Highlights from the Risk Roundup Columns of 2022
The dynamics of a direct selling business model present unique obstacles and a wide array of risks for company leaders to address and overcome. The Risk Roundup contributors of 2022 provided expert advice on overcoming these challenges. We have selected key insights from these thought leaders for this year in review. Please visit SocialSellingNews.com for the complete articles.
A Gambler’s Guide to Tax Compliance
January 2022 Issue By Brian Brown, Sr.
When it comes to mitigating risk in sales tax compliance, all bets are off on the rates and processes remaining the same everywhere, for everything. It’s just not going to happen. Something somewhere is always being revised. The cards are stacked against direct selling organizations that have to navigate a particularly challenging environment of thousands of jurisdictions, unique product taxability, and W9 and 1099 document management, among the dozens of other compliance complexities.
Beyond the hard costs of managing tax compliance yourself is the luck of the draw on audits. In a survey commissioned by Avalara in 2021, emerging small businesses (ESBs) were less likely to be audited than small and midsized businesses (SMBs) (9% versus 19%). When ESBs were audited, they spent considerably less on overseeing the audit than their larger counterparts spent: $1,471 versus $4,679. In other words, audits were 218% more costly for SMBs than ESBs. To hit the jackpot would mean never being audited, but to play your cards right would mean having an audit protection guarantee through an automated service provider.
Being audited doesn’t necessarily mean you’ve even done anything wrong. So what triggers the audit penalties? Reasons include everything from late filings to consumer use tax liabilities and failure to register in a state when required. Yet sales tax rate or rule errors and missing exemption certificates were the top two reasons.
These top two are especially relevant to direct selling organizations that have nexus throughout the United States because of the independent contractor relationships. Managing those rules and rates across the thousands of jurisdictions only amplifies the potential for a mistake. Depending on whether your direct selling business has fully embraced e-commerce or is operating within a more traditional buy and resell/wholesale distribution model, the necessity of managing exemption certificates becomes more cumbersome.
Properly managing sales tax avoids the constant raising of the stakes that many direct selling organizations expose themselves to as they hit rocket ship growth. The scrutiny of direct sellers is already high on income and product claims, so avoid raising the stakes any more than it already is.
Reducing Risk Through Proactive Meetings with Elected Officials
February 2022 Issue By Kerry Tassopoulos
To focus on the opportunities and threats, one area of opportunity is a company’s relationship with elected officials. Whether they like it or not, every direct selling company is impacted by the laws and regulations enacted in Washington, D.C., and state capitals across the United States.
First, they may need to determine who they know—their “warm market.” Have executives met their local community’s mayor, city council member, state representative, governor, congressman, or senator? If not, it may be beneficial to conduct an informal survey of employees to see who has and further identify who on the team has a professional or personal connection with an elected official.
Next, company executives can look at understanding the issues—this is “evaluating the opportunity.” Whether they are interested in government or not, knowing what laws and regulations affect their business is critical. They need to take time to learn what is happening on the legal and regulatory front and rely on third parties (such as company lawyers, accountants, business advisors) to be their “eyes and ears” and update them on current issues as well as future initiatives, which will impact the company, the salesforce, and products and services.
Finally, companies must tell their story—this is the “selling opportunity.” Executives should contact their elected official and schedule a meeting with them or their staff. Just as a company tells its story to its salesforce, prospective distributors, vendors, and the media, it should be shared with elected officials too. They represent individual constituents, but also businesses, so they want to know about direct sellers’ successes and the challenges they face.
What to Do When a State Agency Alleges Your Distributors Are Employees
April 2022 Issue By Larry Steinberg and William Miller
In early 2021, a client of the Buchalter law firm received a notice from California’s Employment Development Department (EDD) that the EDD was conducting an audit to determine whether the client’s independent distributors were properly classified as independent contractors, instead of employees.
At the outset, it should be said that having a government agency allege that your independent distributors are misclassified is daunting, and can be even more of a threat than a private lawsuit. When a misclassification allegation is made in a lawsuit, it is often made in tandem with other claims, and there is an opportunity to settle the lawsuit on favorable terms without needing to directly address or resolve the independent contractor issue.
In the case at hand, it was explained to the auditors that the client is a network marketing company with a multilevel compensation plan, and the auditor was educated on the MLM business model. The auditor was also provided with the client’s policies and procedures and independent distributor agreement.
It was important to show the auditor that the relationship between the company and its distributors was governed by a contract, and the business itself operated under policies and procedures that also defined the relationship.
To combat these threats, it is essential to have policies and procedures that detail the role of a distributor as an independent contractor, clear and consistent accounting for all of the distributors that are classified as independent contractors, and to be able to access all of that information easily.
A company should work with its legal counsel to develop a detailed fact-based outline describing, under the relevant state and federal factors, why it believes each of its distributors are independent contractors. This process will allow the company to identify and address any factors that may present challenges during a government audit or lawsuit, and to make any necessary adjustments to the contractual relationship between it and its distributors.
5 Risk Areas to Avoid for Canadian Direct Sellers
July 2022 Issue By Robert G. Kreklewetz
Canada is often viewed as a natural extension of the American direct selling ecosystem: It has a common dominant language, similar culture, convenient land border and a market of over 38 million people.
While having many similarities, there are still unique legal and regulatory features that prove to be risk areas for direct selling businesses operating in Canada. But all of this can be easily avoided with the right planning, structuring or advice, including an appropriate “Canadianization” of Plan Documents and overall business strategies.
Below, is a review of five recent Canadian developments that direct selling companies operating (or thinking about operating) in Canada should consider knowing about.
- Structural Recruitment and the Canadian Competition Bureau
Most Canadian provinces and territories require direct selling companies operating there to be licensed, and many require different levels of licensing and registrations. Sometimes, these licenses require the direct seller to obtain a positive “Advisory Opinion” from Canada’s version of the FTC—which is called the Canadian Competition Bureau (the “Bureau”).
While initially confined to Advisory Opinions for new market entrants, the Bureau has now started asking existing direct selling companies (even those present in the Canadian market for decades) to update their compensation plans in order to obtain new Advisory Opinions where required for provincial licensing purposes.
- NFR Issues
Direct sellers of natural health products (NHPs) wanting to test the Canadian marketplace have been relying on Health Canada’s Personal Importation Policy (the Policy). Commonly referred to in the industry as the “not-for-resale” policy, or “NFR” for short, NFR can be properly structured and used to send NHPs into Canada on a non-commercial basis.
Unfortunately, NFR is not well understood, and often is misused or incorrectly used. This risks increased scrutiny from Health Canada and potential stoppages or seizures at the border at the time of initial import.
- Canada Customs Audits
Outside of the NHP space, direct sellers have also been facing more and more commercial import audits—perhaps as a result of Canada Border Services Agency’s (CBSA) post-COVID-19 push to extract tax revenue from cross-border business.
- Individual Direct Seller Licensing
Established Canadian direct selling businesses know that in addition to their own direct seller license, certain provinces and territories require each individual distributor to obtain their own direct seller license before they can sell in that jurisdiction.
- Independent Contractors vs. Employees
The status of distributors as independent contractors or employees remains a particularly Canadian issue, as Canadian direct selling companies do NOT have the benefit of the IRS’s special deeming rule in 26 USC 3508 (which deems direct sellers to be independent contractors).
Navigating Landmines – The Willable Business
September 2022 Issue By Brent Kugler
Many—some would even say a majority of—direct selling companies have provisions in their consultant agreements that allow a sales consultant to pass their business to an heir or beneficiary upon their death. It’s a great marketing tool. How many jobs, professions, or business opportunities allow a worker to pass their hard work and success on to their children or heirs?
Other than the classic family-owned business, there are very few business opportunities that can easily be passed on to one’s heirs. Many direct sales companies continue to provide such an opportunity.
For a direct sales litigation attorney, “transfer upon death” provisions can be problematic because they present potential landmines that can be avoided altogether by simply not allowing the practice. Isn’t that what life insurance is for? But alas, it’s such a great marketing tool!
Because many companies favor keeping transfer upon death policies in their consultant agreements, it is critical that these policies are drafted in a manner to not conflict with other key provisions in the agreement. It is just as critical that companies exercise care and caution in how they transfer a consultant position to an heir or beneficiary, so they do not trigger any unintended adverse consequences to the company, its consultant hierarchy or its compensation structure.
The starting point is the consultant agreement. A well-drafted consultant agreement should clearly define what an independent consultant’s business is and is not. When a new consultant enrolls with “XYZ Company,” the consultant generally receives a bundle of contractual rights (i.e., the right to purchase and sell products, sponsor other consultants to purchase and sell products, earn compensation pursuant to the company’s compensation plan, participate in periodic incentives, etc).
While the consultant agreement is where the willable business is defined, the agreement is also where potential landmines must be avoided for companies to allow a consultant to pass their business to an heir or beneficiary by will. This is because a transfer upon death provision creates tension with other provisions in the consultant agreement.
As important as it is to ensure that the transfer upon death provision does not conflict with or negate language in the consultant agreement, it is just as important for companies to avoid mistakes when facilitating the transfer of the business to the heir or beneficiary. It is here where many companies fall short and mistakes get made.
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