John Cowan
The Sleeping Giant in the Tax Department: Inaccurate Sales, Consumer Use and VAT Payments

Sales, use and VAT tax calculations can put your retail business at risk. Automation can help.

April 29, 2010
by John Cowan

Everyday business decisions can have huge — and often unintended – sales tax, consumer use tax and value-added tax (VAT) implications. For example, if you are a regional clothing retailer, deciding to allow customers to purchase goods in one location and ship them to another location (or accept store returns from another jurisdiction or from Web purchases) can create significant tax issues; suddenly, every store needs a way to apply the correct tax for customers shipping to any jurisdiction in the entire country — and if your business is global, for any intra country transactions. If you decide to introduce new products, it's easy to overlook special “tax holiday” exemptions affecting them. In addition, if you operate a chain of grocery stores, simply choosing to sell ice cream treats in a single, eight-ounce serving (rather than larger containers) may put you out of compliance in certain jurisdictions.

These examples help to illustrate the incredible complexity of sales, consumer use and VAT tax — and why so many companies find themselves either overpaying or underpaying these indirect taxes. As a retailer, you face increasingly complex jurisdictional tax laws, must accommodate special tax rates and rules and have unique compliance requirements. The tax laws themselves are also constantly changing, making it even more difficult to understand the implications of business decisions. From 1998 to 2008, there have been 2,859 net-new sales tax rules implemented in the U.S. alone, 5,341 sales tax changes and more than 99,000 total unique rules across sales, consumer use and VAT taxes.

Tax Departments Are Accountable But Not in Control

Complicating matters is the way that sales, consumer use and VAT taxes are typically managed on a day-to-day basis by most retailers. Let's take a closer look at sales taxes as an example.

Most likely, your sales tax data — the rates and rules relevant for all of your sales channels — are manually maintained in spreadsheets by tax professionals and then handed off to IT so it can be downloaded to store point-of-sale (POS) systems overnight; given the complexity of tax laws, there's a high likelihood of manual errors — particularly state and local tax holidays. Complicating matters is the fact that most merchandising systems simply aren't designed to handle the level of tax data complexity retailers need to manage.

Alternatively, you may have a rate file card (using a spreadsheet) that shows generic sales-tax rates or bracket schedules relevant for the products you sell in the location in which they are being sold. In addition, tax exceptions are typically handled at the store level by sales associates — a risky proposition because these employees lack the tax expertise to handle these exceptions correctly.

Think about the opportunity for error given the number of tax changes that your department needs to maintain and the fact that:

  • Not everything is covered by standard tax rates because they are not granular enough. (For example, if a chain of café shops sells a customer a whole pie instead of just a slice, the taxability may be different. In situations like these, sales associates, by default, have control over taxability — not the tax department — and make uninformed decisions.)
  • Acquisitions and mergers can suddenly thrust your tax department into new product categories where they have little or no product-specific expertise.
  • The deployment of new business and customer service models — such as allowing customers to ship purchased items to other states — brings with it unexpected, new taxability risks.
  • You are responsible for determining who is purchasing certain goods and for what purpose before you can determine taxability. For example, if you are an agricultural-supplies retailer and a clerk in Vermont sells fertilizer to a farmer claiming an agricultural-tax exemption, without asking if he's going to use it for commercial (exempt) or personal (non exempt) use, you can be held liable for uncollected tax. Should your sales associate determine that the exemption is appropriate; the transaction must be properly documented and auditable.

As these examples illustrate, the real challenge is not dealing with any single rule or subset of rules, it is that you have to comply with all of them in the face of constant change. It's all too easy to have transactions fall through the cracks between manual effort, fragmented operational systems, POS systems and changes in both your business and the actual tax legislation.

The High Cost of Inaccuracies

Given the complexities of sales, consumer use and VAT taxes, it is likely that you are either overpaying or underpaying indirect taxes. In most cases, companies are not even aware of indirect tax problems until it is too late because tax decisions are often handled manually or by disconnected systems that limit visibility and control.

Underpaying indirect taxes can put your business at risk for fines and potentially massive back payments. Auditors can extrapolate these penalties and back payments based on two or three months of recent transactions and determine the amount due on all similar transactions going back three to seven years. Due to the large, error-prone effort to fully comply, companies typically carry reserves for tax penalties as normal operating procedure. While it was at times easy to carry these reserves as a cost of business in the boom times, it's no surprise that retailers are looking for ways to lessen their reserve requirements to improve their bottom-line performance.

Alternatively, you may be inadvertently overpaying indirect taxes and having to recover payments from state governments or other countries. Recovery processes are very complex, which is why many customers use consulting firms to handle tax recovery work. Recovery agents can help you recoup these funds. But if, for example, you need to recover $5 million, your business is out those funds for strategic investment, cash flow and growth. In addition, in order for you to receive refunds, states have to budget for it, so it can take several years for you to receive them. Finally, incorrectly charging sales taxes can jeopardize your brand and customer relationships. For example, if your sales clerks unknowingly charge sales tax on an item impacted by a tax holiday in certain states, your company potentially faces bad press and must contact all customers, apologize for the error and reimburse for taxes overpaid. In certain cases, high-profile companies have even been sued over indirect tax calculation errors — mistakes that often make headlines.

Can your business continue to afford these types of costs and risks, especially in today's economy? The good news is that by making the right technology investments today, you can fix indirect tax processing going forward — and free your company from the unpredictable, costly impacts of underpayments and overpayments in the future.

To read on about the risks associated with inaccurate transaction tax payments and understand how your company can implement the right solution to overcome the costly business issues outlined above view the full article: The Sleeping Giant in the Tax Department.

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John Cowan is director, Oracle and Retail Solutions at Vertex Inc.,has spent 15 years in the tax automation industry working in various roles at Vertex Inc. He directed Vertex’s early efforts with ERP and POS partners to integrate Vertex tax systems for the benefit of our mutual clients.

* This article was previously published by Integrated Solutions for Retailers.