Sales Tax Quality Process and the Manufacturer/Distributor
Originally published: May 2012
by Avalara, Inc.
Copyright © 2012
Reprinted with permission
Sales and Use Tax Challenges Facing Manufacturers and DistributorsIn interviews with manufacturers, the following challenges were cited as the biggest struggles they face regarding sales and use tax:
- Tracking thousands of SKU numbers that cross taxability rules or vary in taxability based on state
- Getting the rates right and filing the reports correctly
- Surviving an audit (which in this business is inevitable)
- Keeping track of all the smaller jurisdictions and their special districts
- Ensuring a seamless process that is auditable
- Figuring out what is taxable and what isn’t
- Tracking use tax
- Selling to Retailers (Resellers)
- Selling Direct to Consumers
- Input Item Taxability, Use Tax and Direct Pay Permits
- Drop Shipping on Behalf of a Distributor or Retailer by a Manufacturer
- Installation, Repairs and Nexus
Selling to Retailers (Resellers)Both manufacturers and distributors make direct sales to retailers or other distributors. Sales made that are intended to be resold to consumers can be exempted from sales tax collection under a resale exemption. Since sales taxes are required to be paid only once, the theory behind a resale exemption is simple: the customer (consumer or end user) will pay sales tax on the full retail price so when the reseller purchases from the manufacturer or distributor, they can be exempt from paying sales tax on that transaction. Resellers who want the benefit of the exemption must present manufacturers and distributors with current and effective proof of their resale intentions.
The most common form of this proof is the Exemption Certificate. 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.
For many manufacturers, this may mean less than 50 certificates if they only sell to large distributors or wholesalers who receive shipments in only a few locations. However, 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.
Selling Direct to Consumers
A necessary element of selling direct to consumers in today’s world is a functional and accurate online interface to sell your parts and products using the Internet. Easy integration of sales tax rules and laws is critical to making the online checkout process smooth and trouble-free for consumers. It is your obligation to ensure that accurate and current rates, taxability rules and boundaries are applied for each taxable sale. However, not all products, services or parts are created equal.
Manufacturers and distributors who are under pressure to manage costs generally seek technology that can automate their processes, thus reducing costs and generally improving quality control. Selecting an automated solution that integrates with your online shopping cart to deliver instantaneous and accurate sales tax calculations is critical to customer satisfaction. Adjusting the sales tax after the shopping cart experience delivers a final cost can cause heartburn with your customers when they see that the online statement does not match their credit card amount.
Input Items Taxability, Use Tax and Direct Pay Permits
Based on state, some products are not taxable if used to build manufacturing equipment but the same product might be taxable when used to repair the manufacturing equipment. So, if that product is a small bolt, how do you handle taxability if some of its uses are taxable and some are not? Do you purchase everything and pay sales tax up front? You would then need to track, calculate, and request a refund of the necessarily paid tax on items that were used for an exempt purpose.
The accurate and early identification of use tax liability, properly exempted items and properly taxed items is a special challenge for manufacturers. According to the Connecticut State Department of Revenue website, “…a determination of the proper rate of tax is dependent on the type of item purchased and how and where the manufacturer will use it.” As an example, the same item, let’s say bolts, may be used in the manufacturing process on equipment, but also on a conveyor. Depending on the state, conveyors may not be considered part of the manufacturing process. The conveyor may be considered as part of the inventory movement process because it is used to convey the product to a final location or to shipping, which may or may not be taxable in a given state. One alternative is the Direct Pay Permit.
Many states allow manufacturers to use “Direct Pay Permits.” The Direct Pay Permit allows a manufacturer to make purchases without paying sales tax. When a part purchased using a Direct Pay Permit is pulled from inventory, the part must be tracked for how it is used and tax accrued if it is used in a taxable manner, or usage tracked if used in an exempt manner.
Another struggle manufacturers face is when they make bulk purchases that are then shared among multiple internal plants or facilities. If plant A runs out of bolts, they are shipped from a central inventory instead of direct from a vendor. The central inventory must track where each item goes and for what purpose in order to establish taxability of that item. In the example above, a bolt for a repair to a conveyor system might be taxable in one state, but exempt in another. So you must know:
- the inventory item used was a bolt
- which state it was shipped to
- the purpose of the bolt
- the taxable nature of that purpose
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. In some states, there may be several different possible tax rates depending on the item and how and where it is used.
Each state will have their own specific qualifications for a manufacturer in regards to whether or not you can use Direct Pay Permits. You must apply and be approved and also understand clearly what you can purchase sales tax-free using the Direct Pay Permit. However, 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.
Drop Shipping on Behalf of a Distributor or Retailer by a Manufacturer
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.
Installation, Repairs and Nexus
Which portion of the services and how they are taxed, varies from state to state. Keeping track of this information for each state can readily become a nightmare for many manufacturers.
Knowing whether installation services and repairs constitute nexus and under what circumstances is critical when complying with any potential liability to collect and remit sales and use tax. When entering new states with any type of business activity, it is always wise to include a sales tax nexus study to assure whether or not you will be creating a sales tax responsibility by your activities in that state.
In a Nutshell: Create a Repeatable, Consistent Process for Sales and Use Tax Compliance
- Accurate sales and use tax calculations for collections that take into account product taxability, location, rules and regulations.
- An exemption certificate management process that enables digital collection and storage of exemption certificates as well as transaction association and timely renewals.
- Flow-through returns processing that provides a liability worksheet for review for each return filed, empowering your company to have oversight and visibility to all your sales and use tax liabilities and remittance.
- Best practices in managing your sales and use tax processesand easy access to all data in case of an audit.
- Up-to-date sales and use tax rates and information.
Critical features to look for in an automated solution:
- Easy integration with your back-end financial applications and/or inventory management software.
- Ecommerce integration capability.
- Geospatial technology to ensure “to the rooftop” level accuracy for locations.
- Accuracy and speed.
- Accessibility of information—anywhere, anytime.
SaaS Solutions Can Be Cost-Effective
- Accuracy: Real-time, immediate calculations
- Eliminate Burden on IT: Reduced or eliminated IT support
- Reporting: Reporting and management of sales and use tax data and exemption certificates in a centralized database.
- Easy Access to Information: Accessibility of information during an audit.
- Cost Reduction: No new hardware or software investment.
Avalara’s AvaTax gives you the control to implement a quality workflow process in managing exemption certificates; a method of applying sales tax, when appropriate; and a flow-through process for filling out sales tax returns and remitting any sales and use tax liability.