FTA Task Force on Electronic Data Interchange: a status report.

In October 1994, members and staff from a number of professional tax organizations joined together in a project now referred to as the Task Force on Electronic Data Interchange (EDI) Audit and Legal Issues for Tax Administration (hereinafter referred to as "the Task Force" . Brought together under the auspices of the Federation of Tax Administrators FTA, Task Force participants were drawn from the FTA, the Multistate Tax Commission (MTC), the Institute of Property Taxation (IPT), the Committee on State Taxation (COST), and Tax Executives Institute (TEI). The objective of the Task Force is to:

Submit a final report providing (a)

an explanation and background of

electronic data interchange, (b) its

impact on the state tax audit and

tax administration process, and (e)

recommendations to be provided

to the governing bodies of FTA,

MTC, COST, IPT, and TEI....

The underlying premise of the Task Force is that, as a collaborative effort of business taxpayers and state tax administrators, its efforts will persuade the States to adopt, in whole or part, rules and procedures reflecting its recommendations. The Task Force, however, is not charged with reconciling or harmonizing the possibly divergent views of its constituent members on discrete issues because, as a collaborative effort, its interim or final reports likely will not fully represent the views of the members or member organizations. Hence, none of the conclusions reached, or recommendations made, should be ascribed to individual members or their organizations, though obviously there exists hope that a consensus will be attained on one or more issues. Moreover, each State remains free to develop EDI guidelines that differ from those adopted and recommended by the Task Force.

I. Organization of The Task Force

The Task Force is composed of a Steering Committee and two Work Groups. The Steering Committee, chaired by New Hampshire Tax Commissioner Stan Arnold, provides general direction to the Task Force, identifies the legal and audit issues to address, provides timetables and deadlines, etc. The 22-member Steering Committee is evenly divided between representatives from the state tax organizations (FTA and MTC) and business taxpayer organizations (IPT, COST, and TEI).

Two Work Groups, also composed of representatives from business taxpayers and state tax administrators, are charged with fleshing out the issues and developing working recommendations for Steering Committee consideration. The Work Group on Recordkeeping and Legal Issues was assigned the task of developing a proposed model rule or regulation relating to the maintenance, retention, and availability of electronic business, tax, and accounting records for state tax audit purposes. This group will also address certain "in-bound" EDI transactions, i.e., issues associated with electronic filing of state tax returns. The agenda for the EDI Audit Approaches Work Group includes making recommendations concerning systems audits, computer-assisted audits, sampling issues, documentation required to support refunds, confidentiality issues, and the educational needs of taxpayers and state auditors.

The Task Force's objectives and mission are currently in flux. One important issue is whether the Task Force should address the development of new or uniform state recordkeeping guidelines for electronic tax accounting systems. After outlining the factors bringing the state tax agencies and business taxpayers together, this article discusses this issue and its implications.

II. Needs of Taxpayers and the States

A. Recordkeeping

Owing to the efficiencies and economies associated with automating routine purchasing, payment, invoicing, and cash collection functions with technological solutions, EDI transactions, which produce no paper documents, have become pervasive. Should the records produced and retained in EDI transactions not be accepted as a legitimate source of records supporting taxpayers' reported tax liabilities, however, the efficiency and cost savings attributable to EDI will be diminished.

It remains an open question whether a State may legally require taxpayers to create redundant paper documents and records rather than simply produce or make available machine-sensible EDI-based records. At the same time, it seems unlikely that courts will permit a taxpayer to claim that it has no obligation to produce paper records, especially in circumstances where such a claim might frustrate a State's ability to conduct a tax audit. On the other hand, taxpayers should not be exposed to state assessments -- whether on a jeopardy basis or not -- based solely on an auditor's estimate of a taxpayer's liability simply because records were not reduced to a prescribed paper format.

In addition to EDI, transactions involving evaluated receipts settlements (ERS) also present challenges for taxpayers and taxing authorities,(1) as do corporate procurement cards and audit issues arising from their use. Finally, there is the question of alternative storage media. Taxpayers that maintain substantial volumes of paper-based records will benefit from regulatory measures permitting the use of microfilm, microfiche, and optical imaging techniques. Given the significant cost reductions in record retention and retrieval that may be achieved through their use, one would expect the States to relax recordkeeping requirements for the preservation of original paper records so long as the tax audit function is not impaired. Hence, taxpayers have a strong interest in assuring the acceptability of EDI-based records.

The States have recognized the trend in automating business processes, the efficiencies to be derived from automation, and the effect on tax liability determinations. Indeed, some States have embraced technological innovations far faster than the federal government by imposing or permitting, in certain instances, electronic return filing and payment requirements. Moreover, by initiating the Task Force under the auspices of their professional association, the States have recognized an obligation to adapt to changes in the business environment in order to minimize burdens imposed on taxpayers. The principal motivation underlying the States' participation in the Task Force, however, is to preserve or enhance their ability to verify a taxpayer's liability through audits of available books and records.

B. Audits

The central goal of most taxpayers is to minimize the intrusiveness and expense of tax audits and related activities. Beyond that, taxpayers would also benefit if the States permitted the use of sampling methodologies to support refund applications.(2) In addition, taxpayers would benefit if States could be persuaded to accept electronic resale and exemption certificates in lieu of paper documents. In view of the States' increasing demands that taxpayers file tax returns electronically, taxpayer desires to employ and retain electronic exemption certificates should seemingly be accommodated.

As summarized in the Task Force's mission statement, the States are "concerned about the impact on the tax administration process as taxpayers make increasing use of EDI technology... [and about] developing audit approaches to the audit of EDI-based companies." Specifically, the States are concerned about (1) the potential for alteration of electronic records; (2) State access to electronic records; (3) the ability to audit the taxpayer's system and access the system documentation; and (4) the training of state auditors.

The factors enumerated by the mission statement collectively evince the States' desire to ensure the integrity of taxpayer records and to prevent EDI processes from impairing the audit function. Significantly, however, some tax agency representatives have adopted a more expansive view of the Task Force's scope and purpose.

III. EDI or EDP?

The Task Force's name suggests a focus limited to issues spawned solely by the use of EDI. The description of the Task Force's mission and objectives, however, includes a footnote defining EDI as encompassing "electronic recordkeeping and other paperless processes." Furthermore, while the mission statement seemingly contemplates relatively minor adjustments in state laws and audit procedures to accommodate electronic commerce (by making references to, for example, the "absence of paper records," taxpayers' "shift to EDI," and to "auditing electronic transactions," some tax agency representatives clearly wish to expand the scope of, and the tools employed in, audits of taxpayers with electronic tax accounting systems.

In some respects, the Task Force's misnomer may have slowed progress toward the group's objectives. In particular, the scope of the recordkeeping requirements to be defined by the Legal and Recordkeeping Workgroup is far greater than some taxpayer representatives envisioned.

Consequently, while both State and taxpayer representatives agree that state rules should be modified as necessary to accommodate electronic commerce, consensus beyond that limited objective has been slow to develop. Some tax agency representatives envision a model recordkeeping regulation patterned after the federal model contained in Rev. Proc. 91-59. Standing alone, however, that model is deficient for the States since it does not address important features and requirements of state revenue systems -- especially sales and use and property taxes -- and the complications in allocating transactions or income among multiple States. As a result, the States have proposed to supplement the basic approach of Rev. Proc. 91-59 with provisions found in proposed California Regulation 1698.

Taxpayers believe that the approach in Rev. Proc. 91-59 and the proposed California regulation on electronic records generally overreach and are excessively burdensome. As a result, taxpayer representatives on the Task Force believe the proposed recordkeeping rules should be circumscribed, focusing upon the minimum conditions the States may impose upon the electronic records created by taxpayers. They contend that taxpayers should be given broad discretion to retain only those records minimally necessary to support the reported liabilities and to permit the States to verify the liability. Thus, taxpayer representatives recently submitted to the state representatives a draft regulation that reflects the narrower approach. Additional meetings of the Workgroup have been scheduled at the end of September to compare the proposed approaches and to attempt to reconcile the differences.

IV. Conclusion

The formation of the EDI Task Force represents a significant milestone of cooperation among business taxpayers and state tax administrators. It is the first effort undertaken by the Federation of Tax Administrators to bring taxpayers and state revenue officials together to work actively on a subject of mutual interest. Should the Task Force achieve its twin goals of accommodating the States' needs for access to authentic and verifiable records while minimizing the burden of recordkeeping and tax audits for taxpayers, other task forces and cooperative ventures will likely follow.

(*) This article is adapted from a paper originally presented at the Institute for Property Taxation's 1995 Annual Conference, which was held in Indian Wells, California, from June 25 to June 28, 1995. That original paper was prepared and delivered by Manuel Davila, Tax Vice President-State and Local for AT&T Corporation; Barbara Barton, Manager State Research & Planning with Electronic Data Systems Corporation; and Robert S. Goldman of the Tallahassee, Florida law firm of Vickers, Caparello, Madsen, Goldman & Metz. Mr. Davila expresses his appreciation to Ms. Barton and Mr. Goldman for their efforts in preparing the original paper, and to Jeffery P. Rasmussen, Assistant Tax Counsel of Tax Executives Institute, for his assistance in adapting the paper for publication. (Along with Mr. Davila, Ms. Barton and Messrs. Goldman and Rasmussen are members of the FTA Task Force.) (1) In an ERS transaction, there is no invoice (electronic or otherwise) and the purchaser essentially decides what the tax treatment should be. (2) Heretofore, States have permitted sampling techniques only in support of additional assessments against taxpayers. Permitting sampling techniques in support of refund applications would clearly reduce taxpayer costs in making such applications and improve the balance between taxpayers and the States.

MANUEL DAVILA is Tax Vice President-State and Local for AT&T Corporation in Morristown, New Jersey. A member of Tax Executives Institute's New Jersey Chapter, Mr. Davila is a vice chair of the Institute's State and Local Tax Committee, and one of TEI's representatives on the Federation of Tax Administrator's Task Force on EDI Audit and Legal Issues for Tax Administration, serving on its Steering Committee.