Managing Sales Tax Exemptions Diane Yetter May 11, 2017
Introduction Sales are taxable unless a specific exemption or exclusion Proceed with caution when determining which transactions qualify Careful examination of state laws must be made There are inconsistencies in the exemptions offered across states, specific state definitions which must be met, and in some cases surprising exclusions. 2
Introduction (cont.) Exclusions are statutory and apply regardless of the customer and do not require exemption documentation Common Exclusions include services, clothing, food, and medicine Exemptions are based on the customer and do require some sort of documentation: Nature of the Transaction Nature of the Use Nature of the Purchaser 3
Introduction (cont.) Keep in mind the seller s responsibility for exemptions Customer must declare exempt status and provide documentation If documentation isn t captured, tax liability can become seller s responsibility at time of audit 4
TRANSACTION EXEMPTIONS 5
Transaction Type Exemptions Sales for Resale All sales exempt purchases for resale. Tax is imposed on the sale at retail of taxable property and services to the ultimate consumer. Hawaii taxes wholesale sales at a reduced rate Wholesale, Distributor, or Retailer purchases Intermediary sales in the production process qualify for the resale exemption. Items used in production of other goods Raw materials and items that become a component part of the manufactured item for sale qualify for the resale exemption. 6
Transaction Exemptions (cont.) Sales for Resale (cont.) Service purchases If property and services are incorporated in providing a taxable service, the property and services may qualify for the resale exemption. The items or services purchased by the service provider normally need to be passed on to the service provider s customer to qualify for the exemption. 7
Transaction Exemptions (cont.) Interstate Commerce The sales tax is imposed on sales where transfer of title or possession occurs within the taxing jurisdiction. Therefore, if a sale occurs in interstate commerce, the original state where the sale occurs cannot tax the transaction. The destination state, however, will likely subject the transaction to its use tax. If the vendor is registered to collect the destination state s tax, the use tax should be collected and remitted to that state. If the vendor is not registered, the purchaser has the liability to remit the consumer s use tax. 8
Transaction Exemptions (cont.) Interstate Commerce (cont.) In order to document that a sale occurred in interstate commerce, the invoice should indicate that transfer of title or possession occurred in another jurisdiction. This can be shown through: Freight terms, Delivery charges, or Other documentation 9
Transaction Exemptions (cont.) Occasional/Casual/Bulk Sale A typical statute may define an occasional sale as the sale of tangible personal property (TPP) not held or used by a seller in the course of an activity for which he is required to hold a certificate of registration The exemption is usually limited to those taxpayers not regularly engaged in selling TPP In some states, the exemption applies to items sold outside the normal course of business (e.g. a publishing company selling computers). The exemption is sometimes limited to a certain number of sales or a specified dollar amount. 10
Transaction Exemptions (cont.) Occasional/Casual/Bulk Sale (cont.) Some states exempt the sale of business assets in conjunction with the sale of a business or an identifiable segment. The bulk sale needs to be one sale to one customer and not broken out to other purchasing parties or it loses its identity as a bulk sale. Some states exclude from the definition of a taxable sale specific transactions such as incorporations, mergers, liquidations, or the sale of an entire business. Many states require the filing of a bulk sale notification. 11
USAGE EXEMPTIONS 12
Usage Exemptions States offer various different types of exemptions based on the use of a certain item. Historically, these exemptions have been granted to encourage investment in the state by various industries. In order to claim the exemption, the seller must obtain appropriate documentation from the purchaser. In most cases this is an exemption certificate. 13
Usage Exemptions (cont.) Manufacturing Exemption Many states offer an exemption for machinery and equipment used to manufacture items of tangible personal property for sale. The definition of manufacturing varies from state to state, and is rarely defined in the same manner as the taxpayer would define manufacturing. The definition of equipment can vary also, and some states are beginning to include chemicals, consumable materials, and other property not previously considered to be equipment in their definitions. 14
Usage Exemptions (cont.) Manufacturing Exemption (cont.) The following items may be included in a state s manufacturing exemption: Machinery and equipment used directly in production Repair or replacement parts for manufacturing equipment Utilities used to power manufacturing equipment Packaging supplies and equipment Pollution control equipment Research and development equipment and supplies 15
Usage Exemptions (cont.) Manufacturing Exemption (cont.) The following items may be included in a state s manufacturing exemption: Computers used in the manufacturing process Leases of qualifying manufacturing equipment Repair and services to qualifying manufacturing equipment Other items necessary to the manufacturing process 16
Usage Exemptions (cont.) Temporary Storage Some states exclude, from their definition of use, property which is stored in the jurisdiction temporarily before shipment outside the jurisdiction. This exclusion is usually embedded in their definition and is not listed separately as an exemption. Therefore, you must look closely for this exclusion. In some states, Arizona for example, the exemption for temporary storage only exists if the property enters the state from outside the state and is governed by the Use Tax Statute. 17
Usage Exemptions (cont.) Temporary Storage (cont.) In order for the temporary storage exemption to apply, usually there can be no use of the property prior to its shipment outside the state. Some states allow repackaging, testing or other incidental use. Other states will view these actions as use, and subject the property to tax. 18
Usage Exemptions (cont.) Temporary Storage (cont.) Purchase planning can utilize temporary storage exemptions if bulk purchases are made of administrative, marketing, or sales materials. Make sure the necessary documentation is provided to the vendor to substantiate the exemption. This can usually be a statement indicating temporary storage. If the temporary storage exemption is utilized, remember to self-assess the use tax on the value of the property in the ultimate use state. 19
EXEMPT ORGANIZATIONS 20
Entity Exemptions Different purchasers may be granted exemptions under state statutes. These exemptions are granted by the legislature or are based on federal prohibitions. When an intermediary purchases goods intended for consumption by an exempt entity, the states vary whether the intermediary can invoke the ultimate consumer s exemption. 21
Federal Government Government States are prohibited from taxing direct sales to the Federal Government under the principal of federal sovereignty and the supremacy clause of the U.S. Constitution. Some states specifically include an exemption for sales to the Federal Government. Others simply exempt sales that they are prohibited from taxing under the U.S. Constitution. For all sales to the Federal Government, evidence of the sale must be retained in order to claim the exemption. To qualify for the exemption the sale must be made directly to the federal government and paid for by federal funds 22
Government (cont.) State and Local Government The exemption for state and local governments is purely a product of the legislative process and of legislative grace. States are free to provide exemptions without question of discrimination against other non-governmental agencies. Some states provide exemptions to state governments of other states only if the other state provides a similar exemption. Not all states provide an exemption for sales to themselves. 23
Government Contractors The tax treatment of purchases by government contractors remains a troublesome issue in many states. Since sales to the Federal government are constitutionally prohibited from taxation, many government contractors believe their purchases for Federal contracts should be exempt. Clearly, items that are incorporated into the TPP sold to the Federal government or any other entity would be exempt under the resale exemption. Disputes arise with government contractors consumable purchases and contracts involving improvements to real property. 24
Exempt Organizations States are free to choose whether to tax non-profit organizations and charitable organizations. Certain requirements must be met for an organization to qualify for a sales tax exemption. Many states tie their exemption to federal provisions under Section 501 of the Internal Revenue Code. Other states tie their exemption determination to the purpose of the organization, i.e., charitable, religious, or educational, or simply not-forprofit. Most states require an application by the organization for the exemption to apply. Additionally, a separate exemption number or letter may be issued for the sales tax exemption. 25
Exempt Organizations (cont.) For most states that grant an exemption to non-profit organizations, the exemption is for their purchases of items used in conducting their exempt activities. If the organization makes sales that compete with for-profit companies, their sales are often either subject to sales tax when sold or taxable when purchased. Examples of potentially exempt organizations are schools, churches, non-profit hospitals, charitable organizations, and PTAs. Donations of goods to charitable organizations are normally taxable and use tax should be accrued by the donor. 26
EXEMPTION DOCUMENTATION & SUPPORT REQUIREMENTS 27
Exemption Documentation Understanding the jurisdiction s rules with the authority to tax a specific transaction is important for company operating in many locations Each state may have specific guidelines for the type of certificate it will allow. Uniform Multijurisdictional Exemption Certificate (http://www.mtc.gov/resources/uniform-sales-use-tax-exemption- Certificate) Accepted by 38 states Many states add stipulations Streamlined Sales Tax Exemption Certificate (http://www.streamlinedsalestax.org/index.php?page=sst-exemptioncertificate) 28
Exemption Documentation (cont.) Documentation Applicable Jurisdiction Blanket vs. Single Purchase Order Certificate Good Faith Paper vs. Imaged Electronic Certificate Registration/Exemption Number Renewal Period/Expiration Date 29
Exemption Documentation (cont.) Resale certificate Signed document which indicates that the purchaser intends to resell the goods. It is usually provided by a retailer to a wholesale dealer. Usually provided as blanket form. This means that the resale certificate applies to all items purchased from the vendor. Some states require their own specific certificate. Other states will accept the Multi-Jurisdictional Exemption Certificate or the Streamlined Sales Tax Exemption Certificate. Still others will allow a statement of resale on the purchase order. Some resale certificates expire. Update regularly. 30
Exempt Organization Certificates Document provided by the purchaser to the vendor indicating that the purchaser is a qualified exempt organization under the laws of the purchaser s state The federal IRS letter granting 501 exempt status generally does not meet the requirements for state purposes on its own. Just because an organization is exempt federally does not mean they are guaranteed an exemption from sales tax. The purchase must generally be made directly by the organization and paid for with the organization s funds. 31
Exempt Use Certificates Document provided by the purchaser to the vendor to substantiate a particular use of the goods purchased Types of Exempt Use Certificates Manufacturing Pollution Control Agricultural R&D Prime Contractor In order for an exempt use certificate to be valid, a description of the use of the property is required. 32
Interstate Commerce Exemption Documentation Sales delivered into interstate commerce are not subject to tax in the seller s jurisdiction although there may be a tax due in the state of delivery Seller must document that goods were delivered out of state Generally, no specific forms 33
Direct Pay Certificates Document that a purchaser provides to the seller when the use of the goods is unknown at the time of the purchase. The purchaser accepts responsibility to determine the taxability of the goods and remit the consumer s use tax when applicable. May only be valid for sales and use tax Not every state provides for direct pay certificates Some states limit the types of items that can be purchased under the direct pay permit to those items where taxability is unknown. Sellers are required to obtain the direct pay permit from the purchaser 34
Drop Shipments Retailer/seller accepts order from customer/end user Retailer places order with supplier Retailer directs supplier to ship goods direct to customer/end user Supplier bills the retailer at wholesale price Retailer bills customer at retail price 35
Drop Shipments (cont.) 36
Drop Shipments (cont.) The transaction between the manufacturer and the retailer is considered a resale transaction. The issue then becomes what is appropriate documentation to support the exempt transaction. Some jurisdictions will allow alternate documentation (certificate from the retailer s home state, MTC Uniform Sales and Use Tax Certificate) if the retailer does not have nexus and is not required to register. Other states require their own registration number in order for a valid resale certificate to be provided. Some states will accept a pass through exemption if the customer is an exempt entity or is also reselling the goods purchased. 37
EXEMPTION MANAGEMENT TOOLS 38
Exemption Certificate Management Tools Form Packages There are a number of sources to obtain blank forms that can be used to prepare exemption certificates. Many states provide blank forms for downloading on their website. There are vendors that provide either form packages in electronic or paper medium to customers. Some electronic forms packages provide key entry capability. 39
Exemption Certificate Management Tools (cont.) Validation Packages Some of the more sophisticated systems provide scanning capability and validation of the scanned form and data against state requirements. The specific fields are keyed from the scanned document and validated for the appropriate exemption number format. Generally also provide significant reporting functionality to assist in the management and updating of certificates received. Some provide interfaces to tax calculation packages If a validation package is used, the data will need to be interfaced into the tax calculation or billing system 40
Exemption Certificate Management Tools (cont.) Calculation System Interactive Packages Most of the tax calculation packages include an exemption certificate entry component in their product. This is used to establish customer exemptions that should be applied during the tax calculation process. In some products, there is the ability to cross reference to a scanned copy of the certificate. Reporting capability is limited and can t provide the same level of functionality as the validation packages Many of the calculation systems have validation packages as an additional product offering which would integrate into the calculation system. 41
Exemption Certificate Management Tools (cont.) Hosted and Service Solutions Some providers offer a service component where they will manage the request, renewal and approval processes. The application is usually hosted and maintained on the provider s servers. The client has access to the certificates and communication to the customers can be customized to meet the needs of the client. The customer accesses the software remotely to provide their exemption certificate to the provider 42
Exemption Management Vendors Avalara www.avalara.com E-Doc Solutions www.edocsolutions.com Second Decimal www.seconddecimal.com Sovos www.sovos.com Thomson Reuters - https://tax.thomsonreuters.com/products/brands/onesource/indirect-tax/ Vertex www.vertexinc.com 43
EXEMPTION CERTIFICATES MAINTENANCE BEST PRACTICES 44
Exemption Certificate Maintenance The renewal period of exemption certificates varies by state and by type of exemption. Exemption certificates expire more often than resale certificates Some states exemption certificates do not expire Recommended to update all certificates that don t otherwise expire every 3-5 years Retain all prior certificates that could be required under audit Electronic data accepted in SST states Scanned certificates must be readable and unchangeable 45
Exemption Certificate Maintenance Best Practices Get exemption certificates even in states where you are not registered Match customer names in your system with the customer name on the certificate At a minimum, confirm the right number format Some states provide the ability to validate certificates or may even require it Maryland provides an online verification tool Kansas and North Carolina also provide online verification tools 46
Resources Visit the Sales Tax Institute: http://www.salestaxinstitute.com/iofmspring2017 For links to helpful information regarding sales tax 47
Questions/Comments Diane L. Yetter YETTER tax meets technology Sales Tax Institute 910 W. Van Buren, Suite 100-321 Chicago, IL 60607 diane@yettertax.com (312) 701-1800 x2 Twitter: @YetterTax and @SalesTaxInst YouTube Channels: Yettertax, Salestaxinstitute 48