Tax Type
Retail Sales and Use Tax
Description
Audit procedures; Method of calculating unreported sales
Topic
Collection of Delinquent Tax
Date Issued
06-21-1995
June 21, 1995
Re: §58.1-1821 Application: Retail Sales and Use Tax
Dear***************
This will reply to your letter of August 29, 1994 in which you, on behalf of your client,************** (the "Taxpayer"), seek correction of a sales and use tax assessment for the period of February, 1991 through January, 1994.
FACTS
The Taxpayer is in the fast food restaurant business. The Taxpayer was audited and assessed tax, penalty and interest based on discrepancies found in the Taxpayer's sales journals. The Taxpayer's monthly sales and use tax returns are prepared based on the information obtained in their monthly sales journals. The monthly sales journals are prepared based on the Taxpayer's daily activity sheets. In an effort to reconcile the daily activity sheets to the monthly sales journals, the auditor discovered that not all sales were carried over to the monthly sales journal, thereby resulting in an under-reporting of sales on the Taxpayer's monthly sales and use tax return.
The Taxpayer was able to provide the auditor with daily worksheets for certain months in 1991. Based on the information provided for 1991, the auditor was able to calculate the under-reporting of sales based on the discrepancies between the daily activity sheets and the monthly sales journal. The Taxpayer was unable to provide daily activity sheets for 1992, 1993 and 1994, therefore, the auditor used the cost-of-goods sold markup method to determine gross sales for these years. Once the monthly markup sales figures were calculated for 1992, 1993 and 1994, the auditor did a comparison on the actual gross sales reported on the Taxpayer's monthly returns and picked up the difference as unreported sales.
The Taxpayer is taking exception to the auditor's method of calculating unreported sales. The Taxpayer feels the industry standard does not accurately relate to their operation based on location of business, robberies and break-ins. Based on these factors, the Taxpayer feels the food purchases amount to be higher than normal, thus inflating sales when applying the cost-of-goods sold markup method.
DETERMINATION
Virginia Regulation (VR) 630-10-30 (copy enclosed) provides that every dealer liable for the collection and remittance of sales and use tax is required to keep and preserve for three years adequate and complete records necessary to determine sales and use tax liability. This regulation goes on to list what records must be retained.
When 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 tax liability. In audits where sales records are unavailable or incomplete, it is a common and accepted practice to project sales on a cost-of-goods sold markup method. In determining the cost-of-goods sold markup percentage, the department employs the Almanac of Business & Industrial Financial Ratios. This publication provides "average" ratios based on total "cost of operations" for the various industries. In the case of fast food restaurants, such factors as direct cost of operations, cost of goods sold, direct labor costs, separate operating expenses, and payroll are all taken into account in deriving the various ratios applicable to the food establishments.
According to the Almanac. the cost of operation factor for the retail food industry is 2.25. According to the Taxpayer's 1990 income tax return, the cost of operation factor is 2.35. However, according to the auditor, the Taxpayer's records were incomplete at best and the only verifiable "cost of operations" expense available was the "cost of goods sold". In an attempt to accurately and fairly derive a sales figure for those periods in which the Taxpayer's records were incomplete, the auditor applied a slightly higher mark-up factor of 2.5 to the single "cost of goods sold" figure available. Thus, the mark-up factor of 2.5 was utilized to obtain sales figures for 1992, 1993 and January 1994 (this mark-up was used due to the lack of other verifiable information such as direct cost of operations, direct labor costs, payroll, and separate operating expenses). It should also be noted that the auditor addressed part of the Taxpayer's concern by allowing a credit against cost of goods sold for break-ins experienced by the Taxpayer.
It is clear in this case, based upon the records available, that taxes collected "in trust" were underreported to the department. As complete records were not available, the department worked with the Taxpayer to develop reasonable estimates and based on this work, l believe that the liability resulting from this audit has been accurately and fairly calculated. Virginia Regulation (VR) 630-10-80.C.1 provides for the application of penalty to audit deficiencies and states, in part, "the application of penalty to audit deficiencies is mandatory, but its application may be waived at the discretion of the State Tax Commissioner based upon the extent of the dealer's compliance with requirements for collection and payment of sales tax and requirements for payment of use tax or good cause". Due to the fact the Taxpayer did collect the sales tax, held the tax "in trust" for the state, and did not remit all sales taxes due to the state, l find that the Taxpayer's compliance with the sales and use tax requirements does not merit the waiver of audit penalty.
It is also noted in your letter that the Taxpayer would welcome the opportunity to meet with representatives of the department. If the Taxpayer feels there is additional information supporting their claim, a member of my staff will be most happy to meet with them. Please contact******* Office of Tax Policy, at ********if a meeting is desired.
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- Sincerely,
Danny M. Payne
Tax Commissioner
- Sincerely,
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OTP/8437K
Rulings of the Tax Commissioner