Sales and Use Tax Compliance Agreements.

Task Force on EDI Audit and Legal Issues for Tax Administration

In March of this year, the Federation of Tax Administrators, through a steering committee of its Task Force on EDI Audit and Legal Issues for Tax Administration, released the following report. Organizations contributing to the development of the report were the Committee on State Taxation, Federation of Tax Administrators, Institute for Professionals in Taxation, Multistate Tax Commission, and Tax Executives Institute. TEI's representatives were Barbara Barton of Electronic Data Systems Corp., who chairs the Institute's Advanced Technology Committee, and Barbara A. Timek of AT&T. TEI members Debra Abbott of The Coca-Cola Company, Barbara Connolly of Illinois Tool Works, Inc., and Sandra Robertson of Georgia-Pacific Corporation also served on the task force.

Foreword

The Task Force on EDI Audit and Legal Issues for Tax Administration (Task Force) was formed to coordinate efforts between the business community and tax administrators in analyzing and addressing the issues posed for tax administration by electronic data interchange and related business processes. The Task Force is comprised of representatives of the Committee on State Taxation (COST), Institute for Professionals in Taxation (IPT), Tax Executives Institute (TEI), Multistate Tax Commission (MTC), and Federation of Tax Administrators (FTA). This report is the sixth in a series of Task Force reports on issues relating to electronic commerce, emerging business processes and tax administration.

As part of the Task Force, the Electronic Business Processes work group was formed to examine the tax administration and compliance issues associated with certain emerging business processes. The work group is also exploring alternative processes that can reduce the burden associated with sales and use tax compliance and administration for taxpayers and taxing authorities alike, one of which is the development of Sales and Use Tax Compliance Agreements (SUTCAs) between taxpayers and taxing agencies.

SUTCAs raise a number of policy and administrative issues. This report is intended to aid both taxpayers and taxing agencies in evaluating and answering those issues. It describes SUTCAs and their operation as well as outlines the perceived benefits and costs associated with them. In addition, the report reviews the major elements likely to be present in a SUTCA and discusses a number of issues that are likely to affect the operation of a SUTCA and, therefore, ought to be considered in arriving at an agreement.

The report concludes by reviewing activities that need to be undertaken in evaluating a SUTCA at the conclusion of its term. The report is intended solely as an educational document for taxpayers and tax administration agencies; it makes no recommendations on whether SUTCAs should be used or the manner in which they might be implemented.

The Steering Committee wishes to acknowledge the contributions of all individuals who devoted their time and effort in developing and refining this report.

Stanley R. Arnold, Steering Committee Chair Commissioner, New Hampshire Department of Revenue Administration

Introduction

In recent years, American business and government organizations have undergone some radical "re-engineering" and transformation in an effort to improve and streamline their operations. As part of this effort to "do more with less," both taxpayers and tax agencies have been examining their existing processes to determine if efficiencies and improvements can be made.

Traditional techniques of sales and use tax compliance and administration are, in some cases, prime candidates for such re-engineering efforts. From the taxpayer perspective, traditional approaches to compliance are seen as paper-intensive and labor-intensive with little value. Further, taxpayers find that audits by taxing agencies to determine if they are in compliance involve a significant burden. From the taxing agency perspective, sales and use tax audits are also seen as resource-intensive and time-consuming, particularly when they involve taxpayers that are trying diligently to comply.

As a result, taxpayers and taxing agencies are examining several avenues for simplifying sales and use tax administration and compliance. One approach is for taxing agencies and taxpayers to enter into Sales and Use Tax Compliance Agreements (SUTCAs) with one another. SUTCAs are, at their core, up-front agreements between the taxpayer and the tax authority that detail the manner in which the taxpayer is to calculate and report tax on its purchases and the manner in which tax compliance is to be evaluated on audit. As such, they hold potential for reducing the burden of sales and use tax compliance for all parties.

There is a high level of interest in SUTCAs among taxpayers and taxing agencies. For this reason, the Business Processes Work Group determined it would be advisable to develop this report examining SUTCAs. The report explores the operation of SUTCAs and outlines the perceived benefits and costs associated with them. In addition, it reviews the major elements likely to be present in a SUTCA and discusses a number of issues that are likely to affect the operation of a SUTCA and, therefore, ought to be considered in arriving at an agreement. The report concludes by reviewing activities that need to be undertaken in evaluating a SUTCA at the conclusion of its term.

The report is intended solely as an educational document for taxpayers and tax administration agencies; it makes no recommendations on whether SUTCAs should be entered into or the manner in which they might be implemented.

1. Considerations Prior to Entering a SUTCA

   1. Sales and Use Tax Compliance Agreement Defined

      A Sales and Use Tax Compliance Agreement (SUTCA) is an agreement between a taxing agency and a taxpayer providing simplified procedures under which the taxpayer is to calculate and remit unpaid sales or use tax on its purchases. The agreement commonly provides that the tax to be paid on purchases covered by the agreement is determined by applying an agreed-upon tax rate (determined through a review of the taxpayer's purchasing history) to the aggregate of the taxpayer's covered purchases, rather than being determined on a transaction-by-transaction basis. SUTCAs are known by a variety of names, including managed compliance agreements, effective use tax rate agreements, formulary sales and use tax agreements, negotiated rate agreements, alternative use tax payment methods, and simplified procedure agreements.

      SUTCAs are sometimes confused with managed audits because of the similar terminology that is used. While both SUTCAs and managed audits involve cooperation and written agreements between the taxing agency and the taxpayer, there are distinct differences between them. SUTCAs involve an "up-front" agreement specifying the manner in which tax is to be computed and remitted at the time of a purchase, the accuracy of which will be evaluated at a later point. A managed audit, on the other hand, is a post-transaction review in which the taxing agency and taxpayer agree that the taxpayer will audit its own books and records in accordance with procedures established by the taxing agency. Managed audits are conducted in lieu of traditional audits directed by taxing agency personnel. Nevertheless, managed audits adhere to the traditional audit paradigm in their focus on transactions that occurred during past audit periods. SUTCAs, on the other hand, govern the handling of tax obligations on a prospective basis.

   2. Operation of a SUTCA

      There is no rigid blueprint for the design and implementation of a SUTCA. Instead, it is usually the result of negotiations between the taxing agency and the taxpayer, and both the agency and taxpayer should approach the formulation of a SUTCA with a spirit of flexibility and cooperation. Generally, the taxpayer will present the taxing agency with a proposal from which the parties work in fashioning an agreement that will meet the needs of both parties and comply with the applicable tax laws.

      There are three central features to a SUTCA.

      * The taxpayer will remit tax on certain categories of its purchases directly to the taxing agency, rather than to its vendors. To this extent, a SUTCA resembles a direct pay agreement.(1)

      * The tax to be remitted is determined by applying an agreed-upon tax rate or taxable ratio to the total of a taxpayer's purchases rather than determining the taxability of each transaction individually.(2) The rate or ratio to be applied is determined from an analysis of taxpayer's prior purchase history during a base period that is representative of the taxpayer's operations covered by the SUTCA.(3) Through proper analysis of a representative base period, a SUTCA can closely approximate the tax that would be due if it were determined correctly and individually for each transaction, presuming all other relevant elements remain the same.

      * Audits of periods covered by a SUTCA do not involve a determination of whether tax was over-paid or underpaid on a transaction-by-transaction basis. They focus instead on determining whether the taxpayer complied with the provisions of the agreement during its term. They also usually involve an evaluation of the degree to which the basis used for tax calculation and remittance in the SUTCA accurately reflected the operations of the taxpayer during the audit period and whether any adjustment to the basis on which tax has been remitted is necessary.(4)

      Importantly, all provisions of a SUTCA are subject to negotiation and mutual agreement by the taxpayer and the taxing authority. Other provisions generally in a SUTCA include, but are not limited to, the term and scope of the agreement, procedures for accommodating business and tax law changes, records the taxpayer must maintain as well as provisions addressing reconciliation and possible "true-ups" at the conclusion of the term...