Over the past few months I’ve been asked several questions about how to get refunds of sales taxes paid to vendors or how to recover the tax that your business paid to vendors by passing the cost on to your customer. Both of these can be difficult questions to resolve because the rules can vary widely by state. Despite those obstacles, let me offer some thoughts on this issue.
Why is tax being charged?
The first question I normally ask people that call me on this issue is “Why are they charging you tax?” In most cases, the transactions involved are third-party drop shipments where the vendor has nexus in the ship-to state (and must charge tax) but the retailer (that’s most likely you in this scenario) does not have nexus or is not able to provide the vendor with a resale exemption certificate that is valid in the ship-to state. As such, the retailer is charged sales tax based on the rate in the ship-to state on the wholesale cost of the shipment. That’s even if you, as the retailer, are planning on reselling the products you bought and paid sales tax on.
The first step the retailer must take to avoid being charged tax is to provide their vendor with an exemption certificate that is valid in the ship to state. The validity of the certificate is based on the state law of the ‘ship-to’ state. Of the 45 states that have a state level sales tax, 35 of those states will accept the certificate of the retailer’s ‘home state.’ (Here’s a list of states who won’t accept your out-of-state resale certificate.) Assuming that the retailer is registered in their home state, the first line of attack is to ensure that the retailer has provided their ‘home state’ resale certificate to their vendors to eliminate tax in those states.
In the 10 states that won’t accept the home state resale certificate, the retailer is confronted with two choices. The first choice is to register in some or all of these 10 states so that your company can provide a valid resale certificate. In most cases, the act of registering will require that the retailer charge and collect the tax on the full retail sales price of the product sold.
Sales Tax Recovery
If the retailer cannot provide their vendor a resale certificate that is valid in the ship-to state, the vendor has no choice but to charge tax on their sale to the retailer. Once tax is charged the question arises on how to recover the tax. For this article I will address the effectiveness of three following methods.
- File refund claim with the “ship to state”: To file a claim of refund with the ‘ship to state’ to recover the taxes paid to the vendor, the retailer will be required to prove that the tax charged is not proper. The only valid claim is that the purchase is for ‘resale.’ Because the retailer is not registered in the ‘ship to’ state it cannot provide a valid resale certificate that would be essential to be successful in their refund claim. In short, a refund claim is only going to be successful if the retailer registers in the state and provides their vendor with a resale certificate. Absent that, the state will deny the refund claim.
- Claim a credit for tax on the sales tax return filed: This is a viable option but this can only work if the retailer is already registered with the state and is filing returns. If the retailer is already registered, the retailer should be able to provide their vendor with a resale certificate and avoid the tax from being charged in the first place.
- Include a line on the customer’s invoice for the tax paid to the vendor: Short of just ‘eating’ the sales tax charged by the vendor and considering it a “cost of doing business,” some retailers are including a line on their invoice for “tax paid to vendor” and are reimbursing themselves for the tax paid to their vendor. In almost all cases, the tax included is only based on the wholesale price of product sold. As such, the customer can easily determine the cost of the product sold. Further, there is no valid way for the customer to verify that the tax shown on the invoice is actually the tax charged by the vendor.
In one discussion I had with a retailer on this issue, they told me that they were just going include the phrase ‘sales tax’ and include the amount of tax that their vendor had charged. I strongly warned them that just labeling the tax charged to them by their vendor as ‘sale tax’ gives the impression to customers and to the state that the retailer is ‘charging tax’ to the customer and not just passing on the tax that was charged to them by their vendor. If that conclusion is reached, the state will expect that your company remit the tax that appears to have been collected and could even pursue significant penalties for collecting and not remitting tax.
For retailers are not registered for sales tax in the ship-to state where the vendor is charging sales tax, there is no 100% great way to recover sales tax charged by vendors. The retailer cannot file a refund claim and it cannot claim the tax charged on their return because they are not filing a return. One possible solution is to pass this tax on to the customer with a very clear indication on the invoice that the tax shown on the invoice is the tax charged to the retailer by their vendor. Even this method may not be acceptable in many states.
Depending on the amount of tax being charged to the retailer by their vendors, the retailer may need to evaluate the cost of registering and collecting the tax due against the amount of tax being charged to the retailer and possibly reducing the retailers profits.