Could a corporation claim a sales-tax bad debt because its former president allegedly diverted a customer's payment?

Plain-English summary

The corporation claimed a bad-debt deduction for $25,680 of sales even though the customer had paid that amount to the corporation's former president. The corporation argued that the payment was not legally collected because the officer allegedly diverted the funds.

Counsel rejected the deduction. Even assuming the diversion occurred, the corporation had not shown that the customer's debt was worthless. A loss caused by an officer's diversion was not itself a sales-tax bad debt; the deduction applied only to debts arising from retail sales.

Counsel also found the ten-percent negligence penalty supported because the corporation failed to report about 87.5 percent of its sales during the audit period, including printed-material sales from April 1, 1961 through March 31, 1963, while charging customers tax reimbursement. The letter concluded that the determination was correct and invited additional information within 30 days.

Common questions

Why was the customer's account not treated as worthless?

The customer had paid the former president. The alleged loss arose from diversion of those funds, not from an unpaid retail-sale debt shown to be worthless.

Did the accountant's illness excuse the penalty?

No. Counsel said the underreporting was not excused by the accountant's other work and illness, particularly because no correction was made after accountants changed.

Citations and references

• The corporation's August 6, 1964 petition for redetermination and August 18 letter (described in the source)
• The Board audit covering printed-material sales from April 1, 1961 through March 31, 1963

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/130-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/130-0200.pdf

Original ruling text

130.0200

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

September 28, 1964

[X]

Attention:

[X]

Gentlemen:
Your petition for redetermination dated August 6, 1964, has been referred to the legal staff. It is hoped that the matter can be resolved through correspondence. A review of the file indicates that at the time of the completion of the audit report, you disagreed only with the disallowance of a bad debt deduction in connection with certain sales to
[X] and with the 10 per cent negligence penalty. You letter of August 18 states, however, that the corporation is protesting the entire amount of the determination. Since the measure of liability (without considering the bad debt claim) represents sales of printed materials on which you collected tax reimbursement from your customers, it is difficult to see the justification for your position. The bad debt claim, as we understand it, relates to sales to [X] in the amount of $25,680, which amount was paid by [X] to the former president of the corporation, Mr. [Y]. It is your contention that the debt was not legally collected from [X] because the funds were illegally diverted by Mr. [X]. Assuming this were true, the corporation nevertheless would not be entitled to a bad debt deduction since it has not been established that the purported debt of [X] is “worthless.” The fact that the corporation may have suffered a loss due to the diversion of funds by a corporate office would not, of course, furnish a basis for a bad debt deduction for sales tax purposes. The deduction may be taken only with respect to debts arising from retail sales. The 10 per cent negligence penalty was imposed because the corporation failed to report some 87 ½ per cent of its sales during the audit period. Sales of printed matter were not reported at all during the period of April 1, 1961, through March 31, 1963. On all such sales, however, tax reimbursement was charged to customers. It is our opinion that these facts amply support the imposition of a negligence penalty. We do not believe such negligence can be excused merely because the accountant was preoccupied with other accounts and was ill for lengthy periods. Even after the change in accountants, no effort was made to report the previously unreported sales, although tax was reported on sales of the same nature after March 31, 1963.

[X]

-2-

September 28, 1964
130.0200

From a consideration of all of the information at hand, we must conclude that the determination is correct. If you have any additional information to present in support of the petition for redetermination, please advise us within 30 days. Very truly yours,

Patricia McKinney
Assistant Counsel
PM:spg
cc:

Long Beach – Subdistrict Administrator