As companies and consumers emerge from a year of isolation, the common question is, what does the “new normal” look like? Will buying and selling patterns revert or even partially revert to pre-Covid-19 patterns, or has the U.S. economy and the way businesses operate changed forever, requiring a reboot of compliance practices and procedures?
After 15 months of pandemic lockdown, the world finally is beginning to open up. Despite the physical world having been on hold, businesses continued to evolve, and many thrived during the Covid-19 quarantines. A recent study shows that only 20% of B2B buyers said they would revert to in-person sales post Covid-19. This will bring more complexity to B2B transactions.
Despite the complexity in determining which products and services are taxable in the various jurisdictions across the country, there are some best practices that companies can adopt to help minimize the burden and risk of over/under taxation:
1. Create a taxability matrix
It is imperative that companies which offer a diverse array of products and services map those products and services to the taxability parameters in the 45 states that impose tax. For all but the simplest of companies this will require a software tool which connects the organizations’ enterprise resource planning (ERP) and point of sale (POS) system(s) to a taxability matrix. It is important to remember that not all software systems are comparable, and human intervention will be required. An independent view on which software system best suits your organization is advisable as the wrong decision on software selection can prove costly and risky.
2. Assess any past exposure before committing to current sales tax
One of the most common foot faults of companies that are under pressure to initiate a sales tax collection and remittance process is to immediately register to collect in all states where they have a physical or economic presence without any regard to prior years. Although counterintuitive, we encourage companies to first assess prior years’ potential exposures before registering to collect tax in a state.
The reason is that in several states companies are prevented from entering into voluntary disclosure agreement (VDA) programs if they already have registered and/or are filing sales tax in a state. The advantage of entering into a VDA program is that the potential lookback period is limited to three to four years, penalties are waived, and, in some instances, interest is waived as well.
If audited in some states, penalties and interest can equal or exceed the amount of tax. Washington is one such state that imposes penalties that can exceed 55% for any unremitted liability, (Washington Revised Code Section 82.32.090(1)-(3) and Section 458-20-228(5)(c)). In a large number of other states penalties tend to range between 25% and 30% of any tax due. (Arizona, the District of Columbia, Idaho, Kansas, Louisiana, Massachusetts, Michigan, New Jersey, North Carolina, North Dakota, Oklahoma, Pennsylvania, South Carolina, Tennessee, Vermont, Washington, West Virginia, and Wisconsin all impose 25%. New York is 30%, and Arkansas is 35%)
3. Consider sales tax implications of service offerings
It has been our experience that among the most overlooked areas giving rise to sales tax are businesses that are providing either professional or technical services which are delivered either via hosted websites or subscription/license fee arrangements. Anytime software is involved in the delivery of services there is the likelihood sales tax is due on a portion or all the amounts billed to customers.
Determining the taxability of an organization’s service offerings may require review of all customer contracts to determine which agreements (or components) are taxable. Depending on the volume of customers and agreements, conducting such a review can oftentimes be an arduous and time prohibitive process. The use of artificial intelligence or AI is becoming a valuable tool to aid in the review process. With machine learning, AI can be applied to identify key characteristics among large data files or complex contractual arrangements to categorize key components that would make the delivery of the customer service taxable. Examples would include:
- The existence of software license fee arrangements
- Reference to data or information processing
- Contractual terms around hosted websites
- Existence of bundled service and product offerings
We encourage all companies that have either a large customer base or diverse service offerings to explore the use of AI, in coordination with professional tax advisors to assess the taxability of past and current revenue streams.
4. Be proactive in gathering and tracking exemption certificates
The importance of collecting, retaining, and reviewing exemption certificates cannot be overemphasized. The rules relating to taxable vs. non-taxable activities are complex, even for the most sophisticated taxpayer. Exemptions from tax in large part apply depending on who or what is the consumer of the goods/services. In such instances, sellers are required to charge the applicable tax, unless they receive a properly executed exemption certificate, which they believe in “good faith” entitles the buyer to be exempt from tax—typically, because they either are a reseller of the goods or services or are a qualified exempt organization.
Typically, exemption certificates and the required information are state specific; however, buyers can produce multistate exemption certificates that are accepted by numerous jurisdictions. There is no universal multistate exemption certificate that can be applied toward all states that impose sales tax.
Why Exemption Certificates Matter
The failure to collect properly executed certificates poses significant risk to a taxpayer.
Upon audit, sellers will be required to produce properly completed exemption certificates in order to avoid tax being assessed on the seller. The seller will be required to produce a properly executed exemption certificate covering the period the sale(s) occurred or produce evidence the buyer remitted the tax directly (either via self-imposing use tax or via a direct pay permit).
In some jurisdictions, the taxpayer has a limited amount of time, either after the sale or upon request, when under an audit, to produce a properly executed certificate. For example, Texas requires a properly executed resale certificate to be received “at the time the taxable transaction occurs.” All certificates obtained on or after the date an audit commences are subject to verification. Sellers have 90 days after written notification from an auditor to produce validly executed certificates. (Texas Tax Code Section 151.104(d), effective June 17, 2021)). Other jurisdictions have similar guidelines. The periods tend to range between 45 and 120 days upon audit request.
Further complications can result when a state auditor uses estimation techniques in quantifying the state sales tax liability deemed due during a select audit period. If failure to produce a valid exemption certificate results in an “error” or uncollected tax for a period, the error can be used to estimate the aggregate liability due throughout the audit. So, even a small transaction, when used to estimate an error factor across a typical two-three-year period, can result in a large audit assessment.
5. Seek proper advice
As the economy continues to expand, so will the manner and nature in which goods and services will be delivered to customers. The continued evolution to digital solutions, while driving increased results, creates added complexity from a sales/use tax compliance perspective. Sales tax impacts all aspects of the business, including sales/marketing, accounting and finance, IT, procurement, delivery, and ultimately the sales tax reporting process. It is important that companies address the potential implications across all functions on an integrated basis involving independent advisors with the skills and experience to help navigate the terrain. Selecting professionals that can help measure the cost/benefit of various alternatives, including selecting and implementing the right sales tax compliance system, is an important step in achieving the right result for your organization.
So, what does the “new normal” look like when it comes to sales and use tax matters? No one knows for certain, but trends clearly point in the direction that digital product and service offerings will continue to accelerate, requiring that the sales tax implications of these transactions are carefully scrutinized.
From a sales tax perspective, this means that those responsible for administration of sales tax will be looking to transform historic practices and adapt to increased digital delivery of goods/services. Therefore, partnering with or outsourcing to professionals and service providers that can help seamlessly facilitate the compliance process—which enhances the customer experience while improving the accuracy and efficiency of sales tax determinations—will be critical.
Correspondingly, trends already are indicating that the states are stepping up their use of digital products and tools, including the use of AI to identify organizations that are not in compliance with the new economic nexus guidelines. Once identified, they are keen to focus on areas which give rise to potential increased tax liabilities.
In summary, the “new normal” likely means tax and financial leadership will need to not only increase efforts to retain or improve efficiencies, but also work closely with business personnel to deliver value-added solutions in serving their customers.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Bob Peters is a managing director and national practice leader of Sales and Use Tax Services at Duff & Phelps, a Kroll business. Bob is based in the Chicago office.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.