Don’t wait until appeals to defend positions in a sales and use tax audit
A look at why waiting for the process to play out is often the wrong approach
With states more aggressively pursuing revenue, sales and use tax audit activity is ramping up. Companies can manage such an audit in ways that can save them time, money and effort. Far too often, companies take an unnecessarily adversarial approach to audits or ignore audits completely, figuring that they can just appeal any findings with which they disagree.
By preparing for the audit, cooperating with the auditor and maintaining open channels of communication, companies generally get better results with considerably less aggravation.
The data dump approach
Many sales and use tax audits are conducted as follows. The auditor shows up and requests data, usually covering a three- to four-year period. The company assumes that its systems and practices are correct and presents the auditor with a data dump. The auditor disappears into a black hole, combing through the information and piling up exceptions that the company will have to later rebut.
Herein lies the problem-–many of those exceptions can be avoided if the company communicates with the auditor throughout the audit process, as opposed to being reactive after the fact.
Consider invoices. To the auditor, they are often unclear. What are actually services can appear to be goods. From the auditor’s perspective, these untaxed goods are an exception. The company reviews the exceptions and then has to appeal, since the amounts in question actually apply to services. Even if the company has the documentation in place to allow it to prevail on appeal, it has wasted the time and effort necessary to challenge the exception. If the company had simply made it a practice to keep in touch with the auditor throughout the audit process, asking for a chance to address any questions that arose, it likely could have prevented the invoices in question from being treated as exceptions in the first place.
Instead of merely providing a data dump, companies should try a different approach. Before the auditor arrives, the company can review the information request and make sure that its systems will be able to generate the necessary information. Looking at that information from the auditor’s perspective, a company can ask what items are most likely to raise questions and be prepared to address them. Instead of just dumping the data on the auditor upon arrival, the company can walk the auditor through some of the most likely concerns, and try to guide the auditor toward the appropriate position. Companies should clearly communicate that they are available to address other issues as they arise and then establish a schedule to touch base.
The auditor’s point of view
Consider for a moment the auditor’s position. Because states are starved for revenue, auditors are under tremendous pressure to find missed taxes, and their performance is often judged on their ability to do so. Once they’ve listed something as an exception, they will be ill-disposed to listen to arguments for reversing their position. It’s far easier to get them to take a second look at a disputed issue before they’ve reached a final decision.
Also, by maintaining a collaborative relationship with the auditor, companies can try to help guide the auditor’s efforts and, at the least, remain aware of the scope of the examination. If companies just dump data on the auditor, the auditor will be digging through records without any input from the company at all. That’s a recipe for a long list of exceptions.
Why appeals aren’t the best approach
Consider the nature of the appeals process. The first level is an administrative appeal, not tax court. Administrative appeals officers work with the auditors and the state department of revenue. Often, their inclination is to deny all appeals and then push the taxpayer for a settlement. Many taxpayers accept a settlement just to avoid the risk and expense of continuing the appeal in tax court. Companies usually stand a better chance of convincing the auditor that their original position is correct before the auditor considers it an exception than they do of winning on that position at an administrative appeal.
While the tax court is independent of the department of revenue, and thus more open to considering a taxpayer’s interpretation, the expense of pursuing a case to tax court and the downside of a potential loss makes the risk of continuing an appeal to that level unattractive in many cases.
Companies should consider a sales and use tax audit to be a transaction like any other—one in which they communicate and try to reach a mutually satisfactory result with the other party. Taking this approach is likely to lower both the final tax bill and the expense and effort of reaching it.