Tax Type
Individual Income Tax
Description
Operates a restaurant as a sole proprietor, underreported sales
Topic
Appropriateness of Audit Methodology
Collection of Delinquent Tax
Date Issued
08-24-2004
August 24, 2004
Re: § 58.1-1821 Application
Retail Sales and Use Tax - *****
Individual Income Tax - *****
Dear *****:
This will respond to your letter in which you seek correction of the sales and use tax assessment issued to your client, ***** (the "Taxpayer"), for the period September 1997 through December 2000, and the resulting individual income tax assessment issued to ***** (the "Proprietor") for the taxable years ended December 31, 1999 and December 31, 2000. I apologize for the delay in the Department's response.
FACTS
The Proprietor owns and operates a restaurant as a sole proprietor. The Department conducted a sales and use tax audit for the period September 1997 through December 2000. The Department determined that the Taxpayer did not have adequate sales records to substantiate the amount of sales reported. The auditor utilized the cost-markup method to estimate taxable sales for the audit sample period.
Utilizing standards provided by the National Restaurant Association, the auditor compared reported sales to the cost of goods sold to determine underreported sales. During the audit, the Taxpayer provided the cost and sales price information for each menu item, but did not provide a breakdown on which to determine a composition of daily sales. The markup used for the audit period was based on that reported by the Taxpayer from September 1997 through April 1998. The underreported sales were used to generate an assessment for sales and use tax for the audit period. The auditor also used the underreported sales to adjust sales reported on Schedule C of the Proprietor's 1999 and 2000 individual income tax returns, resulting in assessments of additional income tax and interest.
The Taxpayer contests the auditor's methodology for calculating sales, maintaining that the method used involves assumptions that overstate the sales tax liability and, in turn, the Proprietor's individual income tax liability. Further, you state that the Taxpayer's records had been properly maintained, but were destroyed in a flood. The Taxpayer also asserts that gross sales figures reported included sales tax for purposes of determining the audit liability.
DETERMINATION
Retail Sales and Use Tax
Title 23 of the Virginia Administrative Code ("VAC") 630-10-30 provides, in part, that every dealer liable for the collection and remittance of sales and use tax is required to keep and preserve for at least three years adequate and complete records necessary to determine its sales and use tax liability.
When complete records are not available for inspection and examination by the Department in the course of an audit, the auditor must resort to other measures to determine the actual tax liability. In such instances, the Department is authorized under Va. Code § 58.1-618 to estimate the tax liability and assess the tax estimated to be unpaid. This statute deems such estimated assessments to be prima facie correct. In this case, the auditor established cost of goods sold to percentages based on known purchase prices and known selling prices. Upon being presented with additional information, the Department revised the audit to reflect a more accurate cost of goods sold.
You assert that the Taxpayer's sales to cost of goods sold ratio was higher than the national average because it was in an economically depressed area and it initially maintained a lower markup to establish itself in the area. You state that the Taxpayer's costs were also higher than the national average because it purchased a significant quantity of perishable foods from local retail grocery stores rather than from traditional wholesale channels.
The Taxpayer provided menus from other restaurants as evidence that its prices were lower than other restaurants in the region. The auditor noted, however, that the menus were of little comparative benefit for purposes of supporting a different cost markup without corresponding information, such as portion size and the composition of sales by menu.
As the Taxpayer failed to maintain adequate records during the audit period to substantiate its actual tax liabilities, the Department used the available records for the period in question to estimate the Taxpayer's liabilities. In regard to the Taxpayer's request for a different markup factor, the Taxpayer has not provided evidence to refute the markup used in the audit. In fact, the auditor adjusted the markup factor when the Taxpayer located additional records during the course of the audit.
Based on the foregoing, and absent evidence to the contrary, I find no flaw with the audit methodologies and the resulting markup factors applied in this case and, therefore, find no reason to revise the audit findings. Accordingly, the sales and use taxes assessed to the Taxpayer are valid.
With respect to overreporting, a representative from the ***** Office will contact you so that you may show evidence of such overreporting during the audit period or evidence of an error in computation of the cost of goods ratio. After the auditor's review is completed, the audit will be revised as warranted and a revised audit report will be issued.
Individual Income Tax
The 1999 and 2000 individual income tax assessments for additional tax and interest were issued as a result of the additional income identified in the audit of the Taxpayer. In accordance with the determination set forth above, the Taxpayer's 1999 and 2000 individual income tax assessments will be revised in conjunction with the revisions, if any, to the sales and use tax audit. If warranted, a revised audit report will be issued.
The Code of Virginia sections and regulations cited are available on-line in the Tax Policy Library section of the Department's web site, located at www.tax.state.va.us. If you have any questions regarding this determination, please contact ***** in the Office of Policy and Administration, Appeals and Rulings at *****.
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- Sincerely,
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Kenneth W. Thorson
Tax Commissioner
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AR/41251E
Rulings of the Tax Commissioner