A Cautionary Tale About the Sales and Use Tax

Tax savings can sometimes sound too good to be true. Here's an example of how one CFO at a drilling manufacturer got a quick education about underp...
Ted ProctorJuly 18, 2013

CFOs and their staffs need to get up-to-speed on sales and use tax in their states, not only for what they may be overpaying but what they may be underpaying.

For example, I had just joined Center Rock Inc., a privately-held drilling tool manufacturer based in Berlin, Pennsylvania, as their CFO in November 2011.  Those early days were typical of a new job: meeting new people, learning about the company’s products, industries served, etc.  The company was also in the midst of a new Enterprise Resource Planning (ERP) system implementation scheduled to go live in two months.  And we had a major debt refinancing that was happening at the same time.  Full-on crazy times!

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In my role as CFO, I was introduced to a firm that helped businesses obtain refunds of overpaid sales and use tax.  I had not done a lot of work with sales and use tax so I asked them to give me a brief explanation of his project.  He explained that many companies find adhering to the tax to be a confusing process. So the firm basically tries to help by digging through a company’s sales and purchasing records, by looking for transactions where taxes were paid by the company in excess of what was required, and by finding a refund on behalf of the company.

Sales and use taxes vary by state, after all.  In the state of New York, for example, sales tax applies to retail sales of certain tangible personal property and services.  Use tax applies even if one buys tangible personal property and services outside the state and uses it within New York, according to New York’s Department of Taxation and Finance.

In our home state of Pennsylvania, sales tax is required to be charged and then remitted to the state on all non-exempt sales. There are some industries which are exempt such as oil and gas production which happens to be our largest customer group.  So for our firm, most of our sales are not subject to sales tax.

On the purchasing side, however, we are required to pay a use tax, which is the opposite side of a sales tax.  However, some of our purchases are exempt.  For example, raw materials or any other items which are directly used or consumed during the production of our products are exempt.  As you might expect, the line blurs very quickly for firms like ourselves so many companies end up paying tax where they are not required to do so or do not pay tax when they should.

The firm I hired would do all the work: pull the source data, compile the spreadsheets, submit a refund request to the state, and obtain the refund on our behalf in those cases where we had overpaid. It appeared that it wouldn’t cost my firm any money out of pocket.  And the upside was that we could recover money that we didn’t even know about. 

At that point that little voice in the back of my head started saying something about “beware of those things that seem to be too good to be true” but I was being pulled in so many different directions at the time that I ignored it. Sure enough, nearly a year later we received a refund from the state of Pennsylvania for about $80k, less the half withheld by the hired firm as agreed upon. All in all, it was still a nice little bit of upside.

But shortly after we received our refund we got something else from the state of Pennsylvania— a sales and use tax audit.  As any CFO knows, audits are never fun.  I tried to convince myself that this would be different since we hired a firm to comb through our books.  

The firm, which was paid on a contingency basis, took its 50% cut from the refund; now the auditors were coming after the underpayments. Common sense told me if we had overpaid on some sales and use tax transactions than it makes sense that there were an equal number of transactions where we had underpaid.  

To make a long story short, we ended up owing the state of Pennsylvania $76k in underpaid sales and use tax.  Again, common sense and statistics worked out almost perfectly on this.  We overpaid by $80k and we underpaid by $76k.  It was basically a wash, except for the $40k we paid out to find the over payments.

Stories like ours are becoming much more common. After learning our lesson about the pitfalls of sales and use tax, we beefed up on training so that we could be smarter about the tax from here on out and hopefully reduce the amount of both over- and under-payments. Part of that plan now also includes having a written sales and use tax policy for staff.

Ted Proctor is CFO of Center Rock Inc, a provider of drilling tools, services and accessories.