RD346 - Review of Retail Sales and Use Tax Collection and Distribution Processes - September 2013


Executive Summary:
*This report includes the reporting requirements for Enactment Clause 2. of Chapter 614 of the 2011 Acts of Assembly, due October 1, 2012, and the reporting requirements for Code of Virginia § 30-133.2, due October 1, 2013.

In accordance with Section 30-133.2 of the Code of Virginia, we performed a review of the collection and distribution of the Retail Sales and Use Tax with a focus on the collection and distribution of local sales and use taxes. We conducted this review in multiple phases and we issued an interim report based on the initial phase of our review in November 2011.

In fiscal year 2012 the Commonwealth collected approximately $4.9 billion in retail sales and use taxes. Over $1 billion of these revenues were distributed to localities as a one percent local option tax. The Department of Taxation (Taxation) collects the tax and determines the local portion which is distributed to the locality where the sale or activity occurred.

Overall, the sales and use tax distribution process requires a joint effort between Taxation, localities, and businesses. There are a number of controls and processes in place to help ensure that locality distributions are accurate and made to the correct locality. When an error is detected, Taxation processes an adjustment to correct the distribution and transfer the funds to the correct locality.

Over the last several years, Taxation has implemented some new controls to reduce the number of locality distribution errors and improve the process. As a result, the error rate in the locality distributions has been steadily decreasing and was well below 1 percent in fiscal year 2012.

Error Rate for Local Sales Tax Distributions

Local Distribution Amount

2010: $979,588,558
2011: $1,010,204,536
2012: $1,052,521,923

Errors Identified and Corrected

2010: $11,663,142
2011: $8,655,713
2012: $5,725,742

Error Rate

2010: 1.19%
2011: 0.86%
2012: 0.54%

Business registration errors continue to be the primary source of most locality distribution errors. Taxation has taken steps to reduce business registration errors; however, some may still occur. Any changes to the business registration process need to consider the impact on businesses, and changes that could increase costs for businesses or complicate the registration process may not be viable options.

Timely identification and correction of distribution errors is important to minimize the fiscal impacts on affected localities. The process for identifying distribution errors is highly dependent on localities reviewing information provided by Taxation. The level of effort and resources dedicated to this process varies and is directly related to the size and characteristics of the locality.

While we found the overall process to be sound, we recommend that Taxation consider automating all or parts of the distribution transfer request process and the reconciliation process for localities. In addition, Taxation should continue efforts to reduce business registration errors and enhance communication and training opportunities for localities.

As required, we are also recommending annual benchmarks Taxation should use to measure the effectiveness of the local sales and use tax distribution process. We recommend Taxation continue to calculate an annual error rate for local retail sales and use tax distributions. Based on our analysis of the error rates, we recommend 1 percent as a reasonable threshold, meaning if the error rate exceeds 1 percent in any given year, Taxation should perform additional analysis to determine the causes of the errors and if further actions are required.