Could a restaurant overturn a reconstructed sales-tax audit after it deducted voluntary gratuities twice and disputed overpayment credits?

Subject

Restaurant audit reconstruction was upheld after gratuities were deducted twice

Plain-English summary

Virginia upheld a restaurant's sales-tax audit after finding that the restaurant repeatedly deducted voluntary gratuities twice when computing taxable sales. The issue surfaced when the restaurant requested a refund and the Department reviewed its returns. The audit then assessed tax on underreported sales and untaxed assets, with penalty on tax collected but not remitted.

Because the restaurant's calculations were consistently wrong, the auditor reconstructed taxable sales from the best information available. The auditor began with tax collected, subtracted local meals tax shown on the locality returns, compared the result with payments in the Department's records, and divided by the 5% rate used for the audit period. The calculation also accounted for penalty, interest, and the dealer's discount.

The restaurant did not provide evidence that this method was unreasonable. Virginia therefore upheld the assessment, applied the state overpayment credits it could verify plus refund interest, and directed the restaurant to seek any refund of locally paid tax from the locality itself.

What this means for you

• Dealers must keep records sufficient to determine taxable sales and purchases.
• Repeated return errors can lead Virginia to reconstruct liability from the best available information.
• A taxpayer challenging an estimated method needs evidence showing why the reconstruction is unreasonable.
• State and local payments must be reconciled with the government that actually received them.
• Voluntary gratuities should not be deducted twice when computing taxable sales.

Common questions

What error caused the underreporting?

The restaurant deducted voluntary gratuities from gross sales and then deducted them again in taxable-sales calculations or as exempt sales.

How did the auditor reconstruct taxable sales?

The auditor used tax collected, removed the local meals-tax amount, compared state payments, and divided the result by the applicable 5% rate.

Were any overpayment credits allowed?

Yes. The Department applied the credits its accounting records confirmed and calculated refund interest against the outstanding liability.

Why was no state credit given for alleged local overpayments?

Those amounts had been paid to the locality rather than the Department, so any refund had to be requested from the locality.

Citations and references

• Va. Code §§ 58.1-633 and 58.1-618.
• 23 VAC 10-210-470.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-119

Original ruling text

July 1, 2010

Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear *:

This will reply to your letter in which you seek correction of a retail sales and use tax assessment issued to * (the "Taxpayer") for the period August 2006 through March 2008. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer, a restaurant, contacted the Department seeking a refund for taxes overpaid to the Department. While verifying the refund claim, the auditor found that the Taxpayer had consistently made errors in calculating taxable sales when filing its monthly sales tax returns. The error resulted when the Taxpayer deducted voluntary gratuities from gross sales and then deducted them a second time, either in the computation of taxable sales or as exempt sales. Therefore, the auditor conducted a sales and use tax audit to determine whether a tax liability exists. As a result of the Department's audit, the Taxpayer was assessed the tax on underreported sales and untaxed assets. Penalty was applied to tax collected and not remitted.

The Taxpayer disagrees with the auditor's computations and claims that credit was not given in the audit for the overpayment of tax, penalty and interest paid to the Department and to the * Commissioner of the Revenue (the "Locality"). The Taxpayer claims that the omission of these credits represents double taxation.

DETERMINATION

Virginia Code § 58.1- 633 states 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 requirement is further explained in Title 23 of the Virginia Administrative Code 10-210- 470.

When a dealer fails to maintain adequate records, the Department is authorized by Va. Code § 58.1- 618 to use the best information available to reconstruct a dealer's sales or purchases to determine whether a tax liability exists.

Because the Taxpayer consistently made errors in calculating taxable sales, the auditor reconstructed the tax liability based on tax collected. To determine the retail sales and use tax paid, the auditor deducted from the total tax collected the meals tax paid to the Locality according to the meals tax returns filed by the Taxpayer. The auditor compared the sales tax collected and the tax payments made according to the Department's records. The auditor divided the results by 5% to determine taxable sales for the audit period. The auditor calculated the audit liability taking into consideration penalty, interest, and the dealer's discount.

In this instance, the auditor relied upon the best available information to reconstruct taxable sales to determine the audit liability. The Taxpayer has not provided any documentation or evidence to prove that the method applied in this case is unreasonable. Based on the foregoing, and absent evidence to the contrary, I find that the audit methodology was properly applied. Accordingly, there is no basis to revise the audit assessment.

Regarding the overpayments, the auditor found that the Department's accounting system adjusted two sales and use tax returns that resulted in a total credit of *, ( and **). Based on the Department's records, the auditor was unable to confirm the remaining overpayments claimed by the Taxpayer.

Regarding the Taxpayer's argument that credit should be given in the audit for taxes overpaid to the Locality, these taxes were paid to the Locality and were not remitted to the Department. Therefore, the Taxpayer should seek a refund from the Locality for any taxes that may have been overpaid to such Locality.

CONCLUSION

Based on the above determination, the assessment is correct. The Taxpayer acknowledges that the * credit was applied to the final audit report. According to the Department's records, the credit for *** was outstanding and has been applied to the bill. Refund interest accrued on the overpayments will be calculated and applied to the outstanding liability. An updated bill, with interest accrued to date, will be sent to the Taxpayer. No additional interest will accrue provided the outstanding balance is paid within 30 days from the date of the bill.

The Code of Virginia sections and regulation cited are available on-line at www.tax.virginia.gov in the Tax Policy library of the Department's web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Linda Foster

Deputy Tax Commissioner

AR/1-3152798174.T