Sales Tax Quality Process and the Manufacturer/Distributor

Sales Tax Quality
Process and the
Sponsored by Avalara, Inc.
Copyright © 2012
Sales and Use Tax Challenges Facing
Manufacturers and Distributors
In 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 audit-able
• Figuring out what is taxable and what isn’t
• Tracking use tax
As any good manufacturer knows, having a repeatable, consistent
process enables greater quality control. And quality control helps ensure
compliance. Let’s review the following areas where sales tax can pose
specific challenges to manufacturers and distributors and how they
would benefit from a quality control process that reduces cost and risk
and improves performance:
• 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
Page 2 of 10. Sales Tax and the Manufacturer © Avalara 2012
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.
Page 3 of 10. Sales Tax and the Manufacturer © Avalara 2012
Selling Direct to Consumers
A few manufacturers will sell their final product direct to consumer.
Often though, spare parts, updates, replacement wear items, or even
repairs are more common sources of a manufacturer’s consumer-direct
sales. Direct sales to consumers, even if they do not include large
amounts of money or whole items, typically incur an obligation for you
to properly collect and remit sales taxes. Consumer sales are usually
transacted by phone or online, via a web interface or ecommerce store.
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.
Page 4 of 10. Sales Tax and the Manufacturer © Avalara 2012
Input Items Taxability, Use Tax and
Direct Pay Permits
Manufacturers are generally located in a single state or perhaps two
states, so their risk is a bit lower when it comes to product taxability,
right? This might be true for sales tax obligations but not necessarily
true for use tax obligations. The manufacturer must ensure accuracy
for their own use tax burden on products consumed or services
purchased. Product taxability affects items you purchase to use in
your manufacturing process, items related to shipping or even a
part in a final product.
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 unnecessarily 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.”1As 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.
Page 5 of 10. Sales Tax and the Manufacturer © Avalara 2012
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
It is a lot to track and execute accurately.
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.
Page 6 of 10. Sales Tax and the Manufacturer © Avalara 2012
Drop Shipping
on Behalf of a Distributor
or Retailer by a Manufacturer
A distributor or wholesaler will sometimes request the manufacturer
to drop ship their product to either their location or sometimes to their
customer’s location. If you are shipping direct to the distributor, and the
product is considered tax-exempt for resale, then no tax is required – only
resale documentation. But if you are shipping direct to the consumer
on behalf of your customer, the sale is complicated by the possible
combinations of nexus that can require collection or documentation.
Knowing what documentation you need to maintain for which states
becomes a major challenge—especially as ship-to destinations may
vary widely if your customer, the distributor, has you ship to their
customers in numerous states.
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.
Page 7 of 10. Sales Tax and the Manufacturer © Avalara 2012
Installation, Repairs and Nexus
Installation of finished items or even servicing working models can create
nexus (presence) in states where your manufacturing or distribution
center is not located. Each state has different determinations on what
counts as installation or repair services and whether your team entering
the state and performing the job constitutes nexus and thus sales tax
collection or documentation obligations. To complicate the matter further,
if you use a third party vendor to handle the repairs or installation of your
products, you may have created a condition that constitutes nexus as well.
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.
Page 8 of 10. Sales Tax and the Manufacturer © Avalara 2012
In a Nutshell: Create a Repeatable,
Consistent Process for Sales and
Use Tax Compliance
As with other manufacturing processes, having a repeatable,
consistent process with sales and use tax compliance means automation.
Automating sales and use tax compliance with a solution that ensures
that consistent, accurate process means a solution that delivers:
• 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
• Best practices in managing your sales and use tax processes
and easy access to all data in case of an audit.
• Up-to-date sales and use tax rates and information.
Using an automated solution for sales and use tax compliance
helps manufacturers and distributors stay up-to-date with the
latest changes in sales and use tax information. Consistency,
repeatability and accuracy help to reduce audit risk and potential
negative assessments.
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.
Page 9 of 10. Sales Tax and the Manufacturer © Avalara 2012
SaaS Solutions
Can Be Cost-Effective
When looking for a solution to help automate your sale tax process,
numerous options are available. The options range from lookup tables
to dedicated software located on a resident computer to Software-as-aService (SaaS) options. The benefits of using a SaaS solution include:
• 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.
In addition to these benefits, some SaaS solutions, such as Avalara’s
AvaTax, provide seamless integration with your existing Enterprise
Resource Planning (ERP) and financial applications. This capability enables
you to associate exemption certificates with customers and transactions
and provides ease of processing for your invoices including sales tax
and/or exemption status. Having a certificate management system that
enables you to have renewals tracked automatically, online collection
and storage of certificates and simplified workflow with tax department
oversight empowers your company to ensure a quality process. And that
quality process will reduce your risk of exposure to audits and failure to
file timely.
Avalara’s AvaTax gives you that 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.
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rights governing the subject matter in this document. Except as expressly provided in any written license
agreement from Avalara, the furnishing of this document does not give you any license to these patents,
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Learn more about AvaTax. Call 877.780.4848 today.
Avalara––Making sales tax less taxing.
Page 10 of 10. Sales Tax and the Manufacturer © Avalara 2012