Could Virginia estimate a grocery store's taxable nonfood sales when the store had no records for most of the audit period?

Plain-English summary

Virginia upheld the reconstructed sales estimate because the grocery store had no records for 2009-2011 and did not prove the audit wrong. Dealers were required to preserve suitable sales and purchase records. When those records were unavailable, the Department could use the best information available.

With the store's approval, auditors observed all transactions on August 8 and August 24, 2012. They projected average daily nonfood sales into monthly amounts and compared those figures with the filed returns. A shopping test found that 6% of nonfood items had incorrect barcodes and were taxed at the reduced 2.5% food rate. Auditors also projected untaxed phone-card sales from the two observation days.

The Commissioner found that methodology reasonable. Because an assessment was presumed correct and the store offered neither supporting records nor a substantive explanation of error, it did not carry its burden of proof.

The tax estimate remained, but Virginia removed compliance and amnesty penalties that had been assessed in error on this first-generation audit. Financial hardship alone did not justify relief without financial statements; the store received 45 days to submit a business financial-information statement for a possible offer in compromise based on doubtful collectability.

What this means for you

• Missing sales records can permit the Department to reconstruct taxable sales.
• Observation days, barcode testing, and product-category projections may support an estimate.
• A general objection or hardship claim does not prove an assessment wrong.
• Penalty treatment can differ from the underlying tax determination.
• Collectability relief requires financial documentation and follows a separate process.

Common questions

Q: Why were two observation days allowed to affect the whole audit period?
A: The store lacked records, and the ruling found the agreed observation methodology reasonable under the best-information-available authority.

Q: What was the barcode issue?
A: The test found 6% of nonfood items were coded so they received the reduced 2.5% food-tax rate.

Q: Were all amounts upheld?
A: The tax estimate was upheld, but the compliance and amnesty penalties were removed.

Q: Did financial hardship cancel the assessment?
A: No. The store first had to provide financial statements for a doubtful-collectability review.

Citations and references

• Va. Code §§ 58.1-205, 58.1-618, 58.1-633, and 58.1-635.
• 23 VAC 10-210-470 and 23 VAC 10-210-2032.

Subject

Nonfood sales incorrectly taxed at the reduced food tax rate of 2.5%.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-145

Original ruling text

July 26, 2013

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

Dear *:

This is in reply to your letter in which you seek correction of the retail sales and use tax assessment issued to * (the "Taxpayer") for the period May 2009 through April 2012.

FACTS

The Taxpayer operates an independent grocery store. The Department's audit disclosed that the Taxpayer did not have any financial records for the years 2009, 2010 and 2011. The Taxpayer states that these records were destroyed in 2012. Because the Taxpayer did not have any records, the Department's auditors applied an alternative methodology to evaluate the Taxpayer's sales tax compliance. The Taxpayer disagrees with the methodology used by the Department's auditors to develop the assessment. The Taxpayer, however, does not offer any reasoning or explanation related to its disagreement but asks for an adjustment to the Department's assessment. The Taxpayer asserts that payment of such an amount would cause a financial hardship to the Taxpayer's business.

DETERMINATION

Estimate of Sales

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's records were unavailable, the Department's auditors conducted an observation of the Taxpayer's business. In such an observation, the Department's auditors positioned themselves at the Taxpayer's business and observed all of the sales transactions that were made during certain business days. In this instance, the auditors selected two days with the Taxpayer's approval, August 8, 2012 and August 24, 2012.

Based on the results of this observation, the auditors were able to determine average daily nonfood sales. These average sales were projected to determine monthly nonfood sales. A comparison of the monthly nonfood sales to the Taxpayer's monthly sales tax returns filed with the Department for the audit period disclosed that the Taxpayer underreported its monthly nonfood sales.

The Department's auditors also conducted a shopping test to determine if bar coding was properly applied on the Taxpayer's products for sale. It was determined that 6% of nonfood items did not have the correct bar coding and resulted in nonfood sales being incorrectly taxed at the reduced food tax rate of 2.5%. The 6% error rate on food sales was projected over the audit period to determine the underreported bar coded sales.

In addition, a review of phone card sales for the two observance days led to a projected monthly average on which the Taxpayer was not charging the sales tax. The Taxpayer was informed to begin charging the tax on such sales.

Based on the fact that the Taxpayer did not have any records and the observation methodology applied in this case, it was determined that the Taxpayer underreported its sales to the Department. After reviewing the information provided and the audit report, I find that the Department's methodology used to determine the audit liability was reasonable.

Virginia Code § 58.1-205 provides that any assessment of tax by the Department is deemed prima facie correct. The burden is on a taxpayer to prove the assessment is erroneous. Lacking the documentation to support its claim, the Taxpayer has not met the burden of proof in this case.

Penalty

Virginia Code § 58.1-635 mandates the application of penalty to tax deficiencies. Title 23 of the Virginia Administrative Code 10-210-2032 generally provides that penalty will not be assessed in first generation audits. Based on a review of the audit computations I find that the compliance and amnesty penalties were assessed in error. Accordingly, The Department's audit will be adjusted to remove the assessed penalties.

Financial Hardship

The Code of Virginia grants the Tax Commissioner the authority to accept an offer in compromise if the assessment is of doubtful liability or doubtful collectability. Information included in the Taxpayer's letter indicates that payment of the Department's assessment would cause financial difficulties. The Taxpayer, however, has not submitted any financial statements that reflect or verify an inability to pay the outstanding balance of the assessment. Without such information, the Department is unable to consider an offer in compromise based on doubtful collectability.

Accordingly, I have enclosed a Financial Information Statement for Businesses. This form will allow the Department to review and analyze the Taxpayer's financial situation. If the Taxpayer would like to pursue an offer based on doubtful collectability, it should complete this form and submit it to the Department along with a letter seeking waiver of the balance due based on doubtful collectability. Upon completion of the Department's review, a response will be issued based on the information presented.

The completed forms supporting the Taxpayer's claim of doubtful collectability should be sent to: Offer in Compromise Team, Collections Section, Virginia Department of Taxation, Post Office Box 1880, Richmond, Virginia 23218-1880. You may also contact a member of this team at (804) 367-8045. If the Department does not receive a completed form within 45 days of the date of this letter, it will be presumed that the Taxpayer will not submit an offer in compromise based on doubtful collectability, and collection action will resume on the outstanding balance of the assessment.

The Code of Virginia sections and regulations cited are available on-line in the Laws, Rules and Decisions section of the Department's website located at www.tax.virginia.gov . If you have any questions regarding this determination, please contact * of the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5333533362.Q