There are some things in this world that appear to be interchangeable, but really aren’t: diamonds and cubic zirconia, Tabasco and hot sauce, Drew and Jonathan Scott. While these things (and twin TV host brothers) may look the same, they are different. They are as different as Texas Sales and Use Tax Exemption Certificates and Texas Sales and Use Tax Resale Certificates.
For those business owners who have never been through a sales tax audit, the idea that the state can audit your records for several years can come as a shock. The statute of limitations for a sales tax audit varies from jurisdiction to jurisdiction. In Texas, the statute of limitations is four years. That means that an audit generated in 2018 can cover periods in 2014.
Most taxpayers know that in Texas software is subject to sales and use tax. It is common for taxpayers to assume that software is taxable but modification services are not taxable. The assumption is based on the perceived absence of software modification in the listing of taxable services. Software modification is taxable if the software is being modified by the party that sold the software. Software modification is not taxable if it is performed by a party that did not sell the software.
It is popular to offer software with monthly access fees. Instead of selling the software itself, access to the software is sold. Some vendors incorrectly think this distinction renders the charge for access nontaxable. Instead, the access fees are deemed to be the sale of software as a service. The fees are subject Texas sales or use tax. However, twenty percent (20%) of the charge is exempt from sales or use tax because the charges are characterized as data processing by the Comptroller of Public Accounts.
There are taxpayers who pay consultants to look for and retrieve overpayments of sales and use tax. There are several ways to perform this service. One option is to reduce sales tax remittances or request a refund from the vendor without the approval of the state taxing authority. Another option is to submit a refund request directly to the state taxing authority.
As a rule of thumb, if you have an accounting system that works, barring any change to the services or products offered, do not change the invoicing system. It is not uncommon to have a ”good” audit result under one accounting regime and have a sizable tax deficiency due to a change in the accounting system.
Advocates typically share the plan of action for addressing audits. We engage with clients as much as the client allows. As the taxpayer, it is your right to ask questions, understand your matter, and be involved in decisions that will directly impact your company and/or your job. Ask how your advocate is going to approach the situation. Understand the basis of any challenge. Ask how your position will be proven.
When some taxpayers receive notices of audit deficiency, they hire consultants to challenge audit findings. In some instances the use of third party consultants is advantageous because there is a legitimate error in fact, audit methodology, or application of the law. However, there are other instances in which the taxpayer really has no basis on which to mount a challenge. It is the unique responsibility of the taxpayer to define their goals upon receipt of audit findings.
When the accounting staff changes it is not uncommon for the manner in which transactions are documented to change. The advisability of change depends on whether the invoices actually supported the desired tax treatment of transactions before the change. If perfectly good procedures are changed for the sake of change, you could be looking at a nasty tax bill. If invoices dictate that tax was due and tax was not charged, the tax is owed.
NOTE: The examples used reflect Texas tax rules. However, the principal that changes in accounting/ billing procedures, the manner in which contracts are written etc., may alter tax responsibilities is universal.
Taxpayers often ask the difference between sales tax and use tax. I use this analogy. If you purchase paper from the store, you pay sales tax. If you purchase the same paper from a third party on the internet and that supplier does not charge sales tax, you pay use tax. Sales and use tax are complementary taxes. If an item is subject to tax in your jurisdiction, one or the other is due. Sales tax is collected by the vendor. Use tax is remitted directly to the state taxing authority by you (the purchaser).
In Texas, yes, with few exceptions, sales tax should be charged on taxable products and services until the client issues the properly completed exemption, resale or direct payment exemption certificate. (Nexus is assumed.)
A seller should obtain a properly completed exemption, resale or direct payment exemption certificate at the time of the sale with a few exceptions. If the seller is audited and the appropriate resale, exemption or direct payment exemption certificate is not obtained, the sales tax and corresponding penalty and interest can be levied against the seller.
Auditors review two areas during an audit: sales and purchases. This article focuses on the review of sales invoices. If this area is handled incorrectly, the Comptroller will seek the deficiency from the party being audited. However, the deficiency is the liability of the purchaser and the seller may seek compensation from the purchaser for any assessment of tax.
Most people think if a representative of the state taxing authority makes a statement that is incorrect and they owe tax as a direct result of following inaccurate advice, they can challenge a deficiency based on a detrimental reliance argument. This is not true. Detrimental reliance is a legal term of art that has been defined. In order to mount a successful challenge to a deficiency finding in Texas, you must satisfy all of the following requirements:
Some taxpayers intentionally employ vague contract language. Clients most commonly share that they use vague contracts because (1) a form is the industry standard or (2) they want to be able to capture as much work under one master contract as possible without negotiating a separate contract. Whatever the reason, I have two problems with vague contracts. First, how can your accounting staff ensure the tax treatment is correct if the transaction isn’t fully documented? Second, how can an auditor determine the tax treatment was correct, especially if an exemption was granted? The failure to be clear can be very expensive when the sales tax auditor comes to call.