Tax Type
Retail Sales and Use Tax
Description
Audit sample techniques; "Gross-up" method; Overcollection of tax; Multistate building supply retailer
Topic
Collection of Delinquent Tax
Date Issued
03-22-1994
March 22, 1994
Re: §58.1-1821 Application: Retail Sales & Use Tax
Dear********
This will reply to your letter of December 21, 1992 and your meeting with members of my staff on March 30, 1993 concerning the sales and use tax audit assessments of ******** (the "Taxpayer") for the periods December 1, 1986 through September 30, 1991 .
FACTS
The Taxpayer is a multistate retailer of building supplies. Several of its stores were audited, and audit assessments were generated using the department's sampling procedures. The Taxpayer contests the sampling procedures stating that the samples were not representative of the period audited. In addition, the Taxpayer has raised other issues which will be addressed separately.
DETERMINATION
Sample Method
The Taxpayer contends that the sample periods selected in the audits were not representative of the entire period in that they were not based on a random selection method. Further, the sample periods do not allow for factors such as seasonal business patterns, changing weather conditions, changing customer base, and changing economic conditions.
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 client. When sampling techniques are understood and properly applied, the final result should be within a narrow percentage range of the actual amount that would be determined by a detailed audit. The courts have held that a tax assessment issued by the proper assessing authorities is prima facie correct and that the burden of evidence is upon the taxpayer to prove otherwise. Please see the enclosed opinion from the Office of the Attorney General dated January 3, 1975 supporting the department's use of the sample technique.
The department has historically used the block sampling method when conducting audits. Every effort is made to objectively select the sample periods that are representative of the period being audited and to reach a consensus with the taxpayer concerning the validity of the sample. We have found this approach to be expedient, as well as equitable, to both the taxpayer and the Commonwealth.
Before requiring that a detailed audit be conducted or a sample period be adjusted or extended, the Taxpayer must provide evidence that the existing sample is not representative of the audit period as a whole.
Computation of Error Factors in Sample
In performing the audit, the sales deficiency was computed using gross sales as a base to extrapolate the results of the sample, whereas, the Taxpayer contends that using exempt sales would generate a more accurate result. In addition, the purchases deficiency was computed by using gross sales as the base to extrapolate the results of the sample. The Taxpayer contends that using a purchase base is more appropriate than using a sales base when computing a purchase deficiency.
When auditing sales, both taxable and exempt sales are subject to review in the audit. Obviously, exempt sales are audited to verify if the sales are, in fact, exempt. However, taxable sales are also subject to review to ensure that the Virginia tax was charged for Virginia sales. This review is especially important in stores located close to the geographical boundaries of Virginia, since it is possible to charge another state's tax on a sales transaction which should be taxed in Virginia. In that both taxable and exempt sales are subject to review during an audit, it is not inappropriate to extrapolate the sample based on gross sales instead of exempt sales.
In conducting an audit of purchases, it is often difficult for a taxpayer to provide purchase information on which to extrapolate the results of a sample. Therefore, when increases and decreases in gross sales vary directly with purchases, the use of gross sales to extrapolate the results of a purchase sample is an acceptable audit procedure. However, if the Taxpayer can provide purchase information appropriate for extrapolating the results of the purchase sample is provided, such information will be utilized to extrapolate the results of a sample.
Overcollection of Tax
Virginia Regulation (VR) 630-10-24(D) provides that:
Any dealer who collects tax in excess of a 4.5% rate or who otherwise overcollects the tax, ... must remit any amount overcollected to the state on a timely basis. (Emphasis added.)
The term "otherwise overcollects the tax" includes situations where a taxpayer erroneously collects from a Virginia customer the tax for another state when the Virginia tax should have been collected. In such instances, the taxpayer becomes liable to Virginia for the tax erroneously collected and remitted to the other state.
In these circumstances there is a possibility that the Taxpayer can obtain a refund from the states for which the tax was erroneously collected and remitted. Furthermore, upon evidence that the overcollected tax has been remitted to your customers, the department will allow the appropriate credit or issue a refund including applicable interest.
Gross Up Method
You contend that the method used to compute the tax overstates the sales price of items sold. The "Gross Up" method is used by the department as a convenient method to generate an audit report which reflects the tax that the Taxpayer erroneously collected and remitted to another state. Using this method, the sales price on an invoice is increased to a taxable measure that, when the Virginia tax rate is applied, would result in the other state's tax that was charged. Generally, this taxable measure is computed by dividing the other state's tax amount shown on an invoice by the Virginia tax rate. The Virginia tax rate is then applied to the taxable measure in determining the amount of tax to be assessed in the audit. In instances where the tax rate of the other state is higher than the tax rate of Virginia, the taxable measure will exceed the actual sales price on the invoice.
There are alternatives to using the "Gross Up" method. For example, the audit could be computed using the actual invoice sales price to compute the Virginia sales tax. Then the difference between the Virginia tax and the other state's tax could have been added to the assessment. Another alternative would be to adjust the audit program to compute the tax at the tax rates of the other states, and assess accordingly. However, the use of these alternatives would generate the same tax assessments as the "Gross Up" method. Furthermore, this method has long been used by the department to compute the tax of other states erroneously collected from Virginia citizens.
Border State Audits
Some of the Taxpayer's stores are located in states that border Virginia, and often sales are made to customers located in Virginia. When a sales invoice shows a Virginia mailing address without charging the Virginia tax, the invoice was held taxable in the audit as being delivered into Virginia. The Taxpayer contends that these sales could have been picked up by the customer in the out-of-state store or delivered to a job site or other location outside of Virginia.
VR 630-10-51 states in part that the sales and use tax, "[D]oes not apply to sales of tangible personal property in interstate or foreign commerce." However, the regulation provides that:
-
- A sale in interstate commerce occurs only when title or possession to the property being sold passes to the purchaser outside of Virginia and no use of the property is made within Virginia.
The burden of proof is on the Taxpayer to provide documentation to verify that the possession of tangible personal property sold to customers occurred outside of the Virginia. The fact that a sales invoice does not show shipping charges is not, in and of itself, proof that merchandise was not shipped to Virginia. For example, a company can agree with its Virginia customer that if the customer purchases a large quantity of merchandise, the company would pay the freight for the customer. In this instance, shipping charges would not be billed on the sales invoice, yet the merchandise would be shipped to Virginia and be subject to the Virginia tax.
Labor Charges
VR 630-10-37, in accordance with Va. Code §58.1-603 and the definitions of "sale at retail" as set forth in Va. Code §58.1-602, provides that:
-
- An operation which changes the form or state of tangible personal property is fabrication.... A person regularly engaged in the fabrication of tangible personal property for sale at retail must collect and pay the tax on the sales price of the property.... The tax applies to the total charge for the fabrication of the tangible personal property on a special order for a consideration, including labor, even if charges for labor are separately stated. The tax applies to the for the fabrication of tangible personal property for users of consumers who furnish, either directly or indirectly, the
The department has traditionally held that tangible personal property which is cut, sawed, shaped, bent, threaded, welded, bored, drilled, punched, machined, sheared, or otherwise subject to an operation which changes the property's form or state is considered to be "fabricated." Such operations are deemed to represent a taxable service in accordance with the above regulation, notwithstanding the fact that the materials used in the work may have been furnished by the customer.
Subdivision 2 of Va. Code §58.1-609.5 exempts, "[a]n amount separately charged for labor or services rendered installing, applying, remodeling or repairing property sold." Therefore, repair or remodeling labor separately stated on an invoice is not subject to the tax.
Transportation Charges
The Taxpayer contends that the transportation charges associated with certain purchases are exempt pursuant to VR 630-10-97.1.
While VR 630-10-97.1 provides for an exemption for separately stated transportation charges, VR 630-10-107 further provides that transportation charges billed in conjunction with handling charges, are subject to the tax. Therefore, to the extent that shipping and handling charges are billed on purchase invoices as one charge, the entire shipping and handling charge is subject to tax.
Exemption Certificates
Va. Code §58.1-623 provides that:
-
- All sales or leases are subject to the tax until the contrary is established. The burden of proving that a sale, distribution, lease, or storage of tangible personal property is not taxable is upon the dealer unless he takes from the taxpayer a certificate to the effect that the property is exempt under this chapter.
VR 630-10-20, additionally, provides that an exemption certificate which is incomplete, invalid, infirm, or inconsistent on its face is never acceptable, either before or after notice. If the Taxpayer is provided a certificate from the customer which is incomplete, the Taxpayer should seek to obtain a completed certificate. If the customer does not provide a completed certificate, the Taxpayer must charge the tax on the transaction.
I find that the auditors allowed sufficient time to obtain completed exemption certificates where the exempt status of the customer or the transaction was in question.
Missing Invoices
The Taxpayer states that they were unable to furnish sales invoices for a small number of transactions. As a result, the sales price shown on these invoices was obtained from other accounting records and included in the sample. The Taxpayer contends that instead of including the entire sales price of these invoices in the sample, the taxable portion of the sales price should be estimated by prorating the sales price by an appropriate taxable percentage.
When conducting sampling procedures, it is important that all items in the sample are available for examination. If an item is not available for examination, the burden of proof is on the taxpayer to provide other corroborating evidence to verify that the items are exempt from taxation. Without this evidence, the department must conclude that these items are taxable.
You proposed an offer in compromise to settle this case as an alternative to having the department's auditors make a detailed examination of each issue addressed herein. While I agree that a settlement is the most expeditious manner in which to bring this matter to a resolution, I find the amount of the offer you have submitted to be unacceptable. However, I will allow an additional 30 days from the date of this letter for you to respond to the counteroffer made by my Tax Policy staff on February 25, 1994.
Sincerely,
Danny M. Payne
Acting Tax Commissioner
OTP/6615N
Rulings of the Tax Commissioner