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For SaaS and other digital-first companies scaling across borders, exemption certificates represent a hidden tax compliance minefield. What should be simple paperwork that allows business customers to legally buy from you without paying tax, can quickly descend into a quagmire of paperwork. Worse, tax exemption certificate mistakes are an audit risk.
Here’s how automation and truly global tax support streamline those pesky tax exemption certificates and save the day.
What Are Exemption Certificates?
Quick Definition and Why They Matter
A tax exemption certificate is basically a get-out-of-sales-tax-free card. It's a document that lets businesses buy products without paying sales tax. In the US, sales tax exemption certificates ensure that only the person reliable for sales tax, the end user, pays that tax.
Only certain types of businesses or other entities can legally use an exemption certificate to avoid sales tax. They include:
- Resellers – companies making purchases that they plan to resale. I.e. a store purchasing inventory from a distributor.
- Government entities - Many government entities do not have to pay sales tax when making purchases.
- Schools – Schools are often exempt from paying sales tax on purchases of items that will be used for educational purposes. Even private schools can be considered exempt organizations.
- Nonprofits – Depending on nonprofit status and how items will be used, certain nonprofits don’t have to pay sales tax on purchases.
U.S. vs. International Context
Exemption certificates are primarily a U.S. sales tax concept. While other countries using VAT or GST systems also allow certain transactions to occur without tax collection, the mechanics work quite differently.
U.S. Exemption Certificate Management (ECM)
In the United States, exemption certificates make transactions truly tax-exempt. When a qualifying buyer provides a valid exemption certificate, no sales tax is collected on that transaction because the buyer meets specific criteria (such as being a reseller, nonprofit, or government entity).
Key characteristics of U.S. exemption certificates:
- Create actual tax exemptions
- Typically handled manually for larger organizations
- Not usually validated at checkout in real-time
- Require proper documentation and record-keeping
- Subject to state-specific rules and formats
International VAT/GST ID Verification
Unlike in the US, with VAT and GST systems, providing a valid tax ID doesn't make the transaction exempt. Instead, it shifts the tax obligation. When an international customer provides a valid VAT or GST ID, the transaction may still be taxable, but the responsibility for paying the tax shifts from the vendor to the customer via the reverse charge mechanism.
Key characteristics of VAT/GST ID verification:
- Shifts tax obligation rather than creating true tax exemption
- Commonly validated at checkout in real-time
- Used for B2B transactions across borders
- Part of broader VAT/GST compliance frameworks
When operating globally, businesses need separate processes for U.S. exemption certificate management and international VAT/GST ID verification. The compliance requirements, validation methods, and indirect tax implications are fundamentally different between these systems.
Why Exemption Certificate Management Is So Important
Tax Compliance and Risk
Governments are highly invested in ensuring they get every dollar, euro, krona or dirham of the tax money they are owed. So when a business takes advantage of their right to buy goods tax free, or to sell goods to a buyer without that buyer paying tax, that business needs to carefully document their actions to avoid tax trouble.
In most scenarios around the world, a seller is considered liable for collecting tax. Therefore, if your business fails to collect sales tax (or VAT, or GST) on a transaction, you must ensure that your reasoning was documented. In the US, you’d do that by collecting and maintaining an exemption certificate from your customer. In the EU or other countries around the globe, if you’re applying the reverse charge mechanism, you’d do that by validating their VAT or other tax registration number.
What happens if you fail to document your reasoning for not collecting tax? Your business can be held liable for the uncollected tax. On top of that, you’ll be assessed penalties and interest accumulating from the date of the erroneous transaction.
Remember, this can happen if the sale was totally legal but you never collected or have lost your documentation. It’s crucial to have an exemption certificate management (ECM) plan in place.
Complexity for Growing Companies
Exemption certificate management isn’t simple.
For one, exemption certificates can expire. Your business may make the first few tax-exempt sales to a customer with a valid certificate, but if that expiration date passes, then any following transactions can no longer be tax free.
Further, many e-commerce and billing systems are now set up to allow for customer self-service, and that includes entering their tax identification details. However, that also allows for more mistakes or even fraud.
And last but not least, especially in the U.S., each state has its own rules and laws when it comes to accepting tax exemption certificates. For example, 10 states don’t allow tax free sales to buyers without an out-of-state exemption certificate. The U.S.’s largest single market, California, is one of those tricky states. Managing tax exempt sales rules and regulations in multiple states and countries can strain even the most experienced finance teams.
Manual Management is Time-Consuming
Most teams handle management of exemption certificates manually. This means dealing with folders full of documentation or clunky spreadsheets–and often both. Finance teams find themselves manually checking the status of an exemption certificate, which slows down the flow of commerce. Or, worse, they don’t manually check and accidentally make tax free sales that will later leave them on the hook for paying the uncollected tax out of pocket.
And that's not even going into the manual research and knowledge it takes to track the varying exemption certificate rules between jurisdictions.
Manually managing exemption certificates is time consuming, inefficient, and a tax penalty waiting to happen.
The Core Components of Certificate Management
Following exemption certificate management best practices ensures your company doesn’t get into tax trouble.
Collecting Certificates from Customers
Always collect exemption certificates at onboarding or the point of sale. Even if your customers can buy from you self-service, such as through an online checkout, you can set up automations that will require a tax exempt certificate before they can check out without paying tax.
Categorizing by Certificate Type
For most businesses, the most common type of exemption certificate you’ll handle is a “resale certificate.” This is received when your buyer is purchasing your goods (or sometimes services) and planning to resell them to their own customers.
However, depending on your business, you may also sell to governments, schools, or nonprofits. These entities can have different rules and restrictions when it comes to what they can purchase tax free. It’s best practice to tag or segment your different customer types to ensure that you’re applying tax free selling rules appropriately.
Validating Certificates for Accuracy
Different jurisdictions require slightly different information when it comes to tax exemptions, but most require some form of:
- Business name
- Business registration number
- Exemption reason
- Type of goods or services purchased
From there, it’s vital to verify that the information provided by the customer is correct and up to date. Most U.S. states provide an automated method for exemption certificate validation.
For international customers, verifying the current status of the customer’s VAT or GST ID number ensures they are a business so that the tax obligation can be shifted to the end customer instead of your business!
Recordkeeping for Audit-Readiness
Keep an easily searchable database of up-to-date exemption certificates and VAT / GST IDs in case of an audit. When an auditor comes knocking, one of the very first things they’ll do is investigate your tax free transactions, so it’s vital to have your paperwork available and easily accessible.
Need help validating an exemption certificate?
Sphere automatically cross-checks tax IDs at checkout, keeping you compliant.
Tracking Expiration Dates & Renewal Dates
In some U.S. states and other countries, exemption certificates, which are tied to sales tax/VAT/GST registration, expire and must be renewed. For that reason, it’s important for businesses that accept these certificates to make sure that each customer’s exemption status is up to date.
Best practice is to check back in with regular customers at least annually to ensure that their exemption paperwork remains valid.
Automating Exemption Certificate Management
Why Manual Processes Don’t Scale
As your business scales, you’ll be tasked with dealing with more exemption certificates. And that’s where these nitpicky little documents start falling through the cracks. You’re going to accidentally make a tax free transaction to a customer whose certificate has expired. Or inadvertently accept an invalid certificate from someone isn’t playing by the rules.
And then there’s the audit. Exemption certificates are one of the first things auditors ask for, and it’s very easy to lose these pesky docs in an email chain or folder somewhere on someone’s laptop.
Manual processes can work at first, but they don’t scale.
What Automation Should Cover
The right exemption certificate management system handles the heavy lifting for you. That means automated collection workflows that prompt customers for certificates at checkout or during onboarding, eliminating those back-and-forth emails asking for paperwork after the fact.
You'll also want real-time validation that cross-checks certificate numbers against state databases and VAT / GST IDs against international tax authority registries to catch fake or expired certificates or IDs before they become your problem (and your penalty). And when certificates are about to expire? The system should automatically reach out to customers for renewals, not shove that task on your already-busy finance team.
Most importantly, everything should integrate seamlessly with your existing checkout, ERP or other billing system. When a valid certificate is on file, tax exemptions get applied automatically. When a valid VAT / GST ID is verified, the reverse charge mechanism should be applied to all applicable transactions. When there's no certificate or VAT / GST ID, tax gets collected. No manual intervention required.
Benefits of Streamlined Workflows
With automated exemption certificate management, your customers are happy because their transactions run smoothly without delays for status verification. And your finance team is freed up to do other, more important things, because they can be sure that incoming certificates and VAT / GST IDs are being sufficiently validated and are not expired. And there’s no scrambling to find certificate copies and VAT / GST IDs in case of an audit.
Exemption certificate management might seem like a back-office headache, but it’s vital to automate processes to scale and to maintain audit-ready tax compliance.
Choosing the Right Exemption Certificate Management Solution
Features to Look For
Scoping out an exemption certificate management solution isn’t the most scintillating business purchase you’ll ever make. But it’s vital. When seeking a solution, you must have:
- Multi-jurisdiction support - Your solution needs to handle every jurisdiction in which you sell
- Digital certificate collection capability - Customers should be able to provide certificates directly through your checkout or billing system.
- Expiration tracking - Certificates expire, and if you accidentally make a tax-free sale to a customer with an expired certificate, you’re on the hook to pay that tax.
- Automated validation - Your solution should validate the status of certificates seamlessly.
- Integration with your billing and/or tax engine – To speed up checkout, your solution needs to ensure exemptions are applied automatically at checkout.
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Sphere’s Modern Approach
Sphere understands that exemption certificate management is a key part of tax compliance. That’s why it’s built right into our platform at no extra cost. While other solutions nickel and dime customers with extra fees, Sphere handles certificates in our flat $100/jurisdiction/month pricing plan.
Our developer-friendly setup means you can get a certificate management workflow up and running in minutes, not weeks or months. From onboarding new tax-exempt customers to automatically validating their credentials to sending renewal reminders, Sphere allows you to run your exemption management process on autopilot.
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Why Legacy Tools Fall Short
Legacy sales tax compliance tools have traditionally treated exemption management like an afterthought or a nice-to-have. For instance, take Avalara. Their certificate management costs extra, and doesn’t seamlessly integrate with other aspects of their solution. Plus, their US-focused approach leaves multi-market customers scrambling to bolt on additional solutions to handle VAT and GST.
Vertex handles international taxing requirements, but is built for massive corporations, and that reflects in their price. The Thomas Reuters solution is fragmented, where customers are forced to pick and choose what they need rather than implement a solution straight out of the box.
These legacy tools were built for a different era, when the only companies that could sell cross border had large tax teams and deep pockets. Today’s agile, digital-first companies need a modern solution.
Don’t Let Exemption Certificates Slow You Down
As your SaaS or AI company grows and expands into new markets, exemption certificate management only gets more complex. What starts as a few resale certificates from US customers quickly becomes a juggling act of state-specific rules, international VAT validations, and expiration tracking across dozens of jurisdictions.
Exemption certificate management is tricky. Add to that the fact that expired and invalid exemption certificates are some of the most dangerous triggers for fines and penalties, and that means automation is a must.
Sphere makes exemption certificate management global, automated and refreshingly simple. Because it's built in, you don’t have to worry about paying more for certificate management as your company grows. And your tax team, even if that’s just one person, doesn’t have to spend valuable time on the administrative hassle of tracking down and manually varying exemption certificates from all over the world.
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