What does Virginia Ruling of the Tax Commissioner P.D. 20-172 conclude about Audit: Identity Theft, Fraud, Records?

Plain-English summary

This ruling involves a cigarette retailer that was audited under Virginia's compliance program for verifying sales and use tax on cigarettes purchased for resale. The Department's compliance program compared the retailer's tax filings against sales records from five cigarette distributors and found that the retailer had purchased large quantities of cigarettes exempt of tax "for resale" from those distributors — purchases that were not reflected in the retailer's own reported sales. Because the resold cigarettes should have generated collected and remitted sales tax when sold to customers, the Department assessed tax and interest on the shortfall for the audit period of January 2017 through June 2019.

The taxpayer's defense was unusual: it argued it did not actually buy cigarettes in the volume the assessment assumed, and that it had no knowledge of, and never authorized, whoever used its accounts to make some of the disputed purchases from the distributors. In effect, the taxpayer suggested its distributor accounts had been used fraudulently by someone else. However, when the Department's auditor visited on site and asked for invoices and receipts documenting the retailer's actual cigarette purchases, the taxpayer could not produce them at the time, and later faxed only five handwritten receipts. No further documentation was ever produced, either to the auditor or on appeal.

The Tax Commissioner explained that Virginia law places the burden on the dealer to prove a sale was exempt (Va. Code § 58.1-623) and requires dealers to keep adequate purchase and sales records for at least three years (Va. Code § 58.1-633; 23 VAC 10-210-470). When a dealer's records are inadequate, the Department is authorized to reconstruct the dealer's sales or purchases using the "best information available" (Va. Code § 58.1-618) — here, the sales data supplied directly by the distributors. Because any Department assessment is presumed correct under Va. Code § 58.1-205, the burden fell on the taxpayer to disprove it. The taxpayer's unsupported assertion that the purchases were unauthorized or fraudulent, without any corroborating evidence, did not meet that burden.

The Commissioner upheld the assessment in full. The ruling separately notes that if the taxpayer was experiencing financial hardship, it could pursue a settlement based on "doubtful collectability" through the Department's offer-in-compromise process — a distinct avenue from disputing the correctness of the assessment itself.

What this means for you

Retailers and business owners, especially those selling regulated products like cigarettes

If your business is audited and the Department relies on sales/purchase data supplied by your suppliers or distributors, you need your own contemporaneous invoices, receipts, and exemption certificates to rebut that data. A claim that an account was misused or that purchases were unauthorized will not by itself overcome an assessment — you must be able to document what actually happened, ideally with records kept as the transactions occurred, not reconstructed afterward.

Businesses concerned about identity theft or unauthorized account use

This ruling shows that alleging fraud or unauthorized use of a business account, without evidence, is not a substitute for records. If you genuinely believe your accounts were compromised, you should act quickly: notify your distributors/vendors, obtain their records showing the disputed transactions, consider a police report, and preserve any evidence establishing that the purchases were not yours. The Commissioner did not reject the identity-theft theory as legally impossible — it simply found no evidence supporting it in this case.

Accountants and tax professionals

The ruling is a straightforward application of Virginia's recordkeeping and burden-of-proof framework: § 58.1-633 and 23 VAC 10-210-470 impose the recordkeeping duty; § 58.1-618 permits the Department to use distributor-supplied "best available information" when a client's own records are missing; and § 58.1-205 makes the resulting assessment presumptively correct. When advising a client facing a similar audit, emphasize gathering original purchase documentation immediately and, if hardship is a concern, note the separate offer-in-compromise process referenced in the ruling.

Common questions

Q: Did the Commissioner find that the taxpayer's identity theft or fraud claim was untrue?
A: The ruling does not make an affirmative finding that no fraud occurred. It holds that the taxpayer failed to support that claim with evidence, and that an assessment based on distributor-supplied sales data is presumed correct until the taxpayer proves otherwise. The claim was rejected for lack of proof, not necessarily disproven on the merits.

Q: What records did the taxpayer have, and why weren't they enough?
A: The taxpayer could not produce invoices or receipts when the auditor requested them on site, and later provided only five handwritten receipts by fax. No further documentation followed, either during the audit or on appeal. That fell short of the three-year recordkeeping standard in 23 VAC 10-210-470 and left the Department's distributor-based reconstruction of sales unrebutted.

Q: What was the outcome of the appeal?
A: The assessment was upheld in full. An updated bill with accrued interest was to be sent, due within 60 days to avoid further interest.

Q: Is there any relief available if a business genuinely cannot pay an upheld assessment?
A: The ruling notes that a taxpayer experiencing financial difficulty may request an offer in compromise based on "doubtful collectability" by submitting the Department's OIC forms, which is separate from disputing whether the assessment itself is correct.

Citations and references

• Va. Code § 58.1-1821 (application for correction of an assessment)
• Va. Code § 58.1-602 (retail sale definition; resale exclusion)
• Va. Code § 58.1-623(A) (exemption certificates; burden of proof)
• Va. Code § 58.1-633(A) (dealer recordkeeping requirement)
• Va. Code § 58.1-618 (best available information)
• Va. Code § 58.1-205 (assessments presumed correct)
• 23 VAC 10-210-280 (use of exemption certificates)
• 23 VAC 10-210-470 (recordkeeping requirements)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-172

Original ruling text

September 29, 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 to for the audit period January 2017 through June 2019

FACTS

The Taxpayer is a retailer of cigarettes. The Department utilizes a compliance program that verifies retail sales and use tax compliance regarding cigarettes purchased for resale and sales of cigarettes by a retailer or wholesale dealer. As a result of the compliance program, the Taxpayer was issued an assessment for tax and interest on untaxed cigarettes purchased from *, , , , and ** (collectively the “Distributors”). The assessment is based sales information provided by the Distributors identifying the Taxpayer’s purchases of cigarettes exempt of the tax for resale.

It is the Department’s position that the cigarettes purchased by the Taxpayer for resale would have been sold to the Taxpayer’s customers and therefore, the sales tax should have been collected and remitted to the Department in such sales. Based on the sales information provided by the Distributors, it was determined that the Taxpayer underreported sales of cigarettes by the amount of the cigarettes purchased from the Distributors for resale.

On June 25, 2019, during an onsite visit, the Department’s auditor requested the Taxpayer’s invoices and receipts for cigarette purchases. The Taxpayer was unable to provide this documentation at the time and provided five handwritten receipts via fax after the site visit.

The Taxpayer contests the sales tax assessment and claims it did not purchase cigarettes in the volume upon which the assessment was based. The Taxpayer claims that purchases of cigarettes from the Distributors were made without the Taxpayer’s knowledge or permission and the Taxpayer has no knowledge of who may have purchased these products using its accounts.

DETERMINATION

Purchases/Sales

The resale exemption provided under the Virginia retail sales and use tax is found in Virginia Code § 58.1-602. This code section excludes a sale for resale from the definition of a “retail sale,” which is defined as “a sale to any person for any purpose other than for resale in the form of tangible personal property or services taxable under this chapter.”

Virginia Code § 58.1-623 sets forth the requirements for the proper use of exemption certificates and, in section A, provides that “[a]ll 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.”

Title 23 of the Virginia Administrative Code (VAC) 10-210-280 provides further explanation of the proper use of exemption certificates. Subsection A states that a certificate that is incomplete, invalid, infirm or inconsistent on its face is never acceptable either before or after notice.

Virginia Code § 58.1-633 A provides 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 VAC 10-210-470 as follows:

Every person who is liable for 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 records must include…A daily record of all cash and credit sales, including sales under any type of financing or installment plan in use. A record of the amount of all merchandise purchased, including a bill of lading, invoice, purchase order or other evidence to substantiate each purchase…A record of all deductions and exemptions claimed in filing sale or used tax returns, including exemption and resale certificates, returned or repossessed goods, and bad debts…A record of all tangible personal property used or consumed in the conduct of business…A true and complete inventory of the stock on hand and its value, taken at least once each year. Records must be open for inspection and examination at all reasonable hours of the business day by the Department of Taxation.

When a dealer fails to maintain adequate records, the Department is authorized by Virginia 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.

In this instance, the documentation provided by the Distributors shows that the Taxpayer purchased cigarettes exempt of the tax for resale. The cigarette sales records provided by the Distributors show that the Taxpayer made cigarette purchases totaling * exempt of the tax that are not supported by the Taxpayer’s tax reporting documentation.

The assessment is calculated on the cost price of the cigarettes based on the sales documentation provided by the Distributors, as this was the best available information. When documentation was requested from the Taxpayer during a site visit, the Taxpayer could not provide invoices or receipts and subsequently faxed five handwritten receipts to the auditor. Nor further documentation has been provided to the auditor or with the appeal. While the Taxpayer denies that it purchased such cigarettes, the information provided by the Distributor shows that the Taxpayer purchased the contested cigarettes exempt of the tax for resale from the Distributors.

Virginia Code § 58.1-205 sets out that any assessment of a tax by the Department is deemed prima facie correct. This means the burden of proving the assessment is erroneous is upon the Taxpayer. Based on the foregoing, the Taxpayer has not met this burden.

Financial Hardship

The Taxpayer indicates that it is experiencing financial difficulties. As such, the Taxpayer may wish to request an offer in compromise based on doubtful collectability. The Taxpayer must present evidence of doubtful collectability to support a claim of financial hardship. If the Taxpayer wishes to pursue a settlement based on doubtful collectability, please complete and return the enclosed OIC - Fee and OIC B - 3 forms to: Tax Commissioner, Virginia Department of Taxation, Post Office Box 2475, Richmond, Virginia 23218-2475. These forms will allow the Department to review and analyze the Taxpayer’s financial situation. Upon completion of the Department’s review, a response will be issued based upon the information provided.

CONCLUSION

The assessment is upheld as issued. An updated bill, with interest accrued to date, will be sent to the Taxpayer. The outstanding balance should be paid within 60 days of the bill date to avoid additional interest charges.

The Code of Virginia sections and regulations 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, you may contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/3372L