One characteristic of high-performing sales-and-use tax functions is that they frequently conduct internal audits — aka reverse audits or refund studies — to make sure that the taxes they’ve paid were in fact due (see my June blog on a recent Aberdeen Group study). To get a better idea of how reverse audits work, I interviewed Michael Moore, managing director at audit firm CBIZ MHM, who says that his firm has been seeing a lot of interest in this area among clients.

BizTaxBuzz: When businesses do refund studies in-house, what do they commonly overlook? What mistakes do they make?

Moore: One of the main factors in a reverse audit is time. Because of a lack of time, a limited review is typically performed, which is often a product of materiality thresholds that are set for vendor costs, actual taxes paid, considerations for the time to amend returns, and other factors.

Another thing that’s causing mistakes is the reliance on poor system information. Data is only as good as the input that created it, so any errors in that data cause mistakes to be made on the review of the same information. Larger companies in particular have this problem. With more data to accumulate and few personnel involved in that process, having segregated sales-and-use tax line items provided in the accounts payable input is less likely. As a result, many companies are unable to fully rely on their accounts payable information for an accurate analysis of their sales-and-use tax compliance.

Another factor that may contribute to errors is the segregation of oversight of particular activities or accounts. Having operations focus on leases, assets, repairs and maintenance, utilities, construction, bad debts, etc., the sales-and-use tax function is sometimes overlooked. Since opportunities are common in these areas, this can cause errors in the sales-and-use tax refund process.

BizTaxBuzz: Is this something that the internal audit team can cover?

Moore: Internal audit’s focus on the procedures occurring in a company can help identify areas that are potential opportunities. But actually going through the refund process on overpayments of tax will generally fall to the tax department of an organization. This is typically a result of the additional time and effort that’s required to obtain a refund.

Also, because of the materiality thresholds that are inherent in most internal audit reviews, sales-and-use taxes on purchases don’t always come into the review process. Instead, internal audit may focus on whether the amount that was indicated on the invoice was posted to the correct account, instead of whether there might be additional tax due on it. Coupled with that, internal audit may focus more on the implications of a missing tax rather than an overpayment — a liability focus — overlooking the potential refund opportunity.

BizTaxBuzz: What’s involved in reviewing purchases electronically? Are there applications that can be brought in to help?

Moore: An electronic review is a very good way to begin a reverse audit. In most cases, the data provides a focus on where the activity of the company is occurring. Having state, vendor and account details helps the reviewer analyze what research is needed to support refund claims that might be available. Additionally, the electronic review can provide prebuilt schedules for confirmation of the tax payments and refund claim communications and support.

Some of the sales-and-use tax compliance software firms indicate that their software provides ongoing savings by helping with proper accruals and payments. However, the impact of these products is limited to the data that’s being provided. There are a few providers, such as Dynamic Tax Solutions, that focus on future purchasing activity and rely on both the system information and research tools to provide correct information prospectively.

BizTaxBuzz: What are some key best practices for the audit itself?

Moore: One of the most important things is to make sure you fix the problem. Determine what caused the overpayment to occur and address that issue with the individual and/or departments that were part of it. Training and system analysis after you’ve completed the process can help you adjust current practices to avoid overpayments in the future.

As far as the audit process itself goes, beginning with the raw data improves efficiency and helps to provide a resource for correcting the issues. We also recommend implementing a refund process tracking mechanism. States’ budget constraints have caused refunds to be heavily challenged and delayed, so having a tool in place to track the timing, communications, issues, and other factors associated with each refund is very important.

Remember the results of past refunds and audits, and do system checks to confirm that those results are not being repeated. Also, perform random samples on an ongoing basis to identify issues and opportunities. And isolate and research any new or unique transactions to help prevent overpayments from occurring from the inception of those transactions. ###