Sales Tax Law – The Good, the Bad, and the Ugly (mostly very bad)

I'm the founder and primary stockholder of a software company in Boulder. When the legislature first proposed taxing software I supported the measure as I felt we software companies should not get a free ride. When the bill was first passed, I contacted the Department of Revenue asking what we needed to do, so we could comply for sales in Colorado. And with that first attempted contact I started down a road that taught me the incredible frustration and expense of working with governmental taxing authorities. It has also opened my eyes to the incredible job killer we have in the combination of high overhead taxes, unworkable taxing regulations, unresponsive taxing authorities, & a sales tax structure beyond the wildest dreams of Rube Goldberg.

This post discusses sales from the perspective of a business. I have a separate post discussing the use tax.

Let's start with a question I asked both the State and City of Boulder Revenue departments:

Q: We have a customer that has a large presence in Boulder. We sold to a group in New Jersey, to be used in Poland, and paid for out of Chicago. But the Boulder facility may (they aren't sure) use the system with our software, but probably running on servers in New Jersey.

Colorado: If the software is sold for multiple points of use, the purchaser is liable to remit the tax, not the vendor. The purchaser should give the vendor a multiple points of use exemption certificate. Tax should be apportioned on the purchase price on the basis of the location of the users that are licensed to use the product at the time of purchase. If those locations are not know, the purchaser should use its best business judgment to identify the number of expected users in Colorado based on the facts as they exist at the time of the sale.

Boulder: A delivery or download address must be established to determine where taxation should occur. If it is not clear, Boulder would tax the use of the software here unless proof could be provided that a legally imposed tax was charged and paid somewhere else.

We sell software to a large chunk of the fortune 1000. In many cases the software is used in a large number of their offices worldwide, including Boulder. But the use in Colorado is a tiny percentage of the total use. Requiring companies to audit use so that Boulder and Colorado could receive their percentage of the sales tax would be prohibitively expensive. What companies will do in that case is instruct their purchasing departments that they cannot buy from Colorado companies – which would devastate the software industry in this state.

Keep in mind, this is the law today. If either the State or Boulder decides to enforce this against a company, that company will see their sales drop to zero. And when that company is put out of business, all of those jobs are gone. And these jobs will be destroyed for no advantage because this tax will never be calculated – the expense of doing so is too disproportionate.

Problem to business: Potential sales stopper. Significant uncertainty facing any Colorado company selling enterprise software.

Problem to state: Driving companies out of business increases unemployment and decreases tax revenue.

Next, there are several questions where the State & Boulder would differ on if it was taxable. In Colorado we have 89 Home Rule Cities as well as the state. Determining what tax level for an address can be automated (there are programs available). Filing with each jurisdiction is a moderate cost (in time finding out what we need to do, filling out the forms, etc). But determining if a jurisdiction considers a specific type of sale taxable – that is a significant effort & expense and has to be done on a per jurisdiction basis.

Problem to business: Giant sales blocker, because we need to contact the appropriate taxing authorities for any sale in the state, and then wait to get an answer. Significant uncertainty if we are told to ask our tax accountant as the appropriate authorities may not agree with him.

Next was the reaction of the state Department of Revenue to the questions being asked. As we dove in to specifics the Department of Revenue declined to answer as they might constitute legal advice. Now I understand if they give us an answer with the caveat that our accountant might disagree. But if the answers from the State sound reasonable, and my accountant doesn't have a compelling reason why we could save a lot by taking another approach – we'll go with what the State suggests.

Keep in mind, our goal is not to pay the smallest possible amount to the state, it's to first minimize uncertainty and second to minimize total costs (and fighting a tax issue is expensive in time, mind-share, and dollars). Getting specific answers from the state, and thereby paying a bit more in tax – well worth it. What is really bothersome about this is that we approached this relationship trying to be cooperative but the revenue departments insist on a relationship that is antagonistic. Encouraging us to use a tax expert, when a tax expert has a self interest in finding savings that can then lead to disputes – that is fundamentally antagonistic.

I want to note that Boulder at first was very cooperative in answering questions. Their answers was if it existed, they would try to tax it, but they were very cooperative in answering. However once I mentioned that I was going to blog the answers they then required all questions go to Patrick "No Answers" Von Keyserling who does a great impersonation of a brick wall.

Problem to business: Injects uncertainty in every sale. Increases costs.

Problem to State: Increases cost of collecting (tax disputes), reduces taxes collected.

Next comes the issue of getting timely answers. The City of Boulder did great on this measure. But for the State of Colorado the process was:

1. Send an email, get a reply telling me I need to send a letter.
2. Print the email, add a cover letter, mail it.
3. Call 5 times asking for a response.
4. Get a call back, that person asks me to email the questions in.

We have sales of $50,000.00 that can go from hello to sold in a day (rare it's that fast, but it happens). When the total is 50K the government is understandably very interested in getting their taxes. But the use tends to be complex in terms of where the software goes and where the person putting it there is. Sometimes it's a question of is it software or a service. A 3 week delay endangers the sale. And it makes a company value our product less because of the additional overhead of buying from a company in Colorado.

Problem to business: Sales blocker, increased cost.

Problem to State: Reduced tax revenue (due to sales lost because of this delay).

Here's the giant problem with the above. If the economy was doing great then the State making companies less efficient, costing many some business, and driving a few out of business would be no big deal (except to the people that had their money and dreams invested in the companies the State destroyed). But the economy is in the toilet and the true unemployment/underemployment rate is around 18%. We need more jobs. We need to help companies, not hurt them.

Or to put it in terms of pure self-interest to the state, the more companies can concentrate on selling more product, the greater the tax revenue (both from the sales and from taxes from additional employees) and the less the State expenses (fewer people unemployed). Although that does raise the question, does the State fundamentally have a self-interest in the economy improving?

What's my take on this? First off, sales tax is a cost prohibitive way to raise revenue in an economy where more and more of what is sold is bits instead of atoms. We have a growing chunk of the economy where the cost to determine what is taxable will be a substantial proportion of the tax collected. A system this disproportionate is very harmful to the economy of our state. Medium term the only workable solution is to eliminate sales tax except for a few specifics like gas and cigarettes and increase revenue from income and property tax.

I want to stress, I am not proposing lower total taxes, I am proposing we eliminate sales tax and increase property & income tax to make up the difference.

Short term we need to do a couple of things:

1. Get all the major Home Rule cities together and come up with a way to have a central authority that collects all sales tax for online sales. And more importantly, provides a single voice that determines what is taxable. If the 8 largest cities agree on a system the rest will join in. And if Podunkville holds out – who cares, we won't sell to that one city. (Doing this will also encourage out of state companies to collect sales tax – like Amazon.)
2. Get the Departments of Revenue to take a collaborative approach to working with companies. Yes they will occasionally render an opinion that leaves some money on the table. But they'll also make that up and then some with cases where a company pays a bit more because it's the safe decision.
3. Get the Departments of Revenue to answer quickly. I think for the state that means replacing Roxy "not doing anything" Huber with someone competent (Boulder has some good people – steal one of them away). It's inexcusable that the software sales tax law went in to effect and the DoR did not have answers to some very basic questions.
4. Make very clear reasonable rules for when software and other digital products are taxed. The smaller issue is does a transaction count as a product. The big question is where is the taxing authority. And these rules have to be workable and proportionate. If software is delivered out of state and will be on a server where people across the country, including in Colorado, are using it – it should not be taxable.
5. Ask the Department of Revenue to not screw my company over just because I pointed out their Director is doing a lousy job. (Granted this is self-interest, but it would put everyone there out of a job, not just me.)

The above 4 steps can increase jobs in Colorado and increase tax revenue for the State. Implementing the above means instead of wasting time & money on guessing what to do on taxes, I can put it toward additional salespeople. And additional sales has a wonderful multiplier that lets me then hire more people.

In addition, drastically reducing the overhead of collecting taxes will significantly reduce the opposition you get from business over taxes. A business looks at the total cost, not just the amount paid to the government. If that total cost is reduced, opposition drops.

So my question to Governor Ritter, the Legislature, the City of Boulder (and other home rule cities) – are you willing to do the above to increase jobs? (Note to the Republican members of the Legislature – "taxes bad" is not solving this problem.)

Note: I presented some of the above to the Boulder City Council recently and they asked for it in written form. No answer yet but this was real recent so I am hopeful they will, at a minimum, bring sanity to when to tax a transaction. I asked to speak to Roxy Huber who is the Director of the State Department of Revenue to get her take on the above. I was told that she was too busy to talk to anyone, and that she's not doing anything (it was a very bizarre conversation). I asked Evan Dreyer if I could speak to Governor Ritter on this and so far no reply. So I tried to get their side on this.