Supply chain changes could trigger new tax obligations for manufacturers
Manufacturers have always faced unique sales and use tax challenges. Part of that stems from the interconnected and interdependent nature of manufacturing. Consider this: A producer of hot tubs in Utah sources parts from seven countries and 14 different states.
The manufacturing industry also tends to be a prime target for auditors. Some of the most common mistakes found by auditors include:
Failure to register where required
Failure to report consumer use tax
Missing exemption certificates and other document errors
COVID complications
The COVID-19 pandemic has exacerbated challenges because while demand for goods is generally high, companies are faced with worldwide shortages of labor and materials. And some analysts warn that the omicron variant could scramble supply chains further once it spreads to Asia.
Such supply chain issues can impact sales and use tax compliance. For example, significant delays may compel a business to store inventory in transit in a new state. If the state taxes inventory in transit — as some do — that business could suddenly have tax liability in that state.
Alternatively, a company operating with just-in-time inventories may find itself building up excesses of, say, building materials, while waiting for other critical inputs to arrive. The company could pull inventory to build out additional storage facilities or shelves — and end up liable for use tax on the inventory.
And if no one is in the office due to stay-at-home orders, there may be no quick way to find the exemption and resale certificates needed to validate exempt transactions.
Drop shipping
Sales tax obligations also can come into play when manufacturers cut out intermediaries and sell directly to consumers, becoming retailers in addition to manufacturers. There are advantages to selling direct to consumers: It’s something consumers increasingly want, and it can increase margins for manufacturers.
However, it should be done with eyes wide open with respect to tax compliance. Even if you make little in the way of taxable sales to consumers, your exempt sales into a state could establish nexus and create an obligation to register for sales tax, validate exempt sales, and report all sales into the state, including exempt sales. To tax them correctly, you’ll need to know how to source sales and be able to calculate and remit the correct rate of tax for each transaction. (For a primer on economic and physical nexus as it applies to sales and use tax, click here.)
Exemption certificates
Companies with a lot of exempt transactions can benefit from an automated exemption certificate management system. Depending on the size of your company and the number of exempt transactions made, you may need to collect and store 50 certificates, or 5,000. All need to be valid when collected and renewed before they expire, which is complicated by the differing requirements in each state.
If an exemption certificate you had on file with a vendor expires, an auditor may go after the vendor for the tax due — but also could go after you for not remitting use tax on that transaction.
More is better
More information about changes to tax regulations affecting manufacturers — including consumer use taxes and the risk of effectively paying tax twice — can be found at the Avalara Tax Desk, which is a leading source of information on transaction taxes. The full Avalara Tax Changes 2022 report is available at avalara.com.
