Taxability of Freight Charges In Supply Chain Management By Kamal Adeni
Introduction • With the Internet as a framework for expanding into new markets and reaching new customers, multistate commerce has become a reality for traditional “brick and mortar” stores. This has raised many issues in the area of tax compliance. • One area, that is commonly overlooked is the Taxability of charges for shipping items purchased, commonly referred to as freight or transportation charges.
Introduction • The density of tracking the various tax rules is time consuming and an error in misinterpreting the sales tax rules could lead to significant audit exposure. • Therefore, a few crucial areas should be examined carefully when addressing the issue of sales tax on freight – who bears risk of loss, who is paying the freight charges and the method of invoicing.
Risk Of Loss • Title transfer and risk of loss are often overlooked when determining the taxability of freight charges. • Freight is calculated based on volume base, Service Value base, or Sales Value base. • In a sales contract, the terms should be very clearly defined as to when the transfer of title occurs. • When sales contracts or invoices are silent regarding shipping terms, the transaction may be reviewed under audit.
Risk Of Loss • Unless the contract terms are clearly defined auditors are likely to make this an audit issue, assuming freight is included in the definition of price. • In case the sale contact is unclear, vendors will be required to provide documentation of the shipping contract or face having the transaction included in the assessment.
Risk Of Loss • For example, in Nevada FOB destination is taxable and FOB origin is non-taxable. • Based on the silent nature of the sales contract If Nevada is conducting an audit, the auditors may determine that title transferred when risk transferred. • Therefore, freight charges for the entire audit period would be taxable. However, the company could have been FOB origin in the contract, in which FOB origin would not be taxable in Nevada. In that case, title transfer takes on a whole new meaning based on the terminology used in the sales contract.
Payment Of Freight Charges • Another factor to consider is the actual payment of the freight charges. Generally, if customers are paying for the freight charges, title will pass from the vendor to the common carrier on receipt of goods by the common carrier. This is true even though the customer is paying for the freight and the vendor retains control until the very end of the delivery process.
Payment of Freight Charges • For example, a vendor shipping a unit FOB origin can contact the common carrier right up until delivery to the customer and request that the unit not be delivered. • The following illustrations show when title transfers based on the terms of sale.
1. FOB Origin - Freight Paid by Buyer • Buyer pays freight charge • Buyer bears risk • Buyer has ownership in transit • Buyer files claim if goods are lost or damaged in transit. Title transfers to Buyer Common Carrier Buyer Seller
2. FOB Origin - Freight Paid by Seller • Seller pays freight charge • Buyer bears risk • Buyer has ownership in transit • Buyer files claim if goods are lost or damaged in transit. Title transfers to Buyer Common Carrier Buyer Seller
3. FOB Destination - Freight Paid by Buyer • Buyer pays freight charge • Seller bears risk • Seller has ownership in transit • Seller files claim if goods are lost or damaged in transit. Seller hold Title until transfers to Buyer Common Carrier Buyer Seller
4. FOB Destination - Freight Paid by Seller • Seller pays freight charge • Seller bears risk • Seller has ownership in transit • Seller files claim if goods are lost or damaged in transit. Seller hold Title until transfers to Buyer Common Carrier Buyer Seller
Invoicing Method • The taxability of freight also depends on the invoicing method. Nontaxable freight charges must be separately stated on the invoice. If a nontaxable freight charge is bundled with other taxable charges on the invoice, it is subject to tax. The matrix in the next few slides provides guidance regarding the taxability of separately stated freight charges.
Conclusion • The issue of taxability of freight charges can be problematic and frustrating. The seller should review the sales contract and determine when title and risk of loss are being transferred. If the sales contract is silent on the issues, then the Uniform Commercial Code (UCC) should be examined to determine when title transfers. The seller should become familiar with the various states' requirements. The key to minimizing audit exposure lies in clearly defined language in the sales contract and an accurate invoicing method.