What is in this article?:
- Five Indirect Tax Mistakes That Could Cost You Money
- ABB Powers Up Indirect Tax Savings
Sales and use tax processes at many businesses are in need of some serious revamping. Here's where companies get it wrong -- and how one got it right.
For something that's supposed to be one of only two certainties in life, tax surely generates a vast amount of uncertainty. This is especially true in the realm of sales and use taxes, where businesses must cope with a patchwork of thousands of jurisdictions across the United States and constantly fluctuating rules and rates. The average number of rate changes per year is around 800, according to a March report from tax software firm Vertex. Since 2000, 2,631 new indirect taxes have been levied. And the rate of change seems to be speeding up; the average number of changes in 2008 and 2009 was 30 percent higher than the average number from 2000 to 2007.
The average sales tax rate nationwide is around 5.5 percent, and of course it goes much higher when local rates overlay the state levy (as high as 9.4 percent in Tennessee). Unlike income taxes, sales and use taxes have to be collected and remitted whether you make a profit or not; for any given transaction, an error could translate to a direct loss to the company's bottom line.
The complexities of indirect tax compliance result in companies carrying large reserves to cover possible penalties. But the risk is reputational as well as financial, notes Jon Sweet, principal and chief strategy officer with tax solutions provider Ryan Inc. "There's a critical new relationship between the quality of tax management and the overall corporate reputation and market capitalization," he says. "With transaction tax representing such a large portion of overall corporate risk and cash flow, it's critical that the tax function actively participate in mitigating risk."
As a first step in that direction, tax managers may need to convince the upper echelons of management that the sales and use tax process is in need of some serious revamping. Here are some of the more common, and costly, missteps that companies make.
1. Striving for the lowest cost. While many organizations set their sights on maximum cost efficiency, giving too little weight to effectiveness in the equation can backfire. Costs per return vary between roughly $150 and $1,600, according to "Transactional Tax Benchmarking: An Executive Report and Summary of Findings," released in May 2009 by corporate tax solutions provider Ducharme, McMillen and Associates Inc. (DMA). But companies that shoot for the low end are not effectively managing their tax decisions. By reducing the time they spend on planning and research, they end up with higher levels of overpayments. Underpayments are higher, too; companies with the lowest cost per return allocate 22 percent of staff time to audits, as opposed to 15 percent for those with the highest cost per return.
Companies that underinvest in the function tend to remain stuck in what Sweet calls "the low-value loop," a cycle of reacting to demands on an unplanned, as-needed basis. "Compliance can be overwhelming," notes Michael Moore, managing director at audit firm CBIZ MHM. "If employees responsible for the tax area don't have the time they need to prepare and analyze the tax positions the company is taking, the benefits of positive planning won't occur." Another hidden cost is stress and strain on tax professionals, resulting in long hours, burnout, and, in the long run, staffing problems.
2. Skimping on technology. Many companies rely on their ERP and billing systems to handle indirect taxes, often supplemented with homegrown tax databases and spreadsheets. For small companies with limited exposure to multiple jurisdictions, such a setup may work just fine. But as a firm grows, does more business across state lines, acquires nexus in more jurisdictions, and adds customers via M&A activity, it quickly runs up against limitations. Researching the ever-shifting maze of rules and rates becomes increasingly onerous.
Relying solely on a standard ERP system means depending on a salesperson or billing clerk to know not only the right rates, but also the taxability rules, points out Diane L. Yetter, president of Yetter Consulting Services Inc. in Chicago and a 25-year veteran of the tax tech field. While most ERP systems can handle taxability by customer location, taxability by product is a different matter. "This requires somebody to be aware, to override," she says. "Let's say in 80 percent of the states it's taxable, and in 20 percent it's exempt. You might say ‘OK, I'll set it up as taxable,' but let somebody override it at billing time. To rely on somebody to remember when and how to do that manually is obviously very time-consuming and very risky."
Some industries are notoriously complex from the taxability standpoint. Yetter recalls one client, a large contractor, that had 25 different data elements that needed to be evaluated to determine how its deliverables should be taxed. "Was it new construction, a remodel, or a natural disaster recovery? A lump sum or time-and-material contract? Was it residential or commercial? If you have a business like that, before you even get to figuring out the rate, you have to figure out what tax it is or isn't subject to."
In the past few years, sales and use tax technology providers have come up with a host of new automation options. Online monitoring services can accurately determine customers' jurisdiction from an address and feed information about rate changes into your core indirect tax systems. Tax engines have long been the heart of sales and use tax automation, linking up with ERP systems and tax databases to apply complex rules around product types, buyer and seller relationships, and taxable amounts, and exporting data to back-end packages for reporting and filing. They're now available as software-as-a-service products or as part of managed service packages. Exemption certificate management systems can scan these documents to identify the data elements required by tax authorities and process them digitally, eliminating the need to store thousands of paper certificates.
Companies that DMA classifies as "high-leverage" in terms of technology achieve a lower average cost per return: $538, as opposed to $800 for low-leverage firms. However, when you're assessing the ROI, make sure you take into account the potential gains from freeing up tax pros to concentrate on value-add activities. These can be very significant, according to Peggi Rockefeller, director of sales, property, and indirect tax with power equipment giant ABB Group (see sidebar, ABB Powers Up Indirect Tax Savings).
3. Ignoring data quality. Even the most sophisticated tax automation setup will deliver disappointing results if users fail to maintain the quality of its inputs. And this happens surprisingly often. The problem is most acute among companies that don't have access to regular updates on changes in regulations and rates, but changes within the business itself over time can impact the type of data that you need to collect and process.
The experts I talked to were virtually unanimous in placing inadequate data quality management among the most costly mistakes companies make in sales and use tax compliance. For Moore, this one tops the list. "Technology continues to enhance companies' ability to obtain and use data, but the output is only as good as the information that went into it," he points out. Sweet agrees and suggests that companies should conduct internal reviews of data accuracy on a routine basis "to ensure that the dynamic environment hasn't rendered the old way deficient."
4. Neglecting Training. Technology and training investments can, to some extent, substitute for each other. If you have a sophisticated tax engine that's maintained by the tax staff, your A/P and A/R people don't need much more than basic tax awareness, Yetter explains. But if your process is less highly automated and non-tax folks are making taxability decisions, they'll definitely need to be trained. Regardless of the kind of system you have in place, training will likely be necessary for whoever sets tax policy -- whether that's the controller, the CFO, or even the CEO in a small company. "They need to really understand the tax rules that apply to their industry in the states that they do business in," says Yetter.
In addition, consider training for your procurement team to help them take advantage of tax planning opportunities for certain transactions, particularly if you're buying construction services, professional services, or computer software. For example, if you purchase construction work in a lump-sum bundled contract, versus a time-and-material contract, "you could not only change the taxability, and therefore the amount of the tax, but also the incidence of the tax," reports Yetter. "If you structure it correctly, it could be your provider's tax instead of the buyer's tax. In every company, the procurement side can find dollars to bring to the bottom line if they know how to structure contracts appropriately for tax planning purposes."
Indirect tax functions that have training programs in place tend to outperform their peers, according to a study by Aberdeen Group released in May ("Effective Sales and Use Tax Management: Reducing Errors and Increasing Productivity"). Sixty-five percent of firms that Aberdeen regards as best-in-class offer training, compared with 39 percent of industry-average organizations. There are plenty of alternatives to formal in-house programs, notes Moore, including online professional education, local seminars, conferences, and focused professional involvement.
5. Leaving use tax to take care of itself. While most companies are diligent in collecting and remitting taxes on the items they sell, they're often much less systematic in processing tax on the items they buy. The regulations governing use tax are even more complex than sales tax rules. Overpayments and underpayments are rife, but many organizations see this as a "money in, money out" situation over which they have little control and which offers no opportunity for savings. Once again, the burden usually falls on their beleaguered accounts receivable department. "A lot of companies are allowing a person who is paid to process invoices as quickly as he or she can to make a determination on whether something is tax-relevant or not," says Robert Fountain, VP of operations with DMA's tax technology division. Others simply ignore it and hope for the best.
That is, until they get hit with an audit penalty. Consumer use tax often accounts for the largest part of a transactional audit assessment for many businesses, according to "Self-Assessment of Consumer Use Tax," a white paper from tax, business law information, and software provider CCH, a Wolters Kluwer business. "This is when it gets their attention," notes Fountain.But by then the damage is done.