Tobacco tax automation: Is it time to consider new technology?

Amid all the shifts and innovations within the tobacco business, one thing is certain: Excise tax complexity is here to stay for manufacturers, wholesalers, distributors, and retailers. This whitepaper can help you understand how the industry — and taxes — are changing.

Does this sound familiar? Every day, your company’s sales transactions are processed through an intricate system to determine the latest tax liabilities. It’s a labyrinth of spreadsheets, reporting mechanisms, and custom integrations — one that’s been developed gradually over time. With each new tax or regulatory ruling comes another change, and with every tax law change another tweak to the process. Most of the customizations have been overseen by a single point person, perhaps along with an IT contact.

With the growing complexity of state, city, and county excise taxes continuing to expand — can your business keep up this way? It’s a tough scenario many tobacco companies are facing, and an important situation to address with the increasing pace of tax law changes. Amid all the shifts and innovations within the industry, one thing is certain: Excise tax complexity is here to stay. And as each new regulation and requirement arises, adjustments must be made.

Consider the trajectory Other Tobacco Products (OTP) have taken. Once upon a time, just a handful of states collected excise tax on electronic cigarettes and vapor. Then the FDA finalized a rule to regulate all tobacco products, and the level of excise calculation and compliance complexity began to increase tenfold. This is just one example among a sea of many more that makes tobacco tax determination and compliance a highly complicated, highly involved job.

Thankfully, it’s not just IT consultants and tobacco tax teams that are tracking and automating these liabilities. Excise tax specialists are too. And they’re supporting comprehensive automation solutions that have already been shown to save tremendous resources and reduce audit risks in other industries.

In this whitepaper, we’ll explore:

  • Tobacco industry growth and change
  • New tobacco tax challenges
  • The current state of excise tax compliance
  • What tobacco can learn from other industries
  • Outsourcing tobacco tax automation

An industry of innovation

In 2017, Bloomberg published an in-depth report. The headline: Big Tobacco Has Caught Startup Fever. The takeaway: Consumer demands are shifting further from cigarettes, and tobacco companies are at the helm of innovations. “It’s no longer such a stretch to imagine … a nicotine-delivery gadget capable of doing to cigarettes what Uber did to taxicabs or Napster did to the compact disc,” Bloomberg reported. In 2017, global e-cigarette sales were valued at $5B compared to a $92M cigarette market; by 2018, the industry had more than doubled in value to $11.5B.

With the excitement of innovation around new product types — electronic cigarettes, snuff, heat-not-burn products, and more — comes an underbelly of ever-evolving tax rules, rates, and regulations. Tobacco is no longer measured in sticks, cartons, and packs alone, but also in milliliters and ounces. At the same time, new distribution channels have opened the door for manufacturers and wholesalers to sell direct to consumers, and for retailers to act as wholesalers.

These trends toward new types of tobacco products, and new methods for getting them in the hands of consumers, haven’t made excise taxation any simpler. If anything, the opposite is true. As the tobacco industry continues to innovate, taxing agencies continue to seek new ways to regulate.

New tobacco tax challenges

What happens when millions of people abandon one product in favor of another? Tax authorities take note. Such is the case with tobacco. As the smoking population increasingly trades traditional cigarettes for these other tobacco products, tax dollars are diverted to new forms of smoking or nicotine intake. In response, federal and state governments are determining not just how to regulate this multifaceted industry, but also how to enhance tax revenues from these products. As of July 2019, 17 states have specific vaping tax laws in place, as well as a number of large municipalities. This number is expected to grow rapidly, leading to what’s arguably the most wildly disparate (and toughest to follow) range of compliance requirements compared with any other industry in the United States.

For example, in Minnesota, e-cigarettes are taxed at 95% of the wholesale price, while in West Virginia they’re taxed volumetrically at 0.075 USD/ml. In many states an entire e-cigarette starter kit package may be taxed while in other states, a starter kit (or just a pod or cartridge) may only incur sales tax while e-liquid may be taxed at the volumetric rate. Regulators continue to struggle with appropriate taxing structure due to product nicotine content variation and packaging issues. There’s also concern over the true end goal of the tax — whether it’s growing tax revenue or redirecting use of cigarettes to something considered less harmful. 

Often overlooked, the South Dakota v. Wayfair, Inc. decision also recently added a new tax wrinkle. While the primary impact of this case was to expand sales tax nexus for online sellers, it also now requires OTP sellers to collect excise tax in addition to sales tax in nexus states.

It’s critical for online sellers, and any tobacco seller who must collect both tax types, to have a streamlined solution for compliance. Most tobacco companies understand that automation is key to handling any of these complexities, but few are maintaining automation solutions as efficiently as they could.

Excise tax compliance today

Most manufacturers, wholesalers, distributors, and retailers have compliance automation processes in place — ones that have been built over time to address the ever-mounting array of regulatory complexity, ranging from MSA (Master Settlement Agreement) and PACT (Prevent All Cigarette Trafficking) Act reporting to thousands of different states, local, city, and county excise taxes.

These systems are often implemented as add-ons to legacy ERP applications or as custom spreadsheets and manual entries, and they must be updated each time an additional tax law goes into effect or reporting regulation is put in place. They require significant IT and tax resources to modify and test every time there’s a change to taxing or reporting regulations.

To make matters more complex, state taxing agencies often modify required forms and legislative mandates often introduce new reporting requirements. All the while, local, city, and county tax regulations continue to unfold. Every one of these changes, no matter how seemingly small, requires extra effort by tobacco company tax analysts to comply with additional requirements. And if a system is designed to handle only one unit of measure, it can require major changes to handle new ones.

The hidden costs and risks of limited automation

How much time is devoted weekly to tax activities and related IT tasks? Many companies with DIY or inadequate tobacco tax system automation spend too many hours on:

  • Day-to-day monitoring for changes to regulatory rules, rates, and forms
  • Ongoing updates to tweak, test, and deploy new spreadsheet processes
  • Pressing excise tax demands that delay strategic projects
  • A near-insanity level of reconciliation

Bottom line: The ongoing efforts required to maintain inadequate automated compliance systems require extensive IT costs and tax analyst resources over the long haul. Due to the manual nature of custom updates and integrations, they also increase both the risk of reporting errors and the potential for non-compliance penalties.

Most businesses would rather focus on more strategic initiatives to keep them competitive, which means the time is right for tobacco companies to discover the automation solutions currently embraced by other industries.

Best practices from other industries

Many industries with similar excise tax complexity, such as motor fuel supply and distribution, have learned to successfully outsource automation for tax determination, exemption certificate management, reconciliation, and return preparation and filing. By offloading the effort required to track tax rules, rates, and reporting requirements, these companies are able to spend a fraction of the time previously required to build and maintain custom automation systems. This, in turn, allows staff to focus on more strategic work.

The time is right for tobacco manufacturers, wholesalers, distributors, and retailers to consider a similar approach to excise tax compliance automation. By trusting a third party to handle automation, especially when it’s delivered as SaaS, IT and tax teams benefit from shared resources: Tax law research, adjustments, and tests are all handled by dedicated specialists whose full-time work is devoted to fine-tuning automation solutions and ensuring the latest tax laws are reflected. The result? Greater reliability and scalability as well as savings on IT operations and hardware.

Embracing tax automation as a real option

Before embarking on the next round of system upgrades required to maintain tobacco tax compliance or determination, consider leveraging automation of your excise tax function with the experts at Avalara.

Avalara AvaTax Excise and Avalara Returns Excise are continually updated to reflect accurate excise and sales tax rates, and to automate the collection, storage, and management of resale or exemption certificates that are often required. In addition, Avalara automates the preparation and filing of state and local tobacco returns, including electronic filing as required. Transaction details are validated in real time, with warnings when there are missing or invalid fields. These state-of-the-art excise tax automation solutions save tremendous amounts of time while reducing compliance risks, allowing tax and financial leaders more time to focus on strategic-level projects.

How much extra time and effort are you spending on excise tax compliance at your company? Contact Avalara today to discover how much time and energy we can save you. You can learn more at Avalara Excise Tax Solutions or call today 877-803-9818.