So why does this matter? If wrong tax determinations are made by a company's vendors, inefficiencies occur because the tax (cash) paid will remain in hands of third parties unless or until it can be proved to the satisfaction of the vendor that an error was made. This is a time-consuming process during the pendency of which a company's cash remains in limbo.
What are the Dollar Benefits of Tax-efficient Procurement?
Depending on the nature, amount and the jurisdiction of deployment of non-inventory spend, tax savings can be significant.
How can savings be obtained? Saving can be obtained in a variety of ways, including:
- Prevention of incorrect or duplicative taxation (who knows better what is taxable, where its is taxable and when it has been placed in service then the company's tax department);
- Matching the incidence of taxation to when items are actually placed in service (for example, the time period during which a point of sale equipment is purchased and "imaged" (loaded with software) and the time the equipment is actually shipped to, and placed in service by, a store);
- Matching subsequent rebate or discounts with original purchase price (thereby reducing the overall taxable purchase price);
- Facilitating the structuring of the transaction to fit within a statutory or regulatory exemption (particularly applicable with software purchases);
- Unbundling taxable items from non-taxable items (typically services from the purchase of tangible personal property) thereby reducing the taxable base of the transaction; and
- Ensuring duplicative taxation does not occur (where the vendor believes your company will place the asset in use and where the asset is actually placed in service).
Are the dollar benefits the same for all companies? The short answer is no. Why? Because the location of procurement functions, the type of assets purchased and the amount of certain assets purchased all differ from company to company, thus impacting the achievable benefit. Nonetheless these savings can be substantial, permanent and ongoing.
What Are the Practical Advantages of Tax-efficient Procurement?
From a tax perspective, ownership of the transaction (i.e. the ability to determine the amount, subject matter and jurisdiction) of taxation is the single most crucial function to own. Are there non-tax operational and financial reporting benefits from "owning" taxing decisions? Yes, specifically:
- Improving the sales tax audit trail, thereby reducing the time required to respond to state sales tax audits;
- More efficient processing of refund claims when tax errors have been made (this efficiency occurs because the company, as the collecting agent, can apply directly to the taxing jurisdiction, instead of going through its vendors, to obtain refunds);
- Greater certainty regarding tax decisions frees up financial accounting reserves (contingent reserves for non-income taxes are required under FASB Statement No. 5, Accounting for Contingencies.) created for miss-compliance, thereby producing financial statement benefits; and
- Reduction of audit assessments, including related interest and penalty costs, is a risk management goal.
The end result: labor is engineered out of an often over-stretched tax department, tax efforts are better aligned with supply chain objectives and risk is minimized.
What is Required to Achieve Savings?
Typically, in order to achieve tax self-determination, a company must create a captive legal entity for procurement in order to purchase assets tax free for resale to a related entity (under a sales tax resale certificate). The legal entity structure can be quite flexible. The procurement entity can take many forms, (corporation or limited liability company (LLC)) and can be either regarded or disregarded for federal and state income tax purposes. The following is a basic list of minimum requirements:
- A separate legal entity housing certain procurement functions;
- Registration of the entity to collect sale tax in the jurisdictions in which it is required to collect tax;
- Tax systems sufficient to generate internal invoices (between the procurement entity and its related operating entities); and
- A tax decision matrix capable of making taxability and rate determinations for the types of assets purchased in the jurisdictions in which they will be deployed (this functionality is typically contained in most sales tax software).