Could Virginia project a grocery store's three-year sales from a two-day observation, and did the 50% fraud penalty apply?

Subject

Two-day grocery sales estimate upheld, but fraud penalty removed

Plain-English summary

Virginia upheld a two-day observation method to estimate the grocery store's food, nonfood, and phone-card sales across the audit period. The store lacked records supporting the gross and exempt sales reported on its returns.

With the taxpayer's approval, the auditor observed a low-sales day and a high-sales day from an average week, calculated average daily and monthly sales, and compared the projections with filed returns. Later spreadsheets were unsupported by register tapes or other source documents and did not prove the estimate wrong.

The 50% fraud penalty was removed. Although Virginia law permitted that penalty when a dealer intentionally filed a fraudulent return, this was a first-generation audit and the Department found no signs of willful intent to defraud.

Result: the estimated tax and interest stood, but the assessed penalty was removed.

What this means for you

• Keep register tapes and source records supporting gross, exempt, food, and nonfood sales.
• Unsupported spreadsheets are not substitutes for transaction records.
• Observation samples can support a multi-year projection when records are absent.
• Treat phone-card sales correctly and retain their sales data.
• Gross underreporting alone did not establish willful fraud in this ruling.

Common questions

Q: Were two observation days automatically unreasonable?

A: No. The Department found the method reasonable given the missing records and jointly selected low and high days.

Q: Did Virginia reduce the fraud penalty to 6%?

A: No. It removed the penalty entirely because first-audit treatment applied and willful fraud was not shown.

Citations and references

• Va. Code §§ 58.1-633, 58.1-618, 58.1-205, and 58.1-635(A).
• 23 VAC 10-210-470 and 10-210-2032(B)(3).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 15-134

Original ruling text

June 30, 2015

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 April 2010 through March 2013. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer operates an independent grocery store. The Taxpayer did not have adequate records to support the gross and exempt sales amounts reported on the sales tax returns that were filed during the audit period. For this reason, the auditor observed the Taxpayer's sales activity for two days and then computed the audit liability using the sales data for the two-day observation period. The auditor applied fraud penalty to the underreported sales pursuant to Va. Code § 58.1-635.

The Taxpayer disagrees with the methodology used by the Department's auditor to develop the assessment. The Taxpayer claims that it has documentation to support gross sales for calculating the sales and use tax for the audit period. In addition, the Taxpayer claims that the auditor erroneously applied a 50 percent penalty and requests that the Department recalculate the penalty at six percent according to the law.

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 (VAC) 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 not adequate in this instance, the Department's auditor conducted an observation of the Taxpayer's business. In such an observation, the Department's auditor positioned himself at the Taxpayer's business and observed all of the sales transactions that were made during certain business days. In this instance, the auditor selected two days with the Taxpayer's approval, June 17, 2013 and June 29, 2013, which represented the low and high sales days of an average week.

Based on the results of this observation, the auditor was able to estimate average daily food and nonfood sales. These average sales were projected to estimate monthly food and nonfood sales. A comparison of the estimated monthly food and nonfood sales to the Taxpayer's monthly sales tax returns filed with the Department disclosed that the Taxpayer underreported its monthly food and nonfood 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 estimate the audit liability was reasonable. This is consistent with the Tax Commissioner's determination in Public Document 12-176 (11/5/12). In that case, the Tax Commissioner upheld the Department's two-day observation methodology to project sales for the audit period and to compute the resulting tax liability.

Additional Documentation

The auditor contacted the Taxpayer to review the additional documentation. The documentation provided to support the Taxpayer's position sets out sales and exempt sales figures in a spreadsheet for each month of the audit period. When the auditor requested supporting documentation, the Taxpayer had neither register tapes nor other supporting documentation to substantiate the sales figures. Without supporting documentation, the Department's auditor could not accept the additional documentation.

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.

Audit Penalty

Virginia Code § 58.1-635 A provides, in pertinent part:

When any dealer fails to make any return and pay the full amount of the tax required by this chapter, there shall be imposed, in addition to other penalties provided herein, a specific penalty to be added to the tax in the amount of six percent if the failure is not more than one month, with an additional six percent for each month, or fraction thereof, during which the failure continues, not to exceed thirty percent in the aggregate.

This section goes on to provide that in the case of filing a false or fraudulent return with the willful intent to defraud the Commonwealth, a fraud penalty of 50 percent of the tax due shall be assessed. Intent to defraud the Commonwealth shall be established when a dealer reports to the Department gross sales of less than 50 percent of the amount actually due.

Title 23 VAC 10-210-2032 B 3 generally provides that penalty will not be assessed in first generation audits. In this instance, this is a first generation audit of the Taxpayer. For this reason and because there are no indications of willful intent to defraud the Commonwealth, I find that the 50 percent fraud penalty was assessed in error. Accordingly, the audit will be adjusted to remove the assessed penalty.

CONCLUSION

In accordance with this determination, the audit will be adjusted to remove the assessed penalty. A revised bill, with interest accrued to date, will be mailed shortly 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 its payment to: Virginia Department of Taxation, 600 East Main Street, 23rd Floor, Richmond, Virginia 23219, Attn: *. If you have any questions concerning payment of the assessment, you may contact at **.

The Code of Virginia sections, regulations and public document 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/1-5598356127.T