Update on FTA EDI Audit and Legal Issues Task Force.

• Author: Barton, Barbara
• Position: Federal of Tax Administrators, electronic data interchange

EDI Is Growing as Business

Changes

Electronic data interchange (EDI), the buzz word of the 1990s, is keeping many companies and their tax professionals in a state of flux. While dearly streamlining certain operational functions, the business process has far-reaching tax ramifications. EDI is the electronic transmission of business documents between entities (trading partners) using a standard formatted structure. Specifically, this process controls the exchange of data by published standards and allows information to be sent and received by computer systems with different hardware and/or software configurations.

Although EDI has been in place for decades (the American National Standards Institute (ANSI) was established in 1918 to create national standards for EDI), even as late as the mid-1980s only leading-edge companies were using EDI. However, as companies of all sizes in many industries continue to downsize and seek more cost-efficient operations, many are joining the more than 100,000 U.S.businesses that already use EDI and EDI-related processes as an integral part of their businesses. According to the EDI group, Ltd., growth in the EDI market is expected to average more than 15% each year for the next four years.

Although EDI can streamline operations and significantly reduce costs, it can also complicate recordkeeping and audits. These complications increase as companies continue to diversify and expand their sales activity over industry lines. The telecommunications industry is a case in point. After deregulation, these companies began providing numerous services that differed markedly from their traditional lines of service. The fifth largest merger in U.S. history, between WorldCom and MPS, produced a telecommunications giant providing a full spectrum of services to an estimated 500,000 customers, each of whom receives a single bill. Earlier this year, Bell Atlantic Corp. agreed to merge with Nynex Corp. in a transaction worth $22.7 billion. This rapid transformation of telecommunications companies, which are expected to generate between $75 to $125 billion in sales by the turn of the century, raises many issues. For example, how will the electronic systems be consolidated in these megamergers; further, how will companies be able to identify these new services by location?

EDI Continues to Transform

Corporations While Complicating

Audits

One of the key benefits of EDI is the exchange of information and completion of transactions directly between computers, eliminating the need for processing purchase orders, bills of lading, invoices and other traditional paper documents. Considering the broadened industry scope of companies, the evolution of the EDI process, the fact that in certain instances the laws are over 100 years old, and the fact that the audit process used by many jurisdictions today is in transition, it is logical that new issues and challenges will continue to arise.

There is always a need for state governments to maintain a stable revenue stream. Today, it is necessary to increase revenues, heightening the need to quickly develop consistent and clear standards for EDI audits.

How can standard audit processes, which benefit all, be achieved? On the taxpayer side, in organizing the corporate EDI process, it is critical to ensure that legal, audit, systems and tax representation are part of the EDI process team. Requirements should be written to ensure the basic premise that the electronic record should contain all of the information found on the paper document. A description of the commodity being purchased, the price, identification of seller/purchaser, location of delivery, tax amount, tax jurisdiction and type of tax are a few of the required fields. Obtaining the required information upfront, meeting with the tax representatives of the trading partner and joining with internal audit to ensure system integrity will expedite all audit processes. Taxpayers should also ensure that appropriate records are maintained for audit purposes in a format that is readable and available years after a transaction has occurred.

From the perspective of the taxing authority, it is critical that the system be deemed to have sufficient integrity. Once this is achieved, the audit is returned to the normal taxability phase. Arguably, this is the current requirement; the lack of "paper" simply brings the point home more strongly. Unfortunately, the electronic process generates questions that can no longer be avoided. Should a sales tax auditor, for...