Many manufacturers aren’t very concerned about their sales & use tax compliance today. “Whether we pay sales tax on a purchase is all handled by our ERP system. It codes everything as either taxable or exempt and then we self-assess tax as needed” is a common refrain from many controllers. Oftentimes their claims are even reinforced by a clean sales tax bill from their last audit. “We got a nominal assessment on our last sales & use tax audit, so obviously our ERP system is making the correct decision most of the time” is a standard assumption.
Certainly, the automation of the sales tax decision process has made sales tax compliance a lot easier for manufacturers. Complying with sales tax laws has historically been overly burdensome for manufacturers, since in most states whether any given purchase is exempt depends on whether and how that purchase is used in the production process. Each state has different exemptions and even states with similar statutory exemptions have different ways of interpreting them. In the past, in order to make a correct tax decision each purchase had to be examined to verify whether it would qualify for exemption. However, today many manufacturers eschew that inefficient process by instead having the sales tax decision automated based on general ledger account, cost center or material group. The process is as simple as assigning each account or group as either taxable or exempt and then either submitting an exemption certificate for purchases coded to exempt accounts or self-assessing use tax if no tax was charged on a purchase coded to a taxable account. The “decision” of whether an item is taxable or exempt is now just an automated process.
It was always impractical to review each purchase for a potential sales tax exemption, so automating the process does doubtlessly make sales tax compliance much more manageable for manufacturers. However, it may also provide a false sense of security.
The biggest problem is that most companies’ general ledger, cost centers or material groups are not designed with sales tax laws in mind. For example, a “Consumable Supplies” account may have both taxable janitorial supplies and exempt manufacturing catalysts coded to it. Thus, basing the decision on whether to pay sales tax solely on the account cannot bring full compliance. And for those manufacturers who have gotten a clean bill from their recent sales & use tax audit, well, that may provide a false sense of security as well. Although most state sales tax auditors are extremely aggressive in seeking out underpaid tax, few if any will go out of their way to identify overpayments of tax. Using the earlier example, if your company is already paying tax on all purchases that are coded to “Consumable Supplies” it’s possible that the auditor won’t review the account at all, thus failing to notice any tax exempt purchases coded to that account. A nominal assessment from the state DOR may seem like a relief, but the reality is your company could be paying thousands of dollars in overpaid taxes already.
Although it may not be practical to review each transaction on a day-by-day basis, reviewing how your system is treating the taxability of purchases on at least an annual basis can help you spot any potential compliance errors. The statute of limitations for most states is at least 3 years, so there should still be plenty of time to request a refund for any taxes that you’ve overpaid. And if you spot any underpayments of tax, state departments will likely happily still accept your payment, although you may also owe interest or penalty depending on the state the taxes are owed to.
Ultimately, automating the sales tax decision process is a good practice that greatly increases the efficiency in which sales tax exemptions can be applied. But manufacturers should be careful not to take a “set it and forget it” attitude. Whether done internally or through a 3rd party, it’s important to occasionally have a human pair of eyes review how your purchases are being coded for taxability. If not, there could be a significant refund left unrecovered or an inopportune audit just around the corner.