In a sales tax system, tax costs are the final consumer’s responsibility. Manufacturers, with no direct sales path to the final consumer, should then presumably be free from burdensome sales tax obligations. This is an incorrect assumption, and a contributing factor to the significant drains that compliance is placing on many manufacturers. Sales and use tax (SUT) compliance for manufacturers is no longer just a burden – for many, it’s a direct hit to their bottom line.
Like most business-to-business entities, manufacturers do not have to collect and remit sales taxes on most of their sales. Full compliance for a manufacturer means meeting sales tax obligations while also ensuring they do not over-pay use taxes on materials purchased. The complexity increases for manufacturers that operate across multiple jurisdictions.
As head of the indirect tax business at Sovos, my team and I wanted to learn more about the SUT compliance issues keeping manufacturing leaders up at night. We then partnered with Aberdeen and subsequently published a report, entitled Sales and Use Tax Compliance for Manufacturers: Boost Confidence, Ensure Accuracy. The study revealed a central message: Manufacturers of all sizes (ranging from $50 million to over $2 billion in annual revenue) are struggling to manage sales and use tax obligations – and they’re paying for it. It also examined the top challenges collectively shared by respondents, including:
- Increased audit frequency and cost to support
- Managing tax compliance with business evolution (mergers, new business lines, etc)
- Changes to ERP, purchasing and other financial systems
- Increased penalties from audit or filing errors
- Inefficiency in the current compliance process
Adding to the complexity, states are auditing businesses more aggressively, increasing risk and error exposure. As manufacturers grow, their tax departments struggle to keep up with changes impacted by acquisitions and mergers that increase their work load. In fact, the study revealed that over the past two years 24% of filings were submitted late and only 60% were accurate. Collecting sales tax is designed to be a cost-neutral activity- until an audit assessment occurs. Our study found that manufacturers incur penalties of over $55 thousand per audit on average; but it doesn’t stop there. This number is compounded by interest and costs of business disruption as employees switch focus to fulfill audit requests. The biggest audit drains on manufacturing businesses include:
- Time spent responding and supporting audit demands – As the filing process continues to become more complicated – summary data is increasingly being challenged by state and local regulators in the form of increased frequency and scrutiny of audits. Unfortunately, the need to quickly retrieve specific transaction-level data can be a huge struggle for tax and IT teams during an audit. Manufacturers must find ways to provide the requested information more efficiently and quickly.
- Managing customer exemption certificates – Exemption certificates are used to prove a sale was properly completed, tax free. Without the appropriate and complete certificate, the seller becomes liable for taxes, penalties and interest on that transaction. Their tax departments are especially struggling with certificate management because many certificates still exist on paper in a file cabinet. Auditors know this, and will quickly hone in on these transactions. Employees are then forced to comb through paper files, looking to provide the necessary documentation. Often times those documents are insufficient or unavailable.
- Researching and managing taxability rules and changes in systems – Accurate compliance requires an understanding of how products sold and purchased are taxed; but employees struggle to keep up with the rate and pace of indirect tax requirement changes. Considering that Sovos implemented over 161,000 rate and rule changes in our Tax Determination Engine in 2016, tax and IT teams are understandably struggling to keep financial systems updated based on the correct tax rules at the time of the transaction.
One or two SUT specialists are not sufficient to keep up with quickly changing, evolving and data intensive tax compliance initiatives today, much less going forward. Manufacturing businesses relying on spreadsheets and manual processes to research and meet compliance obligations will be more prone to errors and less able to adapt while incurring greater costs.
Solution and Takeaways
Manufacturers looking to improve their bottom lines and minimize compliance risks must enhance their current processes with technology. Employees can then focus on business growth initiatives, rather than daunting compliance and audit-related obligations. Here are three action items for manufacturers to make SUT compliance more efficient within their organization - and ensure accuracy:
- Centralize Compliance
ü Allows greater control of data
ü Improves efficiency
- Invest in Technology
ü Automate workflows for greater efficiency and accuracy
ü Implement an end-to-end solution to automate and manage determination, exemptions and filings
- Proactively Defend
ü Leverage tax automation providers’ expertise to keep tax rules accurate, and updated
ü Prepare for audits with the ability to respond quickly with complete data
Implementing automated processes and systems that can quickly update and manage rule changes will remove manual processes that result in the bulk of these compliance burdens. A technology-driven compliance approach ensures current rules are applied properly; and that the people focusing on SUT are able to quickly adapt to rapid business and regulatory change. Manufacturers using this approach can stay ahead of the evolving regulatory landscape, while empowering employees to focus on growing the business.