Tax Compliance Challenges In Today’s Dynamic World
Manufacturers report several common challenges to properly and efficiently filing, remitting, and reporting on taxable transactions. Tracking tariffs, tax rates, and product taxability rules across jurisdictions staying tax compliant while growing the bottom line, and managing exemptions in preparation for the inevitable audit are a few that frequently top the list.
These days, global trade wars, shifting supply chains, and increasing pressure to find new avenues for growth are adding extra layers of complexity to tax compliance challenges. Here we’ll take a fresh look at how manufacturers can best prepare for tax compliance given today’s dynamic global and domestic circumstances.
Challenge: Tracking tariffs, tax rates, and product taxability rules across global and domestic jurisdictions
Whether or not your business is benefiting from recent global tariffs, there’s no doubt the current trade war is complicating compliance with international tax obligations.
As fluctuating tariffs change the price of goods and inputs, keeping track of which goods are subject to what tariffs and their current rates have become more difficult than ever. Following the news on international tariffs can be time-consuming — but miss an announcement and you could make mistakes that increase costs, penalties, or customs delays resulting in unhappy customers.
Increased prices due to tariffs are forcing many manufacturers to consider shifting their supply chain, however, these shifts often mean new compliance and product taxability rules and rates. Even with conscientious planning for new tax compliances, however, political uncertainty can make it difficult for business leaders to feel confident about where to make changes, or whether to make them at all.
The domestic tax landscape has also changed significantly over the last year for many manufacturers as states pass economic nexus laws that increasingly subject manufacturers to sales tax under certain circumstances (see more on this below under “Direct Selling”).
Challenge: Tax compliance while growing the bottom line.
Technological advances have enabled manufacturing businesses to improve efficiency methods over the years. But as these efficiency measures become standard practice across the industry, many companies are exploring new avenues for growth. Each new avenue for growth, however, is usually lined with significant, and often unfamiliar, tax compliance challenges.
Going global. Entering the international market means not only weathering global tariff fluctuations described above, but also learning and complying with a new set of terminology, systems, rules, and even consequences. Incorrectly reporting factors like Harmonized System Codes (“HS” codes), value-added-tax (VAT), goods and services tax (GST), and tariffs (import duties) can include customs delays, increased scrutiny from tax authorities and auditors, and even costly fines and penalties. To help mitigate these compliance risks, manufacturers need to carefully plan new compliance practices. Many companies use intermediaries or export agents to complete cross-border transactions, but these additional costs to every transaction, reducing profit margins in the long run.
Direct selling. On the domestic front, manufacturers who sell products directly to consumers or through drop shippers in remote states must now be aware of the new and various economic nexus laws states are passing. Most goods are now taxable in 45 states and more than 12,000 jurisdictions (with distinct sales tax rates), often making it necessary for businesses to register, collect, and remit sales tax in multiple states and jurisdictions. This can quickly become overwhelming even for seasoned direct sellers.
Services. Service offerings within such as installation, repair and maintenance, and equipment leasing are becoming as commonplace among manufacturers in the U.S. as the potential for incurring sales tax on those services. Taxability and rates are once again dependent on jurisdiction, however, determining the precise jurisdiction in which a service was performed can be problematic. Crossing state lines to perform a service can be enough to constitute nexus; using third-party vendors to do repairs and installations can also create nexus.
Challenge: Exemption certificate management.
Manufacturers encounter a variety of sales and use tax-exempt opportunities. Two of the most common are:
- Resale exemptions. These are sometimes granted for items intended to be resold to consumers, and the certificates showing current and effective proof of the exemption must be readily available in case of an audit.
- Direct pay permits. These allow manufacturers to purchase items (often machine parts) without paying sales tax, depending on how the item is used.
Exemption certificate management can be particularly difficult, especially when multiple states and/or industries are involved. However, properly documenting and managing exemptions is known to be one of the best ways to reduce the risk of penalties during an audit.
In the case of resale exemptions, manufacturers and distributors must maintain exemption certificate information for each state or locality where the reseller receives a 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.
Direct pay permits require tracking where each item goes and for what purpose in order to establish the taxability of that item. This becomes even more complicated in cases where manufacturers make bulk purchases and items or parts are then shared among multiple plants or facilities. An item might be taxable in one state but exempt in another — even if used for the same purpose.
If an audit reveals a missing, incorrect, or invalid certificate, the manufacturer or distributor could incur costly fines on top of the uncollected tax. Ultimately, it’s up to each business to correctly document which equipment, machinery, products, and uses a jurisdiction has allowed an exemption for and which are taxable. It’s a lot to track and execute accurately. Businesses must obtain required signatures, record expiration dates, and renew certificates as needed. Following changes in taxability and nexus laws is equally important.
Other activities, such as drop shipping to a consumer on behalf of your customer, can also trigger the need to maintain careful documentation. Dropshipping can be further complicated by possible combinations of physical and economic nexus that can mean sales tax collection and remittance to a number of states.
As we can see, manufacturers domestically and abroad are facing a slew of tax compliance challenges. Depending on size and scale, these can range from manageable to overwhelming — even on a good day. Compliance challenges needn’t be daunting, however. There are steps manufacturing companies can take to improve tax compliance efficiency and reduce risk.
Careful planning will help companies develop cost-effective compliance strategies. Planning should include comprehensive research studies that take into account political realities, foreign and domestic rules and regulations, up-to-date tax, and tariff rates, as well as the potential for state variations in sales tax nexus.
As with other manufacturing processes, cloud-based automation can provide a repeatable, consistent process for tax compliance along with a myriad of other benefits, such as:
- Automatically keeping companies up to date with domestic and international regulations and changing import duties;
- Sales and use tax calculations for collections that take into account both domestic and international product taxability, location, rules, and regulations;
- Exemption certificate management processes with digital collection and storage certificates, transaction association, and timely renewals;
- Flow-through returns processing that provides liability worksheets for each return filed that companies can review, granting oversight and visibility to all sales and use tax liabilities and remittance;
- Easy access to all data in case of an audit — anywhere, anytime;
- Reasonable costs. Most automated tax compliance software can be integrated into your ecommerce system, existing ERP, or other financial system without requiring investment in new hardware or software.
Some critical features to look for in an automated solution include:
- Easy integration with your ERP or other back-end financial applications and/or inventory management software that will enable you to associate exemption certificates with customers and transactions;
- Ecommerce integration capability;
- Geospatial technology to ensure “to the rooftop” level accuracy for locations;
- Accuracy and speed;
- Flexibility to grow, scale, and change along with whatever business decisions your company chooses to make.
Avalara’s AvaTax provides seamless integration with your existing Enterprise Resource Planning (ERP) and other financial applications and gives you the control you need to implement a quality workflow process.
Learn more about the sales tax issues manufacturers confront when entering new channels — and how to best deal with them — in How Tax Compliance Is Changing for Manufacturers. Download it here.