Record retention rules of the electronic highway.
This article alerts tax practitioners to die special record retention responsibities associated with computerized accounting and financial systems. It also highlights the concerns of taxing officials (whether local, state or Federal), including potential alteration of electronic records, access to the records, the ability to audit the system and access system documentation, and training of auditors to conduct examinations of electronic records.
Businesses Covered Under a
Records Retention Procedure
Many practioners assume that only large businesses need be concerned about electronic recordkeeping requirements. Although the IRS's recordkeeping requirements in Rev. Proc. 91-59 are specifically required in businesses with assets of more than $10 million, any business with computer tax records not available in hard copy must also comply. The requirements are also mandatory for businesses using computations that cannot be reasonably verified without a computer (e.g., lengthy LIFO inventory calculations).
Accountants should also not assume that their small business clients are not affected. Many companies using EDI are now requiring even their smallest vendors to use EDI; orders are actually refusing to do business with firms that do not use EDI for transmitting information.
IRS Recordkeeping Requirements
Sec. 6001, governing recordkeeping responsibilities, requires every person liable for any tax or its collection to keep prescribed records for so long as they are maternal in the administration of the tax law. Rev. Proc. 91-59 specifies the basic requirements considered essential when the taxpayers records are maintained within an automatic data processing (ADP) system, including microcmputers systems, data base management system and all systemss using EDI technology. The document emphasizes that the use of a service bureau, time-sharing service or value-added network does not relieve the taxpayer of record retention responsibilities. In fact, parent companies may be held responsible for the records of their subsidiaries. For example, domestic shareholders that own more than 50%o of the stock in foreign subsidiaries with data processing centers in foreign countries, or that send data to the domestic corporation for further processing, must ensure that the subsidiary's recordkeeping responsibilities are sufficient to determine the subpart F income includible in the domestic shareholder's gross income (see Rev. Rul. 76-447).
Whether records are electronic or not, they must be maintained, at a minimun until the expiration of the statute of limitations (including extensions) for each tax year; certain records must be retained for longer periods (e.g., those pertaining to fixed assets, losses and LIFO inventories). Documentation providing a complete description of the accounting system, and all subsystems feeding into it, must be maintained. This documentation must include the controls used to ensure accurate and reliable processing and the controls used to prevent unauthorized additions, alterations or deletions. Rev. Proc. 91-59 lists seven specific elements that are required, including record formats, flowcharts for the system and programs, charts of accounts and evidence that checks of the records were performed. Any changes in the ADP system must be documented.
A computerized recordkeeping system does not relieve a business from the responsibility of retaining hard copy records, although Rev. Proc. 81-46 provides authority for keeping hard copy record on microfiche or microfilm. The Service makes clear that hard-copy records are not a substitute for the machine-sensible records required. Businesses that use EDI must retain machine-sensible records which, in combination with any other records (e.g., the underlying contracts, price lists and price changes), contain all of the detailed information required by Sec. 6001. By way of example, the IRS provides that retained records for an electronic invoice must contain such items as identification of die vendor by name, invoice date, product description, quantity purchased, price, etc. This information can be captured at any level within the accounting system, provided the audit trail, authenticity and integrity the retained records can be established.
The IRS recommends that all machine-sensible records be clearly labeled and stored in a secure environment. Back-up copies should be stored at an off-site location, and taxpayers should make periodic checks of all retained records. If disaster strikes and a taxpayer finds its records are damaged or destroyed, under Rev. Proc. 81-46, such a situation must be reported to the local District Director.
It is also the taxpayers responsibility to be able to process die retained records on examination by die IRS. In fact, if at the time of an examination, a taxpayer fails to provide the Service with the computer resources (e.g., terminal access, computer time, personnel) necessary for processing the records, this may be viewed as a failure to maintain books and records under Sec. 6001.
As more and more software is converting from DOS to Windows formats, it is especially important that business advisers be alert to the special record retention problems that may be created. Businesses replacing a system with a new one that is incompatible are required to convert preexisting records to a format compatible with the new system. However, alternative solutions to a complete conversion of records may be discussed with the District Director. Again, any changes in the ability to process the retained records must be reported to the District Director.
State Recordkeeping Issues
In designing a records retention procedure, business advisers should not overlook the special needs and requirements of state and local taxing jurisdictions. Issues that may not have a Federal impact (e.g., place of sale, place of delivery or place of final use and consumption) can be critical in the state arena. For example, an EDI tranction that did not separately record "the sales tax paid" field on a purchase invoice could expose a business to an audit liability for additional use tax.
The Federation of Tax Administrators (FTA), a national organization composed of die principal tax collection agencies of the 50 states, the District of Columbia and New York City, has been in the forefront of electronic media issues. In October 1994, the FTA formed a tax task force of state and private sector representatives, including the Committee on State Taxation, the Multistate Tax Commission, the Tax Executives Institute and the Institute of Property Taxation, which issued a Model Recordkeeping and Petention Regulation to address the particular requirements of state taxing authorities. Copies of the model regulation may be obtained from Stephanie Rosenbusch at the FTA, at (202) 624-5890. See also State & Local Taxes, "Update on FTA EDI Audit and Legal Issues Task Force," The Tax Adviser, Dec. 1996, p.
Arizona recently published its recordkeeping regulation, Arizona General Tax Ruling GTP, 96-1, modeled in large part on the FTA language. Vincent Perez, a Tax Research and Analysis Supervisor with the Arizona Department of Revenue, stated.
Technology is changing so rapidly, we were finding that data processing decisions were being made without considering their full tax ramifications. Arizona GTP, 96-1 provides information that is necessary for Arizona taxpayers using an electronic data processing system. We hope that GTR 96-1 will help taxpayers meet their responsibities and avoid record retention problems from occuring during examinations.
Several other states, including Florida and New Hampshire, are also in the process of updating their laws and regulations to more clearly outline the recordkeeping responsibilities in their states.
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|Author:||Crangle, Jan Steensen|
|Publication:||The Tax Adviser|
|Date:||Jan 1, 1997|
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