Imagine this scenario: In the middle of an acquisition deal, the due diligence review of a company being acquired reveals that the company has underremitted its sales tax liability. The deal is never finalized because of the problem. The company approaches its tax adviser with the news that it failed to remit some of the sales tax it collected and asks for advice. On hearing that, most state and local tax practitioners would cringe. It doesn't matter why the company failed to remit the sales tax it collected from customers -- the company is in serious trouble and could face both civil collection penalties and criminal prosecution.
Although companies often focus on civil collection penalties and other monetary aspects of noncompliance, criminal penalties must also be considered. Failure to fully comply with a state's sales and use tax laws could result in significant criminal penalties, including jail time. And given the need for revenue, criminal sanctions may be used to compel taxpayers to pay any amount they are in arrears.
Understanding the criminal penalties that are available to authorities and how to best minimize them are important aspects of tax compliance for all businesses. States presume that all sales are taxable unless there is an applicable exemption or resale certificate. Given that presumption and states’ increasing aggressiveness in asserting sales and use tax nexus on out-of-state businesses, all businesses (not just retailers) must be aware of their sales and use tax footprint and ensure they are properly complying with the law.
Still, while more states are enacting laws focused on "encouraging" voluntary compliance with sales tax laws, resulting in more criminal penalties being brought against taxpayers, actually proving a criminal violation requires significant effort on the part of authorities. In general, similar to the requirements for an IRS prosecution, most state laws require the prosecution to establish, beyond a reasonable doubt, that a tax deficiency exists, that the taxpayer affirmatively attempted to avoid paying the tax, and that the taxpayer intended to violate a known legal duty to pay the tax.
The requirements of taxpayer actusreus (guilty act) and mens rea (willfulness) can be difficult for the prosecution to establish. For example, a negligent failure to act will be insufficient to establish that the taxpayer acted deliberately. So if a software glitch caused a taxpayer to underremit sales tax, it would be unlikely that the prosecution could establish that the taxpayer purposely acted to evade payment of a tax or had the requisite degree of willfulness.
Nonetheless, simply having criminal charges brought against a company can be damaging from the standpoint of public and shareholder relations. It is easy to be painted as a tax cheat, and no one likes a tax cheat. But regardless of whether the charges are front-page news, a publicly traded company may have to disclose the charges to shareholders, which can affect the share price of the company. So while prosecutors may bring criminal charges simply as a means of encouraging a quick payment of any tax in arrears and deterring future behavior, the company may also need to engage in public relations damage control.
Accountants often refer to the principle of substance over form, meaning that the economic effect of a particular event must be contemplated when accounting for business transactions. But the sales tax could be thought of as a "form over substance" tax, because all sales are taxable unless specifically exempt. That is, if the substance of the transaction is a sale for resale, but the forms are unavailable to evidence that it is a sale for resale, the transaction will not be exempt as a sale for resale and will be subject to sales tax. Businesses should keep that concept in mind when complying with sales and use tax requirements. Failure to do so could result in both civil and criminal penalties.