It’s been almost a year now since the Supreme Court’s South Dakota v. Wayfair decision affirmed the state’s law regarding the taxation of out-of-state sellers. There’s been a lot written in that time about how retailers need to better track sales and compliance with similar laws in an increasing number of states throughout the U.S. One issue that’s received less coverage is the increased responsibility on manufacturers and distributors to maintain records that demonstrate their exemption from sales tax obligations in these same states.
“But We’re Exempt!”
It’s true that manufacturers and distributors are generally exempt from state sales taxes, since the taxes are meant to be imposed at the final stage of product distribution, when a completed product is sold to an end user. If a company manufactures brake pads for cars and sells them to automakers, mechanics, and auto parts stores, these transactions are not intended to be subject to sales tax. The auto dealer, mechanic, or store owner typically collects the sales tax from the customer who buys the product from them.
To exempt these resellers from paying sales tax, states typically have some process for issuing a “resale exemption certificate.” Manufacturers and distributors that have established some type of physical presence in a state (the pre-Wayfair standard) typically collect these exemptions from affected customers. The Wayfair decision created an economic presence test that could impose a requirement on manufacturers to collect exemption certificates and report sales in states where they previously had no filing requirements. Even though it’s the reseller’s responsibility to comply with the exemption requirements in each state, the Wayfair ruling expands states’ ability to pursue sellers for failure to maintain current resale exemption certificates, failure to report exempt transactions, and for failure to collect and remit sales taxes on transactions that are not exempt.
In other words, you could sell the same products to the same customers in the same states that you did last year and now be subject to penalties for failing to report sales and for failing to collect and remit sales taxes from customers who do not provide valid exemption certificates. Even if your sales into those states don’t generate a sales tax obligation, they could still trigger a new reporting requirement.
How to Step Up Compliance
If you make or distribute a product and sell it to other businesses across state lines, it’s time to step back and look at your recordkeeping process to make sure it will support compliance with the new rules. For most businesses, that analysis will mean connecting with a state and local tax (SALT) specialist who can help you work through the following process:
- First, review all existing accounts to make sure that current exemption certificates are on file. Your SALT consultant can help with this review, as some states issue permanent exemptions while others’ exemptions may expire. Exemption certificates are needed for each state where products are shipped. In the brake pad example above, if the retailer’s headquarters are in Georgia but the manufacturer ships to stores in Georgia, South Carolina, Alabama, and Florida, then current exemption certificates need to be on file for all four states. You must collect and remit sales taxes from customers who do not provide current exemption certificates. If your business cannot document the exemption, it can be held liable for the unpaid taxes.
- Sales and accounts receivable departments will need to agree on a process that ensures every new client has the required exemption certificates on file as part of the onboarding process.
- Watch for client expansion into new states. If your business starts shipping products to a new destination state for an existing client, an exemption certificate needs to be on file for that state.
- Work with your SALT specialist to determine the obligations that each state imposes on businesses that ship into its jurisdiction. Your business may be required to register and report sales even if all your transactions in the state are exempt.
- Make sure your software tracks destination states where products are delivered and match up exemption certificates for those customers. Many systems will default to only tracking the central billing address of the customer, and that can mean failure to collect exemption certificates from additional states where your products are shipped.
Some Finer Points
The biggest post-Wayfair concern for manufacturers and distributors is preventing unexpected sales tax obligations based on failure to track customer exemptions in destination states, but there are two more items to bear in mind:
- One unsettled area in this new law is the impact of shipping terms. It’s possible that use of “FOB shipping point” terms may reduce the risk of obligations in other states. When the contract transfers ownership to the customer at your loading dock, it’s possible that the shipping point rules apply and you may only need an exemption certificate from your customer for that location.
- If you qualify for resale exemptions on items your business purchases, remind your accounts payable department to be on the lookout for sales tax charges on invoices you receive. It’s just as important for your business to keep current exemption certificates on file with suppliers as it is for your customers to maintain theirs with you.
To bring your process into compliance with these new rules, do a thorough analysis of your existing procedures and your in-house resources. For many businesses, an important part of this review will be a consultation with a SALT professional who is familiar with the impact of the Wayfair decision on manufacturers and distributors.
For more information on how the Wayfair decision could affect your business, please contact your CRI tax advisor.