When a company undergoes a sales and use tax review, one of three results will be returned: 1) identification of past overpayments and a refund opportunity, 2) detection of unresolved liabilities and potential assessments, or 3) confirmation of a solid process. Experience shows that number three is all too rare. Thanks to mercurial regulations and the speed of business change, it is very difficult for growing businesses to maintain perfect compliance. And while overpayments offer some immediate gratification in the form of potential refunds, reporting overpayments or underpayments can trigger an audit. So why would a company look for trouble by conducting a proactive sales tax review?
There are many scenarios where it makes good business sense to take a comprehensive look at the sales and use tax collection and remittance process and to identify potential compliance issues, regardless of a positive or negative outcome. Four common situations that may prompt a review are:
- Turnover in tax leadership or significant staff positions
- Significant changes in business operations
- Preparation for a merger, acquisition or investment
- Receipt of an audit notice by at least one state
The more things change
The first two scenarios have a common theme of change. While business change can sometimes be disruptive, and can certainly create a need for new processes, it is also a natural time to review what works well and what areas can use improvement. With perpetual changes to tax laws occurring during each state legislative session, it is difficult to know what was taxable two years ago versus what is taxable today and next year.
When new leaders come into a tax department, they need to understand the way the business operates. They will also bring new ideas and question old ones. A sales tax review can be an excellent tool for educating the new tax leadership on how the sales and use tax process works, while providing a framework for accepting new ideas and challenging old ones. The same is true when operations have shifted. Whether a significant strategic change is being implemented, such as expansion into multiple new states, or small adjustments over several years have resulted in an entirely new business model, chances are adjustments to sales and use tax requirements have not kept pace.
Timing reviews to coincide with business or personnel changes creates a logical, and largely impartial, impetus for discovering and resolving past missteps. From that new beginning, periodic comprehensive reviews, similar to those performed by an internal audit function, can cut across organizational silos to extract the granular-level detail necessary for effective compliance and risk management. This routine review, when performed with focused diligence and when benched against future company expansion plans, can predict future compliance challenges in a manner that allows sufficient time for tax planning and better overall decision making.
Pre-emptive risk management
The last two review-initiating scenarios above – due diligence and audit prompts – settle into the area of resolving and mitigating risk in response to specific business scenarios. Risks that can be fully or partially managed by company leadership include: liquidity, compliance, credit, operational, market, strategic, acquisition and other external events. In the case of an impending investment bid or possible merger, identifying, quantifying and favorably resolving risk enhances profitability and increases stakeholder confidence in the ability of management to successfully run an organization. It can also improve the overall valuation, as investors typically overestimate liabilities in order to create safer, more favorable valuations. By demonstrating a proactive, comprehensive approach to sales and use tax compliance, as well as overall tax compliance, a company can place itself in a position to better negotiate value with potential investors or strengthen its position in a merger or acquisition.
Once a company has received an audit notice, the risk conversation is slightly different. Many companies fail to recognize the importance of keeping abreast with state tax law changes until the state tax auditor shows up for an examination that looks back over the past three to four years open under statute. Unfortunately, by then it is too late to favorably resolve any prior-period tax exposure, and the company’s treasury is now at the risk of plunder with exorbitant penalties and interest layered on top of tax liabilities. At this point, it can still be prudent to conduct a self-assessment of existing sales and use tax processes. Auditors tend to focus on underpayments, leaving the identification of overpayments to the taxpayer. If faced with sales and use liabilities in one tax area or jurisdiction, a company may have overpayment refunds in another area that can be used to offset assessments and penalties.
Effective sales and use tax reviews
Once the business case is made to proceed with a sales and use tax review, it should be conducted efficiently and effectively. The proper identification and management of tax risk and the ability to resolve tax liabilities in a manner that is most favorable to the company is time-consuming. Many companies find the task is best suited to a third party that can assess processes without bias and that has a deep understanding of the sales and use tax regulations in the various states, including changes to these regulations that occurred during the years under review.
Specific areas of consideration include:
- Identifying the business geographical footprint, as well as the activities of traveling reps and outside contractors
- Breaking down any organizational barriers which might impede clear and effective communications
- Does the sales department communicate with the accounting/finance department on the introduction of new products and services, which may affect tax collection and reporting requirements?
- Does the human resources department communicate with the tax department when employees are hired in new states, which can have a direct impact on state sales, income and franchise tax filing requirements?
- Understanding processes that are, or can be, automated, including how frequently and through what process, these systems are updated for new tax rates and business configurations
- Determining the prioritization of any task risks (including underpayments and recoverable overpayments) and creating a correlating process improvement plan
- Assessing internal and external resources available to support the resolution process
Upon completion of a comprehensive sales and use tax review and once all prioritized issues have been resolved through appropriate process improvements and possible voluntary disclosures, the business can redirect resources from clean-up detail to tax planning and audit management, as appropriate. In the end, “looking for trouble” via a sales and use tax review can help a company avoid potentially larger future concerns by cleaning up the past and prospectively setting out on the right road to accurate, efficient compliance.