The Challenges of Use Tax Compliance

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THE CHALLENGES OFUSE TAX COMPLIANCE



e Challenges of Use Tax Compliance The Challenges of Use Tax Compliance

Executive Summary An Introduction to Consumer Use Tax

More and more states are increasing audits to collect consumer use tax. All states thatcharge sales tax also charge use tax. Use taxes are meant to minimize unair competi-tion between sales made in and out-o-state. A company buying goods outside thestate or online is required to report and remit consumer use tax or the storage, use, orother consumption o tangible personal property (TPP) that was not subject to salestax. Use tax must also be paid when a business withdraws goods rom inventory or itsown use. It is a business’ responsibility to sel-assess when, and i, use tax is accruedand to pay the state and/or local tax authority on a tax return.

The overall state budget defcit in 2012 is estimated at approximately $125 billion, 1 which has undoubtedly caused much o the increased attention on use tax compliance.States are trying to boost revenue by towing the line on use tax, while also osettingtax dollars lost to e-commerce and changes in the defnition o TPP, such as electronic

music or sotware downloads, which have historically not been taxed in the past.

As use tax compliance grows in importance, businesses suer the consequence o hav-ing to manage cumbersome manual tax calculation. Many smaller businesses lack thesta or resources needed to streamline this task and instead rely on manual process-ing o each and every invoice, which is inefcient, inaccurate, and costly. Inaccuraciesattract auditors, placing a urther burden on companies. Audits can hamper productiv-ity and small companies lack the time and money to check auditors’ fndings. Risks o non-compliance are worse, including penalties, interest, and even jail time i raud isproven. Calculating use tax is particularly complex or industries such as manuactur-ing and construction.

Technology oers a solution by automating the process o calculating, reporting, andremitting use tax. Human intervention is minimized, helping reduce the risk o over orunderpayment. Most sotware solutions also eature dynamic, on-demand tools thatdeliver reports quickly and easily, improving accuracy and discouraging audits. Com-panies also enjoy rapid ROI rom investments in technology solutions due to improvedcompliance.

Sotware solutions include unique eatures that urther enhance the benefts o use taxautomation. For example, AvaTax, by Avalara, eatures a sophisticated tax calculationengine that contains the most up-to-date taxability rules, jurisdictional assignments,and geo-spatial technology to determine sales tax rates at the invoice or Point-o-Sale (POS) level. Automated solutions like AvaTax prevent accounts payable sta romhaving to remember exactly what is taxed, when, and where. And AvaTax uniquelyintegrates with existing accounting systems, as well as any e-commerce, ERP, or POS

application.

Unlike other solutions, AvaTax is oered as a cost-eective, Sotware-as-a-Service(SaaS) model. Small- to medium-sized businesses beneft rom an enterprise-gradesolution without incurring the costs o building, managing, and maintaining a taxmanagement inrastructure. Updates occur automatically in the cloud—perect orcompanies with multiple locations. In addition, AvaTax archives real-time tax inorma-tion or seven years. As an end-to-end solution, AvaTax also oers a ull suite o ullyautomated tax management solutions.

As the toughest economy since the 1930s causes many companies to tighten tbelts, savvy business owners and procurement specialists are leveraging the Ito fnd competitive pricing on goods. With requent sales, and great deals suchshipping, many small- to medium-sized businesses are using the Web to coming and save time. One o the reasons that online shopping is so avorable is o a tax loophole. According to ederal law, e-retailers, and catalog companiesrequired to collect sales tax i they have a physical presence, or “nexus,” in a stas a storeront, warehouse, or other acility. This defnition may broaden i newtion is passed.

The corresponding rise in e-commerce has caused many states to try to imposInternet transactions in an eort to capture lost revenue. New York has alreadlegislation requiring companies with afliate relationships in New York State

sales tax. In addition, several large retailers, including Walmart, Best Buy, SeaHome Depot are jumping on the bandwagon to try to orce Internet companieAmazon to collect sales tax as a way or brick and mortar stores to stay compe

All states that charge sales tax also charge use tax. Use taxes are meant to munair competition between sales made in and out-o-state. To recoup lost tamany states are increasing audit activity to more aggressively collect consumtax. A business purchasing goods rom another company within the same stasales tax, which the seller collects and sends to the appropriate tax agency. A buying goods outside a state or online typically does not pay sales tax, but is to pay consumer use tax or the storage, use, or consumption o tangible persoproperty (TPP). This also holds true i a company is charged less tax than apprthe buyer, or consumer o the goods, is ultimately responsible or paying the d

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today’s businesses struggle to stay aloatring the greatest recession since the 1930s,ying goods online oers a strategy to fndmpetitive pricing. With a ew mouse-clicks,

ay’s savvy CEO or procurement proessionaln locate the best price on laptops or ofcepplies. The corresponding rise in e-commerces caused many states, such as New Yorkd Illinois, to try to impose tax on Internetnsactions in an eort to capture lost revenue.

One reason online shopping is so avorable, isbecause o a tax loophole that does not requiree-retailers and catalog companies to collect salestax unless they have nexus in a state.




For example, a company that buys laptops rom an out-o state supplier must ensurethat use tax is paid correctly wherever the computers are shipped or stored. Compa-nies with multiple business locations in several states, or with a remote sales orceselling into numerous states are especially vulnerable to the intricacies o consumeruse tax. Consumer use tax must also be paid when a business withdraws goods rominventory or its own use. This might occur, or example, when a retailer selling ofcesupplies removes copy paper and pens rom inventory or employee use, or whenitems are used as displays or product samples.

In addition to losing money rom e-commerce, the recession has hit state budgetsparticularly hard with 2012 defcits estimated at $125 billion.3 To make up this lost

revenue, many states are increasing audit activity to recoup lost use tax. Pennsylva-nia’s Department o Revenue has been targeting businesses that ailed to pay use taxin recent years, suspecting items have been purchased out-o-state. This is part o theagency’s eort to oset a budget defcit close to $4 billion. The State Department o Revenue estimates that as much as $356 million in annual use tax revenue is beinglost on products and services purchased online. 4

States are also losing tax revenue on products that have morphed into a dierentdefnition o TPP. Most states have traditionally taxed TPP, including music sales onLPs, cassette tapes, or CDs. However, as MP3 players have become popular and anentire generation now downloads music rom iTunes, the defnition o TPP in regard tomusic has grown blurry. Illinois, or example, collects sales taxes on CDs sold in storesbut not on downloaded music fles. As people buy more music online, the state losesvaluable revenue because MP3 fles are considered to be non-taxable, digital goods.As o last year, state projections showed that Illinois could bring in about $10 million i iTunes downloads were taxed.5

ompany buying goods outside a state andline would typically not pay sales tax andhereore required to pay consumer use taxthe storage, use, or consumption o TPP not

bject to sales tax.

Use Tax and Its Increasing Impact on Busi

Companies are responsible for self-assessing when, and if, usaccrued, and to self-report on tax liabilities.

Any errors discovered in computing use tax must be reported to the appropriadiction on a business’ balance sheet as an open liability. The company must tthe correct amount with their next tax return. The burden is on the company tthat the tax has been reported and paid.

Many businesses today calculate and resolve tax compliance manually, althoprocess proves to be inefcient, time-consuming, and cumbersome. Accountinnel have to manually research tax rates that vary rom state to state, and betwerent counties, cities, and districts. In the U.S. alone, 17,000 dierent taxing jurcurrently exist.6 A maze o tax exemptions and other rules must also be addrean invoice by invoice basis. Unortunately, most small to medium-sized busintax proessionals on sta, and instead rely on accounts payable personnel to mand apply tax laws and keep up with the constantly changing product taxabiThese employees are also tasked with determining where an item was consu

properly documenting in case the company is audited. Companies that cannoequately manage this process must hire additional accounting resources on abasis to maintain tax schedules, veriy tax rate accuracy, examine accounting errors, and manually correct invoices.

Reliance on human knowledge and manual processing results in inaccuraciesare urther compounded by sta turnover. Inaccurate record-keeping in turn atax auditors. This year, the Oklahoma Tax Commission increased its auditing ssales tax collections by 20 percent, which directly correlated with an increase closure notices in that state.7 Aside rom risk o closure, audits also cost compalost productivity—especially small frms that lack the sta to work with auditoto check auditors’ fndings. Some companies over-assess their tax liability to csate—paying more money in an attempt to prevent an audit. Others are orcedaside large sums o money, just in case they are penalized or non-compliancenies that under-assess taxes ace the more serious risk o penalties and intereoutstanding tax payments, and even jail time, i it is proven that use tax was wwithheld, which constitutes raud.

Industry Challenges

Some industries risk non-compliance more than others. For example, manuaers are not required to pay use tax on equipment used in the manuacturing pForklits used to transport products around a plant acility may not be taxableorklits used in a parking lot to transport fnished goods or shipment may bein some states or jurisdictions. Because equipment can be costly, the tax implare signifcant. Unortunately, every state diers in how they assess use tax. So

states claim the manuacturing process begins and ends at the loading dock, others believe it begins with the frst machine in a manuacturing process. In turing, a mistake in determining taxability can cost a company thousands o d

Construction companies also ace problematic tax issues because the nature otrade involves buying materials to be assembled into a new product. For exama construction contract, the contractor is deemed the consumer o any TPP puthat is incorporated into real property and, thus, pays tax on the property purcthis case, the contractor is the “consumer,” even though he may subcontract tlabor to incorporate the materials into the real property.

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High Risk Industries

• Manuacturing

• Construction

• Retail

• Hospitality

• Distribution

• Service or repair

• Medical or dental

Accounting personnel have to manuallyresearch tax rates that vary rom state to state,and between dierent counties, cities, anddistricts. In the U.S. alone, 17,000 dierent taxing jurisdictions currently exist.




However, subcontractors who purchase items or a construction job must pay tax onthe materials. Determining tax liability can be tricky when the line between real orpersonal property becomes vague. Contractors may request owner certifcation toclassiy the property beore executing the contract. Difcult sales and use tax issuesare particularly tough i a construction frm operates in several states. In addition tothe usual issues o complying with dierent law bodies, numerous state and local taxrates, various tax agencies, and the demands o record keeping urther complicate analready complex task.

Technology Solutions

Audits are on the rise and because many smaller companies are struggling to com-ply with use tax requirements, a solution is clearly needed to improve the speed andaccuracy o tax collection and fling. Technology oers a solution by automating thelaborious task o use tax management. By leveraging sotware applications, account-ing departments and accounts payable sta can relieve the burden o manual process-ing. Small- and medium-sized companies especially stand to beneft rom automation.Although enterprise solutions have existed or years, smaller frms have not, to date,had pre-built, aordable technology options available.

Automated solutions dramatically improve efciency by assessing, calculating, andaccruing use tax when invoices are originally processed. All transactions occur in realtime without disruption to existing worklow, and a process that typically took hours ordays can now be accomplished with a ew mouse-clicks.

Geo-spatial technology determines sales tax rates at the invoice level, and a taxcalculation engine, or database, holds tax inormation or every state and local tax jurisdiction in the U.S. instead o relying on people to remember this inormation. Forthis reason, automated solutions dramatically increase remittance accuracy, whichdiscourages the need or audits. Companies can keep accounting personnel ocused onrevenue generation, or value-added activities instead o compliance, creating an im-mediate return on technology investments.

Most sotware solutions also oer tools that deliver the reports necessary to provecompliance. In this way, accounting sta can quickly and easily generate reportswithout having to build them rom scratch. Also, the best use tax management solu-tions integrate seamlessly with a business’ existing accounting system, ERP, POS, ore-commerce applications.

AvaTax, by Avalara, provides an aordable, web-based tax management solution viaSotware-as-a-Service (SaaS). Avalara’s users simply logon to the service through anonline portal—a perect solution or businesses with multiple locations, as web-basedtransaction data is available company-wide. Users access the shared portal to viewtransactions and reports in real time. Auditors can also use the online interace tocheck tax inormation, and run reports rom a central console. Because the tax engine

is hosted in the cloud, updates occur automatically, and manual sotware updatesto the desktop are not needed. This is especially relevant or tax inormation, whichchanges requently.

The SaaS model is particularly cost-eective or small- to medium-size businesses thatcan now beneft rom an enterprise-grade solution without incurring the costs o build-ing, managing, or maintaining their own in-house inrastructures. AvaTax also archivesreal-time tax inormation or seven years or ull compliance with retention standards.All systems are secure with the appropriate, built-in redundancies or managing trans-actional tax data.

tomated solutions dramatically improveciency—a process that typically took hours or

ys can now be accomplished with a ew mouse-ks.

th SaaS, users simply logon through an onlinertal—a perect solution or businesses withltiple locations, as web-based transaction

ta is available company-wide.

Companies face multiple challenges to comply with taxrequirements, so Avalara provides an end-to-end suite of fullautomated tax management solutions:

• AvaTax — Provides a transactional tax solution to calculate and manaand use tax.

• Returns — Provides a single source, automated return, fling, and tax liremittance service.

• CertCapture — Provides an e-compliant, intelligent, automated solutilecting, maintaining, and accessing exemption certifcates

Avalara’s automated tax management solutions are certifed by the Streamliand Use Tax Agreement (SSUTA or SST)—a national eort to simpliy sales and processes or both businesses and states. An additional goal o SST is to reduceand administrative burdens on retailers who collect sales and use tax, particunesses operating in multiple states. Avalara is a SST Certifed Service Provider SST CSP is certifed to fle and remit sales tax liabilities in SST states. Where a bis registered under the SST, voluntary state fling services using a CSP may be

Automation Helps Companies Stay Competitive

Implementing an automated consumer use tax management solution oers advantages to companies that are trying to stay competitive in the midst o asionary economy. In addition to saving time and streamlining worklows, autosolutions such as AvaTax can catch mistakes beore monthly fling occurs—a pcost-eective way to comply with state use tax fling requirements. Automatetions increase the accuracy o a company’s invoicing and are especially helpuand medium-size businesses that have previously been unable to aord entegrade solutions. With new delivery options being developed, like SaaS, and wiend-to-end suites o tax management solutions available, such as Avalara, tocompanies can streamline tax management, reduce compliance risk, and insttime, money, and innovation on growing their business.

As a Certifed Service Provider (CSP), Avalaraallows businesses participating in SST to ullyoutsource their sales and use tax managementprocesses.

Use Tax and Its Increasing Impact on Busness



About AvalaraHeadquartered on Bainbridge Island, Washington, Avalara is the recognized leader inweb-based sales tax solutions and is transorming the sales and use tax complianceprocess or businesses o all sizes. Avalara’s AvaTax amily o products provides end-to-end compliance solutions and is regarded as the astest, easiest, most accurate andaordable way or companies to address their statutory tax requirements. Avalara isthe industry’s most trusted provider o sales and use tax automation solutions and is

one o America’s astest growing companies earning recognitions such as Microsot’sSaaS Partner o the Year or 2010

Endnotes

1 Howard Gleckman. “The Battle Over Internet Sales Tax,” The Christian Science Monitor, March8, 2011.2 Tiany Kaiser, “Walmart, Best Buy Pressure Amazon to Collect Sales Taxes,” Daily Tech,March 21, 2011, http://www.dailytech.com/Walmart+Best+Buy+Pressure+Amazon+to+Collect+Sa

es+Taxes+/article21172.htm3 Howard Gleckman, “The Battle Over Internet Sales Tax,” The Christian Science Monitor, March8, 2011.4 Jan Murphy, “Paying Use Tax or Items You Buy Out o State? Pennsylvania Is Cracking Downin Businesses,” Pennlive.com, February 16, 2011, http://www.pennlive.com/midstate/index.ss/2011/02/paying_use_tax_or_items_you_b.html5 Mike Riopell, “Should Illinois tax iTunes downloads?” Pantagraph.com, April 21, 2010, http://www.pantagraph.com/business/local/article_8b5cc214-4ccd-11d-80a9-001cc4c03286.html6 Avalara.7 Steve Lackmeyer, “Oklahoma Business Closings Increase as Oklahoma Tax Commission StepUp Sales Tax Collections,” NewsOK, powered by the Oklahoman, March 6, 2011, http://newsok.com/popular-businesses-ailure-to-pay-taxes-brings-closings/article/3546268

Getting started with Avalara is easy.Take the next step toward automating your sales tax process.

Call: 877-780-4848Visit: www.avalara.com

The Challenges of Use Tax Compliance

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