For Manufacturers and Distributors, sales tax audit risk isn’t always obvious. And yet businesses in these industries are at the highest risk. As states grow hungrier for additional revenue, increased scrutiny of high-risk industries such as manufacturing and distribution 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 Manufacturers and Distributors, 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 to audit risk. Creating a tax-efficient 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.
Based on interviews with Manufacturers and Distributors, here are the 4 top challenges they face regarding sales tax:
1) Use Tax – 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. Once the identification of use and taxability is determined and documented, then you must ensure that the correct amount of use tax is accrued for each item and file a use tax return in a timely manner. There is a general stipulation that the manufacturer will have a system that clearly tracks and shows the amount of sales and use tax owed.
2) Sourcing Rules – “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.
3) Exemption Certificates – Probably the riskiest and most difficult aspect of sales tax compliance is the management and tracking of accurate exemption certificates. In order for exempt purchases to be documented properly, a manufacturer or distributor must maintain exemption certificate information for each state or locality where the reseller receives product. The same rules apply for sales made by a manufacturer to a distributor or forwarder who intends to either collect tax on their own direct sales, or who intends to sell the products to another reseller. Distributors with multiple resale customers must maintain and continually update exemption documentation for all their resellers and any associated ship-to locations in order to ensure the asserted resale exemption is valid and properly documented. Distributors must also ensure their own tax-exempt status is maintained and exemption certificate information is provided to each manufacturer or supplier they work with. After all, they are considered a reseller in a manufacturer or supplier’s eyes.
4) Drop Shipping – A distributor or wholesaler will sometimes request the manufacturer to drop ship their product to either their location or sometimes to their customer’s location. If you are shipping direct to the distributor, and the product is considered tax-exempt for resale, then no tax is required – only resale documentation. But if you are shipping direct to the consumer on behalf of your customer, the sale is complicated by the possible combinations of nexus that can require collection or documentation. Knowing what documentation you need to maintain for which states becomes a major challenge—especially as ship-to destinations may vary widely if your customer, the distributor, has you ship to their customers in numerous states. As we have seen, whether the product itself is taxable or exempt is not always an easy question. But when a manufacturer drop ships, the freight, handling and/or delivery charges may also be taxable. Every state considers freight costs differently—some only tax a portion of the cost, others tax the whole amount, and some don’t tax it at all. This research needs to be maintained by your tax department on a regular basis to ensure your business stays up-to-date with changes and new shipping locations as your distribution system grows.
Create a 2014 Sales Tax Management Action Plan
As any good manufacturer knows, having a repeatable, consistent process enables greater quality control. And quality control helps ensure compliance. Learn more by reading the whitepaper “Sales Tax Quality Process and the Manufacturer/Distributor.”
The good news is that you can manage sales tax confidently for your manufacturing or distribution business with Microsoft Dynamics GP and Avalara. Contact CAL Business Solutions to start a discussion. 860-485-0910 x4 or firstname.lastname@example.org.
Read case studies of manufacturing and distribution case studies using Microsoft Dynamics GP at www.calszone.com/distribution.
By CAL Business Solutions, Microsoft Dynamics GP Partners Serving Distribution, www.calszone.com