The Department built my sales tax audit from third-party alcohol board records because I wouldn't turn over my own -- can I still challenge the estimate, and are the fraud and amnesty penalties fair?

Plain-English summary

A restaurant and bar was audited for sales tax covering May 2014 through April 2017. It refused to provide records to either the Department's auditor or the accompanying Department of Alcoholic Beverage Control (ABC) agent, both during and after the audit. Left without the business's own records, the auditor reconstructed the liability using what WAS available: ABC alcohol purchase data, the business's own Mixed Beverage Annual Review (MBAR) report, and -- for pricing -- menus and beverage prices borrowed from a related business (also under a separate audit) since this location's own pricing wasn't available.

The taxpayer's appeal raised several objections: that the gross-purchase-markup method didn't properly account for spillage, employee theft, ending inventory, or mixed drinks; that credit/debit card deposits shown on bank statements suggested a lower liability; and that the sample period used to extrapolate the full-period liability wasn't representative. In each instance, the Tax Commissioner found the SAME core problem -- the taxpayer never backed up its objections with actual records (point-of-sale detail, z-tape data, documentation supporting a different sample period), even though the auditor HAD already applied standard spillage allowances and accounted for mixed drinks using the best information actually available. Simply arguing an estimate is too high, without offering objective analysis or documentation showing the correct amount, isn't enough to overcome the legal presumption that a Department assessment is correct -- the taxpayer bears that burden, and here it wasn't met on any of these points.

Fraud penalty -- abated. Virginia imposes a steep 50% fraud penalty when a dealer files a false/fraudulent return, or willfully fails to file, with actual intent to defraud the Commonwealth -- and reporting sales at 50% or less of the true amount creates a presumption of that intent. Regulations generally spare a taxpayer's FIRST audit from penalty. Here, though the shortfall for "tax collected but not remitted" looked large, it was calculated from an ESTIMATE, not from proof that the taxpayer actually collected specific sales tax from customers and knowingly kept it rather than remitting it. Because an estimate alone doesn't prove that kind of actual, willful conduct, the Tax Commissioner abated the fraud penalty.

Amnesty penalty -- upheld. Separately, Virginia's 2017 Tax Amnesty Program let delinquent taxpayers pay up during a limited window with reduced consequences -- but ANY amnesty-eligible tax liability that went unpaid after that window closed draws an automatic 20% amnesty penalty on top of everything else, regardless of fraud. Because part of this audit period (April 2017 and earlier) fell within the amnesty-eligible window and remained unpaid, that 20% penalty applied and was upheld even though the fraud penalty was not.

What this means for you

Businesses facing a sales tax audit who are considering withholding records

Refusing to provide records doesn't stop the audit -- it just means the Department will reconstruct your liability from whatever third-party or related-business information it CAN get (ABC data, a similar business's pricing, bank deposit patterns), and you'll then bear the burden of disproving that reconstruction with real documentation you likely no longer have easy access to.

Taxpayers who believe an audit's gross-markup estimate overstates spillage, theft, or inventory adjustments

A bare assertion that the estimate is wrong won't move an appeal -- bring point-of-sale detail, z-tape data, inventory records, or other objective documentation showing what the correct figures actually are.

Businesses assessed a fraud penalty based on an ESTIMATED (not directly proven) shortfall in remitted sales tax

If the "tax collected but not remitted" penalty rests on an estimate rather than concrete proof you actually collected and knowingly withheld specific tax dollars, argue for abatement -- this ruling recognizes that an estimate alone doesn't establish the willful intent to defraud that the fraud penalty requires.

Businesses with amnesty-eligible periods in an ongoing audit

Don't assume having a fraud penalty abated also wipes out a 20% Tax Amnesty penalty -- the amnesty penalty attaches automatically to any unpaid amnesty-eligible liability regardless of whether fraud is proven, so plan to address amnesty-period liabilities separately.

Common questions

Q: I didn't give the auditor my sales records -- can the Department still assess me?
A: Yes -- the Department is authorized to reconstruct your liability using the best information reasonably available, including third-party records like state alcohol board data or even pricing from a similar business, when your own records aren't provided.

Q: How do I successfully challenge an estimated sales tax assessment on appeal?
A: With actual, objective documentation -- point-of-sale detail, z-tape data, inventory records, or similar evidence showing the correct figures. Simply arguing the estimate seems too high, without more, won't meet your burden of proof.

Q: Why was the fraud penalty removed but the amnesty penalty kept in this case?
A: The fraud penalty requires proof of actual, willful intent to defraud, which an ESTIMATED shortfall alone doesn't establish. The amnesty penalty, by contrast, applies automatically to any amnesty-eligible liability that remains unpaid, regardless of fraud.

Citations and references

• Public Document 99-28 (3/15/1999) -- merely arguing an estimated assessment is overstated, without objective analysis and documentation of the correct tax amount, is not convincing evidence that the auditor's factors were unreasonable
• Public Document 17-156 (9/5/2017) (Guidelines for the Virginia Tax Amnesty Program) -- explains the 2017 amnesty program and the 20% penalty on unpaid amnesty-eligible liability
• 23 VAC 10-210-2032 B 3 -- penalty is generally not assessed in a dealer's first-generation audit

Subject

Records and Gross Mark-up : Amnesty and Fraud Penalties

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-101

Original ruling text

July 27, 2021

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 May 2014 through April 2017. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer, a restaurant and bar was audited by the Department. Because records were not provided, the audit was conducted utilizing information furnished by the Department of Alcoholic Beverage Control (ABC). The auditor acquired alcohol purchase information and the Mixed Beverage Annual Review (MBAR) report filed by the Taxpayer in addition to menus and beverage pricing obtained from a related business. The auditor utilized the pricing from the Taxpayer’s second business to estimate pricing for drinks in this establishment.

The Taxpayer disputes the audit findings, contending the gross purchase markup methods do not sufficiently account for spillage, theft, mixed drinks, ending inventory, and bar prices. The Taxpayer also contests the application of fraud and amnesty penalties.

DETERMINATION

Records

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 the tax due hereunder, and such other pertinent information as may be required by the Tax Commissioner." 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.

The Taxpayer refused to respond to correspondence or provide records to the Department or the assigned ABC agent during and after the audit. The Department’s auditor was only able to review ABC purchases, MBAR reports, and records the ABC agent seized from the Taxpayer’s other business. The auditor utilized the pricing from the Taxpayer’s similar business, also under audit, to estimate the pricing for drinks in this establishment.

The Taxpayer contends the auditor did not account for ending inventory, utilized a spillage allowance that did not sufficiently account for employee theft, utilized incorrect bar prices, and did not provide an allowance for mixed drinks. The auditor did allow for mixed drinks in the calculations, applied the standard spillage allowance, and estimated bar prices utilizing the pricing obtained from the Taxpayer’s second business, as this was the best information available to the auditor. While contending the assessment is overstated, the Taxpayer has not provided any additional records with which the auditor may adjust the calculations. Simply arguing that an estimated assessment is overstated without offering objective analysis and documentation as to the correct amount of tax is not convincing evidence that shows the factors applied in this case are unreasonable. See Public Document (P.D.) 99-28 (3/15/1999).

Electronic Deposits

The Taxpayer contends consumers generally use credit and debit cards for most business transactions. Thus, the Taxpayer argues that examining the bank statements for these transactions supports a reduction in the liability. The Taxpayer has outlined credit card deposits for the sample period, contending a simple observation of these numbers supports the contention that the liability is overstated. The Taxpayer has not, however, provided point of sale detail or z tape data to support the claim of an overstated liability.

Sample

The Taxpayer objects to the sample used to extrapolate the sales and use tax liability. The Taxpayer believes the sample period used does not accurately reflect an average month of sales and subsequently created an error factor that increased the tax liability. The Taxpayer also believes that the daily sales figures derived from the MBAR report are inherently flawed due to the fluctuations between an average day and the high and low days within the month. While the Taxpayer argues that the sample period is not representative, the Taxpayer refused to provide any information to support this contention to the auditor or the assigned ABC agent.

Fraud 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 case of a false or fraudulent return where willful intent exists to defraud the Commonwealth of any tax due under this chapter, or in case of a willful failure to file a return with the intent to defraud the Commonwealth of any such tax, a specific penalty of fifty percent of the amount of the proper tax shall be assessed.

Virginia Code § 58.1-635 B provides that “[i]t shall be prima facie evidence of intent to defraud the Commonwealth of any tax due under this chapter when any dealer reports his gross sales, gross proceeds or cost price, as the case may be, at fifty percent or less of the actual amount.”

Title 23 of the Virginia Administrative Code 10-210-2032 B 3 provides generally that penalty will not be assessed in first generation audits. In this first audit of the Taxpayer, the auditor's application of the penalty for tax collected but not remitted was based on an estimation rather than actual sales reflecting taxes collected but not remitted. An estimate, while authorized to determine a tax liability, does not provide a basis of proof that the Taxpayer actually collected the sales tax and failed to remit such tax to the Department with intent to defraud the Commonwealth, as contemplated in Virginia Code § 58.1-635 B.

Amnesty Penalty

The 2017 General Assembly enacted legislation establishing a Tax Amnesty program, spanning a 60-75 day period that was administered by the Department. The Guidelines for the Virginia Tax Amnesty Program are addressed in Public Document 17-156 (9/5/2017). The Amnesty Laws authorize the Department to administer a Virginia Tax Amnesty Program to increase and accelerate the collection of delinquent taxes. Taxpayers with delinquent returns for amnesty-eligible periods qualified for amnesty benefits. Any tax liability that was eligible for amnesty benefits but remained unpaid is subject to a 20% amnesty penalty in addition to all other penalties. The amnesty-eligible periods for ongoing field audits is the month of April 2017 and prior.

CONCLUSION

Virginia Code § 58.1-205 1 deems any tax assessment issued by the Department as prima facie correct. This means that the burden of proof is upon the Taxpayer to prove that the assessment is incorrect. The Taxpayer has not met this burden, and adjust the tax liability assessed in the audit is upheld.

With regard to the penalties, the fraud penalty will be abated. However, I find the amnesty penalty was properly applied.

In accordance with this determination, the audit will be adjusted to remove the assessed fraud penalty. An updated 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 60 days from the date of this letter bill.

The Code of Virginia sections, regulation 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 regarding this determination, please contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1606L

Related Documents

15-134

99-28

17-156