Walmart Sales Tax Snafu: How Did They Get This So Wrong?

In a sterling example of what big retailers' POS software is not supposed to get wrong, Walmart (NYSE:WMT) has apparently been charging too much sales tax on two-for-one coupon deals in Pennsylvania in violation of the state's law. Walmart insists the way it handles coupons in Pennsylvania has gotten an OK from the state—despite the fact that Pennsylvania law appears to spell out exactly the situation in which Walmart is accused of collecting too much tax.

According to a class-action lawsuit that was moved from state to federal court last week, when a Pennsylvania customer uses a two-for-one coupon, Walmart charges sales tax on both items, but it's only supposed to charge for one. Because Walmart gets to keep 1 percent of the sales tax it collects as a collection fee, the chain is being accused of unjust enrichment from every coupon sale it has made since June 2007.

And the sales-tax overcharge the lawsuit is based on? That was for 21 cents.

The complaint, which was originally filed in state court in Pittsburgh on June 18, says college student Brian Farneth bought two cans of shaving gel on June 8 at a Pittsburgh Walmart with a two-for-one manufacturer's coupon. The POS deducted the price of one of the cans, but charged 7 percent sales tax for both $2.97 cans—a total of 42 cents.

But the complaint cites Pennsylvania Code Section 33.2(b)(2), which spells out discounts that are exempt from sales tax:

Amounts representing on-the-spot cash discounts, employee discounts, volume discounts, store discounts such as "buy one, get one free," wholesaler's or trade discounts, rebates and store or manufacturer's coupons shall establish a new purchase price if both the item and the coupon are described on the invoice or cash register tape.

Then the Code gives several examples. The first one:

"A" purchases two hamburgers from "R" restaurant with a "buy one, get one free" coupon. The price of one hamburger is $1. "R" rings up $2 on the cash register. "R" enters a credit in the cash register for the amount of $1 resulting in an adjusted price of $1. The acceptance of the coupon by "R" establishes a new purchase price of $1 which is subject to 6¢ tax.

(Pittsburgh has its own 1 percent local sales tax, which explains the state's example is a penny short.)

In case that's not clear enough, the complaint also cites a 2005 Pennsylvania Department of Revenue update that spells it out further.In case that's not clear enough, the complaint also cites a 2005 Pennsylvania Department of Revenue update that spells it out further:

The regulations require a retailer to deduct the coupon amount from the taxable portion of the purchase price, if the cash register receipt describes both the item purchased and the coupon that applies to it. The description requirement ensures that a coupon relating to a nontaxable item will not reduce the taxable purchase price. It also protects the retailer by showing why the taxable price was reduced.

The Department interprets the requirement of a description to mean that the cash register receipt makes a clear reference to the item and the coupon related to it or a clear reference that there is an amount deducted on any purchase or a percentage discount on all items listed whether taxable or not.

Of course, this being a Walmart receipt, the receipt includes the UPC codes from both the shaving gel and the coupon. That matters because if the coupon didn't show up on the receipt, it would qualify as a rebate—which isn't tax-exempt—instead of an on-the-spot coupon under Pennsylvania law.

Walmart hasn't filed its legal response to the lawsuit, but did ask to have it moved to federal court, which indicates the potential damages are worth at least $5 million. However, Walmart spokesman Dan Fogleman told a Pittsburgh television station that "Walmart's current systems, with respect to the collection and remittance of sales tax, are in compliance with Pennsylvania's tax laws. We have previously sought an opinion from the state which confirmed this."

So who got it wrong? Is it Farneth's lawyer? Walmart's tax department? The Pennsylvania tax bureaucrat who OKed Walmart's tax logic?

Or did it come from IT—either a subtle bug in the POS code, an inadequately tested change, or a misconfiguration for all the Walmart stores in Pennsylvania, all the Pittsburgh Walmarts or just that particular store?

At this point, there's a good chance Walmart still doesn't know for sure. And if Walmart has tracked down an internal systems problem, it's not in the chain's interest to say anything—especially if it turns out to affect sales-tax calculation in some other states, too.

Worse still, Walmart can't even take the safe route in this case. There is no safe route. If the chain collects the disputed sales tax, it could be slapped with steeper penalties if it loses the lawsuit. If it doesn't collect the disputed sales tax, it could be in trouble with the state—unless it makes up the difference on its own.

All Walmart can do is keep sifting through its POS systems to make sure everything is the way it's supposed to be—and hope it's that tax bureaucrat's fault after all.