3 Sales and Use Tax Concerns Facing Manufacturers and Distributors
- Sales and Use Tax
- January 27, 2015 | Avalara
The following three areas can pose sales and use tax challenges for manufacturers and distributors. Without aid of the right tools, even the most well-intentioned company can suffer from transactional tax errors. This blog discusses three areas of concern and what can be done to address them.
- Input item taxability, use tax and Direct Pay permits
- Drop shipping on behalf of a distributor or retailer by a manufacturer
- Installation, repairs and nexus
1. Input Items Taxability, Use Tax and Direct Pay Permits
The accurate and early identification of sales and use tax liabilities, properly exempted items and properly taxed items is a special challenge for manufacturers. Product taxability affects items you purchase to use in your manufacturing process, items related to shipping or even a part in a final product. Based on the state, some products are not taxable if used to build manufacturing equipment but the same product might be taxable when used to repair the manufacturing equipment. Another struggle manufacturers face is when they make bulk purchases that are then shared among multiple internal plants or facilities. Depending on which location uses the item for what purpose, the product may or may not be taxable.
Many states allow manufacturers to use “Direct Pay Permits.” The Direct Pay Permit allows a manufacturer to make purchases without paying sales tax. When a part purchased using a Direct Pay Permit is pulled from inventory, the part must be tracked for how it is used and tax accrued if it is used in a taxable manner, or usage tracked if used in an exempt manner.
2. Drop Shipping on Behalf of a Distributor or Retailer by a Manufacturer
A distributor or wholesaler will sometimes request the manufacturer to drop ship their product to either their location or sometimes to their customer’s location. If an item is being shipped directly to the distributor, and the product is considered tax-exempt for resale, then no tax is required—only resale documentation. However, if shipping is done on behalf of the customer, the transaction may be taxable. Knowing what documentation you need to maintain for which states becomes a major challenge—especially as ship-to destinations may vary widely if your customer, the distributor, has you ship to their customers in numerous states.
3. Installation, Repairs and Nexus
Installation of finished items or servicing working models can create nexus in states where your manufacturing or distribution center is not located. To complicate the matter further, if you use a third party vendor to handle the repairs or installation of your products, you may have created a condition that constitutes nexus as well.
Which portion of the services and how they are taxed, varies from state to state. Knowing whether installation services and repairs constitute nexus and under what circumstances is critical when complying with any potential liability to collect and remit sales and use tax. When entering new states with any type of business activity, it is always wise to include a sales tax nexus study to assure whether or not you will be creating a sales tax responsibility by your activities in that state.
Want to know what else to watch out for? Use this handy audit checklist to make sure you’re prepared if the Auditor comes knocking.