Could a drilling contractor overturn a consumer use-tax sample because a new business line caused many untaxed purchases?

Plain-English summary

Virginia upheld the auditor's one-year purchase sample but removed five documented asset items from the assessment. The drilling contractor argued that many exceptions came from a new line of business requiring out-of-state purchases, making the sample unrepresentative.

The auditor had already detailed purchases of pipe from one large vendor and kept other purchases in the sample because they were normal and recurring. Sales were used to extrapolate the error factor because the contractor did not provide requested purchase information. The Department found no proof that this method was flawed.

The contractor separately proved that three well-drilling vehicles qualified for exemption and that sales tax had already been paid on two other asset purchases. Those five line items were removed, and a revised bill would reflect the remaining tax and interest.

What this means for you

• A new activity does not invalidate an audit sample when the sampled purchases are recurring and representative.
• Challenge sampling with records and a specific methodological showing, not a general assertion.
• Preserve invoices proving sales tax payment and documents supporting each asset exemption.
• Successful line-item relief does not necessarily invalidate the broader sample.

Common questions

Q: Was the purchase sample rejected?
A: No. The Department found it was properly applied.

Q: Which items were removed?
A: Three exempt asset line items and two asset purchases supported by proof of sales-tax payment.

Q: Was the entire assessment canceled?
A: No. The assessment was revised and the remaining balance was billed.

Citations and references

• Va. Code § 58.1-205.
• Virginia Public Document 12-28.

Subject

Consumer use tax; Sales tax was not paid to the vendor at the time of purchase

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-66

Original ruling text

May 10, 2013

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

Dear

This is in response to your letter in which you seek correction of the retail sales and use tax assessment issued to * (the "Taxpayer"), for the period March 2005 through February 2011. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer is a contractor providing drilling services for commercial and residential water wells and geothermal systems. In addition, the Taxpayer installs pump and filtration systems. The Taxpayer was assessed consumer use tax in the audit in instances where the Virginia sales tax was not paid to the vendor at the time of purchase. The purchases included equipment, pipe, materials, tools and office supplies used in the Taxpayer's drilling operation. The Taxpayer claims that the sample is not representative of the audit period because the majority of the purchase exceptions relate to a new line of business activity that required out-of-state purchases. In addition, the Taxpayer provides additional documentation that the sales tax was paid on two asset purchases held in the audit. Lastly, the Taxpayer provides documentation regarding the purchases of three well drilling vehicles held in the audit that qualify for exemption from the tax.

DETERMINATION

Sample - Expense Purchases

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 to the auditor or the client. When sampling techniques are properly applied, the final results are usually within a narrow percentage range of the actual amount that would have been determined by a detailed audit. The purpose of the audit sample is to determine a factor for errors within a representative selected period. The purpose of the projection is to account for likely similar transactions on which Virginia tax has not been paid.

In this instance, the Taxpayer's asset and purchase records were audited by the Department. A detailed audit was performed on the assets, and the purchases were audited based upon a one year sample. Because the Taxpayer started a new business activity during the audit period, the auditor agreed to detail purchases of pipe from a large vendor. The remaining expensed purchases related to the new business activity remained in the sample because the auditor found these purchases to be normal recurring purchases. In determining the extrapolated purchase measure, the auditor used sales in the extrapolation of the error factor because the Taxpayer failed to provide the purchase information requested during the audit.

Virginia Code § 58.1-205 provides that any assessment of a tax by the Department shall be deemed prima facie correct. The burden of proof lies with the Taxpayer to prove the assessment is incorrect.

Notwithstanding the Taxpayer's general contention, the Taxpayer has failed to prove that the sampling methodology is flawed or unrepresentative of the audit period. The auditor's one year sample period meets longstanding Department audit guidelines. Additionally, the auditor's detail audit of purchases from one large vendor allowed an exception for certain purchases related to the new business activity of the Taxpayer. Therefore, I find the sampling methodology was properly applied.

Asset Purchases

A review of the asset exceptions shows that line items 10, 11 and 12 qualify for exemption from the retail sales and use tax. Pursuant to Public Document 12-28 (3/19/12), these items will be removed from the audit.

In addition, the Taxpayer presents documentation that the sales tax was paid on line items 3 and 4. Based on this information, these items will be removed from the audit.

CONCLUSION

Based on the foregoing, the audit assessment will be revised. A revised bill, with interest accrued to date, will be mailed to the Taxpayer. No further interest will accrue provided the outstanding assessment is paid within 30 days from the date of the bill.

The Taxpayer should remit payment to: Virginia Department of Taxation, 600 E. Main Street, 15th Floor, Richmond, Virginia 23219, Attn: *. If you have any questions concerning payment of the assessment, you may contact at **.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5091011699.T