After a year of sheltering at home, much of the country, if not already inoculated, is planning to secure their “get out of jail” pass via receipt of the long-awaited COVID-19 vaccine and return to some semblance of normalcy. Despite a year in waiting, widespread distribution of the vaccine together with passage of the unprecedented $1.9 trillion Federal American Recue Plan Act (ARPA or “the Act”) points towards increased demand for goods and services across the country.1 As the physical world begins to open up, the overriding question is: what will the impact be on the digital economy and the trend by state and local governments to tax internet transactions?
Prior to COVID-19, many businesses were already well poised to transform much of their past business practices from in-person brick and mortar experiences towards online selling of goods and services. This includes not only retailers but also B2B businesses that are providing extensive service offerings to their customers/clients.
Over the past year, the pandemic has proven that those businesses which embraced the digital marketplace for both offering and delivering services via the web have thrived.2 Not surprisingly, surveys support the notion that both businesses and individuals now overwhelmingly prefer the efficiency of digital self-serve sites and remote human interface over face-to-face interactions. And this trend is NOT expected to change even after folks are free to reenter the physical marketplace.3
Current Digital Trends
In order to keep pace with what now is expected behavior, companies are rapidly modifying their sales and delivery model to offer, sell and, in many cases, supplement the delivery of goods and services through the internet. Software-as-a-Service (SaaS), where businesses provide customers with options to obtain and receive information and content through hosted websites, has now become common business practice. This transformation provides a bonanza of opportunity for state and local governments to increase the types of services and companies which are subject to tax. For unsuspecting businesses, the nuisances of sales and use taxes can be a nightmare.
Sales and Use Tax Implications
The issues companies face include:
- Nexus considerations: Companies are subject to tax based on maintaining either a physical or economic presence in the state. Physical presence in a state occurs by maintaining inventory, facilities and/or employees. Three years ago, the Supreme Court in South Dakota v. Wayfair, also sanctioned that states can tax a company’s sales into the state provided certain state designated threshold requirements are exceeded. The expansion of employees working from home together with increased sales throughout the internet has caused many companies to considerably expand their state sales tax compliance footprint over the past year.
- Expanded service offerings: Over the past several years, virtually all companies, particularly those delivering services are using hosted websites to serve their customers/clients.
- Bundling of taxable/non-taxable activities: The bundling of taxable with non-taxable goods or services can prove particularly problematic for companies. Presently, in most states, only certain “enumerated“ services are subject to tax. However, in most states, the bundling of taxable goods and services with non-taxable services can cause the entire “bundle” to be taxable. Consider for example including warranty services (typically nontaxable) in the bundled price of otherwise taxable goods. Or what now is the common practice of delivering SaaS (often not taxable) through a hosted website which also includes the cost of processing or delivering of information via the same hosted website (frequently taxable).
Over the past year, there was considerable concern that state and local governments would suffer huge revenue losses due to the reduction of business, travel and entertainment movement across the country. Many, in the beginning of 2020, were predicting huge budget shortfalls. The reality is proving a different result, largely due to increased taxation of online sales; many states are proving to have increased revenues in 2020 over the prior year, and only a handful are showing revenue reductions. What now is becoming increasingly clear is that the initial predictions of huge state and local government revenue shortfalls have, in the overwhelming majority of states, failed to materialize.4 This phenomenon, together with the infusion of over $360 billion in federal funds, begs the question of whether the states will continue to aggressively pursue enforcement and expand those services that are subject to tax.5
Current trends appear to be pointed in the direction of more versus less government intervention. One only has to look to recent regulations that were issued in several states which make it clear that sales of goods or services, including SaaS, are subject to sales tax.6
Also, it should be noted that the infusion of federal funds cannot be earmarked for the reduction of any tax currently in existence; however, there is no restriction against the use of these funds to increase enforcement of existing laws, which is what many state and local governments are considering.7
How Companies Can Prepare Themselves
The implications of the above activities can prove to be a significant challenge for businesses. In order to avoid unforeseen sales/use tax risks, companies need to be exceptionally vigilant in:
- Tracking the company’s sales and activities into a state so they know when to turn on sales collection efforts
- Reviewing the bandwidth of existing point of sale and sales tax systems not only to handle current capacity but also to anticipate the expansion either through organic growth or acquisitions can prove to be invaluable when preparing budgets for capital and IT expenditures
- Connecting the front end with the back end of the sales cycle. All too often for valid business considerations companies (particularly service companies) do not want to share with customers the detail costs of certain materials used in delivering their services. So, they bundle those costs with other high-value service offerings. Doing so can drastically expose the remote seller to increased tax risk, with of all their billings being subjected to tax. And if the seller fails to collect the tax from its customer, then the entire burden is on the company if audited.
- Instilling customer confidence: Nothing can shake a client’s or customers’ confidence more than adding additional complexity or time (including service outages) to their sales experience. Ensuring that the correct amount of tax is billed with each invoice reduces future risk that the customer is not overcharged (seeking future refunds) or undercharged (upon audit). It is critical that companies properly map all product/service codes to the correct tax rates by jurisdiction. For most companies, this cannot be accomplished without the help of an outside software tool, but for most, the selection of the right tool and the implementation and updating of the service/product mappings is as important as getting it right “the first time.”
Duff & Phelps, A Kroll Business, is a firm that has no alliance to any third-party software or tax compliance management system, and as such, can provide an independent assessment of a company’s sales and use tax needs. Our Sales and Use Tax Services professionals can assist your organization in all matters relating to sales tax, including assessing and mitigating past exposures, selecting and helping implement the correct software tools, and managing all aspects of your company’s ongoing tax compliance needs.
This article was originally published by Bloomberg Tax.
1.Major components of ARPA include $7.5 billion in funding to “plan, prepare for, promote, distribute, administer, monitor and track COVID 19 vaccines. A sizable portion of the bill provides for aid to businesses, including an additional $7 billion to the Paycheck Protection Program, increasing the total funding to $813 billion; $28 billion to support the battered restaurant and food and beverage business; and over $25 billion to hard-hit small businesses that were economically affected by COVID-19 slowdowns. These amounts are in addition to close to $200 billion that is going directly to individuals in the form of stimulus payments, extended unemployment and food stamp programs. https://www.cato.org/commentary/were-paying-19-trillion-what
2.Online shopping grew 44% in 2020, to over $860 billion.
3.See McKinsey & Company survey, These eight charts- show how Covid-19 has changed B2B sales forever at https://www.mckinsey.com/business-functions/marketing-and-sales/our-insights/these-eight-charts-show-how-covid-19-has-changed-b2b-sales-forever#
5.Tax Foundation, What’s in the $1.9 Trillion American Rescue Act?
6.Many states including Arizona, Connecticut, Massachusetts, Ohio, Pennsylvania, Rhode Island, Hawaii and New York already tax digital services. Other states adopting or considering taxation include Maryland’s recent new tax on digital advertising and tax on sale of digital goods. http://mgaleg.maryland.gov/2020RS/fnotes/bil_0002/hb0732.pdf?utm_medium=email&_hsmi=117408466&_hsenc=p2ANqtz-_Lq7D9hmMhpBwX_lncFNkzC2wPg5GR6-ezQDP1lyRk0g9jBQySxafuUtZ0PHlInJ0zwHKEdNGvPaPRFRYHVChD9e0nRixM7dcIgCfZUs_B9G7EObM&utm_content=117408466&utm_source=hs_email;
Georgia is considering expanding its sales tax to include digital goods.
Montana, West Virginia and Nebraska also are considering adopting similar provisions.
7.The restriction: “A State or territory shall not use the funds provided under this section or transferred pursuant to section 603(c)(4) to either directly or indirectly offset a reduction in the net tax revenue of such State or territory resulting from a change in law, regulation, or administrative interpretation during the covered period that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit, or otherwise) or delays the imposition of any tax or tax increase.”. See also https://www.accountingtoday.com/news/will-tax-audits-and-enforcement-increase-to-make-up-for-pandemic-shortfalls