My auditor included a one-off equipment lease I don't normally enter into in my sample exceptions, which then got extrapolated across my whole audit -- can I get that specific transaction excluded as unusual?

Plain-English summary

A Virginia furniture retailer was audited for April 2020 through March 2023. During the audit, the Department found the retailer had leased product-imaging (photography) equipment from a vendor -- used to photograph its products for advertising -- without remitting the required tax on the lease payments. The auditor included those payments as an exception in the audit sample, whose resulting error factor was then extrapolated across the entire audit period, producing an assessment of tax and interest. The retailer paid the assessment in full and then timely sought correction, arguing the photo-equipment lease was an unusual transaction that didn't represent its normal business and shouldn't have been projected across the whole period.

Sampling and the "isolated event" standard. Sampling is a widely used, valuable audit technique for situations where a full transaction-by-transaction audit wouldn't be worth the cost to either the auditor or the taxpayer. The sample identifies an error rate within a representative period, which is then extrapolated to estimate similar unpaid tax across the full audit period. To remove a specific transaction from that sample (and its extrapolation), a taxpayer must show the transaction was an isolated event and not part of its normal operations (citing P.D. 99-35, P.D. 13-39, P.D. 18-63, and P.D. 23-101).

The key refinement: look at the CATEGORY, not the exact item. The Department drew a direct parallel to P.D. 02-103 (6/24/2002), where a furniture manufacturer disputed including promotional pen purchases in its own audit sample. There, the Department found that even though the manufacturer didn't typically buy THAT specific promotional item, it made other kinds of advertising purchases -- so promotional/advertising spending in general wasn't isolated, even if the particular item was a first (or only) purchase of its kind.

Applying that here. The furniture retailer maintained accounts for advertising expenses across various media types. Even if leasing photo-imaging equipment specifically was new or unusual for this retailer, it fit within the retailer's broader, ongoing pattern of advertising-related spending -- so it wasn't an isolated event removable from the sample. The Department also noted the practical flip side of sampling: because it's a sample, the audit likely didn't catch every instance of untaxed advertising or promotional purchases either, meaning the extrapolation, if anything, may understate rather than overstate the true liability.

Outcome. The assessment was upheld. Because the retailer had already paid it in full, no further action was required.

What this means for you

Businesses disputing a "one-off" or "unusual" purchase included in an audit sample

Don't focus only on whether that EXACT type of transaction is rare for your business. The Department looks at the broader CATEGORY -- if you regularly spend in that general area (here, advertising, across different media and formats), a specific new vendor, format, or item within that category is unlikely to qualify as an isolated event.

Anyone maintaining multiple expense accounts across similar categories (advertising, promotional items, professional services, etc.)

Recognize that maintaining several related spending lines can work against an "isolated transaction" argument -- it demonstrates the category itself is a normal, ongoing part of your operations, even when a specific transaction within it is new.

Taxpayers who've already paid a disputed assessment in full

You can still seek correction afterward, as this retailer did -- paying doesn't waive your right to challenge the assessment's validity through an application for correction.

Common questions

Q: My auditor flagged a purchase I don't normally make -- can I get it removed from the sample as an isolated event?
A: Only if the TYPE of spending (not just that specific item) is genuinely atypical for your business. If you regularly spend in that general category, a specific new purchase within it usually won't qualify as isolated.

Q: Does paying an assessment in full waive my right to dispute it later?
A: No -- as in this ruling, a taxpayer can pay an assessment and still timely file an application for correction afterward.

Q: Could the sample have UNDERSTATED my actual liability instead of overstating it?
A: Possibly. The Department noted that because sampling only reviews a representative period, it may not catch every untaxed transaction of a given type -- meaning the extrapolated result could understate, not overstate, the true liability.

Citations and references

Authorities the Department relied on (described here, not linked): P.D. 99-35 (3/29/1999), P.D. 13-39 (3/20/2013), P.D. 18-63 (5/2/2018), and P.D. 23-101 (8/24/2023) (a transaction must be isolated and not part of normal operations to be removed from an audit sample); P.D. 02-103 (6/24/2002) (a specific item need not itself be typical if the broader category of spending is a normal part of the business's operations) -- part of the same audit-sampling "isolated event" family as the already-enriched P.D. 24-115 and P.D. 25-35.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 24-98

Original ruling text

October 3, 2024

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

Dear *:

This will respond to your letter in which you seek correction of the retail sales and use tax assessment issued to * (the “Taxpayer”) for the period April 2020 through March 2023. We apologize for the delay in responding.

FACTS

Under audit, the Department found that the Taxpayer, a furniture retailer in Virginia, entered into a lease agreement with a vendor for the use of product imaging (photo) equipment but failed to remit the required tax. The equipment included various tangible personal property used to take pictures of the Taxpayer’s products for use in advertising materials. The Department’s auditor included the lease payments in its sample exceptions list used to calculate the Taxpayer’s error factor. This error factor was extrapolated over the audit period to determine the Taxpayer’s total exceptions resulting in an assessment of tax and interest. The Taxpayer paid the assessment in full and timely filed an application for correction, contending that the transactions should be removed from the extrapolation because the equipment lease was an unusual transaction for its business.

DETERMINATION

The Department’s audit utilized sampling to determine the amount of assessed liability. Sampling is an audit technique of significant value that is widely used in both the public and private sectors for all types of audits where a detailed audit would not prove beneficial either to the auditor or the client. When sampling techniques are properly applied, the final results are usually within a narrow percentage range of the actual amount that would have been determined by a detailed audit.

The purpose of the audit sample is to determine a factor for errors within a representative select period. Once the error factor is determined, the factor is extrapolated over the entire audit period. The purpose of the projection is to account for likely similar transactions on which Virginia tax has not been paid. Every effort is made to objectively select sample periods that are representative of the period being audited.

The Taxpayer argues that the inclusion of the equipment lease transactions was improper because it does not typically enter into transactions for the lease of photographic equipment. In order for a transaction to be removed from the audit sample and the extrapolation, a dealer must establish that the transaction is an isolated event and not a part of its normal operations. See Public Document (P.D.) 99-35 (3/29/1999), P.D. 13-39 (3/20/2013), P.D. 18-63 (5/2/2018), and P.D. 23-101 (8/24/2023).

In P.D. 02-103 (6/24/2002), the Department addressed a furniture manufacturer that disputed the inclusion of promotional pen purchases in the audit sample. The Department found that, while the dealer may not have normally purchased the specific advertising items at issue, it made other types of advertising purchases suggesting that the purchase of promotional advertising was not isolated in nature.

Based upon the information provided, the transactions at issue are not of the type that would be removed from the audit sample because the Taxpayer maintains various accounts for advertising expenses across various media types. By its nature as a sample, the audit may not have included purchases of advertising or promotional items on which the tax was neither paid nor accrued.

Accordingly, the assessment at issue is upheld. Because the Taxpayer has paid the disputed assessment in full, no further action is required.

The public documents cited are available online at www.tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at or **.

Sincerely,

James J. Alex

Tax Commissioner

Commonwealth of Virginia

AR/4761.Z

Related Documents

99-35

02-103

13-39

18-63

23-101