Is Your Cannabis Organization Overpaying on Sales and Use Taxes?

Bridge West CannaBlog by Cory Parnell, CPA, Chief Operating Officer of Bridge West

It’s a safe bet that state tax authorities will let you know if your cannabis organization has not paid enough sales and use taxes, but what are the odds that you’ll be notified if you’ve paid too much? The chances are slim — so slim that many cannabis businesses have asked Bridge West to perform reverse audits to identify overpayments so they can request refunds.

Extraction Machine in N. Colorado

Take all your exemptions

In most states, businesses are exempt from sales tax on equipment used in manufacturing.  Many states don’t require businesses to pay taxes on the utilities and materials used in these processes, either. These are just examples of sales and use tax exemptions that might be available. Unless you’re diligent about claiming exemptions, you may be excluding some exemptions to which you’re entitled.

Many cannabis businesses don’t utilize sales and use tax compliance systems to guard against over-paying related to manufacturing.  There are many reasons that may include employee turnover, business expansion, or downsizing, and simple mistakes, which can have damaging consequences.

Look back and broadly

Audits normally extend across businesses, dating back as far as the statute of limitations on state tax reviews. For example, if your state auditors can review all records for the four years preceding the audit, the reverse audit should encompass the same timeframe.

What types of payments does Bridge West typically review? One common type of overpayment is on components of manufactured products, as well as, on the equipment used to make the products. Other areas where overpayments may occur, depending on state laws, include:

  • Manufacturing equipment,
  • Pollution control equipment and supplies,
  • Safety equipment,
  • Warehouse equipment,
  • Software licenses,
  • Maintenance fees,
  • Protective clothing, and
  • Service transactions.

When considering if your organization has overpaid on sales and use taxes in these and other areas, it is essential to have a clear understanding of your operations. For example, if you want to ensure that you are receiving maximum benefit from industrial processing exemptions, you need to know where your manufacturing process begins and ends.

The process for a reverse sales tax audit

Phase One: Feasibility Study

The first phase is that we would perform a feasibility study to identify and estimate the potential sales/use tax refund opportunities. Depending on the size of the company, this usually requires up to two days of review. During this phase, the documentation reviewed is typically a fixed asset listing, chart of accounts, accounts payable detail for selected accounts for a sample period, and access to the invoices.  If available, an electronic download of all accounts payable activity and invoices would also be reviewed. This phase may only cover a certain period, where the results are projected over all time periods within the statute of limitations to estimate the potential refund.  Based on the results of the feasibility phase, a decision will be made regarding the steps to be taken in phase two, the validation phase.

Phase Two: Validation

If an overpayment is identified in phase one: the feasibility, the primary focus of the validation phase is to compile the documentation required to prepare and submit the claim for refund. This often involves meeting with the company personnel who are most familiar with the items purchased, i.e., plant supervisors or buyers, to help provide descriptions for the items being claimed. Summary explanations may also be required if the reason for the exemption would not be obvious to the state’s claim reviewer. In the final step of phase two, the entire refund claim package is presented to the company for review and approval.

Phase Three: Coordinating with the State and Ensuring the Refund is Issued and Received

Once the refund claim package is submitted to the state, the state representative may have questions and request copies of invoices. Thus, phase three includes responding to the state’s requests and ensuring that the refund is issued and received by the company. Similar to the final step when mitigating an exposure, it is important to provide training to company personnel to ensure that a process is in place to capture the exemptions that resulted in the refunds prospectively.

Save Now and Later

Performing a reverse audit can be time-consuming and complicated but can result in a significant gain. Rules and regulations surrounding state sales and use tax refunds are complicated. Bridge West can help you understand them and ensure your refund claims are properly prepared before you submit them.

Bridge West regularly performs reverse audits to help our clients reap tax refund rewards now, and to update their compliance systems to ensure that they do not overpay taxes in the future. To schedule a complimentary and confidential consultation with Cory Parnell, please contact us.