Editor: Frank J. O’Connell Jr., CPA, Esq.
State & Local Taxes
Today’s corporate tax departments are questioning whether they really need expensive bolt-on software for use tax compliance. The software is not only expensive to license, but it can also take considerable time to install. Moreover, the installation fees can easily be 10 times as expensive as the software license fees. As an alternative, tax departments increasingly are able to use their existing enterprise reporting package (ERP) accounting systems to automate use tax compliance through batch processing.
The batch process alternative can solve many of the problems that arise when accounts payable (AP) departments manually determine use taxes owed. A process that relies on AP staff manually analyzing whether each purchase is taxable is overly time-consuming and often inaccurate because they are not trained on use tax matters and are not up to date on tax law changes. A manual process can result in surprise use tax assessments. Manual processes also can fail to catch purchases of taxable goods and services from out-of-state vendors that do not collect the state tax. Use taxes can also be overpaid on items that could qualify for resale, manufacturing, or a variety of other exemptions.
Corporate tax departments can build out functionality within the AP system to set up use tax batch processing. With a little help from AP and the IT department, they can avoid the considerable license and installation fees associated with bolt-on software packages.
The following steps are normally taken to build a batch process to generate a monthly report of use taxes due to various states:
- Enhance AP data entry;
- Identify accounts to be queried on a use tax matrix;
- Create subaccounts where needed;
- Obtain a use tax rate table; and
- Build a query between the AP data, the use tax matrix, and the tax rate table.
Enhanced Accounts Payable Data Entry
A key to enabling batch processing of use taxes is to modify the AP process so that AP personnel separately enter the sales or use tax paid to vendors as part of the invoice processing system on accounts that typically are associated with use tax liabilities. Most AP invoice processing systems permit separate entries of use tax charged by vendors and paid to vendors. Monthly paid invoice reports can then be generated to identify taxable purchases where no use tax is paid.
The AP invoice processing procedures should also include entry of ship-to data. A monthly paid invoice report including this data element is critical to a batch processing system for corporations reporting use tax to multiple jurisdictions. AP should also enter invoice descriptions as part of the invoice processing system. A monthly paid invoice report with invoice descriptions facilitates tax department technical review of material items.
Queries, Subaccounts, and Tax Rates
The use tax liability of most corporations arises in purchases posted to 20 to 30 purchase accounts that are typically examined by state sales and use tax auditors. Most corporations that manually determine use tax have developed a formal or informal “use tax matrix” listing these 20 to 30 purchase accounts and whether use tax should be paid on items posted to that account in a particular jurisdiction. To the extent that an account on the use tax matrix is listed as taxable, that account is queried to identify items where no tax was paid to the vendor as part of the monthly batch process.
Subaccounts can be created if the account category is so broad that it would permit taxable and nontaxable purchases to be coded to one account. For example, a corporation with significant purchases of software might have one purchase account for all software purchases. However, the corporation may be using the software in states that do not impose use tax on remotely accessed software or customized software. Accordingly, in this example, the creation of subaccounts should be considered for remotely accessed software and customized software. Ship-to or location code data could be used to address the multiple-point-of-use issue.
Corporate tax departments that are faced with use tax reporting in multiple jurisdictions can subscribe to a sales and use tax rate table. These rate tables are supported by several vendors and are available online.
As shown below, each month the paid invoice report can be run through the use tax matrix, and the tax rates are applied to the taxable amounts to generate a batch report of use tax due or overpaid. Tax specialists can review the report and focus on material items. The data from the use tax report is then transferred to the monthly state use tax returns.
Integrating New Accounts, Periodic Detail Testing, and Tax Law Changes
Tax department specialists can be consulted when changes occur in the underlying business. They also should be involved in updating the batch process if an expense account that typically gives rise to use tax liability is added to the ERP system. Annual detail testing of a monthly batch by tax specialists is also recommended to confirm that AP data is being captured and reported correctly. Periodic updates to the use tax matrix can reflect tax law changes.
Corporate tax departments challenged by use tax reporting can design a use tax batch process using existing AP systems to avoid expensive bolt-on software license and implementation fees. The automated batch process can save AP considerable time and reduce use tax audit surprises, assessments, penalties, and interest.
Frank J. O’Connell Jr. is a partner with Crowe Horwath LLP in Oak Brook, Ill.
For additional information about these items, contact Mr. O’Connell at 630-574-1619 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.