Did improved systems and business changes justify waiving a second-audit Virginia use-tax penalty when compliance was only 30%?

Subject

No sufficient justification is presented for waiving the penalty.

Plain-English summary

Virginia granted substantial purchase-level relief but did not immediately waive the remaining second-audit penalty. The data-center operator proved that tax had been paid on documented 2008 purchases and that certain 2009 entries were transfers or purchases outside the audit period. Those items were removed, along with related penalty and interest.

For one vendor's missing invoices, the Department accepted the taxpayer's position based on the documented invoice series and the vendor's registration to collect Virginia tax. Duplicates and assets already excluded from the assessment could not generate additional abatements.

The taxpayer's use-tax compliance ratio was 30%. Under the cited second-audit rule, automatic penalty waiver required at least 60%. The auditor had to recompute the ratio after the granted tax adjustments; if the revised ratio reached 60%, the penalty would be waived in full.

If the ratio remained below 60%, the taxpayer's system upgrades and compliance improvements did not independently justify relief. The Department found no convincing detail or evidence showing that claimed business changes caused the poor compliance.

The conclusion also warned that a separate 20% Amnesty penalty could apply only if the taxpayer failed to pay the revised balance within 30 days.

What this means for you

• Purchase-level invoices, asset histories, and transfer documentation can remove audit items even when the overall penalty dispute remains.
• For a second audit, calculate the compliance ratio again after substantive abatements; the revised ratio can change penalty treatment.
• General statements about growth, reorganizations, or improved accounting systems are not enough without records connecting those events to the compliance failure.

Common questions

Q: Were missing invoices always fatal?
A: No. For one vendor, the surrounding invoice evidence and vendor registration were sufficient on these facts, subject to removing duplicates and already-excluded assets.

Q: Was the penalty definitely upheld?
A: Not finally. It would be fully waived if the recomputed compliance ratio reached 60%; otherwise no separate mitigating-circumstance waiver was justified.

Q: Was a 20% Amnesty penalty already imposed?
A: No. The ruling warned it could arise only if the revised bill was not fully paid within 30 days.

Citations and references

• Va. Code §§ 58.1-205 and 58.1-1825(D).
• 23 VAC 10-210-2032(B)(4).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-50

Original ruling text

April 4, 2014

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

Dear *:

This is in response to your letter in which you request correction of the retail sales and use tax assessment issued to * (the "Taxpayer") as a result of an audit for the period March 2008 through February 2011.

FACTS

The Taxpayer primarily operates data centers and provides managed hosting and collocation services. An audit resulted in the assessment of consumer use tax on untaxed purchases of assets and other tangible personal property.

For several purchases made in 2008, the Taxpayer contends that the tax was properly paid to vendors and has furnished documentation to support its contention. The Taxpayer, however, was unable to locate all of the invoices for one of the vendors. For these contested purchases, the Taxpayer requests a tax abatement of *.

For several other purchases, the Taxpayer contends that such transactions were erroneously identified as made in 2009 because they were the result of transfer entries. As such, these transactions had sales or use tax previously paid to the vendor at the time of purchase, or the purchase was made prior to the audit period and, therefore, did not fall within the scope of the audit. The Taxpayer requests a tax abatement of *.

The Taxpayer also requests abatement of the assessed penalties and interest associated with the above requests for tax abatement. In addition, the Taxpayer requests abatement of the remaining penalties assessed because of the substantial changes in business that the Taxpayer experienced during the audit period, the substantial efforts made to upgrade its accounting and finance systems, and the improvements made in documenting its purchasing process and otherwise improving its tax compliance procedures.

DETERMINATION

Virginia Code § 58.1-205 sets out that any assessment of a tax by the Department is deemed prima fade correct. This means that the burden of proving that the assessment is erroneous is upon the taxpayer. For appeals to the court, Va. Code § 58.1-1825 D similarly sets out that it is the Taxpayer's burden "to show that the assessment or collection or action on a transferred credit or other tax attribute complained of is erroneous or otherwise improper." With this in mind, I will address the issues raised in the appeal.

2008 Purchases

Based on a review of the documentation furnished for the first tab of the Taxpayer's workbook ("tab-one documentation"), I find basis for removing these 41 transactions from the audit. This adjustment will result in the abatement of tax in the amount of * as

requested for these items.

In regard to the second tab of the Taxpayer's workbook ("tab-two listing"), the Taxpayer provides a listing of other invoices from one of the vendors included in the tab-one documentation but without any additional invoices because they could not be located. The Taxpayer contends that the prior series of invoices establishes that the vendor was correctly invoicing sales tax to the Taxpayer on the missing invoices and such purchases should be abated. I also understand that the vendor is registered to collect and remit the sales tax to the Department. Based on these facts, I find sufficient cause to accept the Taxpayer's contention. In reviewing the tab-two listing, however, the auditor discovered that several of the 41 tab-one transactions are duplicated in the tab-two listing. According to the auditor, the tab-two listing also includes assets ( i.e. , asset numbers: 10009798, 10009800, 10039140, 10039142, 10039144, 10039146 and 10039148) that were previously removed from the initial audit work papers and not included in the assessment. Accordingly, the revision for this second tab will exclude such erroneously listed assets.

2009 Purchases

Based on the third tab of documentation furnished, the Department agrees with the Taxpayer's reasons for abatement. Accordingly, I find basis for removing the contested transferred assets from the audit. This adjustment will result in the abatement of tax in the

amount of * as requested for these items.

Penalty

To the extent that tax is abated as noted above, the associated penalty and interest amounts will also be abated. In regard to the remaining assessed penalties, its application is generally mandatory unless the level of compliance is sufficient to warrant its abatement or there exists some type of exceptional mitigating circumstance causing the insufficient compliance.

This audit is the Taxpayer's second audit. Pursuant to Title 23 of the Virginia Administrative Code 10-210-2032 B 4, penalty on a second audit may be waived if a taxpayer's use tax compliance ratio meets or exceeds 60%. The use tax compliance ratio for this audit is 30%. Because the level of use tax compliance is below an acceptable level for automatic waiver of the penalty, the auditor was justified in applying the penalty. Notwithstanding, because of the tax adjustments allowed in this determination, the use tax compliance ratio will be recomputed. If the recomputed compliance ratio is 60% or more, the penalty will be waived in its entirety.

While I appreciate the Taxpayer's efforts to improve its use tax compliance procedures and accounting and finance systems, I do not find such improvements to constitute exceptional mitigating circumstances as to justify waiver of the penalty. Furthermore, the Taxpayer has not provided any convincing details or evidence of the substantial changes made to its business and how such changes affected the Taxpayer's use tax compliance. Lacking such details and evidence, no sufficient justification is presented for waiving the penalty.

CONCLUSION

The assessment will be revised in accordance with this determination. A revised bill, with interest accrued to date, will be sent to the Taxpayer. The outstanding balance should be paid within 30 days of the bill date to avoid additional interest charges. The Taxpayer should remit its payment to: Virginia Department of Taxation, 600 East Main Street, 23 rd Floor, Richmond, Virginia 23219, Attn: *. If you have any questions concerning payment of the assessment, you may contact at **.

Please note that failure to remit full payment within the 30-day period may result in the imposition of an additional 20% penalty on the tax due under the terms of Virginia's Amnesty Program. See the enclosure entitled "Important Payment Information."

In regard to the requested telephone conference, I understand that a Department tax analyst contacted you by letter to provide his time availability to discuss the matter and contact information to schedule such a conference. I also understand that no further contact was made by either you or the tax analyst in regard to this matter. If you still wish to discuss this matter, please contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

The Code of Virginia section and regulation 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 * at the phone

number provided above.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5501244274.R