Benefits of Certified Tax Systems
The challenges facing CFO's and accounting and financial professionals today are
numerous. CFO's must ensure that accounting and budgeting functions provide required
information for their organizations, stockholders, and regulators. The need for
information from these groups continues to grow. In addition, tax complexity is
increasing. Depending upon the type of business, taxes can represent significant
payments and numerous challenges. These challenges include complying with the
various taxes and fees that businesses pay on their operations and income, and
transaction taxes on their purchases for use and taxable sales. In addition to
paying these various taxes and fees, CFO's are responsible for ensuring that their
businesses have accounting systems in place to properly account for, collect,
and pay these taxes and fees.
While existing technological solutions can achieve close to 100 percent compliance, tax collection models under consideration by taxing authorities would provide for certification of tax application systems and would provide more certainty for CFO's and tax managers in their tax function. These certified systems provide indemnification to businesses for calculation errors and reduce the liability of businesses for under- and over-collection of taxes. The systems also limit the volume of transactions subject to audit and the audit timeline, thus reducing the audit burden.
Growth of Sales and Use Taxes
Thirty years ago, the task of accounting for sales and use taxes was not as daunting as it is today. Many factors account for this change. The number of multi state businesses has grown significantly from small one-location operations to large corporations with multiple locations in various states and taxing authorities. This growth brought the responsibility to account for the rules, procedures, and laws of more taxing jurisdictions.
The number of jurisdictions levying taxes has also increased. In 1970, less than 5,000 jurisdictions had the authority to levy sales and use taxes. Today the number of jurisdictions that have enacted taxes exceeds 7,500. The number of rates that business must account for has also increased as state legislatures have added rates for various items such as drugs, food, farm equipment, and manufacturing equipment that vary from the general rate. In most states, the sales and use tax rates have grown steadily. In 1967 the general sales and use tax rate in North Carolina was 3 percent. Today its 7 percent (state rate of 4.5 percent and local rate of 2.5 percent in most counties). Wisconsin had a rate of 4 percent in 1970, and today the rate is between 5 percent and 5.6 percent, depending on the location of the sale. Both these states also have income tax levies. In Tennessee, a state without an income tax, the tax rate has increased from 3 percent in 1970 to 9.75 percent (highest combined general rate, state, and local) in 2002. Sales and use tax collections for the District of Columbia and the 45 states that levy the taxes have grown significantly since they were enacted. In 1994, collections were approximately $149 billion dollars and grew to more than $215 billion in 2000.
The expansion of remote commerce and the evolution of e-commerce resulted in a new challenge: collecting tax for online transactions. Online retailers may be faced with the prospect of multiple jurisdictions requiring collection and payment of taxes on every sale they make, including digital delivery of goods and services. E-commerce vendors may eventually be faced with determining tax differently for all taxing jurisdictions. The frequent changes in tax rates requires constant monitoring of rules and laws to make sure the correct tax is being charged on each transaction.
Consequences for Under-Collection And Over-Collection
In sales tax transactions, the seller is able to collect the tax and submit the collections. If a seller does not collect the correct sales tax when the transaction occurs, the seller is generally not able to collect the underpayment from the purchaser. CFO's have to ensure that their organizations have systems in place that accurately account for and collect the appropriate sales and use taxes.
The failure to collect and remit the appropriate amount of sales tax subjects a business to an assessment for the under-collection of tax along with penalties and interest. In addition, the failure to accrue and pay the appropriate use tax subjects a business to assessment for the additional use tax along with penalties and interest. In both cases, these underpayments generally represent the payment of potentially significant unbudgeted liabilities. In addition to under-collection, errors in tax application can also result in over-collection. Over-collection leads to customer dissatisfaction, including calls and compliant letters to the seller. In some cases, over-collection leads to class-action lawsuits that, at a minimum, require time and money to defend. To reduce errors and their exposure to unexpected tax liabilities and corresponding penalties and interest, tax professionals and CFO's need to continually review and update their tax-compliance systems.
Third-Party Tax Application Software
With the accelerating number of jurisdictions levying taxes, it is often difficult for businesses to maintain legacy tax systems. As a result, more companies are turning to third-party tax application software solutions to calculate, report, and remit transaction tax liabilities.
Typical third-party tax software products utilize transaction tax technology (see Figure 1). The software uses the location of the sale to determine the tax location, determines the types and application of taxes, applies any special rules such as exemptions, and stores detailed transaction results for audit reports, tax returns, and statistical reports. Tax application software can provide many benefits to businesses, including more accurate calculations and reporting, improved tax compliance, automation of the returns process, and more efficient use of staff, often resulting in a sales and use tax functions staff reduction.
Figure 1: Transaction Tax Technology — How it Works
Regardless of the system utilized, the business is responsible for errors that arise from incorrectly configured software, which may result in costly audits or class-action lawsuits. The certification of third-party tax application systems would increase the benefits to business and provide indemnification for errors. The indemnification benefit would be very important to CFO's as they strive to improve the accuracy of their compliance systems.
A Certified Tax Compliance Tax System
A certified tax compliance system requires certification by tax authorities who will soon have the power to offer certification and indemnification benefits. Certification involves systems testing and the establishment of standards for the software. To provide this benefit, authorities need legislation authorizing it. In addition, authorities need to work cooperatively on testing and standards to make the process efficient and practical. Many authorities feel the sales tax structure should be modernized as the certification effort occurs.
Since March 2000, taxing authorities have been involved in a simplification project known as the Streamlined Sales Tax Project to modernize the tax structure. They have solicited assistance to identify complexities and solutions. Business professionals and solution providers such as Tax ware have been partnering in the process. The goal of the project is to create a radically different sales and use tax system through simpler procedures, more uniform definitions and rules, required notice of law changes, and greater use of technology. It is anticipated that through this effort tax authorities will create more efficient tax structures that will increase compliance with existing laws and encourage voluntary collection of tax from those companies not currently required to collect. In addition, a simpler system could convince Congress to mandate collection of tax from remote sellers that are not currently required to collect.
The streamlined sales tax agreement that representatives of more than 30 states endorsed in November 2002 contains provisions for modernization. The technology provisions include electronic filing and payments, state-approved databases for rates and jurisdictions and state-provided matrixes for exempt products. The agreement also contains provisions for tax collection models that include certification of all or parts of the tax-application system. These models hold great promise for moving more of the uncertainty of tax compliance and burden from sellers and providing indemnification for errors.
Certified Tax Collection Models
The proposed certification provisions are contained in two models: a certified service provider (CSP) and a certified automated system (CAS). Each model provides more use of technology, the utilization of state-approved and state-provided databases, and product matrixes. The models also limit the liability of the seller for uncollected tax based on errors caused by the certified tax application system, and they reduce the audit burden on the taxpayer.
Certified Service Provider
A CSP is a contractor that is approved by taxing authorities to provide full-service tax collection to sellers. These functions include tax-application software for determining and calculating tax, integration of the software to the sellers products and order-processing system, and the filing of returns and payment of tax collected. A seller utilizing a CSP is relieved of liability for errors in tax application for transactions processed through the system. The CSPs tax-application system is reviewed and tested by taxing authorities to verify that the required databases and matrixes are used and that the system properly calculates and reports the appropriate state and local tax. The CSP must also meet certification standards established by taxing authorities.
The tax calculation and audit file process can be located remotely in a secure environment by the CSP or on a server at the sellers (merchant) location. Figure 2 indicates the parties responsible for various functions required for tax application. In model one, the CSP is responsible for all transaction tax functions related to sales. The merchant is responsible for use tax on purchases for use that are not part of the proposed certification process at this time, and for fraud. One of the proposals of the streamlined agreement is for taxing authorities to move the liability for the misuse of an exemption certificate from the seller to the customer. Therefore, customers are liable for any additional tax due where they incorrectly claimed an exemption.
Figure 2: Proposed Technology Model One — Responsible Party for Functions
Certified Automated System (CAS)
A CAS is a system that has been tested and approved by taxing authorities. The system would include the tax calculation and audit files that would be subject to the same certification and testing as in the CSP model. Sellers that obtain a CAS must integrate the system with their order-processing system, and they are responsible for the filing of returns and payment of tax collected. The seller is relieved of liability for errors for the transactions processed through the CAS.
In the CAS model the seller (merchant) is responsible for integrations of systems, returns, and payments. The certified system provider is responsible for the proper calculation of the tax in a transaction.
Pilot Project
The CSP model was the focus of a pilot project to test the concept of using a third party to provide the tax-application functions of a seller. The pilot included the states of Kansas, Michigan, North Carolina, and Wisconsin. These states worked with the selected contractors to test the contractors application and solution and to provide certification of the application.
Impact of Certification
Businesses currently using third-party software in their tax-compliance program gain significant benefits from the application. The application can determine the appropriate rate and tax, track exemptions, automate the returns process, and maintain an audit file of transactions. Businesses can rely on the software provider to revise the software in response to changes in rates and tax application, and the third-party software helps eliminate instances of under- or over-collection.
Certified systems will provide the added benefits of indemnification of errors and reduced audit burden, both in terms of audit time and defense. The proposed certified service model will go even further and move the tax application function from the seller to a third party approved by taxing authorities.
Existing third-party software helps CFO's meet the challenges and complexities of tax compliance today. Certified tax systems will add the important benefits of indemnification and reduced audit burden and will have a very positive impact on the tax function as CFO's strive to reduce the potential risks that organizations face in tax compliance.
