"Mid-market CFO Benchmark Survey: The Changing Face of Sales and Use Tax Compliance"

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"The Sabrix Solution combines the Sabrix Application Suite software for sales tax, use tax and value-added tax automation with Sabrix Tax Research, delivering SAS 70 certified tax rates and rules for the U.S. and 170 countries."
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Mid-market CFO Benchmark Survey: The Changing Face of Sales and Use Tax Compliance

INTRODUCTION

If you ever need an example of a broken business process, try this one: according to an independent survey of more than 500 finance executives, small to mid-sized companies average more than $327,000 in annual costs to manage sales and use tax compliance, yet still end up paying an average $32,000 each year in penalties and interest due to errors and omissions.

The survey, conducted by Tallman Insights and fielded by Mindwave Research, also reveals that senior finance professionals are not always aware of the total cost of transaction tax compliance. In fact, they routinely underestimate their cost of compliance by as much as 50%, largely because costs are so fragmented across employees, tax research subscriptions, and consultants. Thus, not only are today’s manually-intensive compliance processes sub-optimal, but also there’s a lack of visibility into how sub-optimal they really are.

All this represents not just a waste of money and an exposure to risk, but also a dilution of a company’s focus when it needs to concentrate available resources on building the core business. And it comes at a time when the compliance landscape is increasingly complex, and tax jurisdictions increasingly aggressive, in enforcing compliance via costly audits.

On the positive side, the survey also reveals that the majority of respondents have a strong desire to free themselves from this complexity and to lower their total compliance costs – and would be highly interested in an outsourcing option that wouldn’t just automate processes, but which would also provide the kind of deep tax domain expertise that is prohibitively expensive for mid-sized companies to build in house.

In short, it’s a market poised for a 180 degree shift in how it manages compliance. Read on to further explore how your company’s tax compliance compares to compliance initiatives and processes underway in mid-market companies today.

A PROBLEM OF SUBSTANTIAL SCOPE…AND MULTIPLE DIMENSIONS

Small wonder mid-sized companies struggle with compliance

acing rising budget deficits, states and other tax jurisdictions have drawn a multi-billion dollar target on the backs of businesses – a target representing the annual shortfall that states across the US are experiencing because of non-compliance with regulations governing the assessment, collection, and reporting of transaction taxes: sales, use, and VAT. On the other side of the equation, companies are struggling with the increasing complexity of transaction tax laws, their changeability, and the growing number of tax jurisdictions hungry for their share. Mid-sized companies in particular are struggling with largely manual processes and a lack of meaningful in-house tax expertise as they attempt to comply with today’s dynamic tax environment.

In order to scope out the enormity of the problem and understand the challenges and options facing mid-sized businesses, Tallman Insights and Mindwave Research surveyed 514 CFOs, vice presidents of finance, controllers and other senior finance executives with primary, shared, or influential responsibility for transaction tax management. The respondents came from companies ranging in size from $20 million to just under $1 billion in annual revenue across a range of industries.

The respondents’ answers revealed a world of complexity and expense, an eagerness for solutions tuned to the business realities of mid-sized companies, and a strong interest in an outsourcing paradigm new to transaction tax management.

The sales tax challenge

All companies have a legal obligation regarding tax. Of the survey respondents, 100% reported a sales tax compliance requirement, 70% reported a use tax requirement, and 40% a VAT requirement. And all have a compelling reason to fulfill that obligation. As one respondent, the CFO of a diversified services company, put it: “We want to be accurate, and don’t want to run the risk of an audit. The reality is, if you do it right, you don’t have any issues. If you don’t do it right, it ends up costing you in the long run.”

But just how hard is it to “do it right?” The answer, according to respondents is: “pretty hard.”

Multiplying jurisdictions

There are 13,253 taxing jurisdiction across the US, and more are being created all the time. Jurisdictional boundaries are constantly changing, as are the rates and rules governing compliance in them. In 2008, there were over 1,140 rate changes and authorities added in the US. Of the survey respondents, the average stated number of jurisdictions for which they filed returns was 74.3, though many filed returns for 100 or more jurisdictions.

On average, the surveyed companies filed 86 returns each month. But with business growth, these numbers grew as well, reaching 200+ returns per month for many respondents. But, when it comes to transaction tax compliance, company growth can actually be a detriment. As they expand, many mid-sized companies unknowingly create nexus – a point of presence in a state due to business operations – and with it a commensurate collection and filing obligation in one or more jurisdictions. Keeping pace with ever-changing rules and rates and jurisdictions is cited as one of the most overwhelming tasks by respondents.

Said one director of tax for a retailer with 300 locations nationwide, “You have to pay attention to the local taxes. Are you sure you live in Hillsborough County and not Pasco County? Do you live in the city limits? Do you live outside the city limits but within the police jurisdiction?

What rates apply and how do they apply? As we expand, and states allow local jurisdictions to do more collections, it gets messy.”

Added a CFO for a manufacturer of construction materials, “As we expand to more states, the challenge is the time it takes to get up to speed with more rules and instances. If the future happens the way we think, we’ll be coast to coast. In that instance, managing sales and use tax will be a lot worse for us. The time to manage it gets larger, but your value stays the same.”

“As we expand to more states, the challenge is the time it takes to get up to speed with more rules and instances. If the future happens the way we think, we’ll be coast to coast. In that instance, managing sales and use tax will be a lot worse for us. The time to manage it gets larger, but your value stays the same.”
-CFO for a manufacturer of construction materials

Demanding states

While survey respondent’s businesses blanketed the entire US, respondent’s cited the following states as being particularly demanding when attempting to keep up with rate changes, prepare filings, and deal with audits: California, New York, Georgia, Florida, Texas and Illinois. However, according to Sabrix Tax Research, the most onerous states for combined authority changes and rate changes in 2008 were Missouri, Iowa, North Carolina, Texas and Illinois.

Changeable rates

Managing ever-changing rates is an enormous challenge for mid-sized businesses. Survey respondents cited an average of 16.4% rate changes in a typical month in the states where they filed tax returns. The highest change rate, or rate of “churn,” cited was 50% in a single month. And these figures are probably on the low side, given that less than 50% of the surveyed companies subscribe to third-party rate research, and mid-market companies often have a compliance obligation which they are not yet aware of due to unknowingly creating nexus.

Clearly, companies need to keep up with tax law changes. But that’s easier said than done in the midmarket, where most businesses try to run lean and mean. Noted the CFO of a manufacturer and seller of home building products, “Lack of understanding of state laws that are continuously changing results in audits. Sometimes our auditors aren’t even aware. With the staff we have, sometimes we have to take shortcuts. We just don’t have the staffing dedicated to this particular issue right now.”

Even for companies that subscribe to tax rate research tools, the process of researching changes and loading them into ERP systems was cited as suboptimal by respondents. Common complaints included errors due to manual re-keying and long delays in IT updates resulting in miscalculated taxes due to rates being in effect long before internal systems were updated.

Crossing muddy waters

Increasingly, companies are being exposed to the murkiness that surrounds cross jurisdictional boundary transactions. 80% of respondents reported that they transact business with customers having multiple locations. In fact, on average, 50% of transactions either shipped to different customer locations or were sold from multiple locations. This significantly ups the ante for tax management – unless a company is thoroughly on top of tracking customer and employee locations, it may unknowingly create nexus and thus set itself up for a nasty surprise. Additionally, a company has to be diligent about accurately accounting for cross-jurisdictional goods movement, such as shifting inventory from one location to another.

Exempt or not — the “joys” of product taxability

Pity the company with 5,000 unique products or services – some surveyed companies have this or more. The typical company, on the other hand, has 598, and that is more than enough to cause major headaches when determining what is taxable and what is not depending on who is buying the product. On average, 24% of the product SKUs of the companies surveyed enjoyed a tax exempt status, and nearly 30% of their invoiced transactions were either wholly or partially exempt.

Ensuring that you are accurately determining whether a tax should be charged, and in which jurisdictions, is an enormous challenge and is subject to all sorts of vagaries. For example, if you buy donuts with plates or utensils in Texas, you will be taxed; but without plates or utensils they are exempt. Additionally, anecdotal comments during the survey process suggest that proper documentation of exemption certificates is not often followed, leaving a company exposed during audit.

Exponentially increasing exposure

Numbers count and numbers multiply. For the surveyed companies, the average number of sales invoices processed monthly was 107,000, although the median was 500. But the real problems surface when you multiply the number of transactions times the potential tax rate and jurisdictional changes times the slippery scale of product taxability and exemptions times the likelihood of getting both the right determination plus the right rates to apply across all pertinent jurisdictions.

As a CFO of a firm operating in 40 states put it: “The more you get into it, the more you can see the risk. When you map out the process, you find some clerk is making decisions and if they make the wrong one, you create a liability. Not knowing what the current laws are in the particular states we operate in, I usually find out when some auditor shows up and says ‘you should have been paying taxes on this.’”

The use tax challenge

As thorny and opaque as the sales tax situation is, the obligations surrounding use tax are even more difficult to plumb. One thing is clear however: the typical company often either ignores use tax obligations, or unknowingly doesn’t report them.

Survey respondents reported higher average purchase volumes than invoice volumes — an average of 175,000 executed purchase orders per month. 30% of respondents reported not filing any use tax. Yet use tax is high on the list of items auditors target. Moreover, with companies concerned about the accuracy of their sales tax calculations, it’s highly likely that many companies are over-paying sales tax to their vendors.

Said one CFO: “We probably don’t do as good a job as we should. We need to refine our interpretation of what we should be paying use taxes on.”

“The more you get into it, the more you can see the risk. When you map out the process, you find some clerk is making decisions and if they make the wrong one, you create a liability. Not knowing what the current laws are in the particular states we operate in, I usually find out when some auditor shows up and says you should have been paying taxes on this.”
-CFO of a firm operating in 40 states

THE COSTS OF COMPLIANCE

Compliance efforts cost mid-market companies significant time and dollars

Not surprisingly, the cumulative efforts to stay on top of ever-changing rates and regulations, achieve compliance, and avoid audits are costing mid-sized companies significant dollars. These are dollars they can ill afford to spend, as mid-market businesses already spend a greater percentage of their revenue on back-office functions compared to larger companies.

According to the survey, the average company spends more than $327,000 each on sales and use tax compliance. Expenditures span internal personnel, third-party preparation costs, tax advisory and consulting services, and tax research subscriptions. Most of the expense is in headcount as firms attempt to train sales reps, order entry clerks and purchasing agents how to correctly follow tax rules. And it’s a never ending effort, given the turnover in these positions.

Lack of transparency yields surprises

Moreover, most CFOs underestimate compliance costs by as much as 50% due to the diffusion of spending. With limited visibility into their spend, most were surprised to learn that their own cost itemizations exceeded their perceived totals by such a significant percentage.

Errors add costs

Yet despite this level of investment, tax compliance efforts remain error prone, and average penalties and interest amounted to an annual $32,000. This is despite the fact that 43% of respondents rely on outside tax research subscriptions to stay current on tax rate and jurisdictional changes. These subscriptions, while valuable, are no panacea; most companies reported rekeying errors resulting in incorrect calculations, as well as delays in getting rate changes loaded into internal systems in time to be of value.

The cascading costs of audit

No matter how you try to do it, getting rates and jurisdictional changes under control is critically important. The number of tax audits nationwide is on the rise as jurisdictions compete for their share of the tax pie. 90% of companies surveyed reported receiving one or more notices or audits annually. Nearly 55% received five or more each year. And an unlucky or high-growth mode 9% reported 100 or more notices or audits each year.

Audits represent the invisible costs of compliance. The penalties that result are easily calculated, but the time and resource investments involved are more difficult to quantify. And even harder to quantify is their drain on a company’s focus. In short, they are a waste of valuable time and underscore the importance of making sure that compliance is taken care of upfront, and not after the fact.

Said one treasurer, “At the end of the day, with sales tax, if you do it right it shouldn’t cost you anything more than the cost of administering it. If you do it wrong, it can cost you a lot of money.”

“At the end of the day, with sales tax, if you do it right it shouldn’t cost you anything more than the cost of administering it. If you do it wrong, it can cost you a lot of money.”
-Treasurer

Current approaches to meeting the compliance challenge

So what are mid-market businesses doing to try to achieve compliance and avoid audits? Respondents identified a wide range of approaches to the compliance process. 100% claimed to use their ERP systems somewhere in the process. 30% also built custom software, which is a costly proposition. But manual processes are still the bedrock for most mid-sized companies, and the most common process (32%) included the use of spreadsheets.

Problem recognition – and strong interest in a better way

Significantly, a mere 14% of respondents felt that tax compliance was not a significant issue for them. Over 40% said it was difficult or even an unknown area of vulnerability. And 45% said that the costs of people and systems to manage the process were prohibitive and that they would be interested in a better way.

MAPPING THE FUTURE OF TRANSACTION TAX COMPLIANCE

CFOs would embrace an outsourced solution that enabled them to focus on core competencies while limiting their audit exposure

Increasing complexity and exposure. Mounting costs. Waves of audits. It’s no wonder that companies in the survey cited the desire for a better, more cost effective way to manage the tax compliance challenge. But where to turn?

Enterprise software solutions for managing tax, such as those utilized by large companies, are typically prohibitively expensive for mid-sized businesses to purchase and deploy. It is also prohibitively expensive for a mid-sized firm to build up a meaningful and sustainable base of in-house tax expertise. But without these two weapons in their arsenal, mid-market companies have been operating at a distinct disadvantage vis a vis their larger brethren. But one thing that can level the playing field is outsourcing.

Outsourcing has been done for years, with key business processes such as payroll, employee benefits, HR and expense reporting entrusted to experienced third-party vendors. And it’s not just large companies that are leveraging this kind of expertise and economies of scale.

The mid-market embraces outsourcing

Of the companies in the survey, 75% were pro-outsourcing and already outsource one or more key business processes. The most common outsourced processes were payroll and benefits. With mid-sized businesses spending on average 51% more on finance and accounting services than large companies and 79% more on headcount as a percentage of revenue, outsourcing is a very attractive proposition.

Outsourcing now embraces tax compliance

When it came to transaction tax management, 60% of respondents indicated a “strong interest” in an outsourced offering that would both:

• Automate the end-to-end tax compliance process to remove the hassle, improve the degree of compliance and lower the costs
• Provide tax domain expertise and best practices of the sort that are prohibitively expensive to develop and maintain in house

This echoes the results of a poll of CFOs conducted in the late-90s by the Outsourcing Institute, which indicated that in the area of finance, tax compliance was of primary interest to those willing to outsource. The only problem was, until now, there has been no viable tax compliance outsource solution: one that combines process automation with deep domain expertise.

Roadmap for transaction tax compliance

According to the Outsourcing Institute membership, the top five reasons companies outsource are to:

1. Reduce and control operating costs
2. Improve company focus
3. Gain access to world-class capabilities
4. Free internal resources for other purposes
5. Leverage resources not available internally

These map completely to the tax compliance challenge as experienced by mid-market companies. The companies need to cut the costs of compliance and avoid the penalties on non-compliance. They need to focus on core competencies and issues strategic to the business. They need the same kind of tax management capabilities their larger competitors possess. They need to free up resources for company growth and profitability-oriented tasks. And they need to be able to leverage specialized tax knowledge and expertise to optimize their compliance efforts and stay out of trouble.

As one CFO/controller put it, “A primary value of outsourcing sales, use and VAT tax is being able to allocate resources onto other tax minimization strategies versus clerical work. I’d much rather do that.”

Stated another CFO, “I’m a small fish in this pond, but it’s a big problem for me, just like the ones paying hundreds of millions of dollars in tax.” If there is parity in the problem, doesn’t it make sense to seek parity in the solution? Outsourcing provides that parity for the mid-market.

CONCLUSION

When it comes to transaction tax management, mid-sized companies don’t have a lot of choice. They can either stay the course, which is becoming increasingly complex and risky, and keep using their existing expensive, error-prone processes, or they can change direction 180 degrees and embrace outsourcing as a way to cost-effectively achieve compliance. As only 14% appear satisfied with their present course, and a viable outsource offering for mid-market tax compliance now exists, such a shift appears inevitable.

“A primary value of outsourcing sales, use and VAT tax is being able to allocate resources onto other tax minimization strategies versus clerical work. I’d much rather do that.”

ABOUT SABRIX

Sabrix, Inc. is a leading provider of transaction tax management for companies of all sizes, enabling finance, tax, and IT professionals to achieve accurate, timely, and cost-effective compliance for sales tax, use tax, Value Added Tax (VAT), excise tax and industry-specific taxes and fees. The Sabrix Solution combines the Sabrix Application Suite software for sales tax, use tax and value-added tax automation with Sabrix Tax Research, delivering SAS 70 certified tax rates and rules for the U.S. and 170 countries. The company also offers the Sabrix Managed Tax Service™ (MTS), an outsourced transaction tax compliance service that helps finance departments of small and- medium-sized businesses eliminate the hassle, control their audit exposure, and reduce the total cost of compliance. Sabrix MTS seamlessly integrates with a company’s existing accounting and e-commerce systems, and, similar to outsourced payroll services, operates as a trusted extension of a company’s finance department to address tax compliance from start to finish: address validation, tax rate maintenance, tax determination and calculation, returns preparation and filing as well as audit research and documentation. To learn more about Sabrix MTS contact us at inforequest@sabrix.com, 866.472.2749.

SABRIX®, the SABRIX logo, Consolidated Transaction Tax Management™, Transaction Logic Engine™, SabrixConnection™, Sabrix Data Interchange™, the Tax Control Panel™, and the Sabrix Solution Workbench™ are trademarks or registered trademarks of Sabrix, Inc. or its subsidiaries in the United States and other countries. All other product names or brands are trademarks or registered trademarks of their respective manufacturers or owners.

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CONTENTS

• Introduction
• A Problem of Substantial Scope…And Multiple Dimensions
• The Costs of Compliance
• Mapping the Future of Transaction Tax Compliance
• Conclusion
• About Sabrix