IDC Analyst Connection: Ecommerce explosion makes sales tax compliance even tougher

The rise in online sales makes automating sales tax compliance an imperative for small and midsize businesses, says IDC Research Director Kevin Permenter.

We recently asked Permenter five questions about changes he’s observing as more buyers move to online shopping. Here are his expert insights and recommendations.

How has the pandemic-driven shift to omnichannel commerce affected tax obligations for businesses?

The number of people and businesses selling online and moving toward a digital business model is exploding. At IDC, we’ve seen even traditional companies add digital products and services to take advantage of the rising digital tide. As a result, many more companies are subject to online tax compliance.

At the same time, digital tax compliance laws are increasing at a rate that we’ve never seen before. The landscape of tax compliance is shifting quickly, and it’s happening worldwide. In the United States, economic nexus rules are emerging and changing at both the state level and the city level. In Europe, rules and standards including Making Tax Digital (MTD) in the United Kingdom and the Standard Audit File for Tax (SAF-T) in the European Union. Italy, Norway, Germany, Belgium, and Hungary are implementing slightly different versions of SAF-T.

Businesses also must account for the rise of marketplace facilitator laws that require facilitators to collect and remit sales tax. That’s an additional layer of complexity when conducting business in the digital economy. Marketplace laws will continue to grow as more countries recognize marketplaces as potential sources of tax revenue, especially when the growth of online shopping is making it easier for even small merchants to reach thresholds requiring them to collect and remit taxes.

The complexity involved in staying compliant — maintaining registrations and licenses, meeting reporting deadlines — is simply overwhelming. That’s particularly true for companies that lack the tools they need to cope with the massive complexity.

Omnichannel sales are making tax compliance more difficult and complex than any other time in human history, and no matter how you look at it, the complexity is only going to increase in the next few years.

What typically are the main stages of tax compliance for businesses?

Broadly speaking, businesses must do these things:

  • Understand where they have tax obligations or nexus
  • Register and license to collect tax in those places
  • Determine the taxability and correct rates in each jurisdiction for all their different products
  • Manage documentation for exempt sales
  • Prepare and file returns that meet all appropriate deadlines
  • Maintain documentation for any potential future audits

There are many points of confusion for small businesses within each stage. Determining nexus, for example, can be confusing and really can feel overwhelming. Nexus statutes can vary tremendously from state to state within the United States, and so can a business’s obligations to meet them. This is true whether you’re a U.S. company, or a foreign company trying to sell into the U.S. market.

Then once you’ve determined your nexus and the taxability of your products, you’ve got to accurately calculate how much tax to collect and remit. Software tools can be helpful throughout the entire compliance process, but it’s in the calculation of sales tax where indirect tax tools really earn their money.

It would simply be impossible for the typical small ecommerce vendor to make accurate calculations without the help of sales tax software. These tools harness the collective data on sales tax rates for more than 13,000 sales and use tax jurisdictions in the United States and allow omnichannel retailers to give customers accurate, real-time views of sales tax associated with a product at the point of sale.

How should businesses integrate tax into their payment and checkout processes?

The regulatory landscape for individual online sellers is in constant flux from state and local jurisdictions changing their requirements and procedures, as well as from the businesses themselves gaining new customers in far-flung locales. The heaviest part of this burden falls on small and midsize retailers, because typically their tax management resources — in terms of time, money, and people — are more limited.

Fast and accurate tax calculation is an important aspect of the overall customer experience. It gives buyers confidence they are getting the right price and are doing business with a professional organization that cares about the details. This confidence is critical as online sellers look for ways to differentiate themselves in a crowded ecommerce market.

An additional aspect of the customer experience relates to product returns. Software that can handle charging the correct tax amid the widely varying returns scenarios can also impact customer experience and build brand loyalty.

One more thing: The amount of data that tax managers contend with can be a major hurdle. Moving data quickly and easily between business applications is critical. To get tax compliance right, omnichannel businesses need tax technology that integrates into every system that creates an invoice. When companies explore tax management software, the depth and maturity of their API strategy should be a huge consideration.

How can businesses apply artificial intelligence and machine learning to improve tax compliance?

Tax software vendors are working to embed intelligence within tax compliance workflows, for things like managing exemptions, product codes, tax calculation, and reporting. They also are using robotic process automation and more advanced technology like artificial intelligence (AI) and machine learning (ML) to automate lower-level tasks:

  • Companies already use AI to perform lower-level repetitive tasks like calculating the proper sales tax rate for the proper jurisdiction
  • Software vendors are experimenting with chatbots and virtual assistants to help users determine nexus or collect and/or remit the correct amount of tax
  • Some software vendors are making great strides in using AI/ML to address product classification challenges faced by many ecommerce merchants.

At IDC, we expect these trends to continue and become key factors in determining market positioning among corporate tax software vendors.

What are the biggest areas of tax automation innovation?

The adoption of cloud technology is reshaping the corporate tax management function and the pace of that is only going to increase.

The cloud allows for anywhere, anytime access, which allows businesses to be flexible and agile in coping with rapidly changing business dynamics. In the future, businesses will demand extensive automation functions to cope with the massive data load generated during the sales tax management process.

Data management is another factor. The volume of data and the increasing pace of commerce place immense pressure on tax managers. As a result, integrations built upon solid APIs have become a focal point among tax professionals. APIs let developers and managers quickly add or modify data flows into and out of the software application, which allows tax management systems to be more flexible as business needs change. Tax data can be shared seamlessly between related systems — your CRM, ERP, and online commerce systems — which adds a layer of process efficiency.

Automation also will play a significant role in breaking down the walls of traditionally siloed activities such as tax compliance, inventory management, and accounts payable. It will form the backbone of a data management framework, allowing greater coordination, collaboration, and communication.

Businesses are demanding a single view of their company’s financial position, and the rise of automation finally has made this attainable.

One more thing: AI/ML is rapidly evolving to become an essential element of tax management. Our research at IDC found that more than 76% of tax managers would be willing to pay a premium for software with AI/ML technology. As digital commerce continues to grow, so too will the demand for AI/ML. It’s going to be a “must-have” feature of tax management software in 2022 and beyond.

To learn more about this topic, read our online sellers’ guide to sales tax compliance.

This post is drawn from an IDC Analyst Connection report, sponsored by Avalara and published in February 2022.

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