April 6, 2020
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letter submitted on behalf of ***** and *****, collectively (the “Taxpayer”), in which you seek correction of the retail sales and use tax assessments issued for the period January 2013 through June 2016 and January 2014 through June 2016. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer operates two restaurants in Virginia, ***** (Location 1) and ***** (Location 2). As a result of the Department’s audit, assessments were issued to Location 1 and Location 2 for tax, penalty, and interest for underreported sales and nonfiler periods.
The Taxpayer claims that both locations are small, staffing only one or two employees with no waiter service. The Taxpayer maintains that it has a limited dining area that offers a small buffet for lunch and dinner with average sales being $5 to $8. Based on these facts, the Taxpayer claims that the audit assessments overstate the Taxpayer’s liability because the Taxpayer is not making the level of revenues to justify the assessments.
Further, the Taxpayer claims that the 2013 income tax return used to estimate the audit liability reported inaccurate sales. The Taxpayer provides a copy of its 2014 and 2015 income tax returns and a schedule of sales reported to the locality in Location 1 and claims these documents more accurately reflect the Taxpayer’s sales. The Taxpayer requests that the audits be adjusted to reflect the gross receipts reported on the 2014 and 2015 income tax returns. Lastly, the Taxpayer maintains that both locations have sustained major financial losses since their inception.
DETERMINATION
Dealer Records
Virginia Code § 58.1-633 provides that every dealer required to make a return and collect sales tax “shall keep and preserve suitable records of the sales, leases, or purchases . . . taxable under this chapter, and such other books of account as may be necessary to determine the amount of tax due hereunder, and such other pertinent information as may be required by the Tax Commissioner.” The record keeping requirements are set out in Title 23 Virginia Administrative Code (VAC) 10-210-470.
When a dealer fails to maintain adequate records, the Department is authorized by Virginia Code § 58.1-618 to use the best information available to reconstruct a dealer's sales and purchases to determine whether a tax liability exists. The Taxpayer failed to maintain, or failed to furnish, adequate records to determine the actual sales during the audit period. In this instance, the auditor used the Taxpayer's 2013 for Location 1 and the 2014 income tax returns on file with the Department to estimate the audit liability. I will address the audit methodology used by the auditor below.
Audit Methodology for Location 1
In this instance, the Taxpayer provided no documentation for the audit period to verify sales. The only information available was 2013 and 2014 federal income tax returns on file with the Department. When compared, the sales reported on the Taxpayer's 2014 federal income tax return were 82% below the gross revenues reported on the 2013 federal income tax return. Although the Taxpayer reported gross revenues on its 2013 federal income tax return, no sales tax was reported to the Department. The auditor also found inconsistencies between the gross revenues reported on the 2014 federal income tax return and sales reported to the Department. Because of the inconsistencies in reporting sales, the auditor conducted a sales analysis of four comparative businesses within the same geographical location of the Taxpayer. The revenues reported on the Taxpayer’s 2013 income tax return were less than but comparable to the sales reported by the similar businesses. Therefore, the auditor determined that the 2013 federal income tax return was the best information available to estimate the audit liability.
For 2013, the auditor listed the sales reported on the 2013 federal income tax return filed by the Taxpayer. For 2014, the auditor adjusted the 2013 sales by a 5.7% decrease based on the analysis of the comparable businesses. For 2015, the 2014 sales were adjusted by a 4.08% increase in sales shown by the comparable businesses. The 2016 sales are based on the 2015 estimated sales.
Because the Taxpayer did not provide sufficient records to determine sales, the 2013 federal income tax return was the best available information to estimate the Taxpayer's sales tax liability
Audit Methodology for Location 2
Location 2 operates under a separate federal identification number. Six months after beginning the audit of Location 1, the auditor discovered that the Taxpayer owned and operated Location 2. The Taxpayer had no suitable records available for review to determine sales. In addition, the Taxpayer did not file any sales and use tax returns during the first 24 months of the audit period. It is my understanding that the Taxpayer initially denied any relationship with Location 2 until the auditor provided the Taxpayer with a copy of the 2014 income tax return filed by the Taxpayer.
The auditor requested but was not provided any records to verify revenues reported on the 2014 federal income tax return. When the auditor discussed performing an observation, the Taxpayer did not agree with the auditors being at the restaurant during business hours. For these reasons and because the Taxpayer could not verify the gross receipts reported on the 2014 income tax return, the auditor estimated the audit liability using a cost of sales markup method.
For 2014, the auditor used the cost of sales markup of 28% based upon the 2013 federal income tax return for Location 1 and applied the same markup to the cost of sales reported on the 2014 income tax return for Location 2 to estimate the sales. For 2015, the auditor adjusted the 2014 estimated sales by the 4.08 % sales increase determined in the comparison of the four similar restaurants. The 2016 sales are based on the 2015 estimated sales.
Shortly after being provided with the estimated assessments, the Taxpayer provided the auditor two notebooks with hand written daily sales totals and some daily register tape totals. The auditor explained that the register tapes provided were not sufficient to determine high, low and average sales and the hand written daily sales totals could not be verified. Therefore, the 2013 federal income tax return for Location 1 was the best information available to estimate sales for Location 2.
Burden of Proof
Virginia Code § 58.1-205 provides that any assessment of tax by the Department is deemed to be prima facie correct and that the burden is on the taxpayer to prove the assessment is erroneous or incorrect. In this instance, the Taxpayer has not provided documentation to support its contention that the assessment of tax is incorrect. Further, the Taxpayer provided no documentation with its appeal to verify any of the sales claimed on the income tax returns provided. Therefore, the Taxpayer has not met the burden of proof requirement.
The auditor's methodology is consistent with prior determinations issued by the Department in which estimated assessments were upheld because the taxpayers' records were incomplete. In Public Documents 97-35 (1/27/97), 97-215 (5/12/97) and 98-87 (5/8/98), the taxpayers lacked complete records at the time the audits were conducted. As a result, the Department's auditors used the best information available at the time the audits were being conducted to estimate the taxpayer's sales and use tax liability.
Accordingly, I find that the audit methodology in this instance is reasonable and I find no basis for an adjustment of the tax assessments.
Compliance Penalty
Virginia Code § 58.1-635 mandates the application of penalty to tax deficiencies. Title 23 VAC 10-210-2032 generally provides that a penalty will not be assessed in first generation audits. However, the regulation sets out an exception to this rule that when an audit by the Department discloses that the sales tax has been collected but not remitted, the penalty will apply.
In this first audit of the Taxpayer, the auditor's computation of the compliance penalty for tax collected but not remitted was based on an estimation of the Taxpayer's sales rather than actual sales reflecting taxes collected but not remitted. An estimate, while authorized to determine a tax liability, does not provide a basis of proof that the Taxpayer actually collected the sales tax and failed to remit such tax to the Department. Accordingly, and under the facts in this case, I find cause for a waiver of the assessed compliance penalty.
Financial Hardship
Virginia Code § 58.1-105 B grants the Tax Commissioner the discretionary authority to accept an offer in compromise if the assessment is of doubtful liability or doubtful collectability.
The Taxpayer indicates that it is experiencing financial difficulties. As such, the Taxpayer may wish to request an offer in compromise based on doubtful collectability. The Taxpayer must present evidence of doubtful collectability to support a claim of financial hardship. If the Taxpayer wishes to pursue a settlement based on doubtful collectability, please complete and return the enclosed OIC - Fee and OIC B - 3 forms to: Tax Commissioner, Virginia Department of Taxation, Post Office Box 2475, Richmond, Virginia 23218-2475. These forms will allow the Department to review and analyze the Taxpayer’s financial situation. Upon completion of the Department’s review, a response will be issued based upon the information provided.
CONCLUSION
The audit will be adjusted to remove the assessed penalty. Regarding the offer in compromise based on financial hardship, if the Department does not receive the completed forms within 30 days of the date of this letter, it will be presumed that the Taxpayer will not submit an offer and a revised bill, with interest accrued to date, will be mailed to the Taxpayer. No additional interest will accrue provided the outstanding assessment is paid within 30 days of the date of the bill.
The Code of Virginia sections, regulation and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions about this determination, please contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1067.T