Can an agricultural dealer get audit exceptions removed for exemption certificates verified after the audit, and must the second-audit compliance penalty stand?

Plain-English summary

An agricultural and chemical supply company (selling feeds, seeds, fertilizer, farm machinery, and the like) was audited. The auditor assessed untaxed sales where exemption certificates were missing or invalid, plus the dealer's own untaxed purchases. The dealer appealed on three fronts.

The agricultural exemption and exemption certificates. Virginia exempts many items sold to farmers producing agricultural products for market (Va. Code Sec. 58.1-609.2 (1)), but the exemption belongs to a qualifying farmer, and the dealer bears the burden of proving a sale is exempt (Va. Code Sec. 58.1-623 A) by taking a valid certificate. 23 VAC 10-210-280 requires reasonable care, and a certificate can't be used for items outside its exact wording. Critically, certificates that are incomplete or are obtained during or after an audit get greater scrutiny and are honored only if the Department can confirm the customer's use was valid and proper for the specific transaction reviewed (P.D. 11-8). Applying that:

• For a list of customers whose exempt activity the auditor verified, the related transactions are removed from the audit exceptions.
• For several previously illegible certificates, the dealer supplied legible copies; those will go back to the auditor for review and possible further revision.

Purchases treated as employee reimbursements. The purchase exceptions arose because the dealer's records didn't show whether tax was paid. On appeal the dealer identified certain items as reimbursements to employees; those line items are removed.

Penalty and interest. Va. Code Sec. 58.1-635 makes penalty mandatory on deficiencies, and 23 VAC 10-210-2032 B 4 says penalty is always applied on a second-generation audit unless the compliance ratio hits 85% (sales tax) or 60% (use tax). This audit -- the dealer's second -- showed a 0% use-tax compliance ratio, so the penalty was properly applied; it will simply be recomputed to reflect the audit revisions. No 'exceptional mitigating circumstances' were shown to waive it. Interest (Va. Code Sec. 58.1-1812) can't be waived either -- it's the cost of having had use of money owed to the Commonwealth.

What this means for you

Dealers selling to farmers

Collect a complete, legible exemption certificate at the time of sale, and only for items the certificate actually covers. If you're audited, certificates you scramble to obtain afterward can still help -- but only if the Department can independently confirm the specific sale qualified. Verified customers and legible certificates got relief here; vague or unverifiable ones did not.

Second audits carry an almost-automatic penalty

On a repeat audit, the compliance penalty applies unless your compliance ratios clear the thresholds (85% sales / 60% use). A 0% use-tax ratio guarantees the penalty. Accruing use tax on your own untaxed purchases is the way to keep that ratio up.

Keep purchase records

The employee-reimbursement items were only removed because the dealer could finally identify them. Va. Code Sec. 58.1-633 and 23 VAC 10-210-470 require keeping adequate records (invoices, purchase orders, bills of lading) for at least three years.

Common questions

Can I fix a missing exemption certificate after the audit starts? Sometimes -- but it gets 'greater scrutiny,' and the Department must be able to confirm the exemption was valid for that exact transaction (P.D. 11-8).

Why was the penalty applied even though I got relief? Because it's a second-generation audit with a use-tax compliance ratio below 60% (in fact 0%); the penalty is recalculated on the revised numbers but not waived (23 VAC 10-210-2032).

Can interest ever be waived? No -- interest is mandatory under Va. Code Sec. 58.1-1812 and simply reflects the time value of the tax owed.

Citations and references

• Va. Code Sec. 58.1-609.2 (1) and 23 VAC 10-210-50 -- agricultural exemption for producing agricultural products for market.
• Va. Code Sec. 58.1-623 and 23 VAC 10-210-280 -- exemption-certificate rules; dealer's burden; reasonable care.
• P.D. 11-8 (1/20/2011) -- greater scrutiny of certificates obtained during or after an audit.
• Va. Code Sec. 58.1-633 and 23 VAC 10-210-470 -- recordkeeping requirements.
• 23 VAC 10-210-2032 -- audit penalty and second-generation-audit compliance ratios.
• Va. Code Sec. 58.1-1812 -- mandatory interest.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-108

Original ruling text

June 23, 2020

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

Dear *:

This is in response to your letter submitted on behalf of * (the “Taxpayer”), in which you seek correction of the retail sales and use tax assessment issued for the period August 2013 through July 2016. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is an agricultural and chemical company that sells commercial feeds, seeds, plants, fertilizer, agricultural chemicals, farm machinery, and other agricultural supplies to customers. As a result of an audit conducted by the Department, the auditor assessed untaxed sales in which exemption certificates were not on file or certificates were invalid. The auditor also assessed purchases by the Taxpayer for which no tax had been paid or accrued.

The Taxpayer contests the assessment of tax, contending the exemption certificates disallowed during the audit period were accepted in good faith, and the assessed purchases are employee reimbursements that should be assumed to have had tax paid by the employee at the time of the purchase transaction. Additionally, the Taxpayer requests relief from the assessed penalties and interest.

DETERMINATION

Agricultural Exemption

As a dealer of agricultural supplies the Taxpayer is provided the following important information regarding the retail sales and use tax and its application to the Taxpayer’s sales to its customers.

Virginia Code § 58.1-609.2 (1) provides an exemption from the retail sales and use tax for persons in the business of producing agricultural products for market. The exemption applies to:

Commercial feeds; seeds; plants; fertilizers; liming materials; breeding and other livestock; semen; breeding fees; baby chicks; turkey poults; rabbits; quail; llamas; bees; agricultural chemicals; fuel for drying or curing crops; baler twine; containers for fruits and vegetables; farm machinery; medicines and drugs sold to a veterinarian provided they are used or consumed directly in the care, medication, and treatment of agricultural production animals or for resale to a farmer for direct use in producing an agricultural product for market ; tangible personal property, except for structural construction materials to be affixed to real property owned or leased by a farmer, necessary for use in agricultural production for market and sold to or purchased by a farmer or contractor; and agricultural supplies provided the same are sold to and purchased by farmers for use in agricultural production, which also includes beekeeping and fish, quail, rabbit and worm farming for market. [Emphasis added.]

Title 23 of the Virginia Administrative Code (VAC) 10-210-50 interprets this statute and states that a farmer that is not engaged in the business of producing agricultural products for market cannot claim any agricultural exemptions. The purpose of the statute is to provide an exemption for the agricultural production of a product for market.

The Virginia Sales and Use Tax Expenditure Study issued by the Department in December 1994 as Volume 2, No. 1, explains the statutory exemption and states that many items that are purchased by farmers become component parts or are used in the actual production of agricultural products that are ultimately taxed at the retail level. The exemption for tangible personal property used in the agricultural production of a product for market prevents double taxation of the component parts or products used in the agricultural production of the final product for market. Therefore, tangible personal property used in the production of a product used directly in the production of an agricultural product would qualify for the exemption.

Exemption Certificates

Exemption certificates with regard to agricultural sales were a major area of deficiency disclosed in the Taxpayer’s audit. The following guidance is provided for future reference regarding the proper giving and receiving of exemption certificates provided to the Taxpayer by its customers. Also addressed is the exemption certificate documentation provided by the Taxpayer as a result of the issues raised in the audit.

Virginia Code § 58.1-623 A states “All sales or leases are subject to the tax until the contrary is established. The burden of proving that a sale, distribution, lease or storage of tangible personal property is not taxable is upon the dealer unless he takes from the taxpayer a certificate to the effect that the property is exempt under this chapter.”

The proper use of such certificates is set out in Title 23 VAC 10-210-280, which addresses the above statute and provides:

Reasonable care and judgment must be exercised by all concerned to prevent the giving or receiving of false, fraudulent or bad faith exemption certificates. An exemption certificate cannot be used to make a tax-free purchase of any items of tangible personal property not covered by the exact wording of the certificate.

Public Document 11-8 (1/20/2011) discusses the good faith acceptance of exemption certificates. It states that sellers cannot accept incomplete exemption certificates in good faith. In cases where a taxpayer accepts an exemption certificate that is incomplete or the certificate is obtained during or after an audit, the claim for exemption is subject to greater scrutiny by the Department. The exemption certificate will be accepted only if the Department can confirm that the customer's use of the certificate was valid and proper for the specific sales transaction reviewed in the audit.

With regard to the exemption certificates provided during and after the audit, some customers’ activities were verified by the Department’s auditor and the associated transactions will be removed from the audit exceptions. Those customers are as follows: *, , , , , , , , , , , , , , , , , , , , , , , , , , , and ***.

Several exemption certificates were illegible; however, the Taxpayer has provided legible copies for the following customers: *, , , , , , , , and **. These certificates will be provided to the auditor for review.

Purchases (Reimbursements)

The audit deficiency regarding these transactions resulted from the Taxpayer’s failure to maintain complete records identifying the nature of the transaction and the proper tax compliance. The Taxpayer’s records did not contain adequate information to verify whether sales or use taxes were paid on these purchase transactions that occurred during the audit period. Upon appeal, the Taxpayer has provided information to identify the purchases relating to *, , , , , , and ** as reimbursements to employees for expenses. As such, the corresponding line items will be removed from the audit exceptions.

The Taxpayer is advised that its future record keeping should be governed by Virginia Code § 58.1-633 A, which states:

Every dealer required to make a return and pay or collect any tax under this chapter shall keep and preserve suitable records of the sales, leases, or purchases, as the case may be, 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.

Title 23 VAC 10-210-470 interprets Virginia Code § 58.1-633 and states “[e]very person who is liable for the collection of sales tax or remittance of use tax or both is required to keep and preserve for three years adequate and complete records necessary to determine the amount of tax liability.” Such documentation includes records for all tangible personal property used or consumed in the conduct of business and records for all merchandise purchased including bills of lading, invoices, purchase orders, and other evidence to substantiate each purchase.

Compliance Penalty

Virginia Code § 58.1-635 mandates the application of penalty to tax deficiencies. Title 23 VAC 10-210-2032 B 4 addresses second generation audits and provides that penalty is always applied to second generation audits unless a taxpayer’s compliance ratio meets or exceeds 85% for sales tax and 60% for use tax. The current audit, which is the Taxpayer’s second, reflects a use tax compliance ratio of 0%. Based on this measurement, the compliance penalty was properly applied in the audit.

Subsection 8 of Title 23 VAC 10-210-2032 states that the application of penalty to audit deficiencies will not be waived for "other than exceptional mitigating circumstances.” The Taxpayer has not provided any exceptional mitigating circumstances to support removal of the penalties assessed in the audit. However, the assessed penalties will be adjusted based on the revisions to the audit for the exemption certificates and employee reimbursements.

Interest

Virginia Code § 58.1-1812 mandates the application of interest to any tax assessment. Interest is not assessed as a penalty for noncompliance with the tax laws. Rather, it simply represents a fee for the use of money over a period of time. In this case, the Taxpayer had the use of the money that was properly due the Commonwealth. Therefore, I find no basis to waive the interest assessed as a result of the Department’s audit.

CONCLUSION

In accordance with this determination, the audit will be returned to the appropriate audit staff for removal of the transactions associated with the exemption certificates that were verified. The audit will also be revised to remove the purchases identified as employee reimbursements. The auditor will also review the legible exemption certificates for additional revision if warranted.

A revised audit and revised bill, with interest accrued to date, will be mailed to the Taxpayer. Please remit payment within 60 days from the date of the bill to: Virginia Department of Taxation, 600 E. 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 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 response, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1906L

Related Documents

11-8