Good morning everyone. We're here today to talk about sales tax as it applies to drop shipping. We've got Matt Martin on the line today who's from a partner company of ours called Avalara. Now because of the complex nature of drop shipping, this webinar will not have a Q&A session at the end of the presentation like we normally do. It's very likely one question will lead to a few more questions after that, so in truth, we’d be able to better serve your needs if we spoke to you on the phone about your personal situation regarding drop shipping and taxes. So, at the end of the webinar, we will provide you with contact information so that you can speak to Avalara regarding your unique needs.
Now, I first ran into Avalara a while back at one of our MivaCons and have been working with them ever since. They're great partners and they have great solutions for Miva Merchant’s like yourselves regarding tax in general. So please help me in welcoming Matt Martin to the mich.
Thanks for the intro. Thanks everyone for joining me here for this webinar. Today we are going to be discussing drop shipping. A very complex topic. Drop shipping, who is on the hook for Sales Tax? So to cover a short agenda, We’re going to discuss the state of our states, we’re going to define what is drop shipping, when not to worry, the tax collector’s problem, how it impacts your bottom line, and then we’ll discuss the easiest solution.
So let’s start off with the state of our states or “It’s more serious than we thought.” So while states are beginning to cover from the recession, their focus on sales tax remains key. They have services and programs to deliver to constituents and those programs are paid for from a sales tax collection. As a business you carry the responsibility of collecting or remitting those taxes back to the states and as you focus on your own businesses growth, the states are taking actions to review their tax laws. So what’s taxable vs. what isn’t and they audit business to make sure these business are being taxed. So the bottom line here is we know that all of the states are in deficit and are looking for areas where they can create additional revenue. So sales tax provides critical revenue for the states, right? So other than property and income tax sales tax is the large source of tax revenue in the majority of the forty-six states that collect it. So from a government operations perspective, making sure that each and every sales tax dollar is collected through audits, fines, penalties, and well developed rates and rules is simply good business. Therefore, recovering uncollected sales tax revenue through greater oversight , it makes perfect sense especially given revenue shortfalls of recent years. So it’s easy to see why sales tax is a major source of funding in state budgets. Uncollected sales tax is on the radar of strapped states. So after all, wouldn’t you want to be the politician who recovers uncollected funds from existing tax streams rather than the one who votes to raise taxes? So of course the historically large budget gap faced by states during the great recession only increased the need for sales tax collections. So just the main points here. Sales tax make up nearly half the average state budgets revenue and to break this down, as you can see from this chart from the U.S. Census Bureau general sales tax provide nearly a ⅓ on average of the state budget, second only to individual income taxes. If you add in general sales and gross receipt taxes which include things like motor fuel sales, alcoholic beverage sales, insurance premium sales back up product sales and amusement sales, the total collection of sales tax comprises of nearly half of the average state budget. Sales and use taxes represent a large portion of tax revenues to state office. So basically every state is facing a significant budget deficit. States are hiring auditors at a phenomenal pace. Idaho hired forty-eight auditors in 2012 and in the big state here, California, they are hiring 100 auditors over the next three years to go after online sales tax. States are passing laws to redefine Nexus and this complicates things even more. So we have affiliate nexus, online nexus. States are even passing laws that redefine services and digital content as taxable. Twenty states have passed laws that can tax cloud computing services. They are just looking for ways to make more money.
So what is drop shipping, or “It looks like musical chairs?” Shipping responsibilities to third parties happens in all aspects of life. In business, small and medium size companies will average the economy of scale owned by large specialized companies every day. Speciality providers beat the in house cost to complete the traditional and not so traditional function. The use of third party providers for fulfillment and shipping needs is a common expression of this trend. Most retail venders call these providers drop shippers. Drop shippers are those third party parties. So accept an order from a vendor, bill the vendor for the item and then ship the item directly to the retails customer. The vendor then collects cash from the retail customer and pays the drop shipper for their time and the item they shipped, usually at a wholesale price. So far so good right? Well, for business purposes the drop ship arrangement is a match made in mba heaven. The vendor expands the geographic and time boundaries without investing in new facilities and the drop shipper makes more sales without the hassle of actually dealing with customers. So it’s cool for everyone right? Actually, the model even works for the sales tax collector sometimes.
So the tax is collected on the retail sale and as long as you have your rates and rules in order, an auditor somewhere sighs and they move on to the next target. The sales tax collector has a problem though. If a few facts are apparent in your scenario, ironically, the auditor's concern isn’t directly related to a drop ship model, but instead relates to resellers exemption certificates. The ability of a drop shipper to accept a resellers certificate or not impacts sales tax collection in these transactions.
So the tax collector’s problem, or “The buck stops with you.” So exemptions are certificates. Wait, are we talking about drop shippers or resale exemption certificates? Actually both. So there are two sales here that a sales tax collector might look at. The retail sale from the vendor to the customer and the wholesale sale from the drop shipper to the vendor. Sales tax is not typically collected on a wholesale due to a resellers certificate. But when the wholesale sale is made between a drop shipper who is obligated to collect in a customer’s state on behalf of a vendor, not obligated to collect, the drop shipper might be put in a tight spot. So a drop shipper can exempt a wholesale sale to a vendor if the vendor gives the drop shipper a valid reseller certificate. This much we know. Problems arise when a state refuses to accept a resellers certificate from any other state. That’s the main issue here. So a drop shipper can exempt a wholesale to a vendor if the vendor gives the drop shipper a valid resellers certificate. This much we know. But problems arise when a state refuses to accept a resellers certificate from any other state. So this logic is a little circular, but tight and irrefutable. No vendor can issue a valid resellers certificate from a state they are not registered to resell. So a vendor who is not registered to collect in the same state as their customer can not issue a valid resellers certificate for sales they make in that state either. So put it another way. A vendor can only issue a valid resellers certificate from a state in which they are registered. Most states will accept an out of state resellers certificate or a multi state form, so in those thirty-three states the issue boils down to a simple certificate management.
Let’s take a look at the impact of your bottom line and let’s start with the seller. So the seller when they have to pay sales tax to the shipper if they are not registered in the ship to state and the ship to state does not accept an out of state certificate. So this increases cost of goods sold thus reducing revenue. The seller also has to know which state allow these certificates. Now on the shippers side, the shipper has to know the complex rules in states like California. For example, if you don’t know the retail value of the product shipped, you have to charge tax on 110% of the wholesale costs. The shipper also has to flag a home state certificate in multiple states. They have to know which states accept the certificate and they have the burden of collecting the certificate and managing this as well.
The easiest solution or “Set it & forget it.” More states are seeking ways to increase revenue. WE can’t say this enough. Sales tax collection audits are up in many states. If your tax collection records are not in perfect order, you may be exposing the business to significant fines if auditors pay a visit. So auditors are stressful, time consuming and distracting. If your records are in order audits can go smoothly and quickly. So ask yourself, if an auditor came tomorrow are you prepared or are you scared? Ensure that your process for keeping sales records will not hurt you in the case of an audit. Sales Tax audits strike terror in the hearts of many business owners and what does an audit make you think of? Painful protracted dealings with state auditors. Dangerous strain on your business resources. Or do you think of audits at all? The current economic climate increases your chances of being audited. We always say here in the office, it’s not if it’s going to happen, it’s when it’s going to happen. So with so many states trying to balance their budget, they are increasing their effort to find unpaid taxes through audits. Audits can significantly drain business resources. This is not a message of doom and gloom. If you take the time now to review your process for keeping sales records, it will go a long way towards minimizing your cost in the event of an audit and will require less of your staff’s time. Show the flow of each transaction. An auditor must be able to follow the trail of each transaction and match up all of the documents pertaining to each of the transactions. So watch for items like charge backs, or returns that you might not have adequately documented. First impressions matter. So if the auditor sees that you can effectively show what they ask for you will save money from penalties you might have otherwise incurred for incomplete or incorrect documentation. If your process doesn’t support the above points then take steps to insure that it does now before you get that audit notification. The dreaded audit notification.
So let’s take a look at how to reduce audit risk. You should do such things as a nexus study, stay up-to-date with rate, rule and boundary changes, report consumer's’ use tax, be compliant from day one, especially new businesses and automate with technology. Just going back, when we say be compliant from day one, if you’re launching a new business or product line or even if you’re launching an ecommerce store, being compliant is very important because five years down the road if they notice any hole in your process they’re going to be able to look back at that and after we talked about the penalties and the fines and even back taxes that arise from that.
Also, make sure you have an understanding of your filing requirements, calculations that are rooftop accurate, product taxability coverage, detailed sales records and a process for managing exemption certificates. So how can sales tax automation help your business? It’s going to save time right? No more researching rates or maintaining tax tables. We’re going to have increased accuracy, address validation, and we’re going to mitigate risk. So reports that will mitigate risk in an audit. You will gain efficiency, file taxes and remit payment in minutes. Increase profitability. These are all important so you can focus on growing your business, collections and revenue generating activities.
So this is where our partnership with Miva comes into play. Avalara’s Compliance Cloud Platform. You can see we do everything from tax rate calculation, certificate management. File and return, the word end to end compliance comes to mind. We can help in things like 1099’s, w-9’s, as well as we have a professional services team that can help with nexus studies, registration, deregistration and that’s really just the tip of the iceberg.
So end-to-end compliance. Centralized management with distributed enforcement. With our signature Avatax dashboard management console, Avatax in integrated with your accounting and your ecommerce package in minutes. Fully enabled with the tax ability, nexus, reporting and filing profiles unique to your organization. So from there Avatax simply completes your sales tax function with no change to your existing processing. From rate services to maintenance, reporting and returns, visibly, instantly and accurately. When you consider there are over 12,500 tax regions in North America alone and each of these regions have constantly changing rates and boundaries it is simple to see why automation is vital to organizations of all sizes. But especially to small and mid sized businesses which have limited resources.
Let me explain how Avalara’s technology works. We provide an end to end compliance model that we accomplish via automation. So instead of researching those rates, filing the tax tables and implementing the tax processes, those that use Avalara install software connector that links their software system to our web service. Because it’s cloud software, Avalara is always keeping up-to-date the tax rates, rules and boundaries automatically. When they enter an invoice or take an order online, their system communicates with our web service and it sends a little encrypted xml file with their transactional data and we calculate the tax and return it back automatically into the system. That’s really fast. It’s approximately four-tenths of a second for a round trip calculation. At the end of the month they no longer need to run reports or fill out forms and cut checks and mail them out back to the authorities. When they’ve processed all their invoices, you’ll be able to log into their admin console, run a quick reconciliation and Avalara will file and remit tax automatically. So your company would pay Avalara one amount and we take care of the rest. Again, this is an end to end compliance model that we accomplish via automation and the idea here is to save time, money, mitigate the risk associated with managing taxes internally.
So just like outsourcing payroll, companies that outsource sales tax benefit by:
So that’s all we have today for the webinar. I appreciate you taking the time to listen in. Because each scenario is different, if you have any questions please do not hesitate to email me at firstname.lastname@example.org and my correct phone number is 919-627-9785. I would love to discuss some of your scenarios, we can assess your tax liability and see if there’s any liability issues currently.