Tax Type
Retail Sales and Use Tax
Description
Occasional sale; Gift certificates; Audit penalty; Compliance ratio
Topic
Collection of Delinquent Tax
Penalties and Interest
Property Subject to Tax
Date Issued
02-22-1999
-
February 22, 1999
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****
This is in response to your letter in which you seek correction of sales and use tax assessments issued to ***** (the "Taxpayer") for varying audit periods ending through April 1998.
FACTS
The Taxpayer operates as a fast-food retailer with several restaurant locations in Virginia. During a sales and use tax audit, the Taxpayer was assessed primarily for untaxed purchases. The Taxpayer contests the assessment associated with the purchase of three restaurants from ***** (the "Seller"). You maintain that this purchase is exempt under the regulations governing occasional sales. In addition, the Taxpayer protests the tax on the purchase of gift certificates and the penalty assessed on the use tax portion of the audits.
Each of these contested issues will be addressed as follows:
DETERMINATION
Occasional Sale Issue
The Taxpayer purchased three restaurants from the Seller in October 1995. At that time, the Seller owned and operated five restaurants. After the sale to the Taxpayer, the Seller continued in business with its remaining two restaurants. The Seller sold a fourth restaurant seven months later. Currently, the Seller remains in business with its one remaining location.
You contend that the sale of the three restaurants to the Taxpayer is an exempt occasional sale for the following reasons: (1) the Seller engaged in three or fewer sales in one calendar year; (2) the sale of equipment was not held or used by the Seller in the course of a registerable activity; and (3) the sale of the equipment and other assets constituted substantially all of the assets of the business locations.
Code of Virginia § 58.1-609.10(2) provides an exemption from the tax for an occasional sale as defined in § 58.1-602. That section defines an "occasional sale" as:
A sale of tangible personal property not held or used by a seller in the course of an activity for which he is required to hold a certificate of registration, including the sale or exchange of all or substantially all the assets of any business and the reorganization or liquidation of any business, provided such sale or exchange is not one of a series of sales and exchanges sufficient in number, scope and character to constitute an activity requiring the holding of a certificate of registration.
The exemption is addressed by the department in Title 23 of the Virginia Administrative Code (VAC) 10-210-1080. In part, the regulation defines an "occasional sale" to mean:
A sale of tangible personal property not held or used by a seller in the course of an activity for which he is required to hold a certificate of registration. The words "not held or used by a seller in the course of an activity for which he is required to hold a certificate of registration" mean that a registered dealer is not entitled to an occasional exemption solely by virtue of the fact that the article sold may be of a different class from the merchandise he/she regularly sells....
As a registered dealer operating five restaurants, the Seller was in the business of making retail sales of food and beverages. More to the point, l agree that the Seller did not normally sell restaurant equipment. However, that same restaurant equipment was used by the Seller in its registerable activity (i.e., the sale of prepared food). In this regard, the contested transaction is analogous to Example 2 set out in the regulation:
If Company B, which operates a hotel and holds a certificate of registration for collecting tax on room rentals, sells beds and mattresses used in the hotel, the occasional sale exemption is inapplicable since the property being sold is being used in the activity for which B is required to hold a certificate of registration.
Like the dealer in this example, the Seller used its restaurant equipment in the activity for which it was required to hold a certificate of registration.
You further contend that the sale of equipment and intangible assets constituted substantially all of the assets of the business locations. Had the Seller operated only one location, your conclusion would be correct. The Seller, however, was in the business of operating a chain of five restaurants. As such, the sale of three locations does not constitute the sale of all or substantially all of the Seller's assets. I have reached this same conclusion in numerous rulings and determinations involving similar situations. A representative sample of these is enclosed. Based upon this substantial precedent, the Seller in this case did not sell all or substantially all of its assets.
Accordingly, the assessment associated with the purchase of three restaurants from the Seller is correctly assessed. Keep in mind, however, the assessment extends only to the tangible personal property (e.a., furniture, fixtures, and equipment), but not to any intangible assets or real property.
Gift Certificates Issue
The Taxpayer purchases gift certificate coupons from an out-of-state printer. The price paid by the Taxpayer and the redeemable value (or face value) of the certificates are both $1.00. The printer ships the certificates to the Taxpayer, but forwards the $1.00 per certificate purchase price to the Taxpayer's franchisor. Further, the printer's charges for printing the certificates are paid by the franchisor.
The Taxpayer sells the certificates to customers (for a price of $1.00 per certificate). At this point, the certificates may be redeemed for food and beverages at the Taxpayer's locations or any franchisee location nationwide. The Taxpayer (and other franchisees) then return the redeemed certificates to the franchisor who reimburses the franchisees $1.00 for every $1.00 coupon they redeem.
The application of the tax to gift certificate transactions is set out in 23 VAC 10-210-670 and provides that the "sale of a gift certificate is not taxable. When the owner of a gift certificate redeems it, in whole or in part, for tangible personal property, the transaction is a taxable sale." I understand that the Taxpayer properly followed these procedures regarding the sale of gift certificates to its customers and the subsequent redemption of the certificates for food, drink, and other merchandise.
What is at issue is the Taxpayer's purchase of the gift certificates from the printer. Generally, such purchases are taxable. In effect, the purchase of a certificate (i.e., the actual printed form) is the purchase of a taxable administrative item. The resale exemption does not apply to this purchase because the sale of the certificate to a customer is not a taxable transaction.
In this case, however, the $1.00 cost price/face value of the gift certificate will eventually be returned to the Taxpayer by the franchisor. It does not appear that the contested purchase in this case is the purchase of taxable printing. Rather, the Taxpayer's purchase of each gift certificate (at $1.00 face value) is the nontaxable purchase of an obligation which will be redeemed by the franchisor. Accordingly, these transactions will be removed from the assessment. As a precaution, this determination is based on the observation that the Taxpayer is not purchasing printing. If, in subsequent periods, any part of the Taxpayer's payment to the printer is deemed to be a printing charge, such charge will be taxable to the extent that the printed property is delivered to Virginia.
Assessed Penalty
You request waiver of the penalty on the use tax portion of the assessment. You indicate that since the last audit was performed, the Taxpayer opened five new restaurants which put a heavy burden on the Taxpayer's office staff.
I understand that no penalty was assessed at the Taxpayer's new locations because the auditor treated these as the first audit of a new business. However, penalty was assessed on the untaxed purchases at the remaining three locations. Penalty was assessed because these locations had been audited twice before and the compliance ratios during the current audit period were below what is required to avoid penalty charges on third audits.
The application of audit penalty is addressed in 23 VAC 10-210-2032. As noted therein, penalty will generally be applied on third and subsequent audit unless the compliance ratios exceed 85% for use tax. I understand that the compliance ratios for the Taxpayer's three original locations were 14%, 39%, and 55%. Further, the regulation indicates that penalty will not be waived on second and subsequent audits for other than "exceptional mitigating circumstances." I appreciate that business growth places additional burdens on the Taxpayer's office staff. This condition, however, is not considered an exceptional mitigating circumstance as mandated in the regulation.
Summary
Based on this determination, the purchase of equipment and fixtures from the Seller is correctly assessed. The assessment related to the Taxpayer's purchase of gift certificates will be removed from the assessment. The penalty assessed on the use tax portion of the audit is upheld, but penalty will be reduced to reflect the removal of the gift certificate issue from the assessment.
The assessment will be returned to the audit staff to be revised in accordance with this determination. Because the assessments are fully paid, a refund will be issued to the Taxpayer as soon as practicable. If you have additional questions regarding this letter, please contact ***** in the department's Office of Tax Policy at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner