Effective strategies for exemption certificate management

Collecting, validating, storing, and renewing sales tax exemption certificates is a pain in the proverbial for many tax and finance departments. Yet some tax teams have reduced if not eliminated the burden of sales tax exemptions. What’s their secret? What’s the most effective way for tax and finance departments to handle tax-exempt sales?

Avalara and Hanover Research teamed up to find out how tax teams manage sales tax exemptions and other tax compliance issues. In June 2023, Hanover surveyed nearly 400 accounting, tax, and finance professionals from organizations across Europe and the United States. Participants were asked about their top challenges and priorities, whether their companies have automated finance/tax activities, and other compliance questions. 

The focus of this article is sales tax exemption certificate management. Specifically: 

• How do businesses manage sales tax exemption certificates?

• Are businesses efficient at sales tax exemption certificate  management?

• How can businesses handle sales tax exemption certificates more efficiently?

But first …

Tax authorities understand exempt transactions happen, but they won’t take it on faith that the exempt transactions you make are legitimate. You must be able to demonstrate you had a valid reason to not collect sales tax (like having exempt customers, if you can prove they’re exempt).

So, any time you don’t charge sales tax on taxable sales of tangible personal property, you need to collect a resale certificate or exemption certificate from your buyer — or make sure you have a valid exemption certificate or resale certificate on file. For remote sellers with economic nexus in more than one state, that can amount to a lot of work.

Certificate collection is just the first step. You have to update each exemption certificate before it expires; invalid certificates won’t do you any good. Tracking expiration dates can be a bear because expiration dates vary by state and type of certificate. If you deal with a large number of these documents, keeping track of them can easily get out of hand.

And even if an exemption certificate has no expiration date, it’s important to periodically verify that the information on the certificate, like the business name or tax ID number, is up to date. 

In short, you need to fulfill your sales tax obligations to reduce audit risk for your company. Failure to collect and remit sales tax can lead to negative findings during a sales tax audit unless you have a valid exemption certificate or resale certificate on file.

In the event of an audit, the auditor will probably want to see exemption certificates from the audit period. Properly completed, up-to-date exemption certificates and resale certificates prove the customer qualified to purchase the goods without paying sales tax. But auditors usually don’t try to get eyes on every certificate during a sales tax audit because there are simply too many of them. Instead, they can use sampling and apply their findings to the entire audit period. 

“Sampling is a process of drawing a conclusion about an entire body of information based on measurements of a representative sample of that information,” explains the California Department of Tax and Fee Administration (CDTFA). “Sales and use taxes are transaction taxes, meaning that tax is determined on a transaction-by-transaction basis. Therefore, verification must be done at the source document level. Since in many cases it is economically impractical to audit all transactions, the CDTFA encourages the use of sampling whenever feasible.” 

For taxpayers, there are pros and cons to the method. If most of your sales tax exemption certificates have expired but the sample shows your business to be 95% compliant, lucky you. On the other hand, if your business is 95% compliant but the auditor falls upon the 5% of certificates that are invalid, sampling wouldn’t work in your favor. It’s an audit risk, one of many.

Simply put, managing exemption certificates is important, and given the volume of these documents, it can be hard. So …

More than half of the organizations surveyed (54%) manage exemption certificates entirely or mostly manually; just 3% of accounting, tax, and finance professionals surveyed have fully automated exemption certificate management. Roughly a third of the businesses polled use a mix of automated and manual processes  for collecting exemption certificates and validating them.

Looking just at the North American numbers:

• 54% of U.S. businesses surveyed manage sales tax exemption certificates manually and 36% use an “even mix” of automation and manual solutions  

• 51% of the Canadian businesses surveyed manage exemption certificates manually and 40% use an “even mix” of automation and manual solutions

• 10% of both U.S. and Canadian businesses surveyed have automated exemption certificate management  

Are business leaders satisfied with the way their finance and tax departments handle these documents? Overall, not so much. Fewer than half (49%) of the businesses surveyed described their finance/tax department as either “very” or “extremely” efficient at managing exemption certificates.

Interestingly, European respondents were more likely than North American respondents to say their companies manage exemption certificates efficiently. While 60% of European organizations surveyed described their finance/tax department as “efficient” at managing sales tax exemption certificates, just 37% of the North American organizations said the same.

The North American data also reveals slight discrepancies between the U.S. and Canada. While 39% of tax and finance professionals surveyed in the U.S. believe their companies manage exemption certificates efficiently, just 31% of respondents in Canada said their companies are efficient at handling exemption certificates. 

What do all these numbers mean? Organizations tend to be most efficient at the tasks that are automated, according to researchers at Hanover. The study found that about half (53%) of all organizations surveyed manually manage exemption certificates, and about half (49%) rated themselves as efficient in managing exemption certificates.

Automation can help businesses ensure they collect applicable tax or valid certificates as required. And indeed, Hanover found that organizations tend to automate tasks they struggle with. 

Since fewer North American than European organizations surveyed described themselves as efficient at managing exemption certificates, it stands to reason that more North American than European organizations would be pursuing automated solutions to collect exemption certificates and validate exemption certificates.

And indeed, the data bears that out. 

When the survey was conducted in June 2023, the IT teams of North American survey participants were twice as likely (32%) as their European counterparts (16%) to be initiating automation to manage exemption certificates. Avalara knows companies that have automated the management of sales tax exemption certificates are seeing results.

“We had physical records that we’d go and check for expiration dates,” explains Colleen Bremer, who heads customer service and logistics in the United States for the British company Limbs & Things, an Avalara customer. “It was very rudimentary, and we really could not continue to apply this practice as we grew.” 

Without an automated system in place to manage exemption certificates, audits were especially challenging for Oxbo International, another Avalara customer. “Some of the certificates were very old, some got lost … we didn’t have a process in place to ask clients for updated forms,” explains Barb Mika, who supervises sales accounting for the company. 

Automating sales tax exemption certificate management was a positive move for Limbs & Things and Oxbo International. In fact, Oxbo was able to reduce exemption certificate processing time by 40%.

Businesses worldwide can help reduce audit risk through automation. The right tools can help you collect sales tax as required on taxable transactions and streamline the management of sales tax exemptions. They also help ensure you don't collect invalid certificates or let certificates expire. And they store certificates so they’ll be easily retrievable in the event of audit requests.

Want more insights? Get the State of finance report.

In June 2023, Hanover Research surveyed nearly 400 managers, directors, vice presidents, and C-suite executives at companies based in Canada, Denmark, Finland, Iceland, Norway, Sweden, the United Kingdom, and the United States. More than half (57%) of those surveyed work for organizations with 1,000 or more employees, and 49% are at companies with tax and finance departments of more than 21 employees. Most of the businesses participating in the survey sell internationally.

Minor updates were made to this post on April 25, 2024. It originally published in January 2024.