Tax engines: A cornerstone for tax compliance and efficiency

Introduction

Every soccer game requires a strategy to grapple with the ebb and flow of the matchup—managing substitutions, player positioning and transitioning between defense and offense. These factors are similar in many ways to the dynamics of allocating a company’s budget. Making timely substitutions parallels analyzing market trends to dynamically adjust budget allocations. Placing players in proper positions mirrors strategically allocating funds to maximize growth opportunities. Shifting from defense to offense aligns with how a company shifts their budget allocation to transition from a growth strategy to a value strategy.

Tax engine implementation may first appear to be a daunting task regarding time and budget constraints due to a limited budget allocation. However, the budget expenditure for such a project is able to be reduced by technology-enabled solutions and the return on investment for it creates an attractive business case. By implementing a tax engine, tax functions typically experience an increase in efficiency; this allows tax resources to have greater capacity and be able to assist on higher-level functions to provide greater benefit to the organization. A tax engine is also beneficial from a risk mitigation perspective. A tax engine has the ability to increase taxability accuracy on an organization’s sales and improve future audit results as well as removing the need to monitor legislative changes that affect tax rates in every jurisdiction that your organization sells in. It also offers streamlined exemption certificate management to easily prove in audit defenses.

Advantages beyond an ERP

A question still asked is “Why do we need a tax engine when we can just use an ERP rate table?” Sales tax rates can be acquired from a multitude of sources, for a nominal fee, and updated on a periodic basis to be populated within a company’s ERP. These rates will provide a mostly correct answer for basic sales transactions from a small business selling minimal products and shipping intrastate.

When transactions start to become more complex is where a rate table may not be sufficient for an expanding business. Complex transactions can include interstate transactions, multiple types of products and services with varying taxability, customer exemption recognition, complicated state taxation rules and a host of other considerations. Rate tables also require ongoing research and maintenance to be sure all sales tax rates are kept up-to-date.

A tax engine provides these rate and rule updates in real time and is built to consume all relevant data points to handle more complex sales transaction scenarios. Tax engines are also flexible in that they can consume batched transaction files if a company does not have a direct integration from its ERP, billing or procurement application. A centralized reporting source for all sales and use tax posted transactions is another benefit to utilizing a tax engine. Reporting from the tax engine can be customized to your requirements and is a reliable source of data for general ledger reconciliation and audit reporting.

Uses of domestic tax engines

Sales tax calculation may seem straightforward, but there are many variables that must be taken into consideration when calculating sales tax and charging your customer. It may seem straightforward to merely charge the rate where the customer is located, but the customer location is only part of the address information that needs to be considered for accurate sales tax calculation. Is the address collected from the customer different than the product ship-to location? What is the location where the customer service team is receiving the order? Where is the product ship-from location? Each of these data elements are important for determining the situs and whether sales tax or sellers use tax are collected. A rate table charges a sales tax rate at the ship-to location of the product but does not consider the other important address information. Tax engines will consume each of these addresses, cleanse them for accuracy and accurately situs sales tax based on the native logic built within the engine.

The products and services offered may vary in taxability by state, which is not necessarily functionality that a rate table can process systematically. When using a tax rate table solution, generally the product or service taxability determination is decided manually by human intervention. This can lead to inaccurate decisions and possible mistakes when determining the product and service taxability. A tax engine removes the human element out of the taxability determination. Specific ERP product and service master data is mirrored in the tax engine and mapped to the tax engine codes or categories that reflect the nature of your products and services. The tax engine code and categories hold the rates and rules by jurisdiction, which is part of the managed content paid for in a tax engine license fee. When a sales transaction is processed in an ERP, address information and the product or service master data fields are passed in the API call from the ERP to the tax engine, recognized by the tax engine configuration, and taxability is systematically determined based on the taxability of that product or service in determined situs location. Utilizing a tax engine leads to consistent and accurate taxability across all products and services.

There are also other complex taxing scenarios that can be accomplished systematically by a tax engine. Many states and local jurisdictions have various fees and surcharges that vary based on specific transactional data. There are also sales tax holidays where a state may decrease or remove sales tax for certain products during a period each year. A few states calculate sales tax based on a tiered transaction dollar amount, where one sales tax rate is charged up to the dollar amount threshold and another for the remaining dollar amount. Other states have bracket rounding rules for rounding fractional tax amounts to the nearest penny. This is only a short list of complex taxing scenarios that are almost impossible to tackle with a rate table and manual determination.

Why use a tax engine for purchasing when most vendors should be charging tax due to the South Dakota v. Wayfair Inc. decision? While this assumption is somewhat true, there are still vendors that may not be charging sales tax due to varying state nexus thresholds, or they could be charging the incorrect amount of sales tax. A properly configured tax engine will analyze purchases’ taxability and vendor charged tax, then determine if the sales tax amount charged by the vendor is accurate. If a company has goods movement transactions where exempt purchased inventory is consumed for internal use, the tax engine can assess whether use tax is due on these transactions.

International tax engine advantages

In today’s competitive business landscape, many organizations continue to expand their global footprint and have a significant need to integrate to a global tax engine to replace their native ERP value added tax (VAT) calculation and functionality. As VAT complexities continue to increase, a centralized tax engine helps increase tax determination accuracy, reduce risk and increase efficiency. A centralized tax engine is a global industry best practice for a vast array of organizations. A centralized tax engine enables better visibility and control of indirect tax determination for both the tax and finance departments.

Accounts payable invoice processing is streamlined through quick and easy verification of vendor charged taxes to ensure the VAT rate and amounts are accurate. With a centralized tax engine, a company can receive tax rate and rule content updates automatically, reducing the need for researching tax changes, reducing maintenance, and increasing support of audit defense. Tax configuration changes that occur in the tax engine interface can be completed faster, becoming functional configuration instead of technical coding and saving time for already strained IT resources. Having a tax engine helps ensure having the right data for invoice presentation and for supporting countries adopting real-time reporting requirements. The enhanced functionality allows for scalability by streamlining processes to quickly add new entities and leverage a company’s existing tax engine configuration. A global tax engine is encouraged to be part of a company’s overall strategic road map and growth strategy to ensure alignment with a growing business model, speed to market and expansion to additional countries. 

Simplify the compliance process

Using a tax engine simplifies the overall compliance process. The tax engine can generate a tax data export that has monthly transaction data. This requires a simple reconciliation with a company’s general ledger to ensure all transactions are captured, then can be passed along to the compliance team to prepare the required tax returns. This process reduces the risk of manual errors as well as the time required for the compliance process.

In summary, tax engines are built to calculate sales, seller use, and use tax so an organization can stay compliant with taxing authorities. While this is the basic functionality of a tax engine, a well-designed integration and tax engine configuration will be your reliable decision-maker for complex taxing scenarios and an ally for audit defense reporting.