Could Online Sales Tax Moves Hurt Private Retailers’ Already Thin Margins?

IMGCAP(1)]Privately held retailers are operating with relatively thin profit margins nearly four years after the end of the recession, and some analysts say costs could go up and pinch margins even more if Congress approves the latest effort to get more retailers to collect taxes on their online sales.

Under the Marketplace Fairness Act approved by the Senate, states can require sellers generating more than $1 million in “remote” sales, including those via the Internet, to collect and remit to various states and local governments the jurisdictions’ taxes on those sales. Under current law, businesses must collect applicable state and local sales tax from customers only in states where the firm has a physical presence, such as a store, office or warehouse.

While the House must pass its own version of the bill and both sides would need to work out any differences, much of the debate surrounding the move has focused on the impact on consumers. Some proponents argue that the changes will “level the playing field” for smaller brick-and-mortar retailers competing against online sellers that aren’t yet collecting state and local taxes.

But some smaller retailers using the Internet for sales are opposing it, saying the legislation will stifle the growth of Main Street businesses leveraging the power of the Internet to compete with larger rivals.

“The smallest retailers will likely escape this new requirement,” said Sageworks analyst Tim McPeak. “The compliance burden will hit private midsized retailers the hardest. Retailers in general already have thinner net profit margins relative to other industries.”

Sageworks data from its latest Private Company Report shows that privately held retailers had an average net profit margin of 3.4 percent, compared with an average of 7.3  percent for all other companies in the private sector.  Net profit margin has been adjusted to exclude taxes and include owner compensation in excess of their market-rate salaries. These adjustments are commonly made to private company financials in order to provide a more accurate picture of the companies’ operational performance.

Steve Parish, a principal in the state and local tax practice of the tax and consulting firm McGladrey LLP, said that while the smallest companies may be exempted, many small and medium-sized enterprises will not. And the impact on those companies will be magnified relative to larger private retailers because the smaller retailers, he said, “generally don’t have the capacity or the tax staff to handle all of the undocumented or unaddressed costs associated with compliance under the proposed Marketplace Fairness Act.”

Even though the bill calls for states to provide the related reporting software, businesses will have to configure the software to their own situation, he said. For example, some reseller customers would be exempt from the sales tax, but states have differing requirements for how long retailers must retain related certificates of exemption.

And Parish expects general audit and tax compliance costs will rise as more retailers are thrown into what he calls the “audit roulette pool.”

“I would envision that the states would be very proactive in auditing some of these companies for the sake of saying, ‘We’re educating these companies,’” he said.

McPeak also noted that retailers collecting the tax for the first time will experience pressure to remain competitive against larger sellers by keeping bottom-line prices the same.

“Some retailers won’t have the pricing power to pass along their new compliance costs to their customers and, with these already thin margins, could find it tough to remain profitable,” he said.

Mary Ellen Biery is a research specialist at Sageworks, a financial information company and provider of the Business Credit Report by Sageworks. She is a veteran financial reporter whose works have appeared in The Wall Street Journal and on Dow Jones Newswires, CNN.com, MarketWatch.com, CNBC.com, and other sites.