Corporate procurement card programs: are they paperless chaos?
Many credit and bank card companies are aggressively marketing corporate procurement card' programs under which cards are issued to a broad class of corporate employees for use in purchasing a wide range of goods and services. The procurement card programs offer the companies a streamlined procedure for making and documenting their purchases, saving both time and money. These programs, however, are not without significant tax implications. This article examines the sales and use tax considerations in respect of procurement card programs.
In today's environment of corporate downsizing and out sourcing, corporate procurement card programs have become come an attractive way to reduce, or in some cases eliminate, the relatively high internal costs of the low dollar/high volume corporate purchasing process. It has been estimated that in most large to medium size companies 60 percent of all purchases are individually less than $500 (30% less than $100, which account for less than 5 percent of total purchasing expenditures. The internal cost of these transactions has been estimated at between $120 and $150 per transaction, and this cost is incurred whether the company is purchasing $10 of paper clips or a $1 million computer system.
From an overall business and efficiency perspective, the corporate credit card procurement programs offered by banks and credit card companies (such as VISA, MasterCard, and American Express) make imminent sense. There are, however, potential negative sales/use tax issues that must be addressed in evaluating these programs. There are also significant federal tax questions relating to the documentation of deductible business expenditures and information reporting requirements. Corporate tax professionals need to tactfully raise these issues in order to fully inform management of the potential implications without being perceived as impediments to progress. The only way to positively communicate the Tax Department's perspective is to ensure that tax professionals are part of the team on the front end.
If a company has not yet considered a procurement card program, the tax executive may wish to seize the opportunity to introduce his or her company to the overall benefits that these programs offer. Tax departments are not normally viewed as a source of innovation for the day-to-day business processes. By taking the initiative, the Tax Department is likely to be more positively viewed as an innovator. Equally important, by taking the lead the Tax Department can ensure that the sales/ use tax issues are properly and expeditiously addressed.
How the Programs
Corporate procurement card programs, are marketed to corporations as the "greatest thing since sliced bread" and as the solution to the low dollar/high volume purchase cost issue. The card companies promise, and can deliver, a purchasing process that is greatly streamlined and simplified. Usually, the Accounts Payable and Purchasing Departments can reduce resources (headcount) while achieving overall improved process efficiency and lower costs.
Procurement card programs are relatively new (having developed in the last two to three years), and it is important to understand that the card companies are primarily in the retail (individual consumer) credit card business. With this "retail consumer credit card" background and mind set, the card company's approach to sales/use tax issues may not be fully developed and is rarely explored in the marketing process. What the card companies often fail to appreciate is that the corporate client is in a much different role regarding sales/use tax. In most jurisdictions, corporations are designated to be the agents of the taxing jurisdiction to collect and remit sales tax from consumers. They also are required to self assess use tax on their own taxable purchases (where tax was not charged) and to remit such tax to the appropriate taxing authorities. In contrast, individual consumers are not routinely audited regarding sales/use tax either because of logistics or, in some states, because the law places the incidence of the tax squarely on the corporate taxpayer.
The tax issues confronting the corporate taxpayer are usually glossed over in the card company's marketing presentation as not a problem.' Other responses are that shortcuts and estimates can be used' to satisfy the taxing authorities who will be likely to cooperate with the taxpayer" in an audit situation. They also interject that these tax issues are just "part of the price the company pays" in order to obtain the efficiencies these programs offer. The truth is that some degree of offset in the projected benefits/savings regarding resources and processes is likely to be required to properly address these tax issues. In other words, the great benefits of reduced internal resources and streamlined processes may not be quite as good as advertised.
Regardless, even if these savings are fully realized, the company must still comply with the laws in every state and local jurisdiction in which it does business. If a company does not comply, the states or localities can impose fines, penalties (which are not deductible for federal tax purposes), and interest, and (in cases of fraud or willful negligence) corporate officers can be held personally liable - and may even be subject to incarceration.
How the Programs Work
A company enters into a contract with a bank card company (usually a bank in the case of Visa/MasterCard) and authorizes certain company managers to make defined low-dollar purchases using the card. Most companies define low-dollar purchase maximums anywhere from $500 to $5000. The company also defines what types of purchases are to be made with the card, which may be modified from time to time.
These designated managers, which are issued the procurement cards, are authorized to make purchases directly from vendors without involving the Purchasing department or having to process the related paperwork. The vendors usually ship the purchased items immediately and directly to the cardholder. The bank card monthly statement is also sent directly to the cardholder, who is responsible for reviewing, reconciling, and approving each statement before it is sent to Accounts Payable for payment. The monthly statement is identical in format and content to statements provided to individual credit card customers. Each transaction is listed in summary-level detail. Most card companies offer a customized account coding method to assist in the monthly posting of the credit card activity to internal general ledger accounts.
The Good News
The following are the obvious benefits of implementing this type of program:
Simplification. The purchasing process is greatly streamlined with little or no involvement by Purchasing and Accounts Payable personnel. Paper and paper trails are theoretically eliminated. The streamlining of the process allows resources to be redirected from tasks with little or no value to tasks with value added - especially in the Accounts Payable and Purchasing areas of a company.
Supply Base Reduction. Suppliers that receive numerous orders from various company purchasers are not required to issue separate invoices for each purchase. All monthly purchases using the card are summarized on the card statement, eliminating the issuance of multiple invoices by and multiple payments to the same vendor.
Interval Reduction. By using the corporate card, the purchaser obtains goods and services faster (usually in one or two days as opposed to weeks). The elimination of the usual Purchasing and Receiving processes cause greatly improved efficiency.
Internal transaction Cost Reduction. Overall, the use of a procurement card can reduce internal cost per transaction by an estimated 35 to 40 percent. These internal costs - which include personnel and time costs in handling the paperwork in the Accounts Payable, Fixed Asset, Purchasing, and Receiving functions as well as cost of related supplies and overhead - are reduced significantly under such a program.
From an overall business perspective and especially from an Accounts Payable and Purchasing perspective, these programs offer many valuable benefits including greater efficiency and lower overall costs.
The Bad News
Detail Documentation Eliminated. The obvious concern with the streamlined approach offered by procurement card programs is that, by definition, there is less detail documentation available to the Tax Department to defend against increasingly aggressive sales/use tax auditors. In addition, the corporation (usually the Accounts Payable or Tax Department) has less information to make an informed decision regarding the proper monthly accrual and reporting of use tax on non-taxed purchases.
Point of Sale Tax Data Is Not a Required Input Field. Card companies cannot currently provide the corporate taxpayer with an 'automated' solution to provide the necessary sales/use tax detail. Hence, while the card companies have developed software and hardware to capture this data at the point of sale, individual vendors retain the "option" whether to use it. This apparently is a difficult problem for card companies which are reluctant to mandate the use of the software and hardware.
Monthly Summary Statement. The monthly card statement is in the same format of an individual credit card statement. It does not include the usual necessary detail information required for sales/use tax purposes such as:
* Detail description of item(s) purchased * "Shipped to' location of the goods purchased * Sales tax amount and jurisdiction charged by item
No Audit History (Track Record). Because these programs are relatively new, there has been very little significant state and local sales/use tax audit activity of taxpayers using this process. Therefore, the corporate users of these programs have not yet seen first hand how these issues can affect the corporation financially (assessment of tax, penalties, interest, etc.) in an audit situation.
State and Local Jurisdictions Are Becoming More Aggressive. State and local jurisdictions, and their sales/use tax auditors, are becoming increasingly more sophisticated and aggressive regarding corporate taxpayers. Corporate taxpayers are seen as easy targets in the never-ending search for revenue. As procurement card programs become more widespread and better understood by taxing jurisdictions, they will undoubtedly be seen as a point of vulnerability for companies that have poor alternative documentation procedures regarding credit card purchases.
Alternative Documentation Procedures Required. Because procurement card programs eliminate traditional documentation for purchases, a company must institute alternative processes and apply resources to ensure that card purchases are both properly analyzed for monthly use tax accrual and reporting purposes and properly documented for later review on audit. Usually, the responsibility for obtaining sufficient documentation rests with the cardholder, and the more cardholders a company has, the more difficult it is for a company to ensure that its documentation requirements are being satisfied. This process requires strict adherence to procedures and periodic internal review for non compliance and purchase pattern analysis.
Complex Purchasing Patterns Are Further Complicated. Large companies with operations in numerous jurisdictions can find that there are situations that will be quite complex and that the procurement card program can make them even more complex regarding sales/use tax.
Example: Cardholder located in State A is buying 100 widgets from a vendor in State B, having 50 widgets shipped to State A, and the rest drop shipped to five other States. Two of the other States have no sales tax provisions, in one State (State C) the vendor is not registered to collect sales tax. The vendor charges the appropriate sales tax for State A and the other two States.
This already complicated transaction is made even more complex if a detailed invoice, purchase order, or other similar document is not obtained by the cardholder and properly archived by the company. Someone at the company must have the information available to analyze the transaction in order to determine that use tax must be accrued and paid on the widgets that were shipped to State C, and that the appropriate sales tax was charged by the vendor regarding the other components of the transaction.
On audit (typically, 3 to 5 years later), if detail documentation is not available, an auditor for State A could decide to assume, without proof to the contrary, that all 100 widgets were shipped to State A and that no tax was either accrued or charged. Hence, tax, penalty, and interest could be assessed, with the corporation having no recourse but to attempt to obtain the documentation well after the fact.
Current State of Corporations That Have Implemented Programs. Corporations with procurement card programs generally fall into one of the following categories regarding sales/use tax issues:
* Oblivious: They do not fully realize the potential implications of the procurement card program. * Reckless: They realize the potential implications, but chose not to address them. * Paralyzed: They realize the potential implications, but do not know what to do about them. * Prudent: They realize the potential problems and have implemented interim solutions.
Solutions, Approaches, and Alternatives
Long-Term Solution. The obvious long-term solution is for corporations to insist that the card-issuing companies quickly move toward the automated solution. This would involve a significant change in their current mind set by requiring the capture of sales tax data at the point of sale by all vendors. Once captured, the bank card system could then automate the monthly use tax accrual process and provide clients with the needed data to assist the taxpayer in defending against outside auditors. Virginia has issued a recent ruling (P.D. 95-275) that verifies the state's acceptance of an automated tax reporting mechanism in place of paper invoices. Of course, the reporting process must contain the required data elements.
It is likely only a matter of time before corporations with less than perfect alternative documentation procedures begin being hit with large audit assessments (including penalty and interest). By necessity, these corporations will then put pressure on the credit card companies to provide an automated solution.
Interim Approaches/Alternatives. Until an automated solution emerges, there are a number of approaches and alternatives that corporations can implement to mitigate potential compliance problems and audit assessments. In the short term, the corporation must ensure that there are processes, strategies, and resources in place to:
* Accrue and report use tax on a monthly basis, and * Ensure the monthly card statements and backup are properly archived for audit purposes.
Implement and Ensure Strict Adherence to Internal Procedures, and Provide Properly Resources for the Function(s) Responsible for Tax Reporting. The procedures for card usage and cardholder responsibilities (including specific requirements regarding sales/use tax documentation) should be implemented on the front end and strictly enforced. The process should be internally audited on a periodic basis to ensure compliance. Cards should be pulled from cardholders who do not provide the necessary tax information and documentation, as well as from those who otherwise abuse the company's procedures. The internal audit process should also include an analysis of cardholders for purchasing patterns that could assist in identifying either cardholders or departments with specific sales/use tax problems, or patterns that require less ongoing sales/ use tax analysis (i.e., all exempt purchases, etc.).
The Tax Department should ensure that the appropriate internal corporate personnel and senior management understand that purchases in the procurement card program still need to be analyzed for sales/use tax considerations. The appropriate corporate department (Accounts Payable, Purchasing, or the Tax Department) should have sufficient staff and resources to analyze these transactions to ensure compliance with use tax accrual procedures and the maintenance of proper documentation. Internal automation of processes should be initiated where possible to assist in this manual review and analysis process.
A systematic approach is required for large companies (many cardholders) with purchases in a large number of jurisdictions. Usually, such companies encounter extraordinarily complex situations (e.g., a cardholder in one State may be buying goods, taxable and non-taxable, for multiple sites in other States). Documentation of these transactions and strict adherence to established procedures are essential.
Other Short-Term Approaches
Not Requiring Extensive Resources
Direct Pay Permits. Securing direct pay permits can be a very effective means of controlling procurement card problems depending on the company's purchasing patterns and situation. In States that have provisions for direct pay, the use of such permits simplifies the sales/use tax issues that arise out of the use of procurement cards because none of the corporation's purchases within that State will be taxed, and the corporation is responsible for self assessment of use tax on all purchases. This approach has limited application because fewer than 30 States currently have such provisions. Moreover, obviously each State has different rules on the application and granting of this treatment.
Shortcut/Estimated Approaches. This approach involves the implementatation of shortcut processes using valid and reasonable assumptions in estimating use tax payments to taxing jurisdictions and negotiating the validity of those assumptions on audit. This approach may be somewhat dangerous in that negotiation in the audit process may not give the corporate taxpayer much leverage. However, if a corporation is present in relatively few jurisdictions, has a good working relationship with taxing authorities, and has a well thought out and documented methodology, this approach may be effective.
Another approach is to negotiate on the front end (prior to audit) with the taxing authorities about the propriety and acceptability of shortcut approaches, assumptions, and estimated payment methodology. Although there may be some risk in such an approach, the upfront negotiations may offer a good solution for corporate taxpayers with good relationships with the taxing authorities, especially when purchases occur in a limited number of jurisdictions and the company can document its methodology.
Examples of shortcut approaches are to perhaps limit the usage of the cards to only in-state vendors registered to collect sales tax, thereby eliminating any need to accrue and report use tax on card purchases. Another approach sometimes suggested by the card companies is to not restrict the purchases but simply to assume that all purchases from out of state vendors charged no tax, and that all instate vendors did charge tax. In this scenario, the company would accrue and report use tax on all out of state vendor purchases without any analysis of each purchase. Depending on a company's situation, however, the prospects of either overpaying or underpaying are significant.
Reserve and Hope. This approach is generally to estimate the potential liabilities (including tax, penalty, and interest) and reserve for these liabilities while hoping either that the company will not be audited or that a reasonable settlement can be negotiated with a jurisdiction in the audit process. This is probably the least desirable approach in that a company that adopts an ostrich-type approach and refuses to address fundamental tax issues may find itself headless. There are also significant risks that a state or local jurisdiction could make a case for willful neglect, which would carry with it significant adverse consequences. Worse case, of course, is that the company's officers and management might be held personally liable and even subject to criminal penalties depending on the jurisdiction involved.
MARK D. LOFTIS is currently Senior Manager of Sales/Use, Payroll and Property Taxes for NOrthern Telecom Inc. in Nashville, Tennessee, a company that has a tax presence in all 50 States. Mr. Loftis's responsibility include the management and coordination of all tax planning, compliance, audit, and protest/appeals activity regarding the U.S. operations of Northern Telecom. Mr. Loftis holds a B.S. degree in Accounting from David Lipscomb University and is a certified public accountant licensed in the State of Tennessee. He is a member of the Tennessee Society of CPAs, the Committee on State TAxation, and the Institute of Property Taxation, where he also serves as a member of the Audit Committee.
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|Title Annotation:||sales/use taxes for card programs|
|Author:||Loftis, Mark D.|
|Date:||Mar 1, 1996|
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