The Arms Race in Sales Tax
Though the nation is expressing cautious optimism about the economy, particularly in the second half of 2015 and thereafter, any recovery will follow the traditional pattern of helping some sectors more than others. This is particularly true of state governments, which generally have faced tougher times in the past four years due to growing social obligations and a changing business environment.
The Multistate Advisor observed at the outset of this year that 16 states — from tiny Rhode Island to Illinois — face substantial deficits. And while states like California and Ohio have amassed a budget surplus through fiscal belt-tightening, all of the states are looking to expand their revenue bases in order to drag their budgets into the black.
“The states are hurting for revenue,” noted Cory Barwick, technical product manager for Wolters Kluwer Tax & Accounting US, which publishes the CCH Sales Tax Office, a comprehensive tax calculation system that combines tax rate and taxability content with highly accurate jurisdiction boundary information and sophisticated logic. “Sales taxes account for about 30 percent of every state’s budget. In a troubled economy, it’s difficult for the state to simply raise the tax rates. So they are focusing on other, more aggressive tactics that include going after taxpayers and increasing audit activities.”
“At the same time, you can’t simply provide computations for sales and use taxes and feel that you have met the needs of accountants and their clients,” said John Minassian, vice president of tax content development at Vertex Inc., a leading provider of comprehensive, integrated tax technology solutions for corporations worldwide. “The key is to offer integrated enterprise technology that enables compliance for all taxes that businesses need to file. This may include income taxes, payroll taxes, and value-added taxes, as well as sales and use taxes. Ultimately, the solution should also feature tools to help professionals analyze tax data for audit and planning purposes.”
“The sales and use tax landscape continues to remain incredibly complex, with thousands of U.S. tax jurisdictions and hundreds of tax rate changes each year,” said Carla Yrjanson, vice president of tax research and content at Thomson Reuters, whose ONESOURCE provides indirect tax solutions to manage the entire sales and use tax lifecycle. “Over the last five years we have seen a broadening of activities that create nexus in tax jurisdictions, new tax authorities imposing sales/use tax, and a gradual expansion of goods and services subject to sales tax.”
“When the tax codes were originally created, the economy was mostly focused on the manufacturing of tangible goods,” said Ken Crutchfield, vice president of software products at Bloomberg BNA. BNA Sales Tax Rates delivers sales and use tax rates for every taxing jurisdiction in the United States (including Puerto Rico) and Canada. “As the economy shifted from manufacturing to services, and in particular with the advent of digital commerce, state tax codes have become outdated, and ultimately, have led to eroding tax bases. For businesses, this means a continual onslaught of ongoing tax code changes as states struggle to keep up with emerging service and digital economies.”
“The bottom line is that state and local governments are still struggling for revenue since the downturn,” said Pascal Van Dooren, chief revenue officer for Avalara Inc., a provider of sales tax and compliance automation services in the cloud. “State revenue departments are hiring auditors and chasing down smaller and smaller businesses looking for missed revenue opportunities.”
Rebecca Newton-Clarke, senior editor with the Tax & Accounting business of Thomson Reuters, summarized it this way: “Our globalized world has seen an explosion in electronic transactions that map really uneasily onto the existing sales and use tax laws, which are based on the idea of a physical sale or use occurring in a state, on the idea of a person buying something in a store, the old-school way. With the increase in digital goods, downloaded and remotely accessed software and apps, and Web-based services, the sales and use tax landscape has become incredibly complex, requiring states to address a constantly expanding variety of transactions not involving any exchange of physical property, and companies to stay on top of the implications of new rulings.”
FOUR STATE STRATEGIES
Where they can, states have attempted to use budgetary restraint in an effort to reduce spending to better match revenues with expenditures. But some federal initiatives related to immigration and health care, to name just two, have made this difficult. In addition to belt-tightening, the states have generally engaged in four strategies:
1. Redefinition of nexus. The reigning definition of nexus was established in the 1992 Supreme Court decision in Quill v. North Dakota. The court held that since office supply company Quill did not have a presence in North Dakota, that state had no right to require Quill to collect and remit sales taxes. But that has changed with the advent of the digital economy, with New York and other states cutting agreements with online vendors to have them collect and remit the taxes.
“Nexus laws are under scrutiny,” said Bloomberg BNA’s Crutchfield. “Physical presence is still the litmus test for whether or not a company must remit sales and use tax. However, many states have expanded their interpretation of what constitutes ‘physical presence.’ Since 2008, several states have enacted so called ‘Amazon tax laws’ establishing click-through nexus. These states require out-of-state online businesses to collect sales or use tax for goods sold within the states’ boundaries based on referrals from in-state bloggers. Currently there are at least 16 states that have adopted click-through nexus laws, with many more claiming that nexus laws are already built into their tax code.”
“We look for nexus standards to be expanded and redefined,” added Cory Barwick of Wolters Kluwer. “Services that have traditionally been exempt from sales taxes will have their status reconsidered, resulting in more taxes on services. The larger service industries will use their strength to ‘lobby out’ of sales tax, but smaller services will be increasingly taxed.”
2. Collection of taxes owed. For both sales and use taxes, states are becoming more aggressive in their collections. In addition to taxes owed by businesses, efforts also include taxes and fees owed by individuals.
“There is more of a focus on use tax,” said Ken Crutchfield. “In every state that imposes a sales tax, there is a use tax for items purchased out of state (typically online purchases shipped to a consumer). As more and more companies purchase equipment and materials online from out of state ‘etailers,’ states are ramping up efforts to collect on use tax. For example, many states have created new use tax look-up tables where companies pay a safe harbor amount based on their taxable income. With many states still desperate for revenue to shore up budget deficits, many businesses will need to begin taking this once-forgotten tax more seriously.”
3. Support for a national solution. State and local governments understand that the current system is both too complicated and too burdensome for small businesses. In response, they have looked toward a national solution, either in the form of a value-added tax or support for the Streamlined Sales and Use Tax Agreement that became effective in October of 2005. To date, 24 states have signed onto the agreement, including Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin and Wyoming. The District of Columbia has also agreed to it.
“In the next three to five years, we anticipate an increased reliance on indirect tax as a revenue source for U.S. tax authorities,” said Thomson Reuters’ Yrjanson. “This could be finally bringing to fruition Streamlined Sales Tax and imposing tax on remote sellers, broadening the sales tax base, or it could be something even larger like implementing a federal-level VAT to fund specific government services.”
“The Simplified Sales Tax Initiative has resulted in much greater uniformity across the states,” noted Newton-Clarke of Thomson Reuters. “There are still many differences across the states, however, in terms of what they do and don’t tax. Whether Congress will act in this area, adopting an act that dispenses with the physical presence requirements established by the Supreme Court in Quill, remains to be seen.”
4. Increasing use of technology. Regardless of the other strategies employed, technology will play an increasing role in how effectively the states are able to collect sales and use taxes. For decades, compliance with sales and use taxes has been a matter of manual tracking and computation that requires filing monthly returns on the 20th of every month, mailing checks to the appropriate revenue authorities, and reviewing each invoice to ensure that the amount of tax due has been verified. It also involves a paper file containing exemption certificates for applicable customers, and preparations for the inevitable audits by state and local authorities. This manual process is inefficient and wrought with the potential for costly errors. For most of the solution providers, this means a strong commitment to tax technologies.
“As states become more sophisticated in their use of technology, businesses will need to do the same. And that means automating state tax analysis is more important than ever,” said Bloomberg BNA’s Crutchfield. “Savvy businesses are simply expected to take advantage of the latest technologies available. And because businesses tend to be more nimble than government, implementing cutting-edge technologies will help them to stay ahead of the curve and ensure that they remain compliant on taxes across the board.”
“If the past is any indication, we expect more of the same,” said Van Dooren. “More government complexity, more government audits, and more affordable indirect tax automation solutions. We believe compliance automation is inevitable and will replace manual processes for substantially all businesses, much the same way outsourced and automated payroll compliance management became a standard many years ago.”
“Obviously, the cloud deployment model is being considered in businesses of every size,” said Minassian at Vertex. “There is a tendency among companies to shift from making a large up-front payment for a software license to paying for tax calculation as a service, similar to a utility.”
“Cloud deployment is a strong technology affecting our customers and their clients,” said Barwick of Wolters Kluwer. “Big businesses that used to demand on-premises solutions now see the value in the cloud as a technical solution to their needs, and we are moving all of our applications to the cloud. We have seen a big uptick in the number of customers demanding cloud services available over mobile technologies.”
Beyond the cloud, virtually all of the thought leaders surveyed were in agreement that the core technologies of sales and use tax today are:
-- Mobility. “Mobility enables business to keep pace and stay connected to the business,” said Minassian.
There is interest in the app space for sales and use tax lookup, added Barwick: “There is demand for that, but it is a complex issue because you have to deal not only with where the product is purchased but also where the mobile device is.”
-- Analytics and Big Data. “The key to this is that the answers are in the data, but there is so much of it and it is complicated,” observed Minassian. “The answer lies in being able to analyze the data utilizing software tool sets.”
“The use of sophisticated analytics with built-in tax law and audit trails can help businesses not only forecast the impacts of operational decisions, but also help to mitigate costly errors and audits. Our research shows that over 80 percent of state tax professionals are doing this type of analysis in spreadsheets, which are costly to create and maintain, and are risky — especially if relied upon for financial statement use,” said Bloomberg BNA’s Crutchfield.
Ultimately, serving CPAs and their clients in the diverse types of sales and use tax is not an issue of regulation or technology, though both play a critical role in how the software and solutions are devised.
As Barwick noted, “The real challenge we face is understanding the customer’s business. Technology advances at a high rate, and that demands that we get down to what a business is doing, what they are selling, and how and where they bring their products to market. Solution providers focus on the nuts and bolts of the system, so our customers can get what they need from the software.”