Given the budget shortfalls of most states—including Minnesota—and the continued hiring of new state auditors, sales and use tax audits are becoming more prevalent than ever before.
What should businesses do now to prepare for the possibility of a future sales and use tax audit? If you are assessing the business obstacles of the immediate future, don’t overlook the importance of sales and use tax compliance. It can affect your bottom line if not handled properly.
There is also an important need to be diligent and accurate with your record-keeping, as it is key to a proper determination during a sales and use tax audit. This can be especially challenging for some businesses due to the sheer volume of resale exemption certificates that may need to be collected from customers, kept on file, and updated regularly.
Generally, all sales of tangible personal property and some select services are taxable on the selling price in Minnesota. Use tax is the complement of sales tax and is owed when a retailer has not charged sales tax.
For example, manufacturers are creating a product that is sold to customers for resale to an ultimate consumer. This would make the sale exempt from sales tax for purposes of resale, and a fully completed resale exemption certificate will need to be kept on file as proof for later down the line.
In instances where a business sells its product to the consumer or end-user directly, the business is responsible to collect and remit sales tax, assuming the sale is not to an exempt entity.
On the purchase side, there are certain exemptions and certain taxable items depending on the nature of how the purchase is used. In Minnesota, there is also a refund process to follow on taxable production machinery and equipment called the Capital Equipment Refund.
Up-front exemptions. Sales tax is not applicable for the purchase of materials used, stored or consumed in the production process under the Industrial Production Exemption. Industrial production includes, but is not limited to, research, development, design or production of any tangible personal property, manufacturing, printing, mining, research, development, design, or production of computer software.
Materials stored, used, or consumed in industrial production of personal property intended to be sold ultimately at retail are exempt, whether or not the items used become an ingredient or constitute part of the property. “Production” encompasses any step in the production process and includes the production, fabrication, printing, or processing of tangible personal property for consumers.
Note that to buy items exempt from tax, the purchaser must give a fully completed Exemption Certificate, Form ST3, to the seller.
Capital equipment refund. Unlike many other states, Minnesota does not have an up-front sales tax exemption on capital equipment. Companies must pay sales tax when purchasing equipment, or accrue use tax if not charged. Then, a company must file a claim to obtain a refund of the tax paid on the qualifying equipment. Therefore, this is similar to a rebate process.
Note that if a company fails to file a refund claim before the statute of limitation expires, Minnesota keeps the sales or use tax.
Capital equipment is defined as machinery and equipment purchased or leased, and used in Minnesota by the purchaser or lessee primarily for manufacturing, fabricating, mining, or refining tangible personal property to be sold ultimately at retail. The equipment must be essential to the integrated production process.
?Common audit adjustments
Common errors found under audit on the sales tax side include the following:
- missing or incomplete exemption certificates;
- sales of used equipment and other business assets;
- intercompany transactions.
Common errors found under audit on the purchase side (use tax) include the following:
- out of state and online purchases of office supplies, computers, software, equipment, etc.;
- credit card and/or purchase card (P-card) purchases with no invoice backup;
- delivery charges and local taxes not taxed correctly by vendors, equipment rentals;
- property purchased for resale and then used in a taxable manner;
- inventory withdrawn for personal use;
- inability to produce purchase invoices showing tax paid.
If an auditor finds you owe taxes, there will be interest and potential penalties applied to any errors discovered under audit. If you appeal, interest will continue to accrue during the appeals period.
Make sure you’re familiar with the sales and use tax rules for your business, or hire an accountant who is. Depending on the varying state laws based on where your business operates, the laws may be very complicated.