How are a restaurant's fiscal-year reporting, free meals to employees' families, and complimentary meal cards treated in a sales tax audit?

Plain-English summary

This five-restaurant operator's audit had three moving parts.

Accounting period. Like the related P.D. 20-93, the operator reported on a 52-53 week fiscal year (13 four-week periods) and hadn't attached the explanatory statement required by 23 VAC 10-210-480, so a monthly sample showed apparent underreporting. But reconciling the sales tax returns to the corporate income tax return showed the operator made catch-up payments and its remittances were consistent overall. The audit goes back to field staff to verify proper remittance; if confirmed, the penalty is removed under 23 VAC 10-210-2032 B 3 (first-generation audits, absent certain circumstances).

Employee meals. Va. Code Sec. 58.1-609.3 7 exempts meals a restaurant furnishes to employees as part of wages (23 VAC 10-210-930 C). Free meals to employees are therefore exempt and come out of the audit. But free meals to employees' family members are taxable withdrawals from inventory and stay in. Because the operator didn't distinguish the two, it must going forward track the cost price of meals given free to employees.

Complimentary ('one-on-me') meal cards. Under 23 VAC 10-210-930 E, a dealer that already collected tax from a customer and later gives a redeemable free meal for poor food quality owes no additional tax; but if the free meal is for poor service, public relations, or any other reason, the dealer owes use tax on the cost price of the property furnished. Lacking documentation to separate the two, the Department applies a 65%/35% split (exempt poor-food-quality vs. taxable poor-service) deemed reasonable in P.D. 05-169.

The operator gets 60 days to submit documentation; the audit will be revised accordingly.

What this means for you

Restaurants

• Free employee meals are exempt (part of wages) -- but meals to employees' families are taxable withdrawals from inventory. Track them separately by cost price.
• Complimentary meals are exempt only when given for poor food quality (tax already collected on the original sale). Comps for service problems or goodwill trigger use tax on the cost of the food. Keep records distinguishing the reason, or expect a default split (65%/35% per P.D. 05-169).

52-53 week filers

Attach the explanatory statement (23 VAC 10-210-480). Even without it, reconciling your sales tax to your income tax return can show your remittances were consistent -- and, on a first-generation audit, support penalty waiver (23 VAC 10-210-2032 B 3).

Common questions

Are free employee meals taxable? No -- meals furnished to employees as part of wages are exempt (Va. Code Sec. 58.1-609.3 7). But meals to their family members are taxable withdrawals from inventory.

Do I owe tax on comped meals? Not if the comp is for poor food quality and you already collected tax on the sale. For any other reason, you owe use tax on the food's cost. Without records to split them, a 65%/35% (quality/service) allocation applies (P.D. 05-169).

Can the penalty be waived? Here, potentially -- it's a first-generation audit, and 23 VAC 10-210-2032 B 3 waives penalty in that setting absent certain circumstances, if remittance is verified.

Citations and references

• Va. Code Sec. 58.1-609.3 7 and 23 VAC 10-210-930 C -- exemption for employee meals furnished as part of wages.
• 23 VAC 10-210-930 E -- complimentary meals: poor food quality vs. other reasons.
• P.D. 05-169 (12/13/2005) -- 65%/35% default split for comped meals.
• 23 VAC 10-210-480 -- 52-53 week fiscal-year reporting.
• 23 VAC 10-210-2032 -- audit penalty; first-generation-audit waiver.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-95

Original ruling text

June 2, 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 assessments issued for the period September 2012 through August 2015. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer operates five restaurants in Virginia. The Department’s audit disclosed that the amount reported on the Taxpayer’s sales returns was underreported from the daily sales information provided by the Taxpayer. The difference between the returns and daily sales reports was recorded in the audit as sales tax collected and not remitted. In addition, exempt sales were also assessed in the audit because the Taxpayer did not provide exemption certificates to verify the exempt sales.

In addition, the Taxpayer provided meals to its managers and families as part of their compensation and benefits package. The Taxpayer also provided cards to customers that allow the customer to redeem the card for a free food item. The auditor assessed use tax on the cost of free meals provided to employees’ family members, and the cards providing a free food item to customers. Certain asset acquisitions for which purchase invoices were not provided were also assessed use tax in the audit.

The Taxpayer contests the assessment for tax collected and not remitted on the basis that the audit does not accurately reflect the total amount of sales tax remitted by the Taxpayer for the periods in question because the Taxpayer operates under a 52-53 week fiscal year. The Taxpayer states that it remitted sales tax based on 13 four-week periods throughout the year, not 12 calendar months. Based on this, the Taxpayer believes the sample periods selected for the audit do not correspond to the sales and sales tax reported by the Taxpayer during the audit period. Additionally, the Taxpayer states that the Department’s estimated amount of free manager’s meals is not reflective of the actual transactions. Finally, the Taxpayer requests additional time to provide invoices for certain asset acquisitions.

DETERMINATION

Accounting Method

Title 23 of the Virginia Administrative Code (VAC) 10-210-480 provides:

In the case of dealers regularly keeping books and accounts on the basis of an annual period that varies 52 to 53 weeks, reporting consistent with such account period is acceptable, provided a satisfactory explanatory statement is attached to the dealer’s first return filed under such annual period. Each return filed by these dealers must include all accounting periods which end during the period covered by the return.

It appears the Taxpayer did not provide an explanatory statement with its first return filed under the periods covered by the audit. In addition, the Taxpayer did not include with the return all accounting periods which end during the period covered by the return. The auditor reconciled the Taxpayer’s daily sales reports to the sales tax returns for the sample months selected and found that the amounts reported on the sales tax returns were underreported from the daily sales information that was provided. However, the Taxpayer states that because it remits sales tax based on 13 four-week periods throughout the year, instead of the more common 12 periods, the sample did not accurately reflect the total amount of sales tax remitted by the Taxpayer.

After reconciling the Taxpayer’s sales tax returns to its corporate income tax return, it appears that the Taxpayer made “catch-up” payments throughout various months, and the sales tax remitted to the Department is consistent with its corporate income tax return. Based on this finding, the audit will be returned to the audit staff to verify that the appropriate amount of sales tax was remitted to the Department. If this is found to be true, penalty will be removed in accordance with Title 23 VAC 10-210-2032 B 3, which waives penalty in regard to first generation audits, except when certain circumstances exists.

Employee Meals

Virginia Code § 58.1-609.3 7 provides an exemption from the sales tax for "Meals furnished by restaurants or food service operators to employees as a part of wages." Title 23 VAC 10-210-930 C interprets this Code section and states that “Meals and drinks that restaurants and food service operators furnish to their employees without charge are not subject to the tax.”

The Taxpayer provides meals to its managers and their families as part of their compensation and benefits package. Meals provided to employees free of charge are exempt from the tax in accordance with the statute and regulation. As such, these transactions will be removed from the audit. Meals provided to family members, however, are not exempt from the tax and are considered taxable withdrawals from inventory. These transactions will not be removed from the audit. The audit disclosed the Taxpayer did not distinguish between meals provided to employees and those provided to employees’ family members. Going forward, the Taxpayer should properly account for employee meals by maintaining documentation on the cost price of meals provided to employees free of charge.

Complementary Meals

Title 23 VAC 10-210-930 E states, "A dealer who has collected the tax from a customer but subsequently issues a ticket which is redeemable for a free meal will not be liable for any additional tax on the free meal provided the redeemable ticket was issued to the customer as a result of poor food quality.” When a redeemable free meal ticket is issued to a customer as the result of poor service, for public relations purposes or for any reason other than poor food quality, the dealer must report use tax on the cost price of all tangible personal property furnished in providing the free meal at the time the ticket is redeemed.

The Taxpayer provides “one-on-me” cards to customers that allow the customer to redeem the card for free food items. The Taxpayer is not liable for additional tax where the tax has already been collected from a customer and a free meal is provided to that customer as a result of poor food quality. The Taxpayer should provide documentation that distinguishes between “one-on-me” meals provided as a result of poor food quality and free meals provided for any other reason. If the Taxpayer is unable to provide documentation, a 65%-35% split between complementary meals for exempt poor food quality and taxable poor quality service, respectively, has been deemed reasonable for calculating the tax paid on exempt complementary meals due to poor food quality, in accordance with Public Document 05-169 (12/13/2005).

CONCLUSION

The audit will be returned to the appropriate field audit staff to make the adjustments in accordance with this determination. The auditor will contact the Taxpayer to obtain the information requested for verification and evaluation. The Taxpayer will have 60 days from the date of this letter to submit all required additional information for the Department’s review. Once the revisions are complete, the Taxpayer will be issued revised bills with updated interest to date if any outstanding assessment balances remain. The bills should be paid within 30 days of the bill dates to avoid the accrual of additional interest charges.

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 determination, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1490H

Related Documents

05-169