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Unprecedented taxpayer-initiated MTC joint audit program yields benefits to all parties.

Introduction

Mergers and acquisitions between multi-billion dollar enterprises do not happen every day. Neither do "taxpayer initiated" examinations by the Multistate Tax Commission. But such an undertaking is exactly what happened after the Hewlett-Packard and Compaq Computer merger was announced in September 2001 and completed in May 2002.

Exciting, challenging, beneficial, and maybe even bizzare? Maybe, but we believe it was the right choice for our company.

History

In September 2001, Hewlett-Packard Company (HP) announced its intention to merge with Compaq Computer Corporation. HP acquired 100 percent of Compaq's shares on May 3, 2002, and on December 31 of that year Compaq's operations were merged into HP's operations. Before the merger, Compaq had been rather busy with acquisitions of its own. Specifically, Compaq had acquired Tandem Computers (merged into Compaq in 1999), Digital Equipment Corporation (merged into Compaq in 2000), and then Custom Edge Inc. (formerly known as InaCom, merged into Compaq in 2002).

Due Diligence/Audit Review

After the HP-Compaq merger, the new HP combined sales tax group began an intensive review of the company's audit situation. Several state audits were still inventoried or in progress for Tandem, Digital, and Custom Edge. We also learned that 22 Compaq state audits were queued up but not yet scheduled. We anticipated that virtually all of the states would seek to do "close-out" audits because companies as large as Compaq (revenues of $33.5 billion in 2001) rarely stop doing business. Dealing with the existing audit backlog and knowing that 46 states and 140 local close-out audits were imminent, we felt our best option was to adopt an active approach.

This led the HP sales tax group to hold an audit brainstorming meeting in Houston in September 2002. We had many challenges to address and overcome, including data processing and other computer systems, time factors, and personnel changes. To meet these challenges, it was critical that we identify our business-knowledge sources from the various pre-merger Compaq groups. Most critically, we identified our primary action for success--"streamlining" the process. Hence, the idea of a multi-state joint audit was born.

Approaching the MTC--How the Audit Program Works

Once HP developed the idea of having the Multistate Tax Commission conduct closeout audits for most states, HP reached out to professional associations and outside advisers who had experience with the MTC. We received generally positive feedback, which encouraged us to make an initial call to the MTC on a "no-name" basis. It seemed that an MTC audit would be a reasonable way to proceed, so we called the MTC again, identified ourselves, and set up an appointment in early October 2002 at the MTC's offices in Chicago to discuss this possibility further.

Les Koenig, MTC's Director, Joint Audit Program, began by providing us with a two-page memorandum setting forth the MTC policy on "taxpayer-initiated audits." This document was dated May 1997. Mr. Koenig informed us that if HP decided to proceed, the company would be the first taxpayer ever to be covered by this policy. We complimented the MTC on its prescience and long-range planning.

After an extensive discussion of how an MTC audit might be conducted, HP was inclined to proceed. We learned about the typical process the MTC uses to select companies for audit. The MTC Audit Committee is composed of representatives from the states in the MTC Audit Program. Currently, 17 states participate in sales tax audits and 21 states participate in income tax audits. The Audit Committee meets three times a year to provide oversight for the MTC Audit Program.

As part of the oversight process, the MTC Audit Committee selects audits to be conducted by the MTC Audit Program. This is an annual process. The MTC sends out forms to each state requesting "audit nominations." The nominations are summarized and subsequently discussed at one of the Audit Committee meetings. The MTC Audit Director requests approval for a number of income and sales tax audits depending on the current inventory in the MTC Audit Program. The states then vote on companies to be added to the MTC inventory. The companies receiving the greatest votes are selected for the MTC audit inventory. When at least seven states commit to participate in an audit, one is scheduled with the taxpayer.

A taxpayer may also request a joint MTC audit. The taxpayer initiates the request through the MTC Executive Director, who presents the proposal to the MTC Audit Committee, which reviews the request and makes a decision whether to add the company to the MTC audit inventory.

HP Takes the Plunge

In learning about the MTC audit process, one thing became clear: The normal MTC process would only cover sales tax audits on behalf of 15 states (since then increased to 17 states). That was good, but not optimal.

A number of states already had audits of Compaq underway. These included California, Massachusetts, and Texas, where Compaq had a major physical presence, which portended far more use tax issues than in the typical Compaq "market" state. Even if the states that already had audits under way were excluded, HP had hopes that most of the remaining states with a sales tax that were MTC members--36--could be persuaded to participate in the MTC audit. Les Koenig informed us that the only way that we could possibly generate this degree of participation would be to attend an MTC meeting and make a direct appeal to state tax officials. Accordingly, the MTC invited HP to participate in the next MTC Audit and Executive Committee Meetings in Washington, D.C., in mid-October 2002.

Following HP's presentation, the sales tax audit group met in closed session and approved the MTC audit of Compaq.

Les Koenig and Dan Bucks, MTC's Executive Director, made an extraordinary personal effort to encourage the maximum number of states to participate and to do so as quickly as possible. This effort produced exceptional results--29 states ultimately agreed to participate in the Compaq closeout audits.

MTC Agreement--Timeline and Audit Methods

In November 2002, HP and the MTC audit team met in Houston to discuss audit procedures and timelines. It was agreed that the MTC senior auditor who was assigned this project, Sam Moon, would have the assistance of other MTC senior auditors, as well as guest auditors from some of the participating states. We also agreed that the audit would be conducted in Houston and Colorado Springs, and set an audit completion timeline of 12 months.

Sales and use tax sampling can be daunting under the best circumstances. A special challenge was determining the most efficient and effective method of sampling in light of the various legacy and SAP systems in place during the 36-month audit period. As previously explained, Compaq had acquired three other companies before the HP merger, and each company used a different system. After discussion, we finally agreed on the "block sampling" method of testing, which entailed a three-month block test for accounts payable and accounts receivable, with the exception of procurement cards, fixed assets, and reconciliations. (Only later did we learn that, even using this sampling process, the amount of data involved was overwhelming.) Procurement cards were statistically sampled, and by agreement, fixed assets and reconciliations were audited on an actual basis.

Another major decision made at the audit planning meeting was the selection of months to be sampled. HP and the MTC discussed various issues that would affect whether particular months would be representative of the various data sources from Compaq and its recent acquisitions. The MTC audit team selected 4 months that included one each from 2000, 2001, and 2002 (with another month in 2002 as an additional sample month for Custom Edge, which merged into Compaq in January 2002). HP's hope was that even the states that chose not to join the MTC audit could be persuaded to use the months selected by the MTC for their own audits. Fortunately, this hope was realized with respect to every state conducting audits on its own behalf rather than through the MTC.

Key Advantage of an MTC Joint Audit Program

When summarizing the advantages of this joint audit program, one word stands out: "Streamline." By conducting a joint audit of 29 states, HP was able to streamline all the processes from data capture for the sample periods all the way through to pulling exemption certificates and resolving audit issues. Our customer multistate jurisdiction resale certificates often covered all of the states participating in this joint audit program. In addition, the auditors and HP's audit support staff quickly became resellers and the types of products and services. Because Compaq's customers, products, and services remained constant, we also benefited from continuity across the states. The only major change was the taxing jurisdiction, which was easily addressed by utilizing a matrix and tables.

This joint audit program permitted the company to efficiently close multiple sales and use tax audits and free up audit and IT resources for other projects. Additionally, several non-MTC states and local taxing authorities have willingly adopted the MTC audit processes and procedures, thereby creating more efficient audits even for states that were net formally part of the MTC audit.

Keeping on Track

The audit fieldwork began in January 2003. The MTC auditors traveled to Houston and Colorado Springs on a regular basis in order to complete the audit within the agreed-upon 12-month window. It was estimated that approximately 10 trips would be necessary between January and October 2003, utilizing two to three auditors each trip; HP also committed itself to making audit team resources available for this project.

Our goal was to complete the fieldwork by October 31st. This timeline would allow the MTC auditors to submit their audit results to the 29 states by December 31st. We estimated that all assessments and payments would be completed by March 2004. As of February 1st, we were on track.

Challenges and Benefits of an MTC Joint Audit

Our largest challenge was the amounts of source data. There were thousands upon thousands of line items from four sources (Compaq, Tandem, Digital, and Custom Edge) relating to 29 states and 4 sample months. The computer assisted audit specialist used his expertise to develop tables and matrixes that were key to controlling our data flow.

Our challenges, however, were minimal in comparison to the advantages of the joint audit program endeavor. HP benefited from a much faster completion of audits than would have been possible under any other approach. In addition, a number of states had amnesty programs, which the company could take advantage of. For example, the MTC audit effort enabled HP to qualify for South Carolina's amnesty programs.

In the course of a typical sales tax audit, HP explains various systems, charts of account and other background matters needed by auditors to conduct an audit. The joint audit saved considerable rime, because HP had to explain these items only once, net 29 times. Concomitantly, only one set of MTC auditors needed to collect and analyze the information, net 29. This approach was inherently more efficient for the 29 states as well as HP.

Another benefit of the joint audit relates to what HP referred to as the "hall-lire" of data. The data for the Compaq closeout audits depended on information from four major "feed" systems. There were relatively few individuals remaining in Compaq (in tax, information technology, finance, and administration) who had detailed knowledge of systems, processes, and records necessary to support the audit. What's more, there was continuing attrition of those individuals over time. The sooner that we finished audits, the less likely the company would face assessments because of an inability to provide data, explain a process, or produce exemption certificates.

Summary

In HP's view, this joint audit program was an unqualified success. It enabled the company to streamline the entire process and focus our resources on completing the closeout audits of a multi-billion dollar entity in an astonishingly efficient manner. Net only did we save administrative time, but we were able to achieve additional savings by closing down many old systems.

The entire combined HP sales tax group found working with the Multistate Tax Commission to be an efficient and effective use of our resources. The auditors were professional and experienced in the multiple states for which they audited. The joint audit program was net a simple endeavor. It required expertise, skill, and unwavering commitment to the project. The advantages, however, more than compensated for the effort required.

Was it the right choice? Under the circumstances, it was the perfect choice.

DONNA A. BERNIER is Tax Manager, Audit and Compliance for Hewlett-Packard Company based in Colorado Springs, Colorado, and a member of TEI's Denver Chapter. LES KOENIG is Director/Joint Audit Program for the Multistate Tax Commission based in Chicago, Illinois. DAN KOSTENBAUDER is Vice President--Transaction Taxes for Hewlett-Packard in Palo Alto, California, and is a member of Tax Executives Institute's Santa Clara Valley Chapter. Mr. Koenig contributed materially to this article, even though the narrative presents Hewlett-Packard's perspective.
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Title Annotation:Multistate Tax Commission
Author:Kostenbauder, Dan
Publication:Tax Executive
Date:Jan 1, 2004
Words:2161
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