Estimated Assessment - Audit Methodology
April 25, 2025
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letter submitted on behalf of ***** (the “Taxpayer”) in which you seek correction of the retail sales and use tax assessment issued for the period September 2017 through April 2021.
FACTS
An audit was conducted on the books and records of the Taxpayer, a Virginia dealer, for the period at issue. When the Taxpayer failed to provide adequate information and documentation to audit staff, an assessment on untaxed sales, general expense purchases, and fixed asset purchases was made using available information. The Taxpayer filed an application for correction, contending that the estimates based on federal income tax returns were overstated.
ANALYSIS
The general provisions in Chapter 1 of Title 58.1 of the Code of Virginia govern all taxes administered by the Department. Virginia Code § 58.1-102 provides:
It shall be the duty of every taxpayer to retain suitable records and documents substantiating all information contained on any return required by this subtitle and any such other pertinent records or documents as the Tax Commissioner may require by regulation. The records and documents shall be preserved for a period of three years from the required date for filing a return to which such records or documents pertain.
Virginia Code § 58.1-103 further provides, “All records and documents required by this subtitle or by rule or regulation shall be available during regular business hours for inspection by the Tax Commissioner or his duly authorized agents.”
Virginia Code § 58.1-633 A, which specifically addresses the recordkeeping requirements for the Virginia retail sales and use tax, states that dealers are required to “keep and preserve suitable records of the sales, leases, or purchases, as the case may be, 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.” Title 23 of the Virginia Administrative Code (VAC) 10-210-470 similarly provides that a retail sales and use tax dealer is “required to keep and preserve for three years adequate and complete records necessary to determine the amount of tax liability.”
The purpose of a sales and use tax audit is for the Department to determine a dealer’s tax compliance. As provided in the aforementioned authorities, the Taxpayer is required to maintain proper records and provide them for inspection by the Department, such that the Taxpayer’s sales and use tax compliance can be determined. When the Taxpayer failed to provide the required documentation or records for the audit period at issue, Virginia Code § 58.1-618 authorized the Department to determine the existence of a liability and make an assessment based on information that may be available.
Sales
The auditor reconciled federal corporate income tax returns and Virginia ST-9 filings to verify gross sales, after making unsuccessful attempts to solicit the proper source documentation from the Taxpayer (e.g., point of sales records or internal accounting records). A variance was discovered for each year included in the audit period resulting in an exception measure for unreported sales.
General Expense Purchases
Using the same federal filings, the auditor calculated a purchases measure on which to assess use tax. However, the measure computation was based on cost of goods sold reported on the federal return. Because cost of goods sold are generally items purchased tax exempt for resale, such purchases are not rationally related to a computation of a use tax measure. Instead, the auditor could have used trade or business expense deductions (e.g., rents, advertising, and expenses listed as other deductions) reported on the federal returns in order to estimate a liability.
Fixed Asset Purchases
The auditor assessed an estimated amount of fixed asset purchases subject to Virginia use tax because no purchase records were provided by the Taxpayer. A review of the federal returns, however, indicates that the depreciation deduction decreased over the period of the audit. While not precluding the possibility of an asset purchase, the reduction, coupled with the already minimal amount of the depreciation, indicates a strong likelihood that no assets were purchased during the audit period.
DETERMINATION
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 was overstated.
However, although an estimated assessment is justified, the available records indicate better methodologies could have been employed in order to determine a liability. In accordance with this determination: (1) the portion of the assessment pertaining to verification of gross sales is upheld and (2) the portion of the assessment pertaining to fixed asset purchases is overturned.
The portion of the assessment pertaining to general business expense purchases will be subject to revision to limit the analysis of purchases to those deductions reported on the federal return that could have included taxable purchases. In analyzing these deduction accounts, a determination should be made as to the fact that the Taxpayer likely paid sales tax on at least some of its purchases, and a number of exempt service transactions could have been included in the purchases.
Based on information and evidence provided, the assessment will be returned to audit staff for review and adjustment. Once complete, a revised audit report and updated bill will be issued to the Taxpayer. No additional interest will accrue provided the outstanding assessment is paid within 30 days of the date of the bill.
The Taxpayer is hereby instructed to follow the statutes cited above and is considered to have been notified by the Department of its record keeping responsibilities. See Title 23 VAC 10-210-90. It is also the responsibility of the Taxpayer to stay current regarding any and all changes to Virginia law that may affect its tax obligations. See Public Document (P.D.) 09-118 (7/31/2009) and P.D. 21-63 (5/18/2021). Continued failure to preserve and provide required records could result in assessments, including penalties, in future audits.
The Code of Virginia sections and regulations cited are available online at law.lis.virginia.gov. The public documents cited are available at tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy and Legal Affairs, Tax Adjudication and Resolution Division, at ***** or *****@tax.virginia.gov.
Sincerely,
James J. Alex
Tax Commissioner
Commonwealth of Virginia
AR/3997.Z