When it comes to sales tax and pallets, some companies look at the process as straightforward, while other firms have concerns about their approach. The latter worry they might be leaving themselves exposed to back taxes or other penalties in the event of a tax audit. One of those concerned companies was recently motivated to write an anonymous letter to Pallet Enterprise.
“The issue is the legalities of charging (withholding) sales tax to our pallet customers,” the letter began. “I wish to remain anonymous due to our current situation with our state’s tax department and a customer.”
There is good reason for confusion, according to 50-state tax survey in 2006 sponsored by the Reusable Pallet and Container Coalition (now Reusable Packaging Association). “The question of the taxability of one particular type of tangible personal property, over the years, has been so vexing that many state legislatures have written specific statutory provisions to deal with it: what are generally referred to as ‘containers’ and ‘packaging materials,’” the report stated.
The General Application of Sales Tax
To take a step back to sales tax in general, 45 states impose a sales tax on the sale of tangible personal property to the consumer or final end user. It predominantly includes retail sales, however it often includes rentals, leases and other transfers of custody. As the tax is intended to be levied against the final user, exclusions or exemptions are available for several varieties of intermediate transactions. Examples include sales for resale, sale of ingredients or components of property produced for sale, sale of property consumed in manufacture or production, sales of manufacturing machinery, and sales of containers and packaging, including pallets.
Sales Tax and Pallets
In spite of efforts to clarify allowable exemptions, the RPCC report cautioned that “it can often be difficult to determine when one transaction is taxable and another similar transaction is exempt. Indeed, many intermediate business transactions are subject to the sales tax.”
Following from the discussion above, whether or not pallets are taxable depends on a number of factors, depending upon the intended use, and in some states, also on the type of entity purchasing them. For example, in some states, agricultural producers are exempt.
“Taxability depends on the use of the pallet by the purchaser,” explained Lauren Stinson, president of Windward Tax, a company which specializes in helping companies navigate the sales tax issue. To illustrate the complexity of taxation, Stinson offered four scenarios that could all have different uses and therefore tax implications:
• Pallet purchasers are purchasing them for resale because they are delivering their products to their customers on the pallet. This pallet is “part of their product” and is exempt from sales tax because they are reselling the pallet.
• Pallet purchasers could be purchasing pallets for shipping product to another manufacturing location for further processing. Since the pallet is not going to the final customer, in this case, the pallet could be taxable (depends on the state) because they are not reselling the pallet.
• Pallet purchaser could be purchasing pallets for shipping product to a customer, but then getting the pallet back from the customers. This pallet cannot be purchased for resale (exempt from tax) because the pallet is not being resold. It is coming back to them.
• Pallet purchaser could be using pallets for their own internal use at a manufacturing facility and do not qualify for any exemption.
• Leased pallets often have different tax treatments from pallet sales.
“There are many different scenarios that affect taxability and it is really up to the customer to make the determination whether or not their use qualifies for exemption,” Stinson elaborated. “However, I have seen countless examples where the purchaser wasn’t familiar with sales tax exemptions. As a supplier, educating their customers as to possible exemptions, might keep costs down for the customers where they are paying tax unnecessarily.”
Interstate Shipping of Pallets
One issue of concern raised by some pallet companies has been around interstate shipping, although other operators, such as Frank Falzone, owner of Illinois-based Pallets Plus Inc., find it to be straightforward. “In Illinois, Indiana, and Wisconsin, if the pallet is used to ship out product then it is considered packaging and sales tax does not apply,” Falzone commented. “If however the pallet is used in-plant and never shipped then it is subject to sales tax. The solution is simple: always ask for their sales tax I.D. number with their first order. (If) No I.D., then it is taxable.”
For interstate shipping, the concept of nexus is an important determination. Described as “sufficient physical presence,” the presence of nexus is the deciding factor as to whether or not an out-of-state business is responsible for collecting sales tax.
According to the Sales Tax Institute, “Nexus is created if your company maintains a temporary or permanent presence of people (employees, service people or independent sales/service agents) or property (inventory, offices, warehouses). The temporary presence is created through traveling people visiting states to call on customers or prospects, trade show attendance, or consigned inventory in warehouses.”
Ned Lenhart, president of Interstate Tax Strategies, offered Pallet Enterprise the following advice with respect to interstate shipping:
1. Know in which state your company has nexus. Conduct a nexus study if you need to. The laws vary by state.
2. In each state where you have nexus, know the tax rules for the product you sell. Don’t assume that the rules are the same in every state.
3. In each state where you have nexus, adopt and enforce strict policies about getting and maintaining valid exemption certificates. Know what forms are valid and whether they expire
4. Every sale is deemed taxable unless the certificate is provided. Be prepared to charge tax unless your customer gives a valid certificate.
5. If you charge tax, know the tax base. Specifically, are delivery charges taxable if the product is taxable? It varies by state.
6. Plan your process with the expectation that you WILL be audited.
Taxing Questions
What If “Ship-to” and “Bill-to” States Are Different? One of the questions raised by the anonymous pallet supplier had to do with how tax should be treated when a supplier is selling pallets to a customer in another state, and is billing to a head office in a third state. The answer to this question is relatively straight forward, according to both Stinson and Lenhart. “Sales tax is always based on the rules of the state where title to the property passes from the seller to the buyer,” Lenhart explained. “Absent any unique contractual provision, this is normally the “ship to state” or “destination” state where the customer takes possession. The location of the billing address is irrelevant.”
“Taxability always follows where the sale takes place, which is where the customer receives the product,” Stinson noted. So, in the example provided the correct taxing jurisdiction would be where the customer’s facility was. The “bill-to” has no impact on the taxing jurisdiction. The problem that some sellers face is that in their invoicing system, sales tax is automatically pulled from the “bill-to” information set up in the system. This will always result in the wrong tax getting charged – unless of course, bill-to is the same as “ship-to.”
What If the Out-of-State Customer Picks Up at Your Plant? Stinson noted another tricky scenario, involving the out-of-state customer picking up the pallets from the seller’s location. In that circumstance, the tax jurisdiction is where the seller is located.
Is Sales Tax Liability Something You Should Be Concerned About If You Are Purchasing a Company? Referred to as successor liability, Lenhart stated that this can be a huge issue. He explained, “The purchaser of the business assets of another business assumes the sale tax liability of the seller, whether they intended to or not or whether they knew about it or not. Conducting thorough tax due diligence is the best way to avoid the problem.”
What Is the Responsibility of the Seller with Respect to the Validity of a Customer’s Tax Exempt Declaration? Is the seller on the hook if a customer’s reseller status is found to be incorrect? According to Ned, most states allow sellers who accept a resale certificate in “good faith” to avoid tax assessments under audit. That said, however, the issue of “good faith” sometimes becomes difficult to establish or to refute. Speaking hypothetically, he explained that if the state has published policies that the pallet sales are taxable when delivered to customers in that state and the manufacturer sells pallets to a customer in that state and accepts the resale certificate, they may not be able to rely on that certificate for relief. He stressed that each state is different.
Best Practices
When it comes to sales tax best practices, Stinson offered the following advice to sellers as well as to pallet buyers:
• Have a strong exemption certificate collection process, including the assignment of responsibility for collecting, validating, updating and storing. Make sure whoever is responsible for collecting them knows what forms are acceptable in each state, what information needs to be on each form, how often new exemption certificates are needed (varies by state), and how they can be easily recovered in the event of an audit.
• Make sure that you have an exemption certificate from each exempt customer – for each ship to location.
• Be careful with customers that are acquired, make sure you get all new exemption certificates from the new company.
• Make sure you know where you have nexus (a legal obligation to collect sales tax) and get registered in that state.
• Make sure you have accurate sales tax rates and a good process for retrieving rate updates.
Tips for Buyers
• Make sure you know all exemptions for your pallets you are allowed to claim.
• Make sure you extend proper documentation to your supplier if you qualify for an exemption.
• Make sure you are paying to correct sales tax or use tax if the pallets don’t qualify for an exemption.
If you follow best practices such as those listed above, the sales tax issue can be readily managed. As tax experts stress, however, each state can be different, and it is important to understand the rules for the states where you are doing business.
General tax information for this article was offered by Ned Lenhart, MBA CPA, president of Interstate Tax Strategies (salestaxstrategies.com), and Lauren Stinson, CMI, president of Windward Tax (www.windwardtax.com). Tom Thayer of United Wholesale Lumber Company and Reed Esarove of PalletOne also offered insights.
