Managing Sales Tax Complexities in Merchandise Returns

As the world has become increasingly digital, the retail industry has gone through tremendous transformation. To survive in the competitive landscape and keep up with evolving customer preferences, merchants have had to adapt and learn how to deliver the seamless omnichannel experience that shoppers expect. Delivering that efficiency and convenience comes with operational intricacies that no longer can be managed manually.

Customers expect an easy return process, and they use it to their advantage. There are many shoppers who buy items in multiple sizes and options for comparison. In fact, 40 percent of shoppers bought multiple items online in 2017 with the intent to return all but their favorite, according to customer loyalty company Narvar.

While most shoppers might see returns as convenient and hassle-free, the process is costly and complex for retailers. From restocking and labor costs to the inability to resell a returned item because it either is no longer in style, or was damaged, or went on sale, retailers face a myriad of return challenges that expand beyond a lost sale.

The increase of returns is proportional to the expansion of online sales, which have experienced a growth rate nearly three times that of rate of brick-and-mortar shops. As omnichannel buying has become the standard, the complexity of returns has intensified.

Thirty-eight percent of retailers recognized an increase in “buy online return in store” (BORIS) returns in 2018 compared to 2017, according to the National Retail Federation.

At the same time, 29 percent noted an increase in fraudulent returns. The retailers polled estimated that 8 percent of returns were fraudulent last year. For no-receipt returns, which make up 12 percent of all returns, the fraud forecast jumped to 21 percent.

Retailers lose US$5 dollars for every $100 in returns, notes the 2018 Consumer Returns in the Retail Industry report. Such significant losses translate into higher prices for consumers, as retailers need to recover money lost, as well as a drop in sales tax revenue for state and local jurisdictions.

Customers, especially those returning in person, expect returns to be processed seamlessly. However, not many realize the back-office calculations that need to happen to ensure a return is handled properly and the right amount is credited back.

Keeping Up With Rates and Rules

Forty-five states and the District of Columbia collect a statewide sales tax that ranges from 7 percent in Indiana, Mississippi, Rhode Island and Tennessee to 2.9 percent in Colorado. Those rates, as well as state taxability rules, change constantly. There were 619 standard sales tax rate changes in 2018 alone. In the last decade, there were 2,214 new standard sales tax rates and 3,672 standard sales tax changes.

This complexity doesn’t stop at the state level. In thirty-eight states, local taxes are levied on top of a state’s basic rate, bringing the number of U.S. tax jurisdictions with different rates and rules to more than 11,000. Missouri, for example, has approximately 2,000 local tax rates.

Taxability also varies across product types, adding to the sales tax confusion. Clothing is considered taxable by most states, for example, although a few exempt clothing up to a certain amount or altogether. A few states impose a luxury tax on items of clothing that sell for more than $1,000. Additionally, there are some exceptions to be considered, such as athletic or protective clothing, which are exempt in some jurisdictions.

It would be burdensome if not impossible to manage these complexities manually. Retailers need automated software that provides them with up-to-date content and ensures that proper taxes are applied during a sale and return transaction.

Calculating a Return

The amount of sales tax on a receipt usually is totaled for all items purchased, which means retailers need to recalculate it when select products are returned. This is not an easy job, given that the rates and rules can be different depending on the type of item, and when and where it was sold. Ideally, retailers should keep track of per-item tax amounts to avoid recalculation, requiring an automated system that can store massive amounts of data that can be accessed on demand.

Consumers often buy online and return in store, or bring returns to different locations. Because the rules are different across state lines, knowing the location of the original transaction is critical to calculating the right amount.

A great exampleis New Jersey, with a state sales tax rate of 6.625 percent, and its neighbor Delaware, which is one of the NOMAD states with no sales tax. A Delaware store accepting a return of a purchase made in New Jersey would need to have access to the information about product taxability for the specific items returned, as well as state and local sales tax rates at the time of purchase.

Seventeen states held a sales tax holiday in 2018, which is yet another factor that retailers need to consider when recalculating sales tax on a merchandise return. They are state-specific and can place a potential burden on retailers if not remitted correctly.

If someone buys jeans in Ohio but returns them in Pennsylvania, the transaction could be audited because clothing in Pennsylvania isn’t taxable. To avoid raising red audit flags, stores need to ensure cross-state returns are credited back to the original purchase state. Without a tax solution integrated into POS systems, retailers wouldn’t be able to manage this complexity.

After a return is processed and sales tax is refunded, sellers also need the ability to claim back from the government the tax that was reported and remitted. State approaches to crediting sales tax vary as well.

Some require sellers to amend past returns, while others, especially those with a flat rate across the state, allow for merchants to take a credit on the next return filed — as long as the correct rate is applied. Because of this, when retailers want to close the books, they often end up absorbing the cost of the tax, especially for returns that come in late.

Automating the Process

The rise of omnichannel sales and services comes with a number of complications. A product sold through an online channel and then returned by the customer to a physical store creates a fair amount of tax complexity. When each transaction is multiplied by hundreds of different tax rates, dozens of products, and thousands of customers, the tax math gets extraordinarily convoluted.

In a competitive market, such as retail, customer satisfaction is of utmost importance. A seamless omnichannel returns process is an important element. Studies have shown online shoppers are more willing to shop again with a retailer that provides a satisfactory return experience.

Recalculating sales tax accurately and in real-time during a return can be hard, given the dizzying number of tax variables. A manual process of creating tax schedules and entering the information into a POS system needs constant monitoring and updating to add or remove rates and rules, new locations and SKUs. It can result in errors and omissions, increasing noncompliance risk.

Retailers need to rely on fully automated technology that can streamline operations and ensure accuracy. This includes applying the latest rates and rules, as well as refund and restocking fees. The solution also should integrate with POS and back-office systems, as well as scale to allow the business to expand into new regions or channels with confidence.

Automation can help retailers simplify the tax complexity of merchandise returns, which have grown to be a large and inevitable part of the retail process, so they can focus on growing their business.

Pete Olanday is consulting retail practice leader at Vertex.

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