Recordkeeping for electronic transactions.

Recordkeeping for Electronic Transactions

Business transactions are going paperless, but tax record retention guidelines haven't kept pace. They still contemplate the creation and storage of paper documentation. This article briefly reviews the tax issues raised by "paperless transactions."

Currently, between five to seven thousand corporations use electronic data interchange (EDI) to transmit purchase orders, invoices, and remittance advices between themselves. EDI is the computer-to-computer exchange of business data in a structured format. Especially popular in the automotive, retail, and health care industries, EDI is fast gaining importance in American commerce.

EDI is often used to communicate tax relevant information between independent firms. So the question arises how this information should be retained to satisfy tax auditors. Although the Internal Revenue Service has issued guidelines for the storage of tax information in some automated data processing (ADP) environments, their pertinence to the EDI record retention question is less than crystal clear.

Rev. Rul. 71-20, 1971-1 C.B. 392, calls for the retention of all electronic media (tapes and disks) that store tax-related data. Rev. Proc. 86-19, 1986-1 C.B. 558, generally requires the thorough documentation of ADP systems and the development of audit trails for the tracing of data through the successive stages of processing. These guidelines, however, are designed for computer accounting systems, not intercorporate transaction systems. They were written on the assumption that paper documents, such as invoices and vouchers, support the information in accounting systems. That assumption is important because paper documentation helps auditors verify information. Paper holds information in a stable unit over a long period of time, and it allows easy, visual inspection of information.

EDI and other electronic transaction technologies, such as electronic mail and electronic securities trading systems, invalidate the assumption. Consequently, companies that do business electronically -- not to mention IRS representatives -- have been puzzled over how electronic data should be retained.

Should the data be stored in a log exactly as it was communicated between companies? Or should it be re-formatted and stored in a database after communication? Should controls be placed on any of the data to ensure the information is not changed after origination? If so, how strong should the controls be? Should the taxpayer be capable of rendering plain-English printouts of data when requested to do so by a tax auditor?

These questions, of course, have relevance beyond the federal tax realm. State income tax record retention guidelines usually mimic federal guidelines, and no state has yet issued rules specifically for EDI records. Moreover, although state sales and use tax regulations usually permit the storage of records in electronic formats, few if any states have guidelines on how the computer records are to be maintained. Some EDI users are uncertain exactly how state auditors, who are not always technologically sophisticated, will react to totally paperless transactions.

In my book, EDI and American Law: A Practical Guide, I undertake to identify and examine the full range of legal issues surrounding EDI. The book presents an overview of electronic data interchange: what EDI is, how it works, and how current laws and procedures apply to it. One chapter discusses in detail the applicability to EDI of recordkeeping requirements and internal control procedures, including those relating to tax compliance matters.

Regrettably, there are few definitive answers to the tax questions raised by the book. Although EDI has been used in industry for some years, tax authorities have yet to devote much attention to it. This will soon change because of EDI's rapid growth. Indeed, officials of the IRS have already begun to reach out for help -- they have contacted not only tax organizations like Tax Executives Institute and the American Institute of Certified Public Accountants, but also technology-based groups. Efforts are also underway to draw on the experiences of qualified practitioners as well as the academic community. In preliminary discussions, the IRS has expressed a keen interest in learning more about EDI. The IRS's goal is to develop meaningful recordkeeping guidelines and procedures that anticipate and allow taxpayers to exploit EDI's technology while preserving the IRS's ability to audit compliance with the tax laws.

Corporations that are spearheading the use of EDI no doubt have already faced the question of EDI recordkeeping for tax purposes. The Tax Executive invites its readers to submit for publication their experiences with EDI as well as the suggestions concerning recordkeeping. Your contributions should be sent to "Reader's Forum," The Tax Executive, 1001 Pennsylvania Avenue, N.W., Suite 320, Washington, D.C. 20004-2505.

Benjamin Wright is a Dallas-based attorney and is the author of EDI and American Law: A Practical Guide, which was published by TTDC: Electronic Data Interchange Association. For additional information about the $69.95 book, please contact the association at Suite 550, 225 Reinekers Lane, Alexandria, Virginia 22314. Telephone: [phone]. Fax: [phone].