Presented by Avalara
Until recently, sales tax compliance didn’t make headlines or get a lot of attention from company executives or their investors. But after a major shift in the tax landscape, companies are beginning to think differently about the way they manage their business. High growth companies, in particular, are one of the most affected by these new compliance changes happening at both the federal and state level.
Malcolm Ellerbe, Tax Partner at Armanino LLP, who works with many investor-backed organizations, frequently sees executives at fast-growing companies caught off-guard by tax liabilities that weren’t on their radar. He calls these “inflection point companies,” as they have high year-over-year revenue growth and are now confronting big issues that could have been avoided early on.
Many of these issues arise when a company is entertaining an offer to acquire a company, or getting ready for an IPO. Ellerbe explains, “Discovering large, prior-period liabilities during due diligence, or by your financial statement auditors during an exit, compounds an already complicated process. No executive wants to get caught flat-footed by the auditors or by the Board of Directors with something that can easily be mitigated early on.”
So, what are these tax issues catching company leaders off guard? For many, it comes down to nexus, a company’s connection to a state that warrants a tax obligation. In the past, physical location determined whether a company collected and remitted sales tax to a state, but now with the boom of ecommerce, states are taking an aggressive and creative approach in determining who owes sales tax.
Economic nexus is one such approach. Thirteen states either have or are in the process of establishing rules that hold any company with more than $250,000 in annual sales into their state liable for collecting and remitting sales tax — even when they have no other connection to the state. More states will follow suit in the coming year. This is in addition to several states imposing affiliate and click-through nexus rules on companies as well as holding them liable to register and collect sales tax when they engage in such activities as hiring remote or contract workers or even attending tradeshows.
The list of nexus-creating activities is growing — and so is the confusion. Yet it’s easy to see why states are relying more and more on these measures. Politicians would rather enforce existing tax collection laws to curb revenue shortfalls than face scrutiny for raising taxes, so this is a trend that is likely to continue.
And the federal government has been sluggish about adopting federal remote sales tax legislation, which would standardize sales and use tax collection and remittance across the board. States have been losing revenue, and accordingly are making individual calls. They are justified, after all, in that they are only collecting on a tax that currently nobody pays.
How do high growth companies adapt to the changes?
At a certain point, a company needs to look at its ability to handle calculation of all tax issues and assess whether it needs to offload this activity. Multi-jurisdictional states can be very challenging when it comes to sales tax calculations, as many states not only have thousands of jurisdictions, but also tax stability rules for each and every service or product you sell.
That’s just the domestic perspective. When expanding abroad, companies face not only sales tax costs but landed costs — taxes plus customs, duties, fees, etc. — and it becomes exponentially harder country by country. Large companies have entire departments for these functions.
How are investors reacting to these new regulatory requirements?
From an investor standpoint, taxes are a statutory requirement and thus should be part of customary due diligence before a decision is even made to back a company. A good rule of thumb is to shy away from companies that do not outsource tax compliance. From personal and industry experience, there are very few companies that do not outsource at least some business activities.
Investors should always ask what the company’s plan is to address the issue of tax compliance, especially as founders can get so wound up handling the minutiae of a given stage of development even as their business is evolving. These concerns are certainly more relevant to smaller proportions of venture-backed companies than others, as fledgling businesses won’t have to face these issues for some time as they grow.
Furthermore, such issues are obviously very sector-dependent. However, as evidenced by states’ eagerness to begin collecting taxes on even relatively smaller total revenues, companies can grow to the stage at which they begin attracting auditors’ attention fairly quickly. Thus, even at early stages, VCs should pay heed to their prospects’ strategies for dealing with sales tax and other related compliance issues, and help them recognize how outsourcing may well be the best option for them.
High-growth companies can’t afford to let sales tax to slow them down, especially those that do business overseas. State sales tax authorities traditionally watch companies closely in industries where compliance has historically been lax. One costly sales and use tax audit could spell major problems, especially if you are anticipating a liquidity event. When manual compliance starts to create problems, it’s time to automate. Dozens of business processes are now handled through software and SaaS solutions. Sales tax is no exception. Tax automation software integrated into your existing ERP, ecommerce, or billing system is an easy, affordable, and reliable way to stay on top of tax compliance as you grow.
Avalara helps make sales tax compliance simple for businesses of all sizes, offering an end-to-end suite of solutions that automatically determines taxability, identifies applicable tax rates, accurately calculates taxes, prepares and files returns, remits taxes, maintains tax records, and manages tax exemption certificates.
Global expansion is also handled far more efficiently, as VAT (Value Added Tax) can be tricky and prone to error. Avalara not only simplifies global tax compliance but automates many of the manual steps that cause errors.
Dig deeper: Learn more about the challenges high-growth companies face with sales and use tax compliance with Avalara’s report, Hidden Tax Compliance Challenges for High Growth Companies, powered by Pitchbook.
Pat Falle is Global Chief Evangelist at Avalara.
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