disaster facing various states, counties, cities, and districts. With more and more companies facing net operating losses, thereby eliminating income tax as a major source of revenue for the state and local taxing jurisdictions, we are finding a greater emphasis being placed on sales and use tax as a major source of funding to make up the shortfall. Sales and use taxes are becoming the focus of states for revenue. One area in particular that states are concentrating more on to increase those revenues are your purchases. With manufacturers’ sales for resale, and retailers’ sales in compliance, states are seeking revenue from the purchase side versus the old tried and true sales side. The purchase side of sales and use tax has inherent problems that can create reporting inaccuracies. Some of those problems are a result of “Who is Making Your Tax Determinations?”
From our experience in the field we see that most companies have sales tax software for their sales side, however, most have not addressed the use tax, purchase side, of a transaction in terms of automation. Most sales tax packages were designed for the A/R side of the sales tax equation and were later altered to accommodate the purchase side utilizing the same static matrix established for the sales side. With that in mind, if automation on the purchase side isn’t used, or is limited “Who is Making Tax Determinations” at your company? Who is qualified or trained to make those tax determinations. In a simplistic flow chart we usually have four categories that show the day in the life of a purchase transaction that will need a tax determination at some point. The process starts with “Requisitioning, then moves to Purchasing and then onto A/P for payment. The last stronghold is Compliance where use tax, not sales tax on invoice is usually reviewed and reported to the respective states. These are the front lines for use tax determination on purchases within an organization.
Usually Purchasing and A/P are the two areas commonly responsible for use tax determination on purchases in today’s corporate environment. In most companies the tax department is absent from this process for several reasons. The sales and use tax function may be centralized within a shared services group separated not only from the tax department but informational sources as well. The tax department may also be separated by decentralized transaction tax processes and compliance, for example at the plant level. As we know tax departments are running lean and mean these days with limited resources and more responsibilities which leave less time for proper transactional tax review. And if the tax department is doing a review of transactional tax I know they would love to get rid of it. So if the tax department and their expertise are not involved in the purchase process “Who is Making Your Tax Determinations”, most likely those other overworked groups like Purchasing and A/P. This typical scenario leads to “In-Consistent and Subjective Tax Decisions”.
Over the years we have seen use tax determination accuracy on purchases vary widely from company to company. Rarely do we see a system or process that produces above an 80% accuracy level. And unfortunately, that is often due to “Who is Making Your Tax Determination”. Purchasing and A/P already have a job that is their ultimate responsibility. They are not tax experts nor do they claim to be. Tax determination is not the priority of these groups. If these groups are decentralized in multiple locations “In-Consistent and Subjective Tax Decisions” are usually more frequent. You throw in turnover, large volume of transactions, changes in corporate structure/organization, new vendors, new products, changes in tax law and you have a recipe for “In-Consistent and Subjective Tax Decisions”. The same item purchased one month may be treated differently the next by that same person who is making the tax determination. Two identical items purchased could be used in two different areas making one taxable the other exempt. These tax determinations hinge on a particular individuals interpretation. Interpretation is subjective and in-consistent, resulting in potential overpayments and underpayments of sales and use tax on a regular basis.
Therefore, the challenge before companies is how to shore up their use tax processes and procedures to minimize the over and under reporting of tax. “How do you gain confidence in your tax determinations”? There are several methods used to gain a confidence level in your tax determinations. Typical methods in the past have been taxability training, matrices and reverse audits. However, there are draw backs to these remedies as they usually only provide short term benefits. There are costs associated with training, events we can’t control such as turnover, law changes and the states making it more difficult to recoup historical overpayments. There are approaches that are providing better results.
Fittingly for our computer generation, software is another approach that is gaining functionality. Forerunners such as Taxware, Vertex and CCH to name just a few have made the sales side of compliance tolerable and more efficient over the past decade. Lagging behind in the software compliance arena has been the development of true purchase side software that specifically addresses the use tax issues associated with it. That has changed over the past several years with software packages such as Sabrix and STS Corporate and others. These software packages are specifically designed for the use tax, purchase side of transactional taxes which is so much more complicated than the sales side. They have up to date rates and forms, but even more importantly are the monthly law changes. Taxability decisions will be correctly and consistently made throughout the ages. These packages offer consistency and confidence in who is making your tax determinations.
There is also the use of Compliance Agreements, also known as Single Rate Agreements that have come a long way in acceptance. Compliance agreements are created to establish simplified procedures for the calculation and remittance of use tax. A formulary factor is established and agreed upon with the taxing jurisdiction that is then used to calculate future use tax liability. Unfortunately, this approach is only for the expense side and does not include your fixed assets/capital projects. Utilizing compliance agreements is a cost and resource effective tool to properly remit a company’s use tax on expense purchases.
The inherent problems and challenges associated with the purchase side of sales and use tax exist in almost every company and need to be dealt with. In a perfect world the “Ideal Use Tax Solution would be to automate and centralize all tax determinations for all purchase transactions at line item, distribution level detail. Eliminate the role of Purchasing and A/P in the tax determination process by embedding the Tax Departments’ expertise into a software system eliminating errors. Apply consistent taxability positions now and into the future. Streamline the compliance process creating efficiencies with no manual review and automatic feeds. This will produce more accurate audit results in a fraction of the time and allow quick access to critical data through a data warehouse.
In this “Ideal Use Tax Solution” the object would be to minimize overpaid/underpaid taxes with up to 99% accurate tax determinations, reducing protracted tax audit cycles and cost of audit administration. This solution would also eliminate audit penalties and interest and reduce repetitive stop gaps to get the results you want.
Use tax on the purchase side has been a problem since the inception of transactional taxes. Complying with this tax has created over and under payments, penalties and interest to all required to administer it. States are seeking more and more revenue for their budgets and sales and use tax is on the front line. With so many manufacturers’ sales for resale, retailers’ sales in compliance, states are concentrating on the purchase side. With the inherent problems and challenges of use tax determination facing companies the “Ideal Use Tax Solution” is desirable and achievable.
Dru Beguelin is a Partner at A-SALT Group, LLC where he is a member of a growing practice in the state and local tax arena. A-SALT Group is a dynamic company comprised of professional individuals who bring over 38 years of combined state and local tax experience to bear on your tax needs. His company offers a variety of services focused in the area of Sales and Use Tax, Canadian Sales Tax, and Property Tax.