6 questions for manufacturers to reduce sales tax overpayments
Controlling spend is essential at a time when manufacturers are experiencing an unprecedented level of stress from many directions. Given the amount of change in 2020, one important lesson learned this year is that many manual processes in sales and use tax departments are costly to the business and cannot be sustained. Although it might seem counterintuitive, this is exactly the time when you should be thinking about automating those manual processes to protect and future-proof your business. If you do, you’ll discover considerable value in better managing tax to optimize spend.
One way for manufacturers to reduce spend is by improving controls on sales and use tax obligations. Because each manufacturer has tax complexities that are specific to their unique operations, there is no one-size-fits-all approach. However, there are implications of indirect taxes that all manufacturers need to address. These include overpayments of vendor-charged tax, potential penalties for underpaying tax, managing use tax accruals on inventory movements, and maintaining good relationships with suppliers.
Manufacturers are experiencing amplified sales and use tax complexities due to COVID-19
In 2020, the worldwide COVID-19 pandemic created major shifts in consumer behavior that directly impacted manufacturers. Some manufacturers experienced an explosion in demand for their goods. For example, a sudden surge in demand for medical supplies and equipment had these companies scrambling to move inventory and ramp up production. For other manufacturers, demand dropped significantly. Still others saw opportunities and were able to pivot to new high-demand product lines. In one case, an auto parts manufacturer rapidly retooled to manufacture medical masks that were in short supply.
If these stresses on manufacturers weren’t enough, interruptions across the global supply chain were exacerbated by geopolitical factors, such as escalating trade tensions between the US and China and a worldwide financial crisis. These various financial and political actions have placed a premium on supply chain diversification and a close reevaluation of the manufacturing supply chain strategy – all of which is impacting investment and procurement portfolios.
Save money by avoiding tax overpayments and controlling hidden and unnecessary spend
Manufacturing is changing rapidly. It is critical that your tax team understands the indirect tax obligations and complexities that result from purchasing decisions that are made to facilitate changes in operations. While US manufacturers don’t pay sales tax on raw materials that are used in a final product, they may be responsible for the indirect taxes on purchases of equipment and supplies such as machines, conveyor belts, and forklifts. Typically these purchases are exempt from tax; however, the challenge is for companies to know whether the goods or equipment they are purchasing will be used in a manufacturing or R&D process, which is usually tax exempt or reduced rated.
It’s essential that your sales and use tax department is confident that vendors are charging your business the right tax because overpaying vendor-charged tax can add up quickly to significant amounts of money. If your vendor doesn’t charge the correct amount, your company is responsible for self-accruing taxes to ensure that the correct tax is paid. While indirect tax overpayments can be costly, underpaying the vendor-charged tax can result in substantial penalties. These taxes can be very complex to track and manage, and the burden of accurate payments is on the manufacturer.
To put this in perspective, consider the increased demand for hand sanitizers during the first months of the COVID-19 pandemic, or spikes in demand for air conditioners during prolonged heat waves or snow shovels during particularly snowy winters. In each case, there was an initial increase in costs for the raw materials, but also for other purchases to support the increase in production. These might include costs for computer hardware to process orders, shelving to manage increased inventory, and greater shipping capacity to fulfill orders. Each of these ancillary purchases creates sales and use tax obligations at a time when manufacturers are looking for ways to reduce costs.
A related concern is that audit activity is increasing to make up for revenue shortfalls, and this primarily focuses on your procure-to-pay program. Even slight errors in purchasing can have an enormous financial impact. A small failure in a tax accrual process can turn a modest and necessary investment into tens of thousands of dollars in tax obligations. Other complexities arise from nexus rules and regulations such as those for allocating an expense if the purchased item is used across multiple geographies; for example, you purchase software and use it at locations across multiple states. And, in some states, manufacturers get credits for R&D; other states have exemptions for manufacturing equipment. You need to know which regulations apply to your operations.
The point is, managing and tracking these various taxes requires that your sales and use tax teams understand the tax requirements for your industry in each tax jurisdiction in which you and your suppliers operate — and these requirements change often. Manufacturers are finding this nearly impossible when relying on manual processes because they impose enormous demands on the tax teams’ time and energy and require a high level of specialized expertise. On the other hand, automated indirect tax software solutions can eliminate those human errors, perform tasks more quickly and accurately, and liberate your sales and use tax teams to work in more strategic and creative ways.
Six questions to help you focus your manufacturing sales and use tax strategy
Assumptions can lead to unexpected and negative financial impacts. These assumptions can lead to errors that result in money being “left on the table.” A frank appraisal of your sales and use tax processes is a good place to start so that you can make the right decisions to improve efficiency and protect your business. These six questions can help you with that appraisal:
- Do you know if you’re overpaying vendor-charged tax on manufacturing equipment, raw materials, and other goods and services?
Some manufacturing companies have done reverse audits only to find they had overpaid tax in hundreds of thousands and sometimes millions of dollars. Those overpayments are hidden costs and can be significant.
- Do you know how to calculate tax globally?
Many manufacturing suppliers get this wrong. With e-commerce and other digital channels being rapidly adopted in different parts of the world, suppliers suddenly have a global reach, but they don’t necessarily have global tax expertise.
- Do you know the potential consequences of inaccurately accruing use tax on inventory movements?
A company may often buy items into inventory, without initially knowing how or where those things will be put to use. Once such items are moved and put into inventory, this creates a second point in the transaction lifecycle when the tax team applies a tax analysis. It’s important to have a tax accrual process in place to identify such transactions and calculate tax appropriately to minimize audit exposure.
- Would you know if your manufacturing company overpaid taxes?
If you pay too much and it is discovered, the government is under no obligation to tell you about it or refund that tax. It is up to you to prevent overpayments — and if you find any overpayments, it’s up to you to request a refund. Furthermore, if you rely on third-party consultants to manage this process, that is yet another additional cost as a result of not getting the tax right in the first place.
- Do you know what is subject to tax?
How a product or service is used can determine whether it is taxable. In addition, mixed-use items and items taken out of inventory for consumption (such as for free samples, internal use, or R&D) require tax calculation, which can be complex.
- How are you identifying manufacturing exemptions and tracking exemption certificates?
You can reduce the risk of penalties if you accurately identify and track tax-exempt purchases and exemption certificates. This is a complex process because the exemptions vary by tax jurisdiction. For example, some states have exemptions on products or services for R&D, some for manufacturing equipment, and so on. It’s important to ensure that your customers are supplying you with accurate exemption certificate information and you are exempting sales only when warranted.
Manufacturing companies face unpredictable tax challenges
The challenges manufacturers face are exacerbated by rapid changes in regulations and tax codes, the breakdown and restructuring of supply chains, and shifting market demands. In the Thomson Reuters 2020 Corporate Tax Departments Survey, more than 300 tax managers and executives were asked to reflect on the biggest challenges facing their teams. Even prior to the global pandemic, 30% of the respondents cited a need for new technology as a major challenge. An additional 14% said they faced pressure to create greater efficiency, and 9% were juggling it all with reduced budgets.
Many of these tax leaders understand that technology and automation can help them address some of the challenges they are facing. They realize that technology investments can have an immediate and dramatic impact on the bottom line. And automating procure-to-pay processes could prevent tax overpayments and save money.
For example, Lenovo, a global manufacturer of personal computers, aligned its tax strategies with business processes by automating and integrating its indirect tax processes with Thomson Reuters ONESOURCE™ Determination. This allowed Lenovo to overcome the logistic and geographic challenges of consolidating corporate tax processes globally, streamlining and integrating tax processes with its finance applications.
With a single software solution for US and international transaction taxes, ONESOURCE Determination automatically calculates all tax rates and exemptions based on tax jurisdiction. For every requisition, purchase order, and AP invoice, our manufacturing sales and use tax software automatically calculates the tax value quickly and accurately the first time, eliminating time-consuming calculations and rework. For companies like Lenovo, this is essential to ensure that sales, use, and value-added taxes are calculated correctly in each of their locations around the globe.
The year 2020 with its global COVID-19 pandemic has altered the world forever and has introduced both significant risks and new opportunities for manufacturers. As your business moves forward, don’t let sales and use tax issues cut into profits or keep you from creating distance between you and your competitors. Your organization may be overdue for genuine transformation — moving from manual to automated processes — and this may be the best time to make it happen. Let us help.
Avoid leaving money on the table from overpaid vendor-charged tax and protect your operational spend with ONESOURCE Determination.