In an attempt to collect more tax to balance budgets and reduce tax on residents, many states are changing rules to increase the base of taxes from which they can collect. Most states typically have some form of sales/use tax and some form of income or franchise tax, although many may have different titles and different methods of computation. The complexity of the rules and myriad of taxing authorities creates risk as a business expands geographically beyond the borders of its principal state. Companies in the auto supply chain and their vendors need to be cognizant of the ever changing laws, enforcement actions and their footprint in order to monitor the possible exposure to additional tax obligations. Lack of attention to these risks can result in unexpected enforcement action or a contingent liability identified in a merger or acquisition transaction which can negatively impact pricing and timing.
A state will tax a company for sales/use tax or income tax that has nexus within their state. The nexus rules for each type of tax differs and the income tax variety has a federal law providing a floor of activity that must be met for a state’s nexus rules to apply. Not all states’ nexus rules are the same and, in fact, many have abandoned the traditional activity performed within the state rules to an economic nexus standard which subjects tax when a company derives economic benefits from a state. Also, state laws now treat independent agents as an extension of a company doing business within a state. Obviously, keeping track of the requirements of each state can be an administrative chore. However, a company runs the risk of incurring liability by ignoring the rules.
It is true that many companies within the supply chain will qualify for exemption under an applicable state’s industrial processing rules, which basically exempt from sales tax the wholesale trade of inventory to be used to produce or make a part of the final product to be sold at retail. With this exemption there are many things to address, including making sure the documentation required by each state is procured and maintained and to understand the exemption does not apply to all sales made to or by a company within business to business transactions. As to the first item, sales/use tax audits are heavily dependent on documentation and failure to produce may result in liability. As to the second item, sales of items not used directly in the manufacturing process typically do not qualify for the industrial processing exemption.
The income and income-like tax regimes of the states are somewhat easier to monitor due to the federal minimum nexus standard, but the need for diligence and awareness remains critical. Knowing what is being done in the states beyond the borders of the principal state is an important aspect of monitoring the potential for state taxation. Simply assuming that paying state tax somewhere provides protection can produce a false sense of security, since an enforcing state will not necessarily care if another state has collected tax.
The important message to understand here is that unattended state tax risks can lead to liability exposure and possible serious future tax issues. Companies need to understand and monitor where and what is being done within the states. Addressing the state and local tax exposure in real time can avoid serious problems in the future – problems which could be more costly than the tax and administrative cost. Keeping your state and local tax compliance properly in line with your company’s changing footprint will avoid unwanted exposure in the future.