by Amy Hamilton -- email@example.com
As he considers what his version of the Marketplace Fairness Act of 2013 might look like, U.S. House Judiciary Committee Chair Bob Goodlatte, R-Va., is examining whether to rework not only the small-seller exemption but also the single-audit requirement, according to several sources.
Goodlatte is said to be seeking advice as to how audits of remote sellers should be managed, especially regarding joint audits by multiple states and who should be handling them. He is entertaining approaches that would include requiring multiple states to coordinate a single audit or allowing a remote seller to elect a multistate joint audit.
That would differ from the single-audit requirement contained in S. 743, the Senate-passed version of the Marketplace Fairness Act, which deals with a single audit per state encompassing all taxing jurisdictions within the state.
Specifically, S. 743 would authorize states to require remote retailers with more than $1 million in gross annual U.S. remote sales to collect and remit sales and use tax. To require tax collection, a state would have to be a member of the Streamlined Sales and Use Tax Agreement, which specifies that local jurisdictions will not conduct independent sales or use tax audits of remote sellers, or would have to adopt and implement specific simplification requirements, which include conducting a single audit per state of a remote seller.
Jerry Cerasale, senior vice president of government affairs for the Direct Marketing Association, said the single-audit provision is only one of several considerations. Cerasale said Goodlatte's principles guiding the discussion of the Marketplace Fairness Act have brought the issue of a single multistate audit "right to the forefront" of discussions.
Under Goodlatte's principles, federal remote sales tax legislation must be simple, a requirement that Cerasale said naturally extends to Goodlatte's consideration of the complexity and costs facing remote sellers with audit exposure. Cerasale added that the burdens would be especially acute for smaller remote sellers just above the Senate bill's current $1 million threshold.
Maureen Riehl, vice president of government affairs for the Council On State Taxation, said she's not surprised that congressional staffers are soliciting fresh approaches to the audit provision. Resolving the matter of the multistate audit framework for remote sellers was one of the prime reasons the Streamlined Sales Tax Project was initiated more than a decade ago, Riehl said, but the topic ultimately became one of the big issues set aside because of the difficulty of reaching a resolution.
"The success of the Marketplace Fairness Act will very much hinge on coming to closure on issues that folks just didn't want to talk about earlier," Riehl said. "Well guess what? It's time to talk about them now."
Bringing in the MTC
Opinions differ as to how many remote sellers would need a joint multistate audit in the first place. If proponents' estimates are correct that fewer than 1,000 remote sellers would meet the Senate bill's threshold, most retailers may continue to be audited the same way they've always been.
The Multistate Tax Commission, which already conducts joint sales and use tax audits for participating states, would seem to be the first logical place to look should the Marketplace Fairness Act pass with a single multistate audit requirement. The MTC conducts audits in its capacity as an arm of its member states and other states participating in its audit program.
"We've had a number of states approach us and say, 'Can you do this, and what would it take?'" MTC Executive Director Joe Huddleston said. "We've said, 'Yes we can, and we could start tomorrow.' It wouldn't really take anything, but over time, of course, we would have to ramp up our number of people who are doing sales tax audits."
Goodlatte's principles include a provision on states' rights, but it's unclear whether the states' creation of the MTC would fall within that scope; Goodlatte says that states should be sovereign within their physical boundaries and that the federal government shouldn't mandate that states require remote sellers to collect sales tax.
One technical adviser to congressional staff said that if a Goodlatte bill were to require or allow remote retailers to elect a single multistate audit, it's unlikely the MTC would be chosen to conduct those audits on behalf of the states.
Because of objections raised by businesses, the Streamlined Sales Tax Governing Board did not endorse the MTC as a potential auditor or manager of a centralized registration database, and businesses likely would continue to resist the MTC today, the adviser said.
Those businesses had expressed concerns that the MTC would have information about multistate taxpayers that it could then use to conduct corporate income tax audits. Whether those fears were real or imagined, the governing board set the MTC proposals aside to avoid derailing its larger goals.
Riehl added to the mix the potential impact of Gillette Co. v. Franchise Tax Board on the MTC. In the past year, litigation over how to interpret the Multistate Tax Compact has advanced to California's and Michigan's highest courts, leading to changes in the MTC's membership.
In one year, three states have withdrawn entirely from the compact, while another three have repealed the compact and reenacted modified versions. Meanwhile, the attorney who originated the approach taken by taxpayers in Gillette is warning of likely spinoff litigation challenging the MTC's authority to conduct joint audits on behalf of states that are not full parties to the compact. (Prior coverage: State Tax Notes, July 8, 2013, p. 67.)
The MTC itself is looking into ways to more efficiently conduct joint audits for states where sales and use tax rules diverge.
Audits Under Streamlined Auspices
Rachelle Bernstein, vice president and tax counsel at the National Retail Federation, said she hadn't heard that Goodlatte was considering a single multistate audit approach. But she said such a proposal would make the most sense for states that have adopted a uniform set of rules, such as those that are part of the agreement.
That would bring in another potential player, as the governing board already has authority to assign committees specific duties, including the coordination of joint audits.
Riehl said it's possible that the selection of auditors could fall entirely on the governing board. In fact, as some observers see it, the governing board itself could become an auditor, Riehl said. She added, however, that that's not how the board is designed to operate today.
"I was constantly pushing Streamlined's Audit Committee to come up with a way of doing one audit," said Scott Peterson, who last year stepped down from his position as executive director of the governing board.
An early version of the federal Main Street Fairness Act would have allowed a retailer to request a single multistate audit, Peterson said. The Audit Committee spent years trying to figure out how to make it work, he said.
Peterson said that under one option considered, the single multistate audit would somehow have been coordinated and conducted by the state of the retailer's origin. That approach is similar to a Direct Marketing Association proposal under which the revenue department of the state where the vendor is headquartered would conduct a single audit on behalf of all states and their local tax jurisdictions.
According to Cerasale, that proposal has received pushback from congressional staff the past two years over who would audit remote sellers based in a state without a sales tax.
Peterson said the governing board considered having the multiple state revenue departments involved in an audit of a single retailer create a committee to conduct the joint audit. The committee would be staffed with volunteers, Peterson said, or perhaps with staff from a rotating schedule of examiners from the participating states.
But just how complicated that second option can be became clear this spring when New Jersey Division of Taxation Director Michael Bryan approached the MTC about creating a dedicated multistate transfer pricing audit program. Bryan said that if the MTC doesn't establish such a function, a coalition of interested states could create one themselves.
Bryan laid out some of the difficult questions that approach would raise: How would such a coalition of states hire its staff? Where would that staff be located? Which jurisdiction would govern their civil service requirements and other administrative issues? And how would taxpayer information be shared between states? (Prior coverage: State Tax Notes, May 20, 2013, p. 571.)
Peterson said yet another option considered by the governing board was to hire a third-party source for auditor. The governing board did consider the possibility of the MTC serving in such a role. However, Peterson said, the option of going to the MTC was always just one of several possibilities considered.
Peterson, who previously oversaw sales taxes as director of the South Dakota Department of Revenue's Business Tax Division, said he is frustrated by assertions that a retailer could become subject to perpetual audit by 45 states and the District of Columbia if federal remote sales tax legislation is enacted.
"That's such an easy red flag to throw down with very little substance to back it up," Peterson said.
States could resolve the public relations dilemma created by the fear of nonstop audits by just telling people the truth about sales and use tax audits, Peterson said, which he said are pretty rare unless the retailer is an immense business.
While every state into which the remote seller makes sales would have the legal right to audit that seller, few states audit more than 2 percent of their retailers in any given year, Peterson said. Sales and use tax audits also tend to be conducted only if the revenue department believes someone is committing fraud, Peterson said.
"Fraud is very fact-specific, and very few revenue departments enter into that audit unless they're prepared to go to court," Peterson said.
Peterson said that when the state does conduct a sales and use tax audit, the examiner is usually looking at one of two big things: whether the business itself is buying items and isn't remitting its own use tax to the state, or whether the business is selling taxable items to customers missing an exemption certificate.
Peterson said he has always struggled to understand why any state would go beyond its borders to audit someone collecting its sales tax. If some version of the Marketplace Fairness Act were to pass, not only would states benefit from increased collection of their sales taxes, but the amount of use tax that goes uncollected would drop significantly, Peterson said.
"For me it was always a struggle, because I could never figure out why in the world there'd be this need for auditing," Peterson said.
Small Sellers and Certified Software Providers
Goodlatte is considering making all remote sellers subject to the tax collection requirement by eliminating the small-seller exemption. Bernstein said the National Retail Federation supports making the threshold as small as possible so all businesses are on a level playing field.
"We think the technology is there," Bernstein added.
The Marketplace Fairness Act contemplates remote sellers taking advantage of government-funded certified software providers (CSPs) for automated sales and use tax calculations and remittance, Bernstein said. It's possible that the CSP would also handle most -- or even all -- of the audits for those small sellers that use them, she said.
Peterson said this is basically true, putting on a third hat to explain how. (Following his earlier service at the South Dakota DOR and on the governing board, Peterson is director of government affairs for Avalara, one of the governing board's six authorized CSPs.)
Peterson said that one set of streamlining member states essentially views the CSP as the retailer and audits the CSP's records of customers for all sales into the state that go through the CSP's system. That could wind up being sales for one retailer or for 5,000 retailers, Peterson said. Most of these states have a law that says the CSP is the agent of the seller and is liable for the tax the sellers have.
Peterson said there generally aren't mistakes, but occasionally a piece of documentation might be missing; if there is a mistake, the state will assess Avalara, which has a contract with its sellers that says the party responsible for the error is liable for the assessment.
A second set of streamlining states treats the CSPs' customers as the seller, Peterson said. When one of these states conducts an audit, it will choose Avalara's specific customer that it wishes to audit based on the state's normal auditing practices, and Avalara will provide the customer's records to the state. These states will send Avalara all notices that otherwise would go to the retailer; if there was an error in the seller's tax calculation, Avalara would get the audit assessment, pass it on to the seller, and explain what the notice was about. Here, too, Avalara has a contract with its sellers that says the party responsible for the error is liable for the assessment.
Under both scenarios, Peterson said, the records Avalara keeps are exactly the same, and the states conducting the audits get the records in exactly the same format. He cautioned that the way the CSP auditing function works now isn't necessarily the structure that would be reflected in Goodlatte's bill or what CSPs themselves would advocate.
Riehl said it's possible that the transition to a world where federal legislation authorizes states to require remote sellers to collect sales and use taxes might be smooth for businesses that opt to use a CSP. However, she said, looking at the Marketplace Fairness Act as it stands now, a business still might be looking at multiple audits from multiple sources asking for multiple, different things.
There are streamlining states that have not only their own audit options but also differing approaches to audits involving CSPs. The legislation then creates an alternate category of non-streamlining states, which could require tax collection if they implement their own simplified audit approaches. The MTC would still be conducting its own joint audits, and it's possible that smaller groups of states would enter into joint auditing agreements.
The default is to do audits exactly as they've been done, Riehl said, adding that this would create a "Wild West" atmosphere in which businesses might face audits from thousands of local tax jurisdictions. She said the federal legislation at least contemplates a single-audit approach on a statewide basis, but even this remains the subject of disagreement between state and local governments. "And that's precisely why this hot potato has been passed down the line this entire time to deal with later," she added.
"With the rules of engagement still up in the air, it's not surprising that the audit framework is still a question," Riehl said. "It's a very important feature of the Marketplace Fairness Act, and it's good to know that congressional staff are looking for input on this. But even if, in the end, the Marketplace Fairness Act punts this to the states, there has to be some addressing of what's done in the case of multistate audits."