White Paper - Next Generation Of Sales Tax Solutions

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INTRODUCTION One of the more commonly recurring incorrect perceptions in running online related businesses is the notion that sales taxes are not due on Internet transactions. It should be clear from the outset that Yes, retailers are responsible for sales taxes on Internet based transactions; Yes, retailers must provide clear auditable tracking methods of their transactions, through the entire life cycle of the transaction; and No – these requirements are not relevant to large businesses only, they pertain to retailers of all categories and of all sizes.

The original misperception originates back from a 1992 Supreme Court ruling, known as the Quill case. The Quill case was determined in the pre-Internet arena, but was subsequently applied to online transactions because of the similarity in circumstances. In Quill, the Supreme Court stated that it will not enforce sales tax rules. One rationale for the ruling was that of the undue burden. In other words, because of the inherent borderless nature of Internet transactions – each transaction has the potential of being subject to any-one of the over 7,400

taxing jurisdictions in the U.S. alone. The Supreme Court stated that tax systems are so complex, and there are so many jurisdictions, that it would be an undue burden to require retailers to be familiar with each and every jurisdiction, and comply with all of the different rules and jurisdictions. The Court was very explicit though to say that sales taxes do apply to these transactions, the court merely refused to enforce the rules.

Obviously, lack of compliance is quick to follow failure of enforc ement. As a result – retailers have traditionally failed to calculate, collect and pay sales taxes owing on Internet transactions. Many confused this lack of collection with the Tax Moratorium Act that was enacted in 1998. The Moratorium Act has nothing to do with Sales taxes. The Moratorium Act merely stated that no new taxes could be created on Internet transactions. This Moratorium Act was enacted in response to ideas that politicians started floating for creating new types of taxes especially for the Internet, such as ‘Internet Access tax” or “bit rate taxes.” But the Tax Moratorium Act was very explicit to

have no effect upon existing taxes, such as Sales taxes. States did not enforce Sales taxes for much more practical reasons: there just was not enough activity taking place on the Internet – the dollars were simply not there.

Retailers have traditionally failed to calculate, collect and pay sales taxes In the last two years both these variables have completely changed. There is much activity taking place. In fact, studies are showing that nearly $20B will be left on the table in 2005 as a result of uncollected taxes on Internet transaction. State governments have also operating in the red, and empowered their agencies to new sources of revenue. They to act, and act fast.

been have seek need

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To address these circumstances and respond to the Quill ruling, state taxing agencies banded together to draft and sign the Streamlined Sales Tax Agreement, where emphasis is placed upon rule uniformity and simplification of compliance. The states hope that with this process in place, Congress will pass legislation which will expand the long arm capabilities of the court system, to reach out to out-of state retailers. The SSTP came into effect on October st 1 , when a dozen states formally ratified rules reflecting those rules required under the SSTP, with another six states being in partial compliance – associate members. Nearly all other states have signed the SSTP contract, but it will take them some time until they fully implement the rules. Sales tax compliance does not begin and end with the SSTP however. Current Sales tax rules also apply to online transactions. State taxing authorities

are aggressive in enforcing existing rules, and not waiting for SSTP to come into effect. Barnes-&-Nobles, Borders.com and OfficeDepot found this out the hard way via back-taxes, interest and fines imposed upon them. Thousands of consumers nationwide were recently invoiced for taxes they did not pay when purchasing cigarettes through the Internet. Under Internet Sales Tax Fairness rules, companies are finding that they need to register and pay

sales taxes if they want to sell to state governments. Small companies, with revenue in the low millions, are being hit with audits and penalties of tens of thousands of dollars for failure to collect taxes. Then there is the offer that cannot be refused – start collecting now, and receive an amnesty for failure to collect in the past.

The bottom line is that sales tax compliance is a real issue, independent of the SSTP. Retailers need to be aware of this issue, and address it heads on. It is not one of those situations that you can beg forgiveness after the effect – you will owe penalties and fines for failure to comply on a timely basis. Fortunately, there are solutions that can help you address this issue. In fact, Next Generation Solutions that are being introduced into the market

for further reference; (iv) be hooked into systems that will allow it to track the transaction through its life cycle; so that (v) any changes made to the transaction are reflected in the system; (vi) on a periodic basis as may be determined by statutes and regulations – compile the data necessary for filing; (vii) generate a return and report necessary for complying with statutory filing requirements; (viii) make the return available for review and approval by the retailer; (viii) file the return automatically and electronically straight into the systems of the state taxing agencies on the required date, helping the retailer avoid fines, penalties and interest associated with late filing; (ix) obtain from the retailer funds necessary for payment of tax proceeds; and (x) pay the

promise to make this a painless process, providing a This paper is dedicated to providing simple, cheap, reliable, a review of the Next Generation Solutions, how accurate and effective solution that operates in a they provide comprehensive solutions to address completely automated all sales & use tax requirements, and entirely manner, so that business remove the burden of compliance and auditing owners can focus upon from the retailer. generating business, rather Why, and how, are the than on whether or not they Next Generation Tax Solutions owe taxes, how much, when the “True Compliance Tool”? and to whom. taxes owing on a timely basis, applying The perfect Next Generation Solution electronic funds transfer methods to would be (i) hooked straight into your assure timely payment at the last transaction engine; (ii) provide the possible moment without incurring information necessary to assure that penalties for late payment. the correct tax is being calculated; (iii) save the transaction and tax data

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FIRST GENERATION SOLUTIONS FOR THE SALES TAX MARKET

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A typical sales & use tax transaction can be broken down to different elements. These include the following components:

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Tax determination . This element consists of being able to determine, in real time, what is the relevant jurisdiction that

governs

the transaction, drilling down through the rules of taxation of the given jurisdiction, figuring out the correct tax rate, and applying it, to render an accurate tax calculation. The tricky part of this element is being able to perform these functions in real time.

Transaction Tracking . Sales & use taxes are not determined just upon the tax calculation at the point of the transaction. There are many events that can occur after the point of authorization which could impact the final taxes owing. For example –did the product ship? (if it did not – no taxes are owing); was part / all of the purchase returned at some future date (if the product was returned – no taxes are owing on the purchase); was the transaction subject to some form of an exemption (if it was, was a certificate of exemption completed to substantiate eligibility for the exemption)? All these are events that can occur post transaction, but before the date for filing of the tax return.

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Filing of the Return . As with any form of taxation – a form needs to be filed with the taxing agency, which provides all

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data relevant to the specific taxes being filed. These include data pertaining to the identity of the retailer (who is performing the filing); gross revenue; tax exemptions; returns and refunds; taxes owing; and to which jurisdiction (including local jurisdictions, such as counties, cities, and special local taxes (stadium, public transportation, etc).

Proceeds .

The bottom line of any tax is that of the proceeds that are actually being remitted to the taxing jurisdiction.

These need to reflect the amounts owing, as specified in the tax return. While we oftentimes attach our check to the the return and paying the taxes owing are two distinct actions. Anyone who, in recent

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years, has proceeded to electronically file their personal taxes can attest to this – they file the return and separately proceed to transfer taxes owing under some form of electronic funds transfer.

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Audit . The life cycle of a transaction, and the taxes owing upon it, does not end upon the successful filing of the tax

return and

p a y m e n t o f t h e t a x e s o w i n g . U n f o r t u n a t e l y , t h e r e i s a n e e d t o b e a b l e t o r e

spond to a request for an audit, to reassure the taxing agency that indeed taxes were calculated correctly, were all accounted for, and that the correct forms were filed, and proceeds paid in a timely manner. Audit standards require the retailer to maintain comprehensive reports and trails of the entire life cycle of the transaction, to support and substantiate each decision and action between initiating the transaction through the final payment of taxes.

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First generation technology solutions have been around for nearly twenty five years. These solutions tend to focus upon any one of these elements of compliance, and provide a solution for only one. For example, they might focus upon tax calculation functions or completing tax forms. They will typically not be able to provide a solution for multiple elements of compliance without some sort of external support.

These can get to be quite sophisticated For example, users of SMB financial programs are all familiar with the fact that these programs can print out their tax forms. However these programs do not connect to the up-front element of the transaction. In other words, standard financial programs do not have the ability of connecting to a shopping cart, and provide tax determination in real time when the consumer is authorizing the transaction. In addition, these systems will typically not be able to perform electronic and automated filing of the tax return – they will provide a hard copy of the printed form. This requires the retailer to still sign the form (after checking the data); write the check; insert both into an envelope and make sure they mail it in a timely fashion.

Another example is that of tax calculation engines. While these can get to be quite sophisticated, following complex lines of logic and performing highly complex series of functions in real time, they are limited in scope to their ability to perform tax calculations alone. These systems will typically not have much, if any memory required for tracking a transaction through its life cycle, and will require backend ERP systems to perform the other elements of compliance, such as performing tax filing or addressing audit requirements. One should not confuse the sophistication of such tax calculation engines, with their limited cross functional capabilities.

The retailer needs to perform these functions Notwithstanding the complexity and sophistication of these tools, the fact that they cannot perform the full scope of functions required for compliance means that the retailer needs to perform these functions. Either by way of creating bridges between different technological solutions that were not intended or designed to talk with each other, or bridge them manually. Any of these solutions means that First Generation Tax Solutions do not solve the pain of tax compliance. Inherently, they are more complicated to use, more expensive to implement and maintain, require much resources to operate and, will therefore tend to break more easily and frequently.

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NEXT GENERATION SOLUTION FOR THE SALES TAX MARKET indicator that something is wrong with Conversations with CEO’s CFO’s and for compliance. Next Generation the system. Are these people concerned Solution are deigned to automate any other c-level executive all with how authorization is processed by processing of repetitive and time indicate that these people are the financial institutions?; do they even consuming tasks, and eliminating aware of sales & use tax issues that know who all the players are in a typical data and system gaps. This is a face their company, how difficult it transaction authorization process? No! long winded way of stating that is to comply, and has heard horror and neither should they. Business Next Generation Solutions provide stories of audits, fines an penalties. executives should have to focus on for a seamless solution, which A survey of CFOs of small building their business, and not on removes the entire burden of companies found that they spend, figuring out their response to the state compliance from the retailer. By on average, at least 2 hours per tax auditor, explaining why a software using a Next Generation solution, sales tax return, per filing period. developer does not know why a the retailer should be reassured This number increases dramatically business must distinguish between a that all their needs to address as the size of the company grows customer who purchased their compliance are being taken care of, and revenue increases. doughnut at the counter, or ordered it and they can focus upon their main This presupposes that they have while sitting at a table. Nor should they goal, that of generating business. good First Generation Solutions. be treated as common thieves because The importance of Next Generation Even with good First Generation they paid the correct taxes, just to the Solutions is best understood in light Solutions in place, companies of all wrong county. of the sense of complacency sizes spend many employee work companies are lulled into when, as hours in making sure that data is modern businesses, they use processed accurately, and Recently, Next Generation Solutions technologies to help management transferred from one solution to have started to emerge into the work more efficiently. Management another. A survey of small business tends to set a goal of ‘figuring taxes on market. The goal of Next Generation managers found that they spend a transactions,’ and these First tax compliance solutions is to remove couple of hours a day in Generation Solutions achieved that the pain typically associated with tax transferring transaction and deposit goal. Management mistakenly compliance, and, as a single source, data into their financial systems. assumed that using some form of tax provide for a single solution that Larger companies were found to solution achieves the goal of accuracy addresses all the elements required have many FTE’s dedicated to these and efficiency. The availability and functions. This data processing is A survey of CFOs of small companies use of First Generation Tax Solutions necessary to address the back end found that they spend, on averag tends to lull the business owner to functions of tax compliance – that they have taken at least 2 hours per sales tax retur sufficientbelieve reporting, filing and auditing. steps to maximize efficiencies This high level of involvement, activity and knowledge is a strong

per filing period.

and reduce liabilities.

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In fact, tax auditors will not forgive a retailer for incorrect taxes calculated and paid, even if a reliable First Generation Solution was in use and relied upon. For many organizations, the use of paper forms or First Generation Tax Solutions may lead to millions of dollars in increased costs each year, hard and soft costs. Companies that utilize Next Generation Solutions can achieve significant benefits on many levels. For example, they can reduce costs of capturing data from one system and converting it to another; improve accuracy and reliability of information; cut down on costs associated with maintaining complex audit trails and responding to audit requests; and achieve higher consistency overall in information generated and used by the systems and management in their decision making processes. It is especially perplexing given that the end results of First Generation and Next Generation Solutions appear similar – both end with a tax return that is filed with the taxing authority, and taxes paid. However Next Generation Solutions work on many different levels, increasing the reliability and reducing the overall cost of the entire process. For example, First Generation Solutions that generate tax forms, means

that these forms need to be printed, reviewed, signed, inserted into an envelope, and mailed – in a timely manner. In addition to these hard costs, there are soft costs, which are more difficult to quantify. Forms engines might save some time by eliminating manual entries, however they do not save time over fully automated systems. For example, printed forms require higher levels of review maintenance and human intervention, to distribute, complete, physically manage, and store. The information in the form has limited access and visibility – limited to those individuals with actual access to the physical document. A Next Generation Solution should perform all of these tasks electronically and automatically. By automatically generating and performing an e-filing on behalf of the retailer, and storing the form in information systems readily available to the retailer, the Next Generation overcomes all those deficiencies associated with printed forms. The retailer need not be concerned that they have to activate the function enough time in advance to accommodate internal review and approval processes as well as postal delivery delays. Printed Forms also do not indicate incorrect or incomplete data until physically reviewed. More concerning is that printed forms can be modified

or changed – erroneously or intentionally, so that even if the form

is generated electronically from a First Generation Solution, there is no guarantee that it will not be changed, and filed with the incorrect data. More concerning – that the correct return be filed with the incorrect agency, or the incorrect form will be filed – any of which might automatically trigger an audit. Electronic forms of Next Generation Solutions have built-in, auditable, internal rules of logic that prevent these types of errors and events from occurring. In effect, the systems receive all data directly from the transaction engine and transaction tracking engine, assuring the use of only transaction data, without external intervention, and that it is filed on time, to the correct recipient. While Next Generation Solutions will allow manual bypasses, these are more difficult to implement, and will always record and indicate not only what change was made, but by whom, and when.

A reproducible, auditable trail is the true differentiator between First Generation Form Filing tax solutions and those of fully automated Next Generation Tax Solutions. Next Generation Tax Solutions are the true sales and use tax compliance

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engines. The ability to determine the accurate tax rate in real time, factoring complex issues such as transaction nexus – where the transaction takes place, and taxability of the given product on a line by line item basis in that given nexus, is but one of the issues the engine needs to address. Another point of complexity is the ability to provide transparent, valid audit trails, providing documentation for each and every decision pertaining to the transaction made at any given point of time during the lifecycle of the transaction. The Next Generation Tax Solution provides a unified, single point of access, dataset that seamlessly integrates with all tax calculation, collection and payment modules, rather than requiring different audit trails for each of these steps, leaving to the auditor the act of reconciling these different trails, hoping that the benevolence of the auditor will lead to the desired results. Next Generation Solutions should focus upon flexibility, maintainability; integration and reliability. Performing only two or three of the functions

associated with tax compliance, while admirable and more advanced than what First Generation Solutions typically provide, will still not achieve the goals of the Next Generation Solution. The solution needs to perform all four of the functions under one package. The Next Generation Solution should be flexible enough that it allows for adaptability across different systems, allowing to address many different needs of the retailers.

The solution needs to perform all four o the functions under one package.

In sum, the perfect Next Generation Solution would be (i) hooked straight into your transaction engine; (ii) provide the information necessary to assure that the correct tax is being

calculated; (iii) save the transaction and tax data for further reference; (iv) be hooked into systems that will allow it to track the transaction through its life cycle; so that (v) any changes made to the transaction are reflected in the system; (vi) on a periodic basis as may be determined by statutes and regulations – compile the data necessary for filing; (vii) generate a return and report necessary for complying with statutory filing requirements; (viii) make the return available for review and approval by the retailer; (viii) file the return automatically and electronically straight into the systems of the state taxing agencies on the required date, helping the retailer avoid fines, penalties and interest associated with late filing; (ix) obtain from the retailer funds necessary for payment of tax proceeds; and (x) pay the taxes owing on a timely basis, applying electronic funds transfer methods to assure timely payment at the last possible moment without incurring penalties for late payment.

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NEXT GENERATION SOLUTION – WHAT FUNCTIONS SHOULD THEY PERFORM So what should a retailer be looking for in a Next Generation solution? What type of functionality is it reasonable to expect that these new services provide? What can you reasonably demand of your technology

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Solution. Sales tax compliance requires multiple operations. Starting at the beginning – figuring out what is the relevant jurisdiction and rules, and calculating taxes in real time. But it does not end

there – what about the back end functions of compiling all of the data, completing the tax return, filing the return and sending in the proceeds? Why should these functions be performed by three different software packages? A single package should be required to provide a complete solution to all of the se elements of compliance.

Easy Integration. Do you need to hire an army of technical professionals to figure out how to integrate

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the solution, and hook it to your shopping cart /

cash register? Obviously the answer should be no. There is no reason that the technology solution require more than a couple of hours (if even that) in set-up, installation and

complete integration with your entire commercial environment.

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Zero Maintenance.

The problem about sales &use

taxes is that the rules change on an extremely frequent basis. This means that First Generation solutions require monthly updates and maintenance. When you factor in receiving the updates (which are not free), integrating them and updating the system – this is a highly expensive proposition. You should not be concerned that you will be paying fines because someone failed to update the systems at the beginning of the month. Next Generation Solutions have automated updates so that you

can rest assured that your systems are up-to-date, calculating taxes based upon the most current rules.

provider?

Transaction Tracking. Transactions, by their very nature are dynamic creatures. Comparing a picture of a sales transaction at the point of sale and at the point of reporting your taxes will in all likelihood show many

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changes. Changes that could result from product returns, credits, refunds, exemptions, discounts, and so forth. These changes have to be reflected in the final count. Solutions that are dedicated to tax calculation functions only do not provide this higher level of transaction tacking. Next Generation Solutions need to track this data to assure accurate reporting, making sure that you get credit where credit is due. Audit Reports. Who is not afraid of Sarbanes-Oxley? Personal liability attaches today for failure to track be tracking. Relying

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upon multiple solutions to store different elements of transaction data creates a disjointed audit trail that will not pass muster. With a Next Generation Solution that tracks a transaction through its entire cycle you kill a second bird with the same solution – you automatically obtain a single seamless audit trail for your SoX compliance needs. Real Time Data. We are living in an information age. Information has to be available to the decision makers in real time so that decisions can be made instantly, in reliance upon accurate information. Any delay in

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receiving information places your competitor with a competitive advantage. Gone are the days where you can sit and wait for 12 hours from the time you submit a request for information, and then spend 3 hours trying to figure out what the report says. Data should be provided in

r e a l ti m e , e a s y t o u s e a n d e a s y t o u n d e r s t a n d f o r m a t s . It

should be intuitive, so that you do not need a degree in statistics and computer languages to analyze it.

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Automation of manual processes. If you have people sitting and manually performing technical 7 and repetitive tasks, you have an antiquated system. The modern technical solution should automate these tasks for you, and should be designed so that it can automate any such task that it is not already predesigned to perform. Even tasks that, until recently, you were told cannot be automated.

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Fully redundant, high secure, highly scalable solution. Do not compromise on the security of the system – would you agree to take payments from your customers in a non-secure environment? Reliability, security and the ability to handle any scope of transaction should be fundamental to any tax compliance system you use. Do not trust the sales person on their word – they will typically not know what makes a system secure and reliable. Make sure that the system has undergone extensive testing applying stringent requirements, such as ISO 2000 or NIST.

Electron ic Filing. No system should require you to print out your tax forms, sign the form, print out a check, staple them together and put them in the

mail with enough time in advance to accommodate postal delays. Your income taxes are being filed electronically today on the last day of filing, without having to stand in hour long lines at the postal office. Why not your sales tax returns? The Next Generation Solution should handle back-end electronic filing, regardless of the state to which filing is taking place.

Low Cost. All this is available in cost effective

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tools.

You do not need to pay high fees for Next Generation technology solutions that provide all of the above features. A good Next Generation solution is built around scalability and automation, ease of use without compromising upon quality, all of which mean that the costs associated with using the solution are low, cost savings that a sophisticated vendor will share with their customer base.

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SUMMARY Sales & Use taxes are not bound to disappear – they will stay with us for as long as these taxes are an accepted method for funding of government activity. State and local governments will not allow an entire, substantive, stream of commerce continue its commercial activity tax free, unless there is a conscience decision that these transactions are to be managed tax free. States are starting to come down with a heavy step to enforce taxes in this environment. Those who believe that the failure of local governments to effectively collect taxes on Internet sales indicates that the Internet is a tax free haven, do not truly understand the online environment. It is important to realize that true commercial activity of substance on the Internet is a very new creature – less than five years old. Before 1999 - 2000, people were still afraid to conduct commercial activity on the Internet – it was new, and people did not understand how the Internet operated. Consumers were concerned to insert their credit card number necessary to make purchases online. Till that time period, the Internet was predominantly used as a marketing tool, web sites were fancy brochures, which provided a telephone number for the consumer to call in with their order. That phenomena has changed in recent years, and with it, the attitude of local governments in their approach towards enforcement of sales tax rules. Governments cannot allow billions of dollars to go uncollected under existing tax rules, because that will nullify their ability to increase taxes in other arenas. Accordingly, they have taken steps in recent years to increase their enforcement efforts – tactically and legislatively. Such catch-up steps are typical of government authorities, which are constantly running to catch-up with recent business trends. The fact that they are only several years behind the curve is a feather in the cap, showing that

they realize the importance of this arena. In parallel to the increase in government enforcement activities, technology providers are improving their ability to meet the needs of retailers to balance between the seemingly conflicting interest of minimizing resources and focus upon compliance needs, without compromising upon quality of compliance. The currently emerging Next Generation Solutions are filling those needs. They are increasing efficiencies, reducing human intervention in the process, and leveraging upon seamless automated processes to reduce cost. The automated processes are also operating to increase reliability and accuracy, reduce lead time necessary for filing and paying taxes, as well as addressing the ever increasing requirements for seamless and reliable audit trails. A reproducible, auditable trail is the true difference between First Generation form filling tax solutions and those of the Next Generation Tax Solutions. Next Generation Tax Solutions are the true sales and use tax compliance engines. They develop the data; gather it from the transactions, and address all requirements imposed by state and local governments, including reporting, tax payment and transparent accurate and reliable audit trails.

The bottom line though is that the burden is upon retailer to make their choice. Tax auditors a enforcing the rules with increasing vigilance, and d not accept excuses for failure to collect and pay sal & use taxes on a timely basis.

If we paraphrase from the old adage: “SELLER BEWARE.”