In 2014 there were over 780 sales and use tax changes in the U.S. alone. For businesses, keeping track of these changes in order to calculate, collect and pay the correct tax is not only complicated – it’s risky.
Charge too little and you run the risk of audit penalties and adjustments. Charge too much and the outcome could be even worse. Increasingly, companies that run afoul of the complex web of state and municipal sales tax laws – which often vary within a single city block – are finding themselves the subject of class action lawsuits brought by their customers.
And You Thought an Audit Was Bad…
Not long ago, the biggest threat a company faced from a miscalculated sales tax charge was a visit from a revenue auditor. To avoid this, when they encountered a situation where details of a transaction were missing or uncertain, most companies would err on the side of over-charging the tax and remitting it to the appropriate jurisdiction.
If auditors found an underpayment, they would impose an audit assessment plus penalties and interest. If they found over-collected sales tax, they would issue a credit to the business after the customers had been refunded the tax in a lengthy, documented process. None of this was efficient for companies to deal with, but it was a predictable process with reasonable, simple penalties and outcomes in the event of a miscalculation.
Today, thanks to a combination of increased consumer awareness and a constantly changing set of tax codes, the risk of getting sales tax wrong has increased exponentially. Companies such as Whole Foods, Hertz, and Papa John’s have recently been targeted by class-action lawsuits for allegedly over-charging sales tax and have been pulled into litigation to defend their position.
The Hills Have Eyes
Sales tax compliance has always been a moving target, and particularly challenging for medium-to-large-sized companies that do business across multiple tax jurisdictions. It’s grown increasingly difficult to charge customers exactly what is due as tax authorities continually raise and lower their sales and use tax rates, change what products and services are subject to tax, and expand their boundaries with annexations. Due in part to government revenue shortfalls that have persisted since the 2008 financial downturn and to political volatility within municipalities around the country, the number of sales and use tax changes per year hovers between 700 and 1,000.
Meanwhile, consumers have gotten smarter. Armed with the ability to check sales tax rates on their smartphones on line at the grocery store, and – in many cases – aided by consumer protection hotlines that encourage consumers to report problems, every single customer now has the power to become a tax auditor.
Learning to Loathe Double-Coupon Day
Something as seemingly simple as a coupon can introduce a huge level of complexity into the process of determining the taxable basis of a retail transaction. Many states differentiate between store coupons and manufacturer’s coupons when it comes to calculating proper tax treatment for the goods sold. In California, for example, manufacturers’ coupons do not reduce the taxable basis of the transaction, but the retailer’s own coupons do.
So let’s say a customer buys a $10 bottle of laundry detergent with a $5 manufacturers’ coupon. At a sales tax rate of 8%, the tax due on the $10 item is 80 cents. The same customer buying the same $10 bottle of detergent with a $5 store coupon, by contrast, should be taxed on the $5 sale price, so the tax due would be 40 cents.
That’s just California. In Connecticut, manufacturers’ and store coupons both reduce the taxable basis, so that same detergent would be taxed 40 cents regardless of what type of coupon was used.
This same phenomenon plays out for businesses that deliver. In addition to determining the taxability of the item, they must keep track of the tax jurisdiction they’re delivering in even when the jurisdiction boundary follows non-traditional lines or changes when you cross the street. Get any one of these variables wrong and customers are likely to notice and report it. In the worst case scenarios – where this has resulted in class-action lawsuits – the costs make a tax audit appear downright pleasurable.
In the case of Papa John’s International, which just reached a tentative deal to settle a class-action suit in Florida for allegedly illegally charging sales taxes on delivery fees, plaintiffs claimed the pizza chain collected more than $5 million in sales taxes that were never owed. The case hinged on an obscure law in Florida which states that a separate charge for the delivery of pizza is not taxable if the purchaser had an option to pick it up in-store.
The ultimate settlement amount, while not disclosed publicly, is clearly more than an audit would have cost. Add attorneys’ fees and the reputational damage as this played out in public, and the imperative to get sales tax right becomes very clear.
So, how do companies operating in this environment hope to ever get it right? Are sales tax-related class-action suits just another cost of doing business in the United States? They don’t have to be. While the environment is exceedingly complicated, companies who commit the resources to aggressively tracking these changes and pro-actively adjusting their sales tax calculations to account for them can keep auditors and customers happy.
This is a new paradigm for corporate finance and tax departments that have not historically been focused on monitoring legislative news and listening to customer chatter before it boils over into something larger. Successfully navigating this brave new world of sales tax challenges involves coordinating interdisciplinary groups as diverse as tax, legal, and public affairs and actively self-auditing to make sure your sales tax charges stay in the sweet spot no matter how frequently the laws change or how complicated regional tax nuances become.
Carla Yrjanson is vice president of tax research and content for indirect & property tax, part of Thomson Reuters ONESOURCE.