When Polo Ralph Lauren’s foray into the mail-order catalog business flopped in 1994, it left Joseph Pascucci with a gold-plated — but apparently worthless — education in mail-order tax issues. “A lot of time was spent setting up the business,” recalls Pascucci, vice president of taxes. “A lot of research was done from a tax standpoint.” The research went abegging, however, as Polo issued one catalog before company management decided to bag it.

Six years later, Pascucci’s education is finally paying off. This fall, Polo launches an E-commerce partnership with broadcaster NBC — and Pascucci is point man for tax questions about the cyber startup. “Questions and issues that arise from an E-business are the same as those from the catalog business,” he says. “We had a lot of experience with those issues.”

Pascucci says Polo’s business folks have plenty of inquiries. When it comes to the Internet, many corporate executives seem to be clueless about tax issues. In fact, even some finance managers aren’t clear on the topic. Confused by the current congressional moratorium on multiple and discriminatory taxation on E-commerce, some erroneously believe all Internet transactions are tax exempt. “Some sophisticated clients thought the Internet Tax Freedom Act made the Internet tax free, like some cyber-Bermuda,” says Jim Gannon, a tax partner at Arthur Andersen (www.arthurandersen.com).

The fact is, Internet taxation involves a lot more than sales tax. Sure, the Web changes the way some companies sell. But it also changes how they procure direct and indirect materials, how they hire employees, and how they receive and deliver services. Analysts and vendors regularly project huge savings for companies that move their business processes online. Those savings translate directly into taxable income. The question is: What tax planning do corporate managers undertake when devising E-commerce strategy — if they plan at all?

To help answer that question, eCFO partnered with the e-tax practice of professional-services firm KPMG LLP. KPMG and eCFO surveyed 100 CFOs and 100 tax directors from among the 2,000 largest companies in the United States. We wanted to know about their E-business initiatives — and the tax strategies, processes, and systems that support them. (To view the results of the entire eCFO/KPMG E-commerce tax survey, see “The e-Transformation of Corporate America” at www.us.kpmg.com.)

Lax = Max Tax

Remarkably, 68 percent of CFOs in the survey said taxes play little or no role in deciding how to structure and where to locate an E-business. More revealing, a third of the tax directors and half the CFOs said E-procurement and other Web-based, internal business processes will have no impact on tax planning. Peter Dangoia, recently the domestic tax manager at Boston-based engineering firm Stone & Webster Inc., says that, while tax planning should play a role in any E-business decision, it’s not the main consideration. “Other business concerns would take priority. You don’t have the tax tail wagging the dog.”

Besides, some CFOs don’t believe they get much credit for strategic tax planning — in the virtual or real worlds. Gary Horton, CFO at Reno, Nevada-based Amerco, parent company of U-Haul, says analysts rarely look at actual tax rates. Rather, he says, they look at the effective rate. “They basically pull it off the front of your 10K,” he says. “In most cases, the true tax you pay is in the footnotes. But I don’t think analysts look at it, and if they do, there isn’t much credit given for it.”

Given the millions of dollars in savings that many companies project from Net initiatives, a lack of tax planning could prove costly. Says Steve Rainey, partner for e-tax solutions at KPMG’s Washington-based national tax practice: “You’re talking about more than a third of your savings taken away because taxes don’t play a role in that decision.”

It appears many CFOs don’t know what role taxes play in making E-commerce decisions. In truth, there’s a sizable disconnect between finance managers’ perception of Web tax policy and that of tax directors. One glaring example: More than half the CFOs surveyed claimed that most or all of their companies’ E-business decisions are made on an after-tax basis.

But only 4 percent of tax directors said all E-business decisions are made on an after- tax basis. In fact, four out of ten claimed that no company decisions are made on an after-tax basis. One tax director in the survey felt the communication gap between the CFO and the tax head was deliberate: “They exclude the tax department because they know if they involve it, there might be issues.”

Michael Burke, partner in charge of e-tax solutions for KPMG, thinks many companies take the easy way out. “We suspect most organizations don’t apply an after-tax rate at all,” he notes. “Even those that do are grabbing the effective rate.” One reason few companies may apply real, after-tax marginal rates is the difficulty tax directors have obtaining good information. The systems many companies have in place don’t help tax managers gather the needed data. And if tax directors can’t get the information they need for routine tasks, they’re not likely to get much help assessing their companies’ E-business strategies. “If you don’t have the systems, you need more people,” Rainey explains. “If you use a lot of people, you don’t have the information in time to make a quick decision. The tax group is left further and further behind.”

There are other reasons tax tends to be an E-commerce afterthought. For one, not all Fortune 2000 companies are on the cutting-edge of E-business. “Many companies are paralyzed, not knowing which business model to follow,” admits Rainey. “If they can’t figure that out, they can’t figure out the tax issues.”

And some companies still don’t have online operations in place. Only 41 percent of surveyed companies have some Web-enabled infrastructure built, such as HR or finance systems. The numbers drop when applications pass outside company walls. Etail sales and other customer-focused operations are in place at 39 percent of companies surveyed. But only 26 percent have Internet-enabled procurement systems running or in the rollout stage. Barely one in four operate some Web-based after-sales servicing.

At many companies, therefore, Web-enabled processes are still at an early stage of planning or implementation — the best time, say professional-services consultants, to start thinking about taxes. “That’s the easy time to make them tax efficient,” explains Rainey. “It’s much harder to make changes once the new business is in place.”

Caesar Gets His

Of course, some business decisions render tax issues moot, or at least transfer responsibility away from the tax department. At Polo’s catalogue operation, for example, Pascucci learned plenty about the tax implications of locating a distribution center in various states. But Polo’s new partner, NBC, owns a distribution center in Kentucky and a call center in Minnesota.

Thus the primary questions posed to Pascucci concern sales tax and nexus (a physical presence, such as a retail outlet or warehouse). Polo has retail stores in 16 states. With outlet stores, it’s 36 states. Accepting returns of Web-purchased products at these stores may establish nexus in those locales. Polo must then decide whether to collect sales tax in those states. Here Pascucci defers to the business units. “I would be conservative and charge the tax,” he says, “But that’s a business decision. I just make them aware of the exposure.”

Karl Frieden, a tax partner at Arthur Andersen and author of Cybertaxation: The Taxation of Ecommerce, believes lots of Internet tax planning “is not affirmative; it’s defensive or protective.” And eCFO’s survey bore this out. In fact, assessing their companies’ appetites for tax risk was about the only area in which CFOs and tax directors gave similar answers. Only 4 percent of tax directors and CFOs described their companies’ tax strategies as “very aggressive.” Six out of ten labeled their companies as middle-of-the-road or conservative. “We are not aggressive at all,” acknowledges Richard Rawson, CFO at Administaff Inc., a Houston-based provider of outsourced human resource services. “We pay to Caesar what is Caesar’s.”

And Caesar gets his full cut. One reason CFOs don’t take a more aggressive approach in E-business tax planning is they don’t think it’s worth it. Sixty percent of both CFOs and tax directors said they see little or no competitive advantage to having tax-efficient E-business processes. Further, the respondents agreed with Amerco’s Horton: Only 6 percent said they receive a great deal of credit from Wall Street for the way they manage their effective tax rate.

Accounting practices don’t help. Indirect taxes, for one, aren’t usually broken out in financial statements. Trade and custom taxes are often recorded in the cost of goods sold, while property taxes are rolled up in the SG&A expense. “A lot of tax is embodied all over the income statement,” notes KPMG’s Rainey. But CFOs say analysts rarely burrow into the numbers. “It is a one-sentence deal,” notes Rawson. “Analysts ask what our effective tax rate will be, so they can put it in their model.” Adds John Byom, CFO at International Multifoods Corp., in Minnetonka, Minnesota: “Taxes haven’t been a question analysts and investors have spent any time on with me.”

Ironically, a change in the effective tax rate is often viewed with skepticism on Wall Street. Phil Bounsall, CFO at Brightpoint Inc., an Indiana-based provider of logistics services to the telecom industry, says analysts see a quarterly dip in tax rate as a one-time event — or as a ruse to help meet an earnings-per-share target. But he does believe analysts reward long-term, sustainable tax minimization strategies.

Then again, as the survey showed, few companies have mapped out such strategies — not for E-commerce operations, at any rate. Many tax managers in the poll said their companies are rushing E-business foundations into place without a basic understanding of the tax implications.

That’s a yawning opportunity wasted. “The Internet reduces geographical limitations and creates much more flexibility,” Andersen’s Frieden says. In the long run, such flexibility should help companies reduce what they pay in taxes.

But not if corporate strategists don’t speak to their tax managers. “At the level where those decisions are made, there’s no sensitivity to tax aspects,” one of the respondents noted glumly. “Those decisions are made before they get to us.”

Tim Reason is a staff writer at CFO and a contributing editor at eCFO.

Online Procurement: The Web Giveth …

Sell something over the Web, and you’re immediately faced with the hottest tax issue since the Stamp Act. Determining if a company has nexus in a state — and then assessing the appropriate taxes — can be maddening.

But what if your company purchases goods and materials over the Web? According to tax experts, Web procurement offers serious benefits. By eliminating the need for physical operations, virtual supply chains can help pare a company’s property, as well as payroll, taxes.

But Internet purchasing can also make life difficult for tax directors. Well over half the tax managers polled in the eCFO E-commerce tax survey said E-procurement and other E-business processes made for more-complicated tax compliance. CFOs, however, seem more sanguine. Fully 65 percent said E-procurement would have no impact on compliance.

Boston-based engineering firm Stone & Webster Inc. doesn’t have its own Web-based procurement system. But increasingly, the company buys direct supplies over the Web, says Peter Dangoia, former domestic tax manager for the company. “With the Web, you can send fewer people out to project sites,” he notes. Virtual purchasing can prove to be a tax boon in such states as Pennsylvania, where a hefty tax on equity is based on an apportionment factor determined by a company’s presence in the state. “One of the tests of presence is payroll,” Dangoia says. “So the less payroll you have in that state, the more you can drive taxes down.”

Generally, less tax is good. But E-procurement can also complicate assessment of those taxes, and in turn, can get a company in Dutch with state auditors. “Some Internet applications aren’t up to speed on how to apply sales tax,” Dangoia says. For most of Stone & Webster’s projects, for example, sales or use tax should be levied in states where the supplies are used, not where they’re purchased. But Stone & Webster’s tax department regularly sees Web-based vendors apply no sales tax to the company’s Web purchases. If they do apply the tax, Dangoia says, it’s usually the sales tax of their own state or the rate in Massachusetts, Stone & Webster’s home base. That means the tax chief has to keep a watchful eye on the transactions. “If they charge you nothing, you self-assess,” he says. “But if they charge you their state or Massachusetts, then you have to tell them to fix it.”

Electronic marketplaces can also be a mixed tax blessing. The Earthgrains Co., a supplier of packaged bread and baked goods, recently joined forces with 48 food, beverage, and consumer products companies to form Transora (www.transora.com), a supply-chain E-marketplace. Like many multi-party exchanges, Transora is a separate entity, notes Virgil Rehkemper, vice president and controller at Earthgrains. So he doesn’t have to tackle the tax implications of how or where Transora will be built. Use taxes are not a major worry, either, since they are assessed at the point where the supplies are used. “Our plant locations won’t change,” he notes, “so I don’t see a big tax impact there.”

Other issues may prove more challenging, however. For starters, it’s not clear how Transora (headed by former Sara Lee CFO Judith Sprieser) will provide data about purchases and where they were sent — essential for state and local tax compliance. “I just don’t know right now,” concedes Rehkemper.

While the business benefits of Transora — more-efficient transaction processing and lower prices — outweigh this concern, Rehkemper knows that advances in procurement technology can conflict with his information needs. In 1996, Earthgrains began using procurement cards to replace purchase orders. Despite the pluses, Rehkemper says there were tax drawbacks. “The cost of getting the detail so that we can do accurate assessments of the sales and use tax implications is prohibitive,” he says. “We probably err on the side of conservatism, paying taxes when in doubt.” —T.R.

ERP Systems: This Wasn’t in the Brochure

If makers of enterprise resource planning (ERP) software think they’ve taken a beating from the press lately, they’d best avoid tax directors. “Information systems that allow people to make better decisions have not necessarily translated to the tax department,” explains Steve Rainey, partner in charge of e-tax solutions for KPMG’s Washington-based national tax practice. Rainey says that implementations of earlier ERP releases sometimes ignored the needs of tax directors.

Results from the eCFO E-commerce tax survey support Rainey’s theory. While 62 percent of the CFOs polled said they have ERP systems in place, fewer than half the tax directors in the same survey know about it. A fifth of tax directors whose companies have an ERP system say the software makes collecting tax information even more difficult. By contrast, only 5 percent of the CFOs thought ERP programs make it more difficult to gather tax-compliance information.

“Most CFOs don’t see the details,” surmises Peter Dangoia, until recently the domestic tax manager at Boston-based Stone & Webster. Dangoia claims the company’s Oracle Financials implementation in September 1999 (www.oracle.com) made it more difficult for his department to get information. Stone & Webster’s tax department was involved in the ERP rollout, Dangoia concedes, and some tax problems were addressed early on. But he says limited resources and a serious Y2K problem ultimately pushed many tax issues to the back burner. “When it came down to the wire, the mission-critical issues were done, and tax was not,” he notes. “That caused most of our heartburn.”

Much of the discomfort comes from fairly simple entries. “In the past, we got an accounts payable report for the whole month, which told us which items were purchased,” Dangoia offers. A quick glance at that report was all it took to make sure the correct taxes had been applied. The Oracle system, he says, replaced that report with a single accounts payable total for the month.

Unless Stone & Webster’s tax department has a staff member run an AP register each day, the company’s options are limited. “[ERP vendors] talk about all this drill-down capability stuff, [but] it is a real pain,” Dangoia insists. “You can drill down to the day’s details — to the 13th, say. Well, if you want the next day, you have to go back up to the top and drill down to the 14th.” Dangoia says a fix for this is on the company’s to-do list. “But along with everything else, it is a matter of priorities.”

While CFOs and tax directors disagree about whether ERP apps make tax compliance more difficult, a sizable percentage from both groups said the ability to gather tax-compliance data remained about the same after an ERP installation (45 percent of CFOs, 39 percent of tax directors). Says Rainey: “One would have thought that the whole point of ERP would be to get information better and faster.” —T.R.

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