CMI Study Guide

Separation

the seller’s itemization of the tax amount distinct from the sales price on an invoice (most commonly required)

Absorption

the condition that exists when a seller does not add sales or use tax to the selling price as a separate itemized amount, but instead remits the tax from their own funds (not commonly allowed) – compare to “separation”

Shifting

buyer bears the economic burden of a tax that may be legally imposed on the seller

Seller Privilege type tax

Purchaser becomes liable by contract, not statute

i. Tax is imposed on the seller for the privilege of selling tangible personal property within the state or taxing jurisdiction:
- purchaser liable by contract only
- cannot be assessed against purchaser in audit of purchaser unless seller relieved of liability through purchaser issuance of certificate or “exempt” purchase order.
ii. Tax may be recovered by seller from buyer (called “shifting” the tax burden).
iii. Tax may be included in the price (presumption of inclusion).
iv. Separation of tax amount is not required on invoice.
v. Tax may be absorbed by the seller.

Consumer Levy type tax

Tax is on the consumer collected by the seller and remains a debt to the seller from the purchaser until paid; purchaser is liable by statute not contract
i. Imposed by state on the Buyer (Consumer), but is debt to seller, who is required to collect the tax by state statute
ii. Seller often gets compensation by state for collecting & paying the tax (vendor’s comp)
iii. Tax must be separately stated
iv. Separation required; tax may not be absorbed
v. Tax could be assessed against both seller and buyer
vi. Buyer can request refund directly from state

Transaction type tax

Tax is likely to be collected twice (from seller and buyer) if the jurisdiction is not challenged during audit
i. Tax is imposed on the sale (transaction) of tangible personal property or taxable services, and may be a debt to seller until paid (statutory, not contractual issue)
ii. Seller may be compensated for collecting and paying tax
iii. Tax must be separately stated
iv. Tax may not be absorbed
v. Tax is often assessed against both seller and purchaser
vi. Buyer may have to get an assignment of the right to refund from the seller who remitted the tax in order to pursue a refund claim with the state

Gross Receipts type tax

Tax is a privilege tax with fewer exemptions
i. Tax is assessed on the gross receipts of a business in the state (with the underlying assumption being that of granting the privilege to transact business) cumulative, one transaction at a time
ii. Hawaii and New Mexico
iii. Tax concepts are similar to seller privilege tax
iv. Nearly all services as being taxable with few exemptions
v. Tax can be taxed as part of gross receipts (Hawaii)

Understand compensating taxes concepts

• The state must identify the intrastate tax burden for which it is attempting to compensate, and the intrastate tax must serve some purpose for which the state may otherwise impose a burden on interstate commerce.

• The tax on interstate commerce must approximate, but not exceed, the tax on intrastate commerce.

• The compensating taxes must fall on substantially equivalent events.

Significance of tax department in making business decisions

• First concept to always remember; the earlier the tax department can get involved in the project management process, the better.

• The tax department should be engaged early and planning should be on the upside of the project curve and provide any tax impacts along the way.

• Can lead to more efficiency in costs.

Terms, definitions and concepts related to administration and compliance

• Everything, even used stuff, is considered taxable unless exempted by statute

• Everyone is considered taxable unless exempted by statute

• All receipts related to the sale are taxable unless excluded by statute

• Only transactions defined by statute as occurring within the state are subject to the tax of that state

• Services are taxable by exception in all but gross receipts tax states

There are typically two broad concepts when determining if a taxable event has occurred:

• Has there been a transfer of possession (or performance of a taxable service)? Title, right to use or control (examples: copy machine; access to on-line service), transfer of physical possession (or performance of a taxable service)

• Has the purchaser given consideration to the seller? Cash, virtual currency, promissory note; assumption of debt; barter of goods or services.

Reciprocity

favorable tax treatment in one taxing jurisdiction (generally for taxes paid) conditioned on another taxing jurisdiction’s similar treatment in its own law. Not applicable if taxes paid were not legally due/collected.

4 ways that states measure use tax liability:

Material cost,
inventory/standard cost,
retail/fair market value,
rental value

True object test

if a mixed transaction, the true object (or what the purchaser is really purchasing) us what will be subject to tax.

Intercompany

every company on its own. A parent with subsidiaries and each should have their own registration and filing. A subsidiary is a separate and distinct taxpayer.

Intracompany

1 company with multiple divisions. 1 filing and 1 registration required. A division is part of the operating unit and part of the taxpayer.

Definition of nexus

The connection that a taxpayer (seller) must have with a state before that state may exercise its taxing authority over an entity. From a physical and/or economic standpoint. Economic since 2018 with Wayfair.

Agency sales and use tax nexus

In-State activities performed on behalf of the seller by third parties and/or related parties could result in Agency nexus.

“Click-through” Nexus

presume a remote seller has sales tax nexus when the remote seller participates in certain third-party e-commerce relationships, wherein the remote seller compensates the third-party for a sale referred from the third party’s website. May be moot due to economic nexus.

Affiliate or “Alter-ego” Sales Tax Nexus

deem legal entities which meet certain criteria, including being under common ownership and using common trademarks, to be the "alter-ego" of each other.

Physical presence

existence of a physical link with a state - employees, offices, property within the state. inclusive of third party contractors acting on behalf of company.

Economic nexus

Presence defined by states where a company crosses a specific gross/taxable sales threshold and/or transaction threshold in order to have nexus.

Instrumentalities of interstate commerce

• States cannot cross borders to tax

• Sales in Interstate Commerce are not taxable in state of origin, but may be taxable in destination state

• Purchases in Interstate Commerce are subject to use tax where they are ultimately used, stored or consumed

• Nexus determines the obligation to register and follow the State's tax laws (statutes)

• Multi-divisional, multistate corporations can have significant nexus problems activities of related company can create nexus

Prospective only application of law

Applied only from date of adoption and not effective retroactively.

The (Dormant) Commerce Clause

• “Congress shall have the power to… To regulate commerce with foreign nations and among the several States, and with the Indian tribes.”

• This was imposed to prohibit the states from imposing any law that imposes an undue burden on interstate commerce.

The 4 Prong Test from Complete Auto v Brady determines if a state tax law violates the commerce clause.

1. Substantial Nexus; the tax must be applied to an activity with a substantial nexus to the taxing state

2. Apportionment; the tax must be fairly apportioned

   • Internal consistency; test requires that the tax be such that is the same tax were applied by every jurisdiction, there would be no multiple taxation of the same income, value, or event.

   • External consistency; tests whether the state has taxed only that portion of the revenues from the interstate activity which reasonably reflects the in state component of the activity being taxed.

3. Discrimination; the tax may not discriminate against interstate commerce.

   • Cannot favor intrastate over interstate activities/goods. Taxes that favor in state businesses over out of state are unconstitutional. x

4. Fairly related; the tax must be fairly related to the services provided by the taxing state.

Due Process Clause

No state shall deprive any person of life, liberty, or property without due process of law. Minimum contact with the state and fairness of warning of being subject to the jurisdiction.

Foreign Commerce Clause

4 Prong Test plus No risk of international multiple taxation; no interference with one voice.

Import/Export Clause

forbids a state impost or duty on imports or exports. To promote the free flow of goods between the states.

Equal Protection Clause

nor shall any state…deny to any person within its jurisdiction the equal protection of law; Rational relationship standard, to afford equal protection of its laws to all similarly situated.

Supremacy Clause

The Law of the land; under VI (6) of the Constitution.

Typical organizational structure

• Divisional by tax type; personnel handle a type of tax separately

• Functional by activity; personnel handle full activity of tax (i.e., audits, appeals).

• Separation from appeals; has an independent tax appeal/court system.

• Centralized; all activities related to administration of tax handled at a single/central location

• Decentralized; has various district/regional offices with a headquarters

Powers to impose and regulate tax laws

• Issue rules and regulations, grant extensions, require record keeping, compel testimony, review records, audit, assess, hear appeals, abate penalties.

• Every word in the statute has significance and are written very broadly.

• Ambiguities in imposition favor the taxpayer, ambiguities in exemption favor the government.

Principles of tax collection

• Analyze and document current processes

• Set system parameters which will affect how a system calculates and stores tax information. Explore the use of bolt-on tax programs.

• Set conditions to obtain tax results

• Develop taxability matrices to identify taxability of products by jurisdiction

• Organize and manage exemption documentation and registration information

• Create reporting and/or audit data files

• Consider automation of tax reporting directly from reporting database

• Update processes and procedures and train personnel on the use of the system

Principles of audit administration

Collect unpaid taxes, promote compliance.

Registration requirements and processes

The act of formally enrolling a taxpayer with a state or other taxing jurisdiction for sales and use tax purposes

Registration Required if:

1. The state has enacted a statute covering the seller’s business.

2. The seller is making sales into the state and has nexus in the state. Nexus is reached if:

   • Seller has sales solicitation by employees, representatives, independent contractors & distributors.

   • Seller exceeds $ thresholds of sales or transactions set by the state after Wayfair.

   • Seller has post sale training, service, repair, installation, or engineering.

   • Seller owns or leases property in the state or maintains an office.

Considerations for sales transactions

• Is the obligation legally imposed? Does seller have to collect?

• Is transaction exempt by statute? Resale?

• Is the purchase exempt? U.S. Gov’t

• Is the property exempt? Manufacturing

• How is the tax imposed? Seller or Buyer?

• How should tax be presented on the invoice?

• What is the tax situs location?

• What is the rate?

• How is the tax computed? (discounts, freight)

• Where is the tax decision made? (system, manual)

• Exemption Certificate Issue (valid?)

• Use Tax collection or payment responsibility (transfers between jurisdictions, between companies or from inventory)

Considerations for purchase transactions

• Liability if property purchased without tax then self-consumed? Inventory

• Sales tax exemptions and exclusions generally apply

Considerations for transfer transaction

• Is the sale occasional or isolated?

• Is it merely the sale of stock rather than assets?

• Is the consideration forgiveness of debt?

• Is the sale all or part of the business?

• Is the sale part of the transfer of property into a commencing corporation, partnership, or Joint Venture?

• Does the state require pre-notification of the intended transaction?

Bulk sales provisions

• Many states do not subject the bulk sale of business assets to sales or use taxes, if the sale is of an occasional, infrequent or non-recurring nature outside the regular course of business.

• Bulk sale notification is designed to avoid successor liability and ensure that the state can collect outstanding sales and use tax liabilities of the selling corporation.

• Some states require the buyer to give notice of its intention to acquire a business prior to the acquisition and the time period to notify must be complied with to avoid successor liability.

• Some states provide that, on the sale of a business the purchaser will withhold a portion of the proceeds sufficient to cover any unpaid sales and use tax, interest, or penalty. If the purchaser fails to withhold the amount, it becomes liable.

Taxpayer Rights

• Most states have a bill of rights. Within each is a taxpayer’s right to professional/fair treatment by the taxing authority.

• If as a taxpayer you feel the auditor is not adhering to the requirement, there are avenues to file a complaint.

Exclusions

• transaction outside the general scope of the tax statutes. Common examples include real estate, stocks, bonds, & most services.

• An amount that is not included in the measure of sales & use taxes. Common examples include certain discounts, charges for freight, and charges for installation labor.

Exemptions

• A transaction that is within the general scope of the tax statutes, but is the subject of special provisions removing it from taxation. Common examples:

  • exemptions based on buyer type (charity, school, government)

  • type of item purchased (e.g. food, medicine)

  • certain uses (manufacturing, goods to be resold).

Exemption certificates

• document given by buyer to seller to claim exemption

• Relates to the use of the otherwise taxable property; requires certificate asserting exemption:

  • Resale – customer to resell property & report tax, assumes tax liability if property not resold

  • Direct pay permit – most common for large manufacturers who both resell & construct or consume. Cannot be used to avoid timely payment of taxes or to intentionally shift local tax from one jurisdiction to another. User must self-assess and pay timely

Exemption certificate completion requirements

• Must be complete and contain all information required on the certificate:

• Purchaser information (name, address, SUT permit number, EIN, officer signature, nature of business and what is being purchased)

• Seller information (name, address)

Transferring assets between corporate entities

• Intra-company transfers

  • transfers within one legal entity such as from one department to another department or one division to another division. These transfers may or may not be taxable. However, if the intra-company transfer results in withdrawing from inventory something that was purchased exempt, transferring that item to a taxable use within the entity self-assessment of use tax is required.

• Inter-Company transfers

  • sales occur between legal entities, not divisions. Sales between legal entities have no special exemptions in some states while other states may allow exemption. Sales between entities should be documented at “arms length”. Treat as a sale to a stranger. Collect tax, obtain exemption certificates, and document interstate commerce exemptions.

Measuring tax liability

• Add

  • Everything sold plus

  • Non-taxed purchases plus

  • Other taxable items transferred in

• Less:

  • Reductions (exempt sales) and deductions (exclusions)

• Multiply by rate

Preparing the return

• Verify data with GL, Business Knowledge(usually 10k and is 100k), compare monthly and quarterly

• Remember: Rates change, exemptions change, filing frequencies, return forms, mailing addresses, account numbers.

Penalties and interest

Penalty and interest for late payment/filing.

Secrecy of returns

• Tax data not confidential between taxing agencies.

• Intra-jurisdictional sharing likely

• Information sharing between states and feds

• Information sharing between states and localities

• Information sharing between states through “compacts” and associations. (Multi-State Tax Commission, Federal Administration of Tax Administrators, Special regional programs

Filing responsibilities and liability

Responsibility of the taxpayer.

Origin vs. destination

• Destination (where used) - local tax is based on shipped to location

• Origin (where sold) - local tax is based on shipped from location (issue with SST)
  
  Intra-company transfers may trigger local use tax in the destination location!

Difference among rates

• There can be rate differentials depending on the if the tax is destination based or origin based.

• Most states do not have uniform local rates

Differences among tax bases between state and local jurisdictions

• Most administered by state have similar structure.

• SUT definitions and exemptions of home rule jurisdictions may differ from those in their state’s statutes and regulations

Coding Issues are common

6700 jurisdictions

Home-rule versus state administration

• Home rule jurisdiction:

  • Self-regulating municipality, county or other political subdivision that has authority to levy or administer its own local sales & use taxes. The sales & use tax definitions and exemptions of home rule jurisdictions may differ from those in their state’s statutes & regulations.

  • These jurisdictions do not need to follow the state’s rules or exemptions.

• State administration:

  • Most sales and use taxes are administered by the state except for home rule taxes.

Bulk sale provisions

• Many states do not subject the bulk sale of business assets to sales or use taxes, if the sale is of an occasional, infrequent or non-recurring nature outside the regular course of business.

• Bulk sale notification is designed to avoid successor liability and ensure that the state can collect outstanding sales and use tax liabilities of the selling corporation.

• Some states require the buyer to give notice of its intention to acquire a business prior to the acquisition and the time period to notify must be complied with to avoid successor liability.

• Some states provide that, on the sale of a business the purchaser will withhold a portion of the proceeds sufficient to cover any unpaid sales and use tax, interest, or penalty. If the purchaser fails to withhold the amount, it becomes liable.

Sale for resale

The transfer of inventory may qualify as an exemption for sale for resale

Casual, isolated, or occasional sale

A sale made by a party not in business of selling, or an infrequent sale (usually less than 3 times a year) of property which is not normally held for resale or for which sales tax registration is not required.

Intangibles

Usually not taxable, Intellectual property, copyright etc.

Nature of the tax audit

Audits serve to test the general taxpayer population for compliance with the tax law while promoting general compliance from taxpayers at large

Authority for auditing of taxpayer’s records

General law provides for the state to access whatever records are reasonably required and to use whatever methods are reasonably required, to determine the taxpayer’s correct tax liability.

Managed audits

A managed audit is an audit that the taxpayer conducts upon themselves. Taxpayer compiles schedule for auditor to review to ensure it has been reviewed properly.

Statistical Sampling

• Pros

  • Less prone to bias than block sample

  • Can often use smaller sample size then block, saving time and money.

  • Multiple samples may be combined and evaluated.

  • Can be evaluated quantitatively.

  • Sample results are objective and defensible if sample is drawn properly.

  • Method provides for advance estimation of sample size.

  • Method provides an estimation of sampling error.

• Cons

  • More effort is needed to calculate the sample size (unless the sample has been generated by computer

  • Missing items are easier to detect when using a statistical sample because the auditor is generally checking all sample units off a controlled list.

  • Selection throughout the audit period means more “older” records may be examined as compared with a block sample

  • Common problems when auditing “older records” – harder to find, employees may have left company or forgotten data, data from customers or vendors is hard to get, may be harder to get electronically stored data for earlier periods.

Block samples

1. Sample period normally selected towards end of audit period so easier to collect records

2. Usually easy to calculate sample size because the totals may already be in your records, i.e., daily, weekly, monthly or quarterly

3. Missing items in a block sample may not be as easy to detect compared with missing items from a statistical sample. (Auditors often attempt to include missing items as taxable errors in the audit)

Records and retention requirements

Must be kept for full extent of statute of limitations.

Electronic data interchange (EDI) issues

Must be able to show tax was collected/paid

Auditor’s request for records

Require written requests for information. Protects taxpayer from having the auditor review files that are not allowed under the law. Also provides paper trail of responsiveness

Entrance interview with auditor

• Request reason for audit

• Request copy of prior audit

• Discuss Waivers

• Waivers/Consent to Extend Statute

Statute of limitations and waivers of statute

Waivers should be used on a mutually beneficial basis, such as when the taxpayer requests delays for its convenience. Waiver requests can be used to the taxpayer’s benefit as leverage for auditor commitment to an agreed upon timeline.

Control of the audit and the auditor

• All email and communications with auditor through you.

• Follow the auditor and keep an eye on him/her to see where they go

• Limit who the auditor talks with

The hearing

• Informal – hearing office, representative of audit division, and taxpayer/representative. Hearing officer will issue a decision or determination.

• Formal – conducted by administrative law judges, adversarial including testimony under oath, cross examination of witnesses, submission of evidence, opening and concluding remarks

Appeals processes

• Remedies: Protest; Pay then file refund; File Suit directly to district (Trial Court)

  • Trial Court

  • Court of Appeals

  • State Supreme Court

Claims for refunds

Offset against deficiencies to reduce interest and penalties

Predominant Use

Greater than 50% usage in the production process.

Exclusive Use

100% used in the production process.

Directly Used

Depends on state but could mean to act upon or change a material to form the product to be sold, has an active causal relation in the production of the item, used in handling storage or conveyance of materials, used to place product into package.

integrated plant theory

Concept which recognizes that modern manufacturing facilities are designed to operate as a series of synchronized and integrated processes, from the first movement of the raw materials to the packaging of the final product, all of which are essential to the manufacturing operation and, therefore have a direct effect on the product being manufactured.

exemptions, pollution control equipment

may be exempt if used directly in the manufacturing process.

industrial/enterprise zone

Incentive usually has to be approved before the project.

ancillary equipment

Equipment that is essential to be manufacturing operation but does not directly act upon the product. Conveyor belt etc.

Quality control

used to measure or control the flow of raw materials as they are being processed.

R&D

Enhancing current products or developing new products.

Packaging

wrapping and packaging products for final sale.

Transportation

conveyors, forklifts, piping – may be exempt in some states especially those which adhere to the integrated plant theory for manufacturing.

Catalyst

considered consumables but may leave a trace of the item in the final product therefore, an exemption may be available.

trade-ins, discounts, gifts, premiums, samples

• Trade-In generally any allowance or credit for tangible personal property taken as partial payment by a retailer for the purchase of goods.

• Trade discounts, volume discounts, cash discounts, employee discounts are generally excluded from the taxable receipts as a pricing adjustment.

advertising and advertising supplements

• Print advertising – sale for resale exemption. The supplements become a component part of the finished product that is sold at retail.

• Newspaper exemption.

• Direct Mail – Exempt in some states.

• Co-Op advertising

• Temporary Storage

• Giveaways

• Printing Service

• Photography

• Letter Shop Services

• Creative Services

• List Rental

Retail Exemptions

Resellers, exempt customers, native Americans

warranties

• If the state requires the Retailer to tax the sale of the warranty, the warrantor (the retailer) can purchase the repair parts under a resale exemption.

• If the State statute exempts the sale of the warranty, the warrantor must pay the sale or use tax on the purchase of the repair parts.

• Mandatory – some states will tax the mandatory charge and exempt the parts for resale

• Optional – Some states will exempt the charge but the warrantor must pay use tax on the parts

shipping, transportation, handling charges, packaging

Handling charges generally not exempt from tax. The inclusion of shipping (Shipping and handling) may result in the entire amount being taxed

drop shipments

• Sale where the retailer accepts the customer’s order for goods, but instead of fulfilling that order from inventory on hand, the retailer transmits the order to a third part (drop shipper) to deliver the goods to the retailer’s customer.

• Generally if the retailer has nexus with the customer’s state, the retailer collects the tax and no problems arise. Where neither the drop-shipper or retailer has nexus, no tax will be collected, but no problems arise.

• When retailer does not have nexus but drop shipper does a drop shipper, who is registered or has nexus with the customer’s state may have an obligation to collect. The states are divided.

demonstration/display inventory

Most states will impose a requirement that the merchandise must be held for sale in the regular course of business

mail order sales

• Taxpayer must have physical presence in the state before the state can require them to collect sales tax. Can be established through office, store, plant, warehouse, or other property in the state. Can also be established if any employees or agents working in the state.

• (Pre Wayfair) - Merely having a subsidiary or other related entity, or economic nexus does not create nexus

Internet access is not telecom service

Internet Access not taxable under ITFA

3 Prong Test for State to Tax Telecom

1. Did the call originate in the taxing state

2. Did the call terminate in the taxing state

3. The price of the call is charged to a service address in the taxing state.

Many states have adopted laws or rules to situs monthly recurring fees or flat rate plans to the customer’s place of primary use.

prepaid calling cards

Prepaid phones, cards, and services are considered TPP and not telecom services.

900 service

an inbound toll “telephone communications service” purchased by a subscriber that allows the subscriber’s customers to call in to the subscriber’s prerecorded announcement or live service.

true object test

A test used to evaluate the intent of the parties in determining whether or not a transaction is taxable (often when a transaction involves a mix of products and services. Test applied when determining if the intent was a taxable sale of TPP or the transfer of TPP incidental to a non-taxable service.