Document Number
03-49
Tax Type
Retail Sales and Use Tax
Description
Bad debt deductions
Topic
Appropriateness of Audit Methodology
Basis of Tax
Collection of Tax
Date Issued
05-14-2003

May 14, 2003



Re: § 58.1-1821 Application: Retail Sales and Use Tax


Dear *****:

This is in response to your letter of April 3, 2003, seeking reconsideration of the Department's determination of May 29, 2002, issued to ***** (the "Taxpayer"). That prior determination upheld the retail sales and use tax assessed on the disallowed bad debt deductions claimed by the Taxpayer for the period September 1994 through August 1997.
FACTS

The Taxpayer disagrees with the Department's interpretation of Va. Code § 58.1621 as applied on Taxpayer-issued credit card accounts determined to be worthless. The Taxpayer maintains that the Department incorrectly demands that "payments on worthless consumer credit accounts must be applied to debts resulting from retail transactions prior to debts arising under the terms of a related consumer loan."

The Taxpayer also maintains that the Department has attempted to mandate "a new mechanical or computational requirement not found in the statute" that is "de facto rulemaking in violation of the State Administrative Process Act (the ‘APA’)." The Taxpayer further maintains that the Department "has altered the terms of a private contract between the borrower and lender" and, therefore, has "violated the Contracts Clause of ... both the Virginia and Federal Constitutions."
DETERMINATION

At issue is the proper interpretation of Va. Code § 58.1-621, which sets out the following bad debt provisions:

    • In any return filed under the provisions of this chapter, the dealer may credit, against the tax shown to be due on the return, the amount of sales or use tax previously returned and paid on accounts which are owed to the dealer and which have been found to be worthless within the period covered by the return. The credit, however, shall not exceed the amount of the uncollected sales price determined by treating prior payments on each debt as consisting of the same proportion of sales price, sales tax and other nontaxable charges as in the total debt originally owed to the dealer. The amount of accounts for which a credit has been taken that are thereafter in whole or in part paid to the dealer shall be included in the first return filed after such collection.

In the prior determination, the Department interpreted those bad debt provisions and concluded the following:
    • The consumer's debt to the taxpayer dealer is a liquidated sum that is fixed and determined at the time of sale. It may consist of taxable and nontaxable components plus the sales tax on the taxable components. Thereafter, any additional charges that may accrue on the consumer's account for such elements as late charges, interest, carrying charges, returned check charges, insurance on the item purchased or other fees are not part of "the total debt originally owed to the dealer" as that phrase is used in § 58.1-621. Notwithstanding any credit agreement between the dealer and the consumer that may require payments by the consumer to be applied first to such later-applied charges, when calculating the amount of bad debt credit that may be claimed, § 58.1-621 requires prior payments to be applied first to the original debt in "the same proportion of sales price, sales tax and other nontaxable charges as in the total debt originally owed to the dealer." This result, required by statute, cannot be varied by a contractual arrangement between the dealer and the consumer regarding later-applied charges.

Although you disagree with the above determination, I find that it is consistent with Va. Code § 58.1-621. Therefore, I am not persuaded by the additional arguments presented. Clearly, using the Taxpayer's method of applying payments -- first to finance charges and late fees (e.g., post-transaction charges) and then secondly to sales price -- results in an excessive bad debt deduction. As such, I must conclude that the Department has correctly interpreted the plain meaning of the statutory language set out by Va. Code § 58.1-621. Although you claim otherwise, the Department has not added requirements to the plain language of that statute.

You maintain that the Department has attempted to create a rule that "alters the understanding between the parties" to the Credit Agreement and would change the order in which the Taxpayer applies payments received on worthless accounts. I disagree. The Department's determination sets out the correct interpretation of Va. Code § 58.1-621 for the Taxpayer to use in computing its bad debt deductions for Virginia retail sales and use tax purposes. The payment procedure agreed upon between the Taxpayer and its credit account customers is a commercial arrangement that has nothing to do with the statutory mandates imposed on the computation of bad debt deductions for retail sales and use tax purposes. This is clearly not a case of the Department's ruling interfering with the contractual relations with its customers. Rather, this is a case of the Taxpayer seeking to nullify the effect of an existing statute by shackling the Commonwealth to the terms of the agreement with its customer, to which agreement the Commonwealth is not a party and has not given its consent. The Taxpayer cannot amend the statute with a customer financing agreement so as to unlock the door to the State Treasury for its own benefit.

Notwithstanding any contractual payment application, Va. Code § 58.1-621 requires dealers to take into account "prior payments on each debt" when determining the "uncollected sales price." That requirement clearly includes payments remitted on Taxpayer-issued credit card accounts determined to be uncollectible. Taxpayer elected to augment its retail business, choosing to offer financing to its retail customers through a Taxpayer-issued credit card. By that election, the Taxpayer may not rely upon the separate terms of the financing agreement between Taxpayer and its customers to override the plain language of the statute thereby shifting the Taxpayer's risk of loss on the independent financing transaction to the Commonwealth as an unwilling guarantor, all at the expense of the Commonwealth's clear statutory entitlement to retain so much of the retail sales tax previously remitted as equals the sales tax component of the customer's partial payments against "the total debt originally owed to the dealer." Va. Code § 58.1-621.

Administrative Process Act ("APA")

In regard to your claim that the Department's interpretation of Va. Code § 58.1-621 violates that APA because it "establishes a de facto rule" for applying payments first to the original debt in computing the bad debt deduction, your claim overlooks Va. Code § 58.1-203(C). This Code section provides that "[r]ulings in individual cases shall not be subject to the Administrative Process Act." The prior determination issued to the Taxpayer qualifies for treatment under that statute and, as mentioned above, is consistent with Va. Code § 58.1-621.

Audit sample

In regard to the ten-person audit sample, you maintain that "[i]t was never meant to be a 'test-period'." This is contrary, however, to the auditor's recollection of the events. According to the Department's auditor, the Taxpayer's representative suggested a ten-person sample after the Taxpayer was unable to provide the auditor with all of the documentation needed to support all bad debt deductions made for the entire audit period, the subsequent three-month sample period selected, or the last month of the audit period. I understand that the Taxpayer's representative indicated to the auditor that all bad debts are handled in the same manner and that a ten-person sample would be representative. I also understand that the Taxpayer selected the ten-person sample using small and large write-offs and all types of transactions for a representative sampling of the Taxpayer's bad debt deductions. For these reasons and the reasons set out in my prior determination, I must conclude that the ten-person sample was intended to be a test-period. The Department has never been unwilling to perform a more extensive sample if adequate and complete records existed.

For the reasons set out in my prior determination, I also cannot accept the alternative methods previously proposed by the Taxpayer for reducing the bad debt claims by 5.8% or 1.7%. The 5.8% alternative method does not apply prior payments in a manner consistent with Va. Code § 58.1-621. Although the 1.7% alternative method may be representative of the nontaxable charges from overall sales over a four-year period, it is not representative of the Taxpayer's failure to correctly compute its allowable bad debt deductions.
                      • CONCLUSION
    • Based on all of the foregoing, I find no basis to revise my original determination. Accordingly, the assessment is correct and remains due and payable. A consolidated bill, with interest accrued to date, will be mailed shortly to the Taxpayer. No further interest will accrue provided the outstanding assessment is paid within 30 days from the date of this letter. The Taxpayer should remit full payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Attn: *****, Richmond, Virginia 23230. If you have any questions concerning payment of the assessment, you may contact ***** at *****.

The Code of Virginia sections and regulations cited are available online in the Tax Policy Library section of the Department of Taxation's web site, located at www.tax.state.va.us. If you have any questions about this determination, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.

                • Sincerely,


                • Kenneth W. Thorson
                  Tax Commissioner


AR/45663R

Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46