Banks: Don’t overpay software license sales and use taxes

States may refund excess tax payments

As investments in technology continue to increase, banks and financial institutions that aren’t carefully examining the sales and use taxes on their software licenses may be missing out on substantial savings — and they may have an opportunity to secure a refund if they have overpaid.

The cost of sales and use tax overpayment

Frequently, when banks purchase licenses for software and IT services, sales or use tax is paid on the full value of the software licenses, even when the products are used in multiple states or countries outside of the state where the bank is headquartered, leading to instances of overpayment. Depending on the state where the company is domiciled, that overpayment could amount to hundreds of thousands of dollars or more.

“Say you’re headquartered in a high-tax jurisdiction where the sales tax rate is 9%. You’re spending $10 million a month on software. That will add up to $900,000,” explained Matthew DiDonato, Grant Thornton Managing Principal for Metro New York. “But if in reality only 25% of your staff are using the software in the state where you’re headquartered, you’ve effectively overpaid the other 75% of that $900,000 to that state.”

While tax exemptions exist for software purchases, banks often face challenges with certain jurisdictions that do not accept exemption certifications from purchasers wishing to allocate tax based on where the IT or software will be used. Instead, they can seek overpayment refunds and appropriately administer the tax in the jurisdictions where they’re going to use the software. Use tax is often paid at a lower rate in jurisdictions outside the state where the organization is headquartered. In some cases, the use tax rate could be as low as zero if the bank is exempt in a jurisdiction.

“If the company’s state allows for apportionment of IT transaction costs based on user locations, a potential refund may be available within the statute of limitations period, which is usually three to four years,” said Michael Cronin, Grant Thornton Tax Services Principal.

Specifically, banks headquartered in Maryland, Massachusetts, New York, Ohio, Pennsylvania, Texas, Utah or Washington could benefit from seeking refunds from overpayment on sales and use tax on these purchases as well as prospective tax savings.

Identify cost savings with cross-departmental collaboration

Identifying opportunities for software and IT purchase refunds can begin outside the tax department. Procurement and purchasing teams responsible for processing invoices have the potential to spot abnormalities in spend and identify possible refunds.

“Tax training and guidance is not often given to purchasing and procurement teams. As invoices come in, they may not be looking for anomalies,” Cronin said. “When entering a new IT contract, for example, teams should be thinking about how to approach a transaction in the most tax-effective way.”

Use technology to optimize tax management

Advancements in technology can significantly enhance banks’ tax management and compliance. Tools such as Power BI and Alteryx dashboards can help automate processes to manage and analyze data efficiently.

“Being able to capture and analyze data quickly can help teams identify anomalies,” DiDonato said. “For instance, if monthly purchases are $10 million with an average blended sales tax rate of 6%, any significant deviations can be flagged for further investigation by the tax team.”

Upgraded technology and automation capabilities are also beneficial during the refund claims process, allowing teams to gather information more efficiently, respond to states’ inquiries quickly and obtain refunds faster.