Tax Type
Retail Sales and Use Tax
Description
Audit sampling techniques; Exemption certificates
Topic
Collection of Delinquent Tax
Date Issued
04-11-2001
April 11, 2001
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****
This is in reply to your letter in which you seek a correction of the department's retail sales and use tax audit assessment issued to ***** (the "Taxpayer"), for the period March 1997 through February 2000. Payments totaling have been received and applied against the audit deficiency, leaving a balance of $****.
FACTS
The Taxpayer is a manufacturer and disputes the sampling method used to determine the audit liability. The Taxpayer contends that the sample method used overstates its tax liability, and it has recalculated and paid the deficiency based on its own estimate. I will respond to the issues raised by the Taxpayer.
DETERMINATION
Sampling
Sampling is an audit technique of significant value that is widely used in both the public and private sectors for all types of audits where a detailed audit would not prove beneficial either to the auditor or the taxpayer. When sampling techniques are properly applied, the final result should be within a narrow percentage range of the actual amount that would be determined by a detailed audit.
Sampling is also used to determine tax liability when the volume of transactions is large. In this case, the Taxpayer's volume of sales made during the audit period made it impractical to perform a detailed audit. Using statistical sampling when there is a large volume of transactions reduces compliance costs for both the department and taxpayers without impacting on accuracy.
Every effort is made to objectively select the sample periods that are representative of the entire audit period and to reach a consensus with the taxpayer concerning the validity of the sample. In this case, the auditor used the block sampling method to determine if the Taxpayer was properly collecting the sales tax on its sales. The department has historically used this method when conducting audits. See Public Document's 89-177 (5/31/89) and 83-253 (12/9/83).
Exemption Certificates
In Virginia, all sales, leases and rentals of tangible personal property are taxable unless the contrary is established. Title 23 of the Virginia Administrative Code (VAC) 10-210-280 explains that the burden of proving that the tax does not apply rests with a dealer unless he takes, in good faith from the purchaser or lessee, a certificate of exemption indicating that the property is exempt under the law. A certificate that is incomplete, invalid, infirm or inconsistent on its face is never acceptable.
The regulation further provides that "[a]n exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate." Therefore, the seller must use reasonable care and judgement in selling tangible personal property exclusive of the tax, even when an exemption certificate from the purchaser is in his file. Furthermore, certificates of exemption obtained during or after an audit situation will be accepted only if the department can confirm that the customer's use of the certificate was valid and proper for the specific transaction.
Specific Issues
Exceptions List (Pages 1-3)
1. Items 1 & 2: The Taxpayer states that the listed customer is a seasonal purchaser, but that the audit included pool chemical sales in the sample which were then extrapolated over the entire audit period.
The customer is a recreation association purchasing the pool chemicals for its own use and consumption. In this case, both the auditor and the Taxpayer agreed to a review of three months that represented high, low, and average purchases. The auditor found recurring errors in which the Taxpayer failed to collect the tax on sales to customers. Based on this information, the auditor calculated an error factor for the for the audit period. A review of the sample months reveals that the customer purchased chemicals from the Taxpayer for two of the three months without payment of the tax.
The Taxpayer claims that the items at issue are not representative of the entire audit period. However, for an item to be removed from the audit sample, the Taxpayer must show that the transaction was isolated in nature and not a normal part of the Taxpayer's sales. While the Taxpayer claims that the sales at issue were to a customer who made limited or seasonal purchases, the Taxpayer does not furnish any proof that such sales were isolated in nature and not a normal part of the Taxpayer's sales. Although the Taxpayer may consider an item to be a non-standard transaction, this does not necessarily mean that the transaction constitutes a unique or isolated sale. The Taxpayer must be able to demonstrate that such sales are not a normal part of the Taxpayer's sales operations. There are likely similar transactions outside the sample period in which this customer or other customers have not paid the sales tax. Therefore, to remove the sales in question from the sample base would skew the sample and nullify its validity.
2. Items 3 & 8: In item 3, business with the customer was terminated after this sale, but the sampling process applies the sampled measure to the entire audit period. Item 8 relates to sales of a chemical to a church for use in melting ice.
The Taxpayer made three sales to the customer in item 3 during one of the sample months, and as provided in items 1 & 2, there are likely similar transactions outside the sample period in which these customers or other customers have not paid the sales tax. Accordingly, the auditor was proper in including item 3 in the sample calculations.
Regarding item 8, and as previously stated in the regulations, an exemption certificate cannot be used to make a tax-free purchase of any item of tangible personal property not covered by the exact wording of the certificate. In this instance the property sold is not used in religious worship services, or within the offices, meeting or counseling rooms, or other rooms in the public church buildings which are used in carrying out the work of the church and its related ministries. Accordingly, the auditor correctly held the items in the sample.
3. Items 6 & 7: The Taxpayer contends that exemption certificates were on file for these items, but that the items were not removed from the sample. The items are included in the sample and applied to all three years.
The auditor indicates that for item 6, the Taxpayer obtained exemption certificates at the conclusion of the audit. The Taxpayer was afforded an opportunity to secure exemption certificates from its purchasers in the event that the sales may have been exempt sales for resale. When a dealer is afforded a "second chance" to secure exemption certificates to support untaxed sales, the department's longstanding policy is to more closely evaluate the validity of the certificate because the Taxpayer did not originally rely on the certificate to make the exempt sale.
Code of Virginia § 58.1-609.3(2) provides an exemption from the retail sales and use tax for "machinery or tools or repair parts therefor or replacement thereof, fuel, power, energy, or supplies, used directly in ... manufacturing ... products for sale or resale." The term "used directly" is defined in Code of Virginia § 58.1-602 as "those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing ... process, but not including ancillary activities such as general maintenance or administration." (Emphasis added).
Interpreting the above statutes, Title 23 VAC 10-210-920(B)(2) [copy enclosed] provides for the following:
Items of tangible personal property which are used directly in manufacturing... are machinery, tools and repair parts therefor, fuel, power, energy, or supplies which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process. Convenient or facilitative items... or items that are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing ... (Emphasis added).
In this instance, the exemption certificate was not accepted because the product sold was a general maintenance supply rather than a disinfectant. Accordingly, as item 6 was a maintenance supply not covered by the exact wording of the exemption certificate, the auditor was proper in including the item in the audit.
With regard to item 7, a resale exemption certificate was presented by the Taxpayer. However, it was not clear to the auditor if item 8 was a purchase for resale or for the customer's own use and consumption. If the Taxpayer can clarify this transaction to show that the purchase was for resale, there is cause for an adjustment of the sample. Otherwise, there is no basis for a revision.
4. Item 12: Based on the auditor's comments, this item will be removed from the audit.
5. Items 13, 19, 20 & 21: The Taxpayer states that the customer accrued the tax on these purchases and that they should not be included in the sample.
In this case, the Taxpayer made untaxed sales to certain customers. It may be that these customers are industrial manufacturers, and, if so, these customers may have used the items either in an exempt or non-exempt activity. It is difficult, however, for the department to exempt such sales based on a seller's statements that a customer is purchasing items exempt of the tax. It is for these reasons that certificates of exemption and direct pay permits are so vitally important to retail sales and use tax transactions. However, in this instance, there were no copies of the customer's direct pay permits or any reference to a direct pay permit number in the Taxpayer's files. Accordingly, the auditor was correct in including these items in the sample.
However, if the Taxpayer can secure the direct pay permit number of this customer for verification by the auditor, I will allow for an adjustment of the sample.
6. Items 14 through 17: Taxpayer states that it took all precautions in following proper procedures in making sales to customers, and that proper certificates were on file.
The auditor's comments indicate that properly completed exemption certificates were on file. However, as previously stated, an exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate.
In this instance, the customer presented a manufacturer's certificate of exemption form ST-11. The exemption allows for the exempt purchase of industrial materials for manufacturing, processing, refining, or conversion into articles of tangible personal property for resale. The items at issue, non-disinfecting cleaner, hand soap, soap dispensers, and laundry detergent are not industrial materials and do not enter into the production of or become a component part of the finished product. Accordingly, the auditor was proper in holding the items in the sample.
7. Items 23 through 44: These items were sold exempt to the customer because the customer represented themselves as direct pay permit holders. The Taxpayer states that the customer self-accrued and paid the tax to the Commonwealth.
Comments by the auditor indicate that the Taxpayer did not have a copy of the direct payment permit, or the direct payment permit number. There was also no proof that the customer had accrued the tax and paid it to the department. Without such proof, there is no basis to allow for any adjustment. However, as previously provided, if the Taxpayer can secure the direct pay permit number of this customer for verification by the auditor, I will allow for an adjustment of the sample.
8. Items 47 & 48: Proper certificates on file.
An exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate. The items at issue are cleaning supplies and are similar to those in number 6. Accordingly, the auditor was proper in holding the items in the sample.
9. Items 53 through 61: Taxpayer states that it took all precautions in following proper procedures in making sales to customers, and proper certificates were on file.
The department's response is similar to the response in number 6. The auditor's comments indicate that properly completed exemption certificates were on file. However, as previously stated, an exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate. The items at issue are cleaning supplies that are not used in the production process. Accordingly, the auditor was proper in holding the items in the sample.
10. Items 63 through 89: These items were sold exempt to the customer since they represented themselves as direct pay permit holders.
The auditor's comments indicate that the Taxpayer did not have a copy of the direct payment permit, or direct payment permit number. Again, as previously stated, if the Taxpayer can secure the direct pay permit number of this customer for verification by the auditor, I will allow for an adjustment of the sample.
Exceptions List (Page 4)
1. The Taxpayer acknowledges credits given in the department's audit for exceptions listed in the sample for vendors where it was disclosed that these customers had been audited by the department. The Taxpayer, however, contends that a more fair adjustment would be to remove the exceptions from the sample calculations.
The department addressed this issue in prior responses to other related businesses. In a previous audit, another taxpayer contested a sale held taxable in the audit in which the customer self-assessed the use tax. In Public Document 97-51 (2/10/97), copy provided by the auditor, the Tax Commissioner upheld the sales audit techniques, and the department found no basis for recalculating the error factor. As the auditor has followed the proper procedures in this instance, I find no basis for an adjustment.
Exceptions List (Pages 8 & 9)
1. Items 112 through 197: The Taxpayer states that its supplier was previously audited by the department and that these same items were assessed against them and paid by them. The Taxpayer contends that if any payment is to be made, that it is due from the supplier.
The sample computation is an effort to determine if the tax has been paid on certain transactions regardless if those transactions represent purchases or sales. In this instance, the auditor found that the vendor did not bill the Taxpayer for the sales tax on its purchases at issue, nor were there any records produced reflecting that the items included in the purchase sample were the same items included in the audit of the Taxpayer's vendor. Therefore, to remove the purchases in question from the sample base would skew the sample and nullify its validity. Without such proof, there is no basis to alter the current sample.
Conclusion
Based on all of the foregoing, and with the exceptions noted above, I find no basis to invalidate the sample calculations. However, I will allow the Taxpayer an additional 45 days to acquire the proper documentation not previously made available. The auditor will contact the Taxpayer to review all information necessary to allow for any adjustment to the audit.
If you should have any questions regarding this matter, please contact **** of the department's Office of Tax Policy at ****.
Sincerely,
Danny M. Payne
Tax Commissioner
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****
This is in reply to your letter in which you seek a correction of the department's retail sales and use tax audit assessment issued to ***** (the "Taxpayer"), for the period March 1997 through February 2000. Payments totaling have been received and applied against the audit deficiency, leaving a balance of $****.
FACTS
The Taxpayer is a manufacturer and disputes the sampling method used to determine the audit liability. The Taxpayer contends that the sample method used overstates its tax liability, and it has recalculated and paid the deficiency based on its own estimate. I will respond to the issues raised by the Taxpayer.
DETERMINATION
Sampling
Sampling is an audit technique of significant value that is widely used in both the public and private sectors for all types of audits where a detailed audit would not prove beneficial either to the auditor or the taxpayer. When sampling techniques are properly applied, the final result should be within a narrow percentage range of the actual amount that would be determined by a detailed audit.
Sampling is also used to determine tax liability when the volume of transactions is large. In this case, the Taxpayer's volume of sales made during the audit period made it impractical to perform a detailed audit. Using statistical sampling when there is a large volume of transactions reduces compliance costs for both the department and taxpayers without impacting on accuracy.
Every effort is made to objectively select the sample periods that are representative of the entire audit period and to reach a consensus with the taxpayer concerning the validity of the sample. In this case, the auditor used the block sampling method to determine if the Taxpayer was properly collecting the sales tax on its sales. The department has historically used this method when conducting audits. See Public Document's 89-177 (5/31/89) and 83-253 (12/9/83).
Exemption Certificates
In Virginia, all sales, leases and rentals of tangible personal property are taxable unless the contrary is established. Title 23 of the Virginia Administrative Code (VAC) 10-210-280 explains that the burden of proving that the tax does not apply rests with a dealer unless he takes, in good faith from the purchaser or lessee, a certificate of exemption indicating that the property is exempt under the law. A certificate that is incomplete, invalid, infirm or inconsistent on its face is never acceptable.
The regulation further provides that "[a]n exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate." Therefore, the seller must use reasonable care and judgement in selling tangible personal property exclusive of the tax, even when an exemption certificate from the purchaser is in his file. Furthermore, certificates of exemption obtained during or after an audit situation will be accepted only if the department can confirm that the customer's use of the certificate was valid and proper for the specific transaction.
Specific Issues
Exceptions List (Pages 1-3)
1. Items 1 & 2: The Taxpayer states that the listed customer is a seasonal purchaser, but that the audit included pool chemical sales in the sample which were then extrapolated over the entire audit period.
The customer is a recreation association purchasing the pool chemicals for its own use and consumption. In this case, both the auditor and the Taxpayer agreed to a review of three months that represented high, low, and average purchases. The auditor found recurring errors in which the Taxpayer failed to collect the tax on sales to customers. Based on this information, the auditor calculated an error factor for the for the audit period. A review of the sample months reveals that the customer purchased chemicals from the Taxpayer for two of the three months without payment of the tax.
The Taxpayer claims that the items at issue are not representative of the entire audit period. However, for an item to be removed from the audit sample, the Taxpayer must show that the transaction was isolated in nature and not a normal part of the Taxpayer's sales. While the Taxpayer claims that the sales at issue were to a customer who made limited or seasonal purchases, the Taxpayer does not furnish any proof that such sales were isolated in nature and not a normal part of the Taxpayer's sales. Although the Taxpayer may consider an item to be a non-standard transaction, this does not necessarily mean that the transaction constitutes a unique or isolated sale. The Taxpayer must be able to demonstrate that such sales are not a normal part of the Taxpayer's sales operations. There are likely similar transactions outside the sample period in which this customer or other customers have not paid the sales tax. Therefore, to remove the sales in question from the sample base would skew the sample and nullify its validity.
2. Items 3 & 8: In item 3, business with the customer was terminated after this sale, but the sampling process applies the sampled measure to the entire audit period. Item 8 relates to sales of a chemical to a church for use in melting ice.
The Taxpayer made three sales to the customer in item 3 during one of the sample months, and as provided in items 1 & 2, there are likely similar transactions outside the sample period in which these customers or other customers have not paid the sales tax. Accordingly, the auditor was proper in including item 3 in the sample calculations.
Regarding item 8, and as previously stated in the regulations, an exemption certificate cannot be used to make a tax-free purchase of any item of tangible personal property not covered by the exact wording of the certificate. In this instance the property sold is not used in religious worship services, or within the offices, meeting or counseling rooms, or other rooms in the public church buildings which are used in carrying out the work of the church and its related ministries. Accordingly, the auditor correctly held the items in the sample.
3. Items 6 & 7: The Taxpayer contends that exemption certificates were on file for these items, but that the items were not removed from the sample. The items are included in the sample and applied to all three years.
The auditor indicates that for item 6, the Taxpayer obtained exemption certificates at the conclusion of the audit. The Taxpayer was afforded an opportunity to secure exemption certificates from its purchasers in the event that the sales may have been exempt sales for resale. When a dealer is afforded a "second chance" to secure exemption certificates to support untaxed sales, the department's longstanding policy is to more closely evaluate the validity of the certificate because the Taxpayer did not originally rely on the certificate to make the exempt sale.
Code of Virginia § 58.1-609.3(2) provides an exemption from the retail sales and use tax for "machinery or tools or repair parts therefor or replacement thereof, fuel, power, energy, or supplies, used directly in ... manufacturing ... products for sale or resale." The term "used directly" is defined in Code of Virginia § 58.1-602 as "those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing ... process, but not including ancillary activities such as general maintenance or administration." (Emphasis added).
Interpreting the above statutes, Title 23 VAC 10-210-920(B)(2) [copy enclosed] provides for the following:
Items of tangible personal property which are used directly in manufacturing... are machinery, tools and repair parts therefor, fuel, power, energy, or supplies which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process. Convenient or facilitative items... or items that are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing ... (Emphasis added).
In this instance, the exemption certificate was not accepted because the product sold was a general maintenance supply rather than a disinfectant. Accordingly, as item 6 was a maintenance supply not covered by the exact wording of the exemption certificate, the auditor was proper in including the item in the audit.
With regard to item 7, a resale exemption certificate was presented by the Taxpayer. However, it was not clear to the auditor if item 8 was a purchase for resale or for the customer's own use and consumption. If the Taxpayer can clarify this transaction to show that the purchase was for resale, there is cause for an adjustment of the sample. Otherwise, there is no basis for a revision.
4. Item 12: Based on the auditor's comments, this item will be removed from the audit.
5. Items 13, 19, 20 & 21: The Taxpayer states that the customer accrued the tax on these purchases and that they should not be included in the sample.
In this case, the Taxpayer made untaxed sales to certain customers. It may be that these customers are industrial manufacturers, and, if so, these customers may have used the items either in an exempt or non-exempt activity. It is difficult, however, for the department to exempt such sales based on a seller's statements that a customer is purchasing items exempt of the tax. It is for these reasons that certificates of exemption and direct pay permits are so vitally important to retail sales and use tax transactions. However, in this instance, there were no copies of the customer's direct pay permits or any reference to a direct pay permit number in the Taxpayer's files. Accordingly, the auditor was correct in including these items in the sample.
However, if the Taxpayer can secure the direct pay permit number of this customer for verification by the auditor, I will allow for an adjustment of the sample.
6. Items 14 through 17: Taxpayer states that it took all precautions in following proper procedures in making sales to customers, and that proper certificates were on file.
The auditor's comments indicate that properly completed exemption certificates were on file. However, as previously stated, an exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate.
In this instance, the customer presented a manufacturer's certificate of exemption form ST-11. The exemption allows for the exempt purchase of industrial materials for manufacturing, processing, refining, or conversion into articles of tangible personal property for resale. The items at issue, non-disinfecting cleaner, hand soap, soap dispensers, and laundry detergent are not industrial materials and do not enter into the production of or become a component part of the finished product. Accordingly, the auditor was proper in holding the items in the sample.
7. Items 23 through 44: These items were sold exempt to the customer because the customer represented themselves as direct pay permit holders. The Taxpayer states that the customer self-accrued and paid the tax to the Commonwealth.
Comments by the auditor indicate that the Taxpayer did not have a copy of the direct payment permit, or the direct payment permit number. There was also no proof that the customer had accrued the tax and paid it to the department. Without such proof, there is no basis to allow for any adjustment. However, as previously provided, if the Taxpayer can secure the direct pay permit number of this customer for verification by the auditor, I will allow for an adjustment of the sample.
8. Items 47 & 48: Proper certificates on file.
An exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate. The items at issue are cleaning supplies and are similar to those in number 6. Accordingly, the auditor was proper in holding the items in the sample.
9. Items 53 through 61: Taxpayer states that it took all precautions in following proper procedures in making sales to customers, and proper certificates were on file.
The department's response is similar to the response in number 6. The auditor's comments indicate that properly completed exemption certificates were on file. However, as previously stated, an exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate. The items at issue are cleaning supplies that are not used in the production process. Accordingly, the auditor was proper in holding the items in the sample.
10. Items 63 through 89: These items were sold exempt to the customer since they represented themselves as direct pay permit holders.
The auditor's comments indicate that the Taxpayer did not have a copy of the direct payment permit, or direct payment permit number. Again, as previously stated, if the Taxpayer can secure the direct pay permit number of this customer for verification by the auditor, I will allow for an adjustment of the sample.
Exceptions List (Page 4)
1. The Taxpayer acknowledges credits given in the department's audit for exceptions listed in the sample for vendors where it was disclosed that these customers had been audited by the department. The Taxpayer, however, contends that a more fair adjustment would be to remove the exceptions from the sample calculations.
The department addressed this issue in prior responses to other related businesses. In a previous audit, another taxpayer contested a sale held taxable in the audit in which the customer self-assessed the use tax. In Public Document 97-51 (2/10/97), copy provided by the auditor, the Tax Commissioner upheld the sales audit techniques, and the department found no basis for recalculating the error factor. As the auditor has followed the proper procedures in this instance, I find no basis for an adjustment.
Exceptions List (Pages 8 & 9)
1. Items 112 through 197: The Taxpayer states that its supplier was previously audited by the department and that these same items were assessed against them and paid by them. The Taxpayer contends that if any payment is to be made, that it is due from the supplier.
The sample computation is an effort to determine if the tax has been paid on certain transactions regardless if those transactions represent purchases or sales. In this instance, the auditor found that the vendor did not bill the Taxpayer for the sales tax on its purchases at issue, nor were there any records produced reflecting that the items included in the purchase sample were the same items included in the audit of the Taxpayer's vendor. Therefore, to remove the purchases in question from the sample base would skew the sample and nullify its validity. Without such proof, there is no basis to alter the current sample.
Conclusion
Based on all of the foregoing, and with the exceptions noted above, I find no basis to invalidate the sample calculations. However, I will allow the Taxpayer an additional 45 days to acquire the proper documentation not previously made available. The auditor will contact the Taxpayer to review all information necessary to allow for any adjustment to the audit.
If you should have any questions regarding this matter, please contact **** of the department's Office of Tax Policy at ****.
Sincerely,
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner