Editor: Kevin D. Anderson, CPA, J.D.
Many businesses and industries have embraced the use of company credit or charge cards (corporate purchasing cards, or P-cards). P-cards function as a type of credit card that is underwritten by the business and issued to employees to enable them to purchase goods and services necessary for the operation of the business, rather than the business's requiring a traditional formal requisition, purchase invoice, or purchase order and then paying for the goods or services by check, etc. P-cards offer a number of advantages, such as convenience, streamlining and making the purchasing and payment process more efficient, improving purchasing and spending oversight, cutting costs, etc. However, P-cards can create unexpected challenges, including potential exposure to sales and use tax.
The use of P-cards during the coronavirus pandemic likely has increased exponentially, as many employees transitioned to remote working and brought their P-cards home from the office. Businesses and tax professionals should review the potential risks and ways to ensure compliance, as P-cards may begin to be used by some employees who had not had the cards before or for new types of purchases.
Additionally, due to the reduction in state revenues resulting from the coronavirus pandemic, it is possible that states will step up audit activities to help mitigate the budget shortfall. One way to prepare for a potential audit is reviewing the business's policy and procedures associated with its P-cards.
Characteristics of P-card programs
As explained above, P-cards effectively function as credit or charge cards that can be used by employees to make business purchases. Businesses originally used P-cards in areas where there are many transactions with relatively small dollar amounts, such as maintenance and repairs, which enabled the business to aggregate many transactions in a single billing statement and reduced the time and resources needed to process each transaction. P-cards have become increasingly popular and are now used by companies in many industries and for a wider variety of purchases.
A business that adopts a P-card designates the employees who are authorized to use the card to make necessary business purchases. The employee cardholder is the only person authorized to make purchases on the card. The business can put various limits on the P-card when it contracts for the card from the issuer, such as limits on the size or amount of a transaction (single transaction and/or overall monthly transactions), the types of purchases that can be made, the vendors that can be used, etc.
The process for using a P-card is the same as for a normal credit card. In a face-to-face transaction, the P-card holder presents the card to the vendor and then signs documentation. For telephone or online purchases, the card holder provides the card number to the merchant and receives a receipt for the purchase. The P-card issuer issues a periodic statement of the purchases and bills the business for all purchases made using individual P-cards. The statement typically simply summarizes all purchases, provides the total amount of each purchase, as well as the name and maybe the location of the vendor, but not any separately stated sales tax collected by the merchant.
Use tax risks
The widespread deployment of P-cards is not without a risk of potential use tax liability, particularly during a state audit. Here, the benefits of streamlining the purchasing process also create pitfalls. To elaborate, all states with a sales tax have a corresponding use tax that requires taxpayers to report and remit to the state on taxable purchases where they did not pay sales tax. In the event of an audit, the taxpayer has the burden of proving that sales tax was paid or that use tax was accrued on the purchases that it made. Where purchases are made through traditional means (i.e., a purchase order, delivery, followed by payment), there is a trail of documentation in the form of purchase orders, invoices, and use tax accruals to demonstrate to a state auditor that tax was paid on a purchase.
By contrast, documentation typically associated with P-card purchases is limited to a monthly statement that summarizes all purchases, only provides the total amount of each purchase, as well as the name and perhaps the location of the vendor, but not any separately stated sales tax collected by the merchant. More detailed data is not always available due to the additional cost to both the merchant and the purchasing company.
Several states, including Arizona, Illinois, and Texas, will not accept a taxpayer's claims on the taxability of its P-card purchases without detailed documentation to support the claims. These states will continue to side with auditors in rejecting taxpayers' assertions that sales tax was paid, in the absence of additional documentation or higher-level data (Ill. Dep't of Rev., Letter Ruling No. ST 96-192-GIL (April 12, 1996); Ariz. Dep't of Rev., LR 98-004 (April 10, 1998); Tex. Comp. of Pub. Accts., Comptroller's Hearing No. 43,511 (July 19, 2006)).
How a state conducts an audit can affect the amount of tax assessed when reviewing P-card transactions. A detailed review might result in tax assessed on only the transactions where the business is unable to produce sufficient documentation to support its position that tax was paid. Given that P-card purchases are usually smaller amounts, the total amount of tax assessed might not be material. However, if the audit uses statistical sampling, the auditor will extrapolate the error rate from the sampled transactions to the entire population. In that case, an error on a single P-card purchase could significantly increase the assessed amount once it is projected to the sample population.
Every audit is different, and the sampling methodology varies by state, but the business should work with the auditor to jointly determine the population and methodology to ensure that the sampling technique fairly represents its purchasing activity. Before an audit begins, businesses should realistically assess their P-card practices and determine whether there is potential for material exposure. If the P-card exposure will disproportionately affect the sample, the business can suggest that the P-card transactions be segregated in a separate sample.
Best practices to maintain sales and use tax compliance
Businesses using P-cards can use different methods to mitigate the sales and use tax risk associated with the cards. The foundation for all compliance methods is for the business to collect and retain copies of the receipts. The simplest and most basic method — although not the most cost-effective one — is to review all the retained receipts from P-card purchases. The business could require employee cardholders to provide detailed receipts that at least include the date and time of the transaction, the merchant's name, and its location.
The most effective enforcement technique with this method is to require employees to attach the underlying receipt to their expense report to be reimbursed for P-card purchases. This method is especially helpful where the P-card statement provided by the card issuer contains only information on the merchant and the total purchase price. A variation of this approach is for the business to retain the P-card receipts simply for the purpose of producing them in the event of an audit or periodically reviewing them to ensure sales and use tax was correctly paid.
Another method for a business to ensure compliance with sales and use tax obligations is to place certain limits or restrictions on the employee's use of the card. This can be done in a number of ways, such as using a P-card that can only be used with specific vendors that have been confirmed to charge tax (preferred vendors). Other variations could require employees to verify that tax will be charged before the purchase is made, or require that employees review and mark their purchases if tax was charged; the business then would only accrue use tax on purchases where sales tax was not indicated by the employee. This method relies on the cardholding employees' accurately inputting the purchase data. The effectiveness of placing responsibility on the cardholder generally deteriorates as the number of transactions increases, limiting the situations where this method can be used.
If a business already uses statistical sampling to project the amount of use tax to accrue on other purchases, it could update the statistical model to include P-card purchases in the current use tax accrual procedures. If statistical sampling for use tax accruals is not in place, there are various methods of selecting the sample items to review. However, if a state auditor used statistical sampling in a prior audit (even though prior audit results are not binding on a state), replicating a state's methodology should produce results consistent with the prior audit. Regardless of the methodology, the accuracy of the sample depends on the quality of the review process and the consistency of purchases.
Getting ahead of possible problems
With the anticipated increase in state audits, businesses should proactively review their P-card policies and procedures. Updating procedures or implementing new ones is easier before a state sales and use tax audit is launched rather than during the audit, and an advance review has the additional benefit of giving the business time to accrue any additional use tax before it is too late. Taking these proactive measures could help to significantly reduce the business's sales and use tax exposure on its P-card program.
Kevin D. Anderson, CPA, J.D., is a managing director, National Tax Office, with BDO USA LLP in Washington, D.C.
For additional information about these items, contact Mr. Anderson at 202-644-5413 or email@example.com.
Contributors are members of or associated with BDO USA LLP.