Tax Compliance and the Supply Chain
Avoiding Audit in High-Risk Areas
For businesses providing products and services along the supply chain, sales tax audit risk isn’t always obvious. And yet businesses such as wholesalers, manufacturers, distributors, and retailers represent some of the highest risk industries. Understood as the method by which a product or service is brought to the end-user from the manufacturer in a systematic fashion, the transactions along the way between various companies along the chain can expose a business to audit risk.
This Q&A reviews pressing questions of supply chain audit risk.
Question #1. Why does sales tax matter to businesses along the supply chain?
As states grow hungrier for additional revenue, increased scrutiny of high-risk industries such as manufacturing and distributing result in more aggressive and sophisticated audit tactics. The bottom line is that state sales tax revenue is second only to property tax as a source of revenue for states, and during recessions and periods of slow growth that revenue shrinks. For businesses in the supply chain, this translates into increased sales tax collection requirements and scrutiny by tax authorities. Working in multiple jurisdictions–with numerous rates, various tax exemptions, fluctuating sourcing rules and a myriad of product taxability rules–opens businesses along the chain to audit risk. Creating a tax-efficient procurement process is the best way to protect your business in this high-risk audit environment. Finding a solution that removes the human element from the entire tax compliance process, which automates the product movement touch points between companies in a supply chain, is the growing trend.
Question #2. Do companies along the supply chain ever have use tax requirements?
Like sales tax rules, consumer use tax rules vary by state and apply to sales between businesses along the supply chain. These companies face unique use tax challenges. A company buying goods outside the state or online is required to report and remit consumer use tax for the storage, use, or other consumption of tangible personal property (TPP) not otherwise subject to sales tax. Use tax must also be paid when a business withdraws goods from inventory for its own use, or on items given away as promotions. It is a business’ responsibility to determine when, and how much, to self-assess and pay the state and/or local tax authority on a tax return. For example, a company that buys laptops from an out-of state supplier must identify invoices where sales tax is not billed, and ensure that use tax is paid correctly wherever the computers are shipped or stored. Companies with multiple business locations in several states, or with a remote sales force selling into numerous states, are especially vulnerable to the intricacies of consumer use tax.
Question #3. What is “sourcing” and how does it apply to the supply chain?
“Sourcing rules” govern which state dictates the taxability of a particular sale or transaction. This in turn determines which rates and rules apply to a given transaction. The tax on sales made within a single state, intra-state, is almost always applied based on the seller’s location (“origin sourcing” or ship-from). On the other hand, sales between states, inter-state sales are typically based on customer’s location (or the rules in place at the customer’s location (“destination sourcing” or ship-to). In other words, the end-user’s location typically defines the tax rules that apply to the transaction. In a destination model like we have in most US states, sellers making sales across state lines usually collect tax and adhere to the nexus rules in place at their customers’ addresses. For multi-state companies — especially manufacturers, wholesalers, or distributors — these matters are complicated by the supply chain. The taxability of a transaction can change when a drop-shipper is used. A drop shipper is a third party shipper that delivers goods directly to the customer from the manufacturer. Sales tax and exemption certificate collection, becomes complicated when the drop shipper is located in another state. Think of drop shipments as three separate transactions: Seller to consumer; Distributor to seller; Distributor to consumer. How and when to charge sales tax to the Consumer, and when to issue exemption certificates to distributors are complicated and create risk for companies.
Question #4. Why does manually handling exemption certificates matter so much to overall sales tax compliance?
Probably the riskiest and most difficult aspect of sales tax compliance is the management and tracking of accurate exemption certificates. Since every step along the supply chain involves either a manufacturing exemption or a sale for resale, each company in the supply chain all the way up to the retailer has to both issue a certificate and collect one. Every certificate has to be kept on file. From a sales tax compliance perspective, manually managing tax-exempt sales and associated paperwork not only increases risk of audit, it also ultimately costs more in manpower and other resources than outsourcing does. Most companies are turning to the automation of exemption certificate management, and the integration of an exemption certificate solution into their billing system. By applying tax based on stored certificates, the audit risk is drastically reduced.
Question #5: Create a Sales Tax Management Action Plan
ERP systems are the backbone of any company that works in the supply chain, but end-to-end supply chain tax compliance is difficult for a multitude of reasons. In most cases, calculating sales tax within an ERP such as Sage requires entering and tracking sales tax schedules in each applicable city, county, and state – as well as rules, rates, and boundary changes. Additionally, address validation functionality is limited to ZIP codes and can result in wasted staff time tracking down correct addresses and contact information or charges from carriers for incorrect addresses. When it comes to supply chain efficiency and end-to-end tax compliance within an ERP, using a sales tax management solution that automates compliance within your company’s existing framework is cost effective and relatively easy to implement. More importantly, automated sales tax compliance can free up resources to focus on building the bottom line, as well as reduce the overall risk of your company being audited. But don’t take our word for it. Here’s what one happy customer has to say:
“Avalara AvaTax provides us with functionality that competitive products just couldn’t offer. As we enter transactions into our ERP, AvaTax is working in the background and dropping the accurate tax rate right into the invoice. It’s that simple.”
— Tom Ott Sales Tax Manager Proceq USA (A manufacturer of portable testing instruments)