Sales and use tax shouldn’t just be the responsibility of your A/P and A/R departments.
Although they’re the ones who are experts in sales and use tax liability, your sales and purchasing teams can support Finance by double-checking that the following terms are spelled out in all your contracts:
- Freight On Board (FOB), which determines when tax liability is incurred – either the shipping destination or shipping origin
- Date and location of sale, which determines the jurisdiction where the tax liability is assessed
- The transfer of sales and use tax liability when the buyer of goods becomes the owner
- Special contract terms that may say whether or not tax is included in the price. “Sometimes, states do not allow the tax to be included in the final price,” compliance auditor Pamela Fagan-Shull said in a Premier Learning Solutions workshop on navigating sales and use tax compliance, and
- Shipping instructions addressing any breaks in the transit of goods, such as storage in a warehouse, that trigger additional use tax liability.
Sales and use tax typically owed at destination
According to Fagan-Shull, most states follow the “destination rule,” meaning the seller retains the title of goods until delivered to the buyer, then sales and use tax gets imposed at the shipping destination. But of course, there are exceptions to the rule. For example, if a contract specifies “FOB shipping point,” tax is owed in the state the goods are shipped from, or the point of sale.
Uniform Commercial Code Article 2 offers additional sales and use tax determination guidance. In lieu of a written contract between buyer and seller, the tax liability wording on the purchase order takes precedence over all else. If there’s no purchase order, by default, the invoice dictates who pays whom.
“Your best bet, if it’s not stated, is to (assume) ‘FOB destination,'” Fagan-Shull said.
To avoid double taxation when merchandise crosses state borders, the law says sales and use taxes can’t be imposed on sales made in commerce between one state and another, or between a state and a foreign country, Fagan-Shull said. However, there are notable exceptions to that general rule.
Sales and use taxation can occur during interstate commerce if:
- There’s a break in transit and the property comes to rest in a state
- There’s a break in the transit of goods and they’re “held at the pleasure of the owner for disposal or use,” and
- Interstate movement of goods hasn’t begun (potential movement doesn’t prevent a state from taxing property, Fagan-Shull said).
The logistics of how freight gets transported is also a factor. Fagan-Shull gave an example that if a plane carrying a shipment of merchandise lands at an airport in another state, and the merchandise is then transferred to a truck, the state where the airport is located can collect tax.
Also, strategically adjusting your inventory warehousing based on locations with lower state tax rates can also save you money.
Can the synergy between A/P and Purchasing and A/R and Sales be improved? A good place to start is empowering Purchasing and Sales to make determinations if what’s being bought or sold is tangible personal property or a service, then passing that info along to Finance.
On the A/P side, a purchase order vs. invoice comparison has to be made to determine if sales or use tax is due. If the purchase is intrastate, for instance, sales tax probably comes into play. If the merchandise is coming in from out of state, transferring ownership or changing purpose (change of intent needs to be documented), use tax is involved and you must self-assess it.
A good, audit-compliant assessment strategy for A/P to stay on top of sales and use tax obligations is to make a note on invoices that have tax due, generate general journal entries into your tax account as liabilities, then pay the tax when the applicable return gets filed.
If a purchase is tax-exempt, an exemption certificate or statement must be on file. Some examples of manufacturing exemption items that are usually nontaxable (double-check the specific state tax code if these are taxable/nontaxable):
- Machinery and equipment used in the production of tangible personal property
- Repair or replacement parts for production machinery
- Ingredients and component parts that enter directly into, or become a part of, the products produced
- Manufacturing tools
- Fuels used in the manufacturing process, and
- Other materials used or consumed directly in production.
Meanwhile, A/R has to figure out whether a sales tax applies or if the item is exempt. (Exemption certificates or statements need to be on file.) If a sales tax applies and you have nexus, find out if your company’s registered with the applicable government revenue department.
Purchasing can further support Finance by choosing vendors based in states with low tax rates or no sales or use taxes.