Businesses that do not take the steps to ensure that tax is properly paid for their acquisitions expose themselves to substantial risk, including:

Transcription

1 Taxware, a Sovos Compliance Company INDIRECT TAX The Tough and Tiring Demands of Use Tax Few would argue that sales and use tax compliance is a simple process. Rather, it can be extremely complicated as well as time and labor intensive. Under these circumstances, tax technology becomes a soughtafter and necessary solution. In an ideal world, sales and use tax would be, generally, a revenueneutral activity. The only out-ofpocket cost should be the administrative cost associated with collection and remittance. Many organizations apply significant time, effort and technology to ensure they meet their tax collection and remittance obligations for sales and accounts receivables. However, when it comes to confirming use (vendor) tax calculations, some organizations do not apply the same level of diligence. Businesses that do not take the steps to ensure that tax is properly paid for their acquisitions expose themselves to substantial risk, including: Risk associated with both overpayments (a completely unneeded expenditure that will likely never be recouped) Risk associated with underpayments (and the related risk of penalty and interest imposed upon audit) Often, organizations will set aside substantial reserves to account for underpayment exposure. Cash placed on reserve, by definition, is cash that remains completely unavailable to meet other, immediate, business needs.

2 Vendors and Use Tax: Challenges In jurisdictions with larger populations, state and local combined rates can be as high as 9.5% and losses associated with poor A/P tax compliance can be, and often are, substantial. Therefore, the question remains: Are business purchasers justified in trusting their vendors to understand the nuances of collecting the proper tax? Stated another way: Can businesses accept, largely on blind faith, that vendors apply the necessary time and effort to make sure that the use tax on their invoices is accurate? Tax rates, especially local rates, are subject to change on a month-to-month basis. Basic compliance requires that vendors track and update their systems to account for these changes. However, accounting for proper rates is only the tip of the iceberg. Vendors also need to consider: Origin versus destination sourcing on intra-state transactions Caps and thresholds (For example, does your vendor know that local tax in Florida is capped on the first $5,000 of sales price?) Dependent versus independent local nexus (i.e. Is your vendor collecting tax at all applicable taxing levels?) Product taxability rules (i.e. special rates and exemptions that are particular to certain items) Product taxability rules and nexus can be challenging issues and are likely to rapidly and consistently change based upon new or revised legislative and regulatory enactments. For example, it is extremely important to manufacturers that their vendors fully understand the nuances of the special rate that was recently enacted by the state of California. These types of regulatory changes are happening every day, across all jurisdictions. It s important for organizations to consider how comfortable they are with their vendors properly tracking all of these rules and applying the changes. In addition, it s not uncommon for vendors to not register for tax collection in self-administered localities even if they may have an obligation to do so. Instead, they may simply view the audit risk associated with not registering as smaller than the administrative burden associated with maintaining compliance. Purchasers in these locations, however, will not likely have the same perspective and will be held responsible for self-assessing the correct tax, regardless of the vendor s compliance activities and standards. The remainder of this paper details some of the steps that purchasers can take to increase their level of use tax compliance and covers both the advantages and the concerns associated with each methodology.

3 Techniques for Mitigating Use Tax Risk and Exposure Proactive organizations can take steps in order to avoid the loss associated with tax overpayments and the penalties and interest that may accompany underpaid tax. Available methods include: Direct Pay Permits (DPP) Invoice Verification Tax Tolerance Processing Evaluated Receipt Settlement (ERP) Direct Pay Permits (DPP) The most direct approach to eliminate vendor error is for organizations to completely absorb the vendor s responsibility by obtaining and utilizing a direct pay permit. When a purchaser provides a direct pay certificate and the vendor accepts the certificate in good faith, the vendor is effectively relieved of any tax collection obligation. That obligation is completely transferred to the purchaser. The advantages of utilizing a Direct Pay Permit are: Removes the possibility of costly errors caused by the vendor/seller Defers tax payment, allowing the purchaser to self-assess and remit tax at a time subsequent to purchase Yet, there are drawbacks, such as: DPP is not available in all states DPP authority is often grated at the discretion of state revenue authorities (i.e. all purchasers that apply will not be issued a permit) DPP authority is not applicable to all acquisitions (depending on state rules, it may only be appropriate when the ultimate use of the product is unknown at the time of purchase) It places the entire responsibility of self-assessment and remittance on the purchaser, which can create additional strain on their internal compliance team, especially without the use of tax automation Invoice Verification Invoice Verification is a simple process of manually verifying the tax calculations which appear on vendor invoices. The advantages of invoice verification are: The process is straight-forward and can be accomplished with minimal adjustments to your accounting systems It s flexible and adaptable to the business and a purchaser can determine which invoices they want to review and which vendors they trust However, invoice verification is time and labor intensive, inefficient and far from comprehensive. A tax engine can be used to validate proper tax rates and taxability rules, but with this methodology, this process is completed one invoice at a time.

4 Techniques (Cont.) Tax Tolerance Processing Tax Tolerance Processing is similar to Invoice Verification but much more sophisticated and comprehensive. It involves a purchaser utilizing a tax calculation engine to place themselves in the shoes of their vendor in order to ensure the vendor charged the correct tax. In the end, the purchaser compares the tax on their invoice with the tax calculated by their engine. In the event that the amounts differ, the purchaser will have a set tolerance which indicates how much of a differential they will accept before taking further action. Tolerances can be dollar-based or percentage-based and vary from vendor to vendor. That is, organizations may set different tolerances for vendors that they deem less trustworthy. The advantages of Tax Tolerance Processing are: The process is automated and can be deployed comprehensively Flexibility: Tolerance levels can be based on business needs The disadvantages of Tax Tolerance Processing include: It requires an up-front effort to implement a tolerance process While a tax engine is indispensable in applying proper rates and taxability rules, tolerances are generally established within an organization s accounting system/erp In order to accurately assess whether tax was invoiced correctly, the purchaser must understand the vendor s nexus footprint and shipping locations Purchasers remain responsible for selfassessing any tax that was not properly charged by the vendor Evaluated Receipt Settlement Evaluated Receipt Settlement (ERS) is the product of an agreement between the purchaser and the vendor. In sum, it allows an automated payment to a vendor upon delivery of purchased goods - a traditional paper invoice is not required. The sales price is derived from a price list maintained by the vendor and provided in advance to the purchaser. Companies may not enter into an ERS arrangement with the primary intent of simplifying tax compliance, but nonetheless, it is a factor to consider. Upon adopting an ERS process, the vendor agrees to: Provide accurate price lists for all items that the purchaser may buy Accept an electronic purchase order or some other document from the purchaser which adequately specifies quantity and price Ship the ordered goods prior to receiving payment and without issuing an invoice Not charge tax In turn, the purchaser agrees to: Upon receipt, determine the correct gross amount for the item based on the vendor s price book/catalog and apply any relevant discounts to determine the appropriate sales price Calculate the correct tax for purchased items based on product taxability rules and the appropriate rates Tax must be calculated as if it was being calculated by the vendor (i.e. based on their nexus footprint and locations in order to properly account for origin-based jurisdictions and the possible difference between sales tax and use tax rates) Upon receipt of the goods, the purchaser remits payment including tax. The vendor remains entirely responsible for reporting and remittance to the relevant tax authority.

5 Challenges with ERS For purchasers, some of the tax-related advantages associated with ERS are the following: Complete control over tax amounts paid to vendors No short paying invoices and the corresponding discussion/debate as to the proper tax amount due. However, ERS comes with challenges as well: The Thorny Nexus Within an ERS environment, the vendor is entrusting the purchaser to calculate tax correctly. However, while rates and product taxability rules apply universally, the same is not true with respect to tax collection obligations (nexus). That is, in order to truly sit in the shoes of the vendor, the purchaser must know where a particular vendor does (and does not) have tax collection and remittance responsibilities. For example, if a vendor ships an item to a state or locality where they do not have an existing nexus footprint, the purchaser s tax obligation changes significantly. In this circumstance, they should not pay the applicable tax to the vendor, as the vendor would not have a proper avenue to remit the tax. Instead, the purchaser has a concurrent obligation to self-assess and remit use tax. It s also important to remember that nexus is not static. As a company grows, their nexus footprint may expand, and in an ERS environment, it s crucial for the vendor and the purchaser to share this information in order to ensure continuous compliance. Tricky Locations, Sourcing, and Tax Types One of the fundamental precepts of sales tax is that inter-state transactions are properly taxed at the destination jurisdiction. Many years ago, the US Supreme Court held that any contrary rule would impose an undue burden on interstate commerce. However, the Court does not have the authority to regulate in-state commerce and states remain free to apply either origin or destination based tax on intra-state shipments. Likewise, while sales tax is generally due and payable on intra-jurisdictional transactions, interjurisdictional transactions are often properly subject to seller s use tax. While sales tax and use tax rates are identical at the state level, this is frequently not the case with respect to local-level tax. Many localities have opted to impose a use tax rate that is different than the sales tax rate. Some localities have opted to impose no use tax rate at all. With respect to ERS, this means that in order to properly determine the applicable local tax on a given sale, the purchaser must know: The location from which a particular item will be shipped (Ship From) The location where the vendor records or takes the order (Location of Order Recording or Point of Order Origin) The location where the vendor officially accepts the order (Location of Order Acceptance or Point of Order Acceptance) These locations, in conjunction with the Ship To location, are necessary to determine the applicable local tax on intra-state shipments as well as whether sales tax or seller s use tax is due.

6 Challenges with ERS (Cont.) Additional concerns with ERS: It requires an agreement between purchaser and vendor (i.e. energy spent establishing a trustworthy business relationship) ERS is only an appropriate avenue when the purchaser and the vendor do business with each other on a repeated basis as there is significant effort required for ERS implementation The purchaser and the vendor must commit to the continuous sharing of information with respect to prices, business locations and nexus Tax automation can be an extremely useful tool in implementing an ERS process. Optimally, the engine can properly account for the vendor s nexus and location parameters when determining the applicable tax. Likewise, the engine should have the ability to apply and assess consumer s use tax when an item is purchased in a jurisdiction where the vendor is not registered. Our Solution The complexity of ever-changing tax laws and rates makes compliance very difficult for many companies. Powered by Taxware technology and expertise, Sovos Compliance provides solutions that automate the complex process of calculating, remitting and reporting both sales and use tax liability. Sovos Compliance adds new content to our calculation engine each month and the vast majority of this content can add significant business value on both A/R and A/P sides of the organization. Our Online Tax Calculator serves as a very useful invoice verification tool. Sovos Compliance also provides a properly implemented engine that can robustly support Tax Tolerance and ERS processes. Our sales and use tax solutions rely on content that is updated monthly by our tax compliance team, that continually monitors tax rules in 13,000 jurisdictions to ensure superior accuracy both with respect to rates and product taxability rules. By combining powerful calculation software technology with our expertise, our products serve as powerful tools to support the complex compliance needs of our clients. About Sovos Compliance Taxware, a Sovos Compliance Company Sovos Compliance designs technology solutions to help businesses meet the demands of their unique tax compliance and reporting obligations. Our trusted industry expertise and global research capability enables over 3,000 clients to operate with the confidence to efficiently navigate today s dynamic regulatory environment. Sovos Compliance utilizes a unique ability to turn knowledge into highly functional, scalable software that seamlessly integrates with a wide-array of applications and information technologies used by businesses today. Ultimately, we give clients peace of mind by simplifying tax compliance, providing greater control and visibility and mitigating compliance risk. Contact Us Today Find out how we can put these solutions to work for you info@sovos.com sovos.com 200 Ballardvale St. 4th Floor Wilmington, MA sovos.com