Tuesday, September 28, 2010

Illustrations and Parables: Intercorporate Transactions

Businesses and organizations form corporations for a variety of reasons. The picture below shows a corporate shell around a variety of business activities.

Image1

There are excellent reasons for forming corporations:

1. There are obviously tax benefits.

2. Forming a corporation unifies and consolidates your business activities into one unit. That unit can then act as one, be sued, sue, purchase insurance as a unit, etc.

3. Corporations also limit the potential liability of the owners and facilitate easy changes in ownership (buying and selling stock,offering stock options, etc.).

When there is a transfer of tangible personal property (and certain taxable services) within that corporation (see picture below), there is no sales and use tax impact. Merely transferring such things within your company creates no taxable event. The might be some additional use tax owed if you move something from a low tax jurisdiction to a higher one, but that’s about it.

Image3

The problem occurs when you have subsidiary corporations within a larger corporation (see picture below). Those are all corporations that are owned, either partially or fully, by the parent. Now, when there is a transfer from one division to another, most states will consider that a sale. I repeat: a sale! That means that the transfer that you thought was just a journal entry on the books may become a taxable sale that you weren’t even aware of.

Image2

Companies form these subsidiary corporations for all of the same reasons that regular corporations are formed. And there’s one more reason – acquisitions.

Here’s the horror story:

Several years ago, a guy in, we’ll say, California invented a new machine. It was extremely expensive and it was new technology, so he was having trouble selling it. He finally got some venture capital together, and he started buying up small businesses all over the state and forcing the acquired companies to buy and use the machine. Since he wasn’t buying these businesses to be a tycoon, he left the previous owners in place as general managers, kept the local company names, and left the acquired corporations alone. All he was really trying to do was get his machine used.

He was successful. The machine worked wonderfully, did what it was supposed to do, and made the local businesses, as well as the corporate parent, a great pile of money. Yay!

The local divisions started moving the machines around. Sometimes a local office wouldn’t need one for six months, but the guy in the next county needed four of them for a year. So the machines got transferred from one division to another.

Then the revenuers came and all was lost:

1. When the inventor sold the machines to the local businesses, who, if you’ll remember, were separate corporations, he never charged sales tax. He, and his tax people, assumed that since they were all part of the larger parent corporation, sales tax wouldn’t be a problem.

2. When they transferred the machines from one subsidiary corporation to another, the state ruled that those transfers looked like sales. Which, obviously, nobody had thought of.

The assessment was for about $10,000,000.

I’ll just wait here for a second while you let that number sink in.

I really hate this

Yes, THAT bad.

When the company and their legal representation sat down with the state to talk, the state lawyers were confused. They didn’t know the lawyer across the table. Usually, at these conferences, it’s a sales tax lawyer and everyone pretty much knows everyone else. Who was this guy?

It turns out the owner had brought his bankruptcy attorney. They bluntly told the state that if they went through with the assessment, the company would have to go out of business. 

The variations that you'll see among the states, and that might help if you're in a similar situation include:

1.  Services between closely held companies may not be taxable in states where those services usually are taxable - leasing for example. In the above situation, if they had structured those transfers as leases, there may not have been any liability at all. And if the state didn't grant the leasing exemption, the tax liability would have at least been much less since it would only have been on the rental, not the cost of the machine every time it was moved.

2. States will frequently leave loopholes if the transaction between the two corporations doesn’t “look” like a traditional transaction – no exchange of consideration, the transaction recorded by a journal entry, etc. This probably would not have worked in this horror story since the owner had done nothing to integrate the accounting of the local corporations into the larger parent.  Remember, he left the locals alone.  All they had to do was buy and use his machines.


3. If the transaction meets the test of an occasional sale, the transaction may be exempt. That’s assuming you’re in a state where businesses actually can engage in occasional sales. In this situation, we're obviously not talking about occasional sales.

So the question is, are YOU making sales to your divisions? Are you transferring goods and taxable services from one unit of your corporate family to another part? If so, consider this as a warning…you better figure out what you’re doing. Look at your inter-company billing. Look at those transfer accounts. Talk to a good, local sales tax professional.

Some of the biggest assessments I've ever seen have been in this area. You've been warned.



The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only.  Research these issues thoroughly before making decisions.  Remember: there are details we haven't discussed, and every state is different.  Here's more information

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Picture note: the images above are hosted on Flickr. If you'd like to see more, click on the photo. 

Thursday, September 23, 2010

Whenever the conversation goes this way, I cringe

Frequently, someone will say to me, either in a seminar or in a comment or email “we’re a manufacturer so we’re exempt from sales and use taxes".

If I’m feeling frisky, I’ll usually interrupt them and say, "No you’re not."

They’ll be nonplussed and say, "Oh yes, we’re a manufacturer. We make doo dads."

"No, you’re not exempt because you’re a manufacturer. You’re exempt on some of your purchases because you use them in manufacturing. All of your purchases aren't exempt. And your sales aren’t exempt."

"Well, yeah, OK. If we buy a copier for the office, it's taxable. But everything in the plant is exempt. And we don't have to charge tax on what we sell."

"I'm guessing you're not charging tax on what you sell because you're selling it to others who are buying it for resale. It's got nothing to do with the fact that you're a manufacturer. Hopefully your'e getting resale certificates. And that bit about 'everything in the plant is exempt' is wrong."

Arrrrgggghhhhh! And then I cringe.

Not understanding these exemptions is a dangerous trap to fall into. Manufacturers, in many states, can buy materials and equipment tax free if the purchase will be directly used in the manufacturing process. The rules vary enormously by state, from California who gives virtually no exemptions, to Pennsylvania who is pretty generous. But there aren't any states that just say, "You're a manufacturer so you're exempt."

The only types of organizations that can even begin to make a claim that they're "exempt" are non-profits and government agencies. But even in those situations, the exemption is not total. There are usually restrictions on how they use their purchases and what they can sell tax free. And some states don't even have the exemptions.

Frankly, the only organization that can truly make the claim that they're exempt is the federal government.

So please remember that it's your specific types of sales, purchases, and use that are exempt. The rules are restrictive and they vary from state to state. So don't go around saying you're exempt. You're not.




The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only.  Research these issues thoroughly before making decisions.  Remember: there are details we haven't discussed, and every state is different.  Here's more information

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Monday, September 20, 2010

Illustrations and Parables: Bulk Sales

The View from My RoomI was chatting with an old friend, and he was telling me a sales tax horror story that deserves repeating here. It involves bulk sales (ie. the sale of a business as a whole - lock, stock and barrel, as it were).

Don (not his real name) wanted to expand his computer business. He was based in Illinois, and heard about Arnie, who was in New York. Arnie said he wanted to retire and cash out. Don and Arnie both got their attorneys involved, and Don had his CPA thoroughly review Arnie's books. Don thought he had been very careful. And, because Don was buying the entire business including the inventory, fixtures, equipment, customer list and even keeping the employees on, it was a bulk sale. After the sale was closed, Arnie retired to his new boat in the south Pacific.

A short time after the sale, the New York Department of Taxation and Finance showed up to do a sales tax audit. And they assessed Don, the new owner, for $1,550,000 in sales taxes, almost all of which applied to sales that happened long before he had even heard of Arnie.

You see, Arnie had not been collecting tax on his sales of computer services. Hardware? Yeah, he was collecting on that. But not on the repair labor, which is taxable in New York. And Don, who was from Illinois where those services aren't taxable, didn't even think of this when he took over the business. He continued to make the same mistakes that Arnie had made.

Because Don had bought Arnie's business as a bulk sale, he bought everything from Arnie including any sales tax liability that Arnie had acquired. Don had to write a check to the state of New York that was more than half of the check that he had written to Arnie.

When you buy a business, and it looks like a bulk sale, the state will generally hold the new owner responsible for any sales and use tax debt from the previous owner. Even if the previous owner didn't know about it.

The way to avoid this problem varies from state to state. But it usually involves notifying the state revenuers that the business is about to be sold. The state then has a limited amount of time to either notify the parties that there is an outstanding liability, do an audit, or give the buyer a waiver. Remember, the process varies enormously, but that's the outline.

---

How many ways did this get fouled up?

1. I don't know a lot about business sales, but there's usually not a complete cash out. The new owner holds some of the money back just for this kind of contingency. Don didn't do that.

2. Don and the attorneys and CPA's didn't know about the bulk sale rule. Now they do.

3. Don and the attorneys and CPA's didn't know that repair services are taxable in New York. Now they do.

4. And of course, Don didn't call his old friend Jim. But it never occurred to him because...

5. ...Don didn't know what he didn't know.

---

The obvious question is did Don try to sue Arnie? Yep. But the former owner was in the south Pacific on a boat and not terribly accessible to the courts of New York.

So Don was, how to say this? Screwed. The business closed about six months later. With that gigantic audit assessment, Don didn't have enough cash flow to keep it going.

Truly a horror story.



The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions. Remember: there are details we haven't discussed, and every state is different. Here's more information

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Picture note: the image above is hosted on Flickr. If you'd like to see more, click on the photo.

Other relevant key words: mergers and acquisitions

Thursday, September 16, 2010

Illustrations and Parables: The Steel Mill

You know you want it.I’ve told this story for years in my seminars, so if you’ve heard this one, I'm sorry. Just move along, nothing to see here.

A guy in the seminar was the controller for a steel mill – a BIG steel mill. They take raw iron ore and turn it into steel ingots. Since there’s not a big consumer demand for big chunks of steel, everything they sell is to other processors – for resale.

“We get resale certificates from all of our customers so we’re good there. Every month, we report something like $50,000,000 in sales on our return [it’s a BIG steel mill] and then, on the next line, $50,000,000 in exempt sales."

“We still send the state a fair amount of money every month, but it’s use tax on our purchases.”

One day, the sales tax auditor showed up. After an initial meeting where the controller and auditor seemed to hit it off, he showed the auditor to the usual conference room, gave him some starting audit fodder, and then left him to it.

After lunch, the auditor stopped by the controller’s office. “I think I gotcha,” were his opening words.

“What? You haven’t been here long enough to have ‘gotten us;’ you’ve only been at it for an hour or so.”

“Ah, but I had lunch in your cafeteria. Nice one and the food's good - cheap too.”

“Well, we’re out here in the sticks, so we’ve got to provide all those guys with some decent food. But what do you mean?”

The auditor inhaled, “They charged me $5.00 for the lunch. I also chatted with the manager there, and he said they’re all employees of the mill…you haven’t hired a management company to run the cafeteria.”

“Yeah…” the controller responded suspiciously.

“You are operating a restaurant. You’re making retail sales to your employees, albeit at a pretty reasonable amount. Now I just looked at your returns for the last few years, and you have NEVER reported a taxable sale. Not one dollar. Which makes sense given your business model. But you HAVE been making retail sales – out of that restaurant you’ve got downstairs. Where are you reporting those sales?”

"Uh..."

The final assessment was in the neighborhood of $200,000.

This amount wasn't catastrophic for a big company. But it certainly was embarrassing for that controller and not a particularly career-enhancing situation. You need to look at EVERY class of transaction and determine if it’s taxable or not taxable. This company didn’t even THINK of the cafeteria – they’re a steel mill! But over time, those $5.00 meals for three shifts add up.



The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions. Remember: there are details we haven't discussed, and every state is different. Here's more information

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Monday, September 13, 2010

Sales and Use Tax Links

Business as usual for politicians.
Colorado veterinarians get bit by obscure sales tax, Fido takes the hit. Avalara

Etsy supports sales tax now
If you sell arts or crafts through Etsy (and who doesn't?), you can now collect sales tax. Etsy

Data center rules in Virginia
They've clarified the new exemption - it's not as good as you think. Vertex

10 Surprising Ways Your State May Tax You Next
Actually, this slide show doesn't really talk about any service that isn't already taxed someplace, but it's nice to see the general media talking about this. Kiplinger There's also an article on how things are getting worse for the states. Kiplinger

Department of Talmudic Inquiry: Define 'Candy'
There's a new plan to make the flour-in-candy food rule even more complicated. Argh! Actually, what am I saying? It'll only make it funnier when I talk about it! The Atlantic

In Virginia...energy-efficient products get a sales tax holiday timesdispatch.com

"Bulk Sale" - Notification Requirements and Exemptions
Technical story but don't miss the bottom line - if you purchase a business, make sure you know what the "bulk sale" rules are in the state. You could inherit the sales tax problems the seller had. accountingweb.com

Wacky Sales Tax Rules Cover More Than New York Bagels
More on the complicated rules regarding food taxability. forbes.com



The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions. Remember: there are details we haven't discussed, and every state is different. Here's more information

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Thursday, September 09, 2010

FAQ: Nexus and Independent Contractors

Are there any questions?I was asked this question yesterday, and I realized that it was one of them there frequently asked questions.

"In one example [in a webinars] you discussed how having an employee (even transient) within a state could cause nexus. Does the same apply to independent contractors? We have some sales representatives that are not employees, but who do call on and sell to our customers. Does this vary state to state?"

Yes, the same rule applies to contractors (non-employees). I've not seen any rulings that differentiated between employees and contractors. The real question is what the person is doing for you. If they are representing you and helping you get or close business in the state, that's enough. And no, it does not seem to vary from state to state. As I said, every state seems to treat contractors the same as employees.

One of the reasons for this, I think, is that many employers probably misclassify their contractors anyway. I used to teach a course on this and the rules are a lot stricter than you think. Most of the people that you consider contractors would probably be reclassified as employees if the right people audited you. Thankfully, the sales tax auditor doesn't care about this one. They treat contractors and employees the same when it comes to nexus.

By the way, the contractor doesn't even have to be an individual. If you've got manufacturers rep firms representing you, that can create the same problem.



The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions. Remember: there are details we haven't discussed, and every state is different. Here's more information

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Picture note: the image above is hosted on Flickr. If you'd like to see more, click on the photo.

Tuesday, September 07, 2010

Tips and Gratuities

"Would you like coffee with your hot glazed Krispy Kreme?"The taxability of tips and gratuities is relatively simple.

If the tip is given voluntarily, then it's almost universally not taxable. So if you leave the money on the table, or if you add it to your credit card, there should be no tax on the tip.

However, it gets a little more complicated if it's a mandatory gratuity. What is a mandatory gratuity, you ask? You know those signs that say, "A charge of 17% will be added to the bill for parties of 6 or more." That's a mandatory gratuity. You also see these kinds of fees on bills for banquets and conferences.

The rules for mandatory gratuities obviously vary from state to state. But mandatory gratuities are usually not included in the taxable amount if they are separately stated and all of the money is paid to the employees.

This can present problems for the restaurant, though. They may not want the patrons to know that the employee isn't getting everything. I had a seminar participant who was the accountant for a country club. They charged the members a 25% "service fee" on every food and liquor bill. The members were asking why they had to pay tax since this was supposed to be the gratuity. It turns out that it wasn't all going to the employees. Here the members thought they were being big spenders and that the wait staff was getting all of that money. But in reality, the servers were getting 17% and the rest was going to the club. And the club didn't want the members to know. But because the tax had to be collected on the "service fee" the cat kind of got out of the bag.

In some states, there is an additional restriction even if the employee is getting all of the money. If that gratuity is being used against the tip credit for minimum wage purposes, it's still taxable. And, of course, there are some hardball states that just say, if it's a mandatory gratuity, it's taxable. Period.



The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions. Remember: there are details we haven't discussed, and every state is different. Here's more information

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Picture note: the image above is hosted on Flickr. If you'd like to see more (and I can't imagine why), click on the photo.