Managing indirect tax in the financial services industry

Many organizations in the financial services industry face specific challenges in determining indirect tax. Such challenges often arise due to an elevated level of purchase activity with IT and software, heavy advertising expenses, and managing processes across a wide nexus footprint. Of additional concern, companies in this industry are often under an elevated level of scrutiny and need all processes to be highly documented and controlled.

While such businesses traditionally faced little sales tax complexity — due to their services being categorized as exempt from it — we see this dynamic changing as tax authorities seek out additional revenue streams by continually expanding the number of services deemed taxable.

Discussed below are areas that are particularly difficult for the tax departments of financial services organizations to maintain control over and stay highly accurate within.

Critical considerations for financial services

IT and software procurement

Financial services organizations often have a high level of procurement in IT, software, and maintenance due to the need to employ state-of-the-art, redundant system environments that facilitate high speeds and high volumes of financial transactions that back the business. For the tax department, this can lead to a scramble to keep pace with the treatment of such products and services in a field constantly migrating delivery methods and platforms — an example being the current trend for businesses to purchase cloud services.

As businesses embrace new technologies, the tax department needs to unravel whether an item is a cloud service, hosted, or remotely accessed software, and then navigate through a myriad of terms, such as ASP, SaaS, cloud computing, and whatever seems to be the hot word or phrase of the week.

Even with a “simple” software purchase, it can be difficult to know whether it is customized or canned, where taxability can vary from state to state; whether it is electronically downloaded; and where it is deemed “used.” While the significance of a single purchase may not seem significant, financial services organizations often purchase thousands of licenses at an average tax rate of about 7%. Not taking advantage of classifying the software as exempt due to it being, for example, electronically received in a particular jurisdiction could mean overpaying thousands of tax dollars. As such, the corporate tax department needs to institute a tax policy that analyzes and incorporates multiple pieces of information on the transaction so that an automated decision can be made as procurement takes place.

For example, a financial services firm purchasing from a vendor that produces standard software might wish to establish a tax policy to infer that the software is canned versus customized based on the vendor’s name. Likewise, the absence of a ship-to address might be used to infer electronic software delivery. The data that drives the policy will vary from one organization to the next.

The key is to have a means to leverage the data so that an accurate tax accrual can be maintained through the ever-evolving IT procurement spend. ONESOURCE Determination leverages thoroughly researched tax content and provides tools that enable the tax professional to set tax policy based on data factors such as a general ledger account number, department, vendor name, project number, etc.

As companies have moved toward purchasing software in a SAS model, things haven’t gotten easier for the tax department — with about half of the states exempting this model and half taxing it. To add to the complexity, when a software purchase or a mass purchase of computers occurs, the tax team may need such an expense to be allocated over many jurisdictions so that tax is not simply accrued to headquarters but is properly distributed where such items will ultimately be used. The solution to this additional challenge is often the same as that employed to meet the challenge of advertising purchases.

Advertising materials

The organization's purchase of advertising materials is often an area where the tax department lacks adequate control because the advertising contract for materials is billed to headquarters. However, all the pamphlets, posters, and signage end up being sent to and used by various branch office locations. The problem with this is that from a transaction perspective, the enterprise resource planning (ERP) system isn’t capturing where each item ends up. Consequently, while the tax team should be accruing tax at each location, it’s often left to erroneously accrue it all to the headquarters location.

ONESOURCE enables, for example, the use of headcount or sales percentages to take a single line item and allocate it over as many jurisdictions as required. Furthermore, it will check the item's taxability as not only does it need to be allocated and tax calculated for each location, but the taxability of the purchase also needs to be confirmed.

Empowering the tax professional with a means to apply such allocations helps reduce the audit risk that arises when one simply accrues all tax to the headquarters location and also possibly minimizes the expense, as the item may be spread out among jurisdictions that have a lower tax rate or provide an exemption for the particular type of item. This ability to automatically allocate tax is also useful when managing other purchases like the previously mentioned IT-related items. ONESOURCE provides the ability to accomplish this daunting task — simultaneously performing the allocation and determining the correct taxability of the item.

Nexus footprint

There are additional challenges to manage that accompany having a wide nexus footprint beyond performing tax allocations. Financial services organizations that maintain offices throughout a large region — or even around the world — need strong tax content to rely upon in order to manage the many tax rates of the authorities in which they operate. There can be challenges in manually trying to keep up with rates and tax logic, such as intrastate versus interstate rules, tiered taxes, or reduced tax basis on an item such as data services.

The tax content ONESOURCE provides eliminates the need for manual research, allowing the tax team to focus on tax minimization strategies and creating policies that ensure the highest level of accuracy for the organization. A wide nexus footprint can also mean that office locations are often being constructed or remodeled, which requires an ability to react to tax nuances related to construction services. For example, whether a project is new construction, remodel, or repair can lead to different tax outcomes. ONESOURCE makes it possible to use tax policy tools that enable the organization to incorporate transaction data related to a construction project into its tax policy to handle such nuances and determine the correct tax.

Overpayments

Managing potential overpayments to vendors and the government may also be a challenge faced by financial services organizations. If use tax is inaccurately accrued by the organization and paid to the government, it risks overpaying tax. Likewise, the organization needs to check the tax charged to be certain its vendors are not overcharging.

Unless a system is in place to validate that the tax payments to vendors are accurate, overpayments may take place that are only caught by doing a reverse audit study. Companies do not always like this approach, as they need to pay the tax firm a portion of the overpayment findings if they use a third-party firm, and they worry that this may raise a flag for audit. As a result, they often want a process in place to get the accrual right up front and to be sure they do not overpay vendor-charged taxes.

ONESOURCE can automatically check invoices, line by line, and confirm that the tax charged by vendors is accurate. You can set up a policy to flag inaccurately billed tax for review, short-pay it, or take the action that makes the most sense for your business when you find an error. The ultimate goal is to minimize potential overpayments that might otherwise be overseen and proactively do so as tax determinations are made.

Sales tax — yes, sales tax

Sales tax was often an afterthought for financial services organizations. However, there are two primary reasons you should not overlook them. Firstly, as governments seek additional sources of revenue, the base of taxed products and services continues to grow — expanding into some of the traditional financial services offered, such as demand on deposit service fees. Secondly, financial services organizations themselves can find their traditional offerings to customers expanding into new areas that may be taxable, including IT platform banking services or information services.

It is challenging enough to know how a product or service should be classified for tax purposes and whether a particular jurisdiction has started to tax such services or not. Knowing when and how to charge tax on sales transactions can be new territory for some tax departments in the financial services industry. Accuracy is essential to stay compliant with tax authorities and maintain customer satisfaction levels by getting it right. ONESOURCE, with its robust content, covers the taxability of such newly emerging, computer-based services and products.

Control over the determination process

With the regulatory scrutiny under which financial services organizations find themselves, having well documented control over the tax determination process is often a clear objective. Leaving such determinations in the hands of each person in accounts payable (AP) is usually viewed as a risky approach in trying to maintain consistency and control over the process. Often, with such operations being offshored, the AP personnel are even further removed from having a sense of local tax knowledge.

ONESOURCE provides businesses in the financial services industry the ability to take and demonstrate control over the entire tax process as follows:

• Identifying and documenting tax policies clearly
• Removing non-tax personnel from the tax decision process
• Monitoring access and tracking any changes made to tax policies
• Leveraging certified content to SSAE 18 and ISAE 3402 standards, providing confidence in the tax engine logic and calculations
• Capturing and documenting detailed tax results, making it easy to analyze data and respond to audit inquiries

A powerful solution for the financial services industry

We’ve designed ONESOURCE to manage unique, industry-specific tax challenges accurately and efficiently. Whether it be quickly adapting to handle the taxation of new software and services in the IT space or dealing with the taxation of sales of service offerings you provide, the content and capability of this solution are there to assist.

Learn more about how ONESOURCE has helped this industry navigate these and other tax challenges.