Deal Killer: Sales Tax, Use Tax and Value-Added Tax

Would you believe that sales tax and international value-added tax (VAT) noncompliance is a common reason for a seller walking away during due diligence?  It shouldn’t be a surprise when you consider how complicated it is to manage sales and VAT compliance when each state and country has a different set of rules and rates that are constantly changing.

The first issue that many companies fail to realize is that they may have nexus in a jurisdiction they didn’t think they did.  A business may have sales tax nexus if it has a physical presence (office, warehouse, agency, employees, shipping point, etc) in a particular state.  There are nuances to be careful of for each jurisdiction.  For example, a state may deem you to have a physical presence even if you make regular visits there but have no employees physically residing in that state.  Secondly, it is essential to realize whether you are selling tangible personal property or a service and how each state imposes sales tax on each of those.  Even though this may seem obvious, in certain types of businesses such as software or internet services, there may be a fine line.  Finally, with the current state and county budget deficiencies, sales tax rates and rules are changing rapidly and it’s essential to make sure you have current information.  Beware also that different counties in a state may impose additional sales tax as well.

Failing to pay the correct amount of sales tax can be a large liability to your company or a buyer when they purchase your company.  If four years later, a particular jurisdiction determines that your company should have been collecting sales tax from the end-user, it will be up to your company to recover that back-tax from your customers or the burden will fall on your company.  Even though you may feel safe because you are selling goods over state lines, you should ensure you have resale certificates from your resellers.  That way, if an issue arises, you can make a defensible case for yourself.  If a buyer wishes to purchase the capital stock of your company, the buyer will be highly concerned about a jurisdiction wanting to collect unpaid taxes from them that were incurred while you managed the company.

Value-added taxes (VAT) are typically used by international governments to accomplish something similar to sales tax.  Canada and countries in Europe, Asia Pacific, and Latin America typically utilize value-added taxes instead of sales taxes.  The primary difference is that instead of the taxing jurisdiction receiving all of the tax revenue when the end-user purchases the goods, it receives revenue on each component of the supply chain.  When you make a purchase or import in a VAT jurisdiction, you pay the vendor or customs broker the VAT on the purchase.  When you sell in that same VAT jurisdiction, you collect from your customer the VAT on the sale.  Basically, you pay the VAT rate on your gross profits at a specified frequency but ultimately it is still the end-user paying the entire VAT burden.  For most companies that import into VAT countries, compliance is less of a problem since they pay VAT to the country’s Customs department at the time of import and company wants to recover the VAT they have paid. 

Where we see the largest concerns on sales tax and VAT are companies that generate revenue from downloadable software, Software-as-a-Service (SaaS) and other internet services.  These sales are difficult to track for tax jurisdictions and many companies in the software and internet services business may not understand the sales tax and VAT laws of various locations.  The penalties for not complying with these tax laws may be huge and some countries penalize VAT deficiencies at up to 400%.

As you probably see every year on your tax returns, use tax is the tax on self-reported goods you purchased that were not levied sales tax.  Since US states have substantial budget deficiencies and are increasing sales tax and use tax rates, they are also leading a major initiative in trying to collect sales tax or use tax for purchases from out-of-state retailers.  This may include obtaining records from the leading online retainers or the shipping companies.  As a result, tracking your out-of-state purchases for the purpose of reporting use tax may become a significant concern as well. 
Here are some things you can do to reduce the chances of sales tax, use tax, VAT issues:

• Use resellers if possible and get resale certificates
• Make sure all resale certificates are up-to-date
• Look through your sales and operations to make sure there is no location you could be considered to have nexus
• Check where your sales people visit frequently
• Make sure you are current with the current rates and rules in the jurisdictions you have nexus and the VAT jurisdictions you sell to
• Track out-of-state and out of country purchases more carefully
• Contact a consultant to help you through the process

Don’t allow sales, use, and value-added tax noncompliance issues kill or obstruct your deal.  Correct all issues now.  Contact us if you require names of consultants that can assist you with Sales Tax and VAT compliance.