Tax Compliance Lessons for Lessors
How lessors can approach their tax compliance requirements with greater confidence and control.
November 29, 2007
by Pat Pelino and Wayne Robinson
The leasing industry has reached $800 billion in size and continues to grow. But this industry boom has a dark side as the sheer volume and nature of leasing agreements presents significant tax challenges and increases the risk of audit assessments for lessors.
Businesses that operate across state lines and lease interstate equipment find myriad differences in federal, state and local taxes. Most of these tax processes are complicated and confusing enough on their own, yet companies often exacerbate the challenge by using manual, detailed jurisdiction-by-jurisdiction analyses that attempt to reconcile the varying conditions while maintaining full compliance.
In 2005, our company conducted a survey of tax professionals and state audit officials to identify the most common contributors to sales and use tax assessments and to address ways that companies could manage their tax challenges more efficiently. Seldom, if ever, have state audit officials spoken so candidly about the audit process, and their responses confirmed the pain that most tax professionals have been reporting for the past few years.
When asked about the major reasons for audit assessments, the majority of state tax officials cited unreported tax on taxable purchases, due either to missing or invalid exemption certificates or to incorrectly applied tax rules and rates.
For these reasons as well as the challenge of identifying nexus and jurisdiction rules, many equipment leasing companies still fall short of meeting all the necessary requirements for compliance, despite such dedicated accounting efforts.
By understanding the influencing factors in the U.S. tax law environment, the causes behind each of these audit assessment contributors, and the possible solutions for resolving them, equipment lessors can approach their tax compliance requirements with greater confidence and control.
Tax Law Environment
In recent years, two key factors have shifted the focus and methods for handling federal, state and local tax regulations, and significantly impacted lease tax processes: the Sarbanes-Oxley Act and the Streamlined Sales Tax Project (SSTP).
When the Sarbanes-Oxley Act passed in 2002, one of its major provisions required public companies to be entirely transparent in their auditing practices. This meant evaluating and disclosing the effectiveness of their internal controls as they related to financial reporting. Additionally, independent auditors for companies now had to agree to and adhere to this disclosure policy.
As a result, corporate tax procedures have dramatically changed over the past few years in order to comply with Sarbanes-Oxley. A separate survey conducted in 2005 by Vertex Inc?? highlighted these shifts, showing that the majority of business taxpayers were either testing their internal controls or performing remediation efforts related to those controls.
Streamlined Sales Tax Project
Introduced in 2000, the Streamlined Sales Tax Project is a state-government initiative whose mission is “to develop measures to design, test and implement a sales and use tax system that radically simplifies sales and use tax.” As of 2006, 19 states have conformed their sales and use tax laws to the Streamlined Sales and Use Tax Agreement (SSUTA).
As such, SSTP is an evolving process. Even with “conformance of their laws,” many states have carved out those items that are not included in the conformance. Most notable are motor vehicles (rented or leased) and other transportation equipment.
Furthermore, confusion arises among both the states that do follow SSTP rules and criteria and those states that are not yet participating members. Companies that deal with both camps heighten their chances of confusing the definition sets and thereby increase their audit risk.
For example, states that approved participation in the Streamlined Sales Tax Project have adopted SSTP amendments, one of which defines a lease. In order for a transaction to be considered a lease, the purchase option offered at the end of the lease has to be greater than $100, or one percent of the total payments. If it is less, the transaction is considered a sale, and the tax is due up front on the contract price.
In other instances, some companies have applied these definitions to equipment that may become technologically obsolete within a few years, only to realize they would stay more competitive if they entered the agreement as a lease rather than a sale.
To learn more about the methodology behind the Vertex study mentioned in this article and to continue reading about lease tax compliance in relation to — SSTP, unreported tax on taxable purchases, exemption certificate management, incorrectly applied rates and rules, and nexus and jurisdiction identification, please view the full article at: www.vertexinc.com/AICPA.
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Patricia L. Pelino, CMI, is a tax consultant for the Vertex Consulting Group with over 25 years of tax experience. Her responsibilities have included tax advisory and support of sales and use tax consulting service Engagements. Her tax experience covers sales, and consumer use tax compliance, particularly in the fields of motor vehicle and equipment leasing, manufacturing and retail. Ms. Pelino has also authored industry white papers and has both developed and presented training sessions on various tax topics. Wayne Robinson is a Solutions Manager for Vertex Inc. He has been closely involved with the development of the Vertex Lease Tax O Series. Prior to joining Vertex, he spent 10 years in the public accounting environment, managing a sales and use tax practice and working with clients to improve their sales and use tax process. Robinson has also managed sales and use tax for IBM Corp., where he was responsible for five entities.