The “Good Faith” StandardBy John SerdarJanuary 29, 2021
About half of states in the US (excluding members of the SSTUA) use varying levels of the “Good Faith” standard to relieve sellers of liability when accepting tax exemption certificates. While definitions of “Good Faith” vary by state, in general the standard involves requiring the seller to conduct due diligence, and not simply accept an exemption certificate and hope that the buyer is telling the truth.
Practically speaking, some of the common reasons why certificates are invalidated under the standard include:
- Property is unable to be used for the exempt purpose.
- Example: Purchaser is buying beer, and is claiming that the transaction is tax exempt because it will be used in the manufacturing of rocket engines.
- Purchaser does not sell the type of property in question.
- Example: Purchaser is a liquor store, and is claiming a resale exemption for computer laptops that it does not sell.
- Property may be purchased for resale, but the seller suspects that purchaser will not be reselling it.
- Example: Purchaser is a sporting equipment store and buys golf clubs for resale, but the seller knows the business has a history of giving away golf-clubs to employees “off the books”.
- The provided exemption certificate is invalid.
- Example: The purchaser provides to the seller an incomplete, invalid certificate with fake or unverifiable information.
In many real life situations, invalidations may occur with a combination of events as well as other variations specific to each case. At the root of the standard is the principle that it’s the seller’s responsibility to “connect the dots” so to speak. Whereby a seller is not to be relieved of its sales tax collection responsibility if it accepts an exemption certificate with knowledge that the purchaser will not be using the property in question for the stated exempt purpose, even if the seller’s activity is not fraudulent, and even if the certificate is otherwise fully complete.
This obligation to review and look into the nature of an tax exempt transactions can place significant burdens on sellers to validate tax exemption sales. As many sellers are not investigators by nature, there is an immense grey area as to how far a seller’s obligations need to go to meet the “Good Faith” standard in the applicable state.
This problem is compounded further, because some states have taken the meaning of “Good Faith” to a whole new level. For example, the state of Arizona ask sellers to evaluate a purchase to ensure that the a buyer is being honest, and the seller can only accept a certificate when they feel there is no reason they should deny it. Texas not to be outdone goes even further and has adopted the “should have known” standard for sellers, whereby actual knowledge of the circumstances is irrelevant to the case.
At the end of the day each state has a unique standard as to what may or may not be required, and the enforcement of the standard is rarely ever uniform. As there are too many edge cases to map without turning this article into a law book, we recommend that you consult with a tax professional if you are not sure as to whether you meet the “Good Faith” standard for your particular situation.
We believe the best way to reduce your tax exemption audit risk is to utilize an end-to-end exemption certificate management platform such as EXEMPTAX, and to employ consistent collection and validation policies. To learn more about how we can help, Schedule a Demo Today!