Did Virginia finally uphold fraud, amnesty, and older-period assessments based on an automotive-parts retailer's underreported sales?

Plain-English summary

Virginia did not finally approve or erase the assessments. It sent the taxpayer's new sales documentation back to the auditor for invoice-level review.

The original audit indicated that the automotive-parts retailer had consistently reported no more than half of its actual sales. Under the cited sales-tax statute, that was prima facie evidence of intent to defraud. It supported the 50% sales-tax fraud penalty, the longer six-year assessment period, and corresponding adjustments to the proprietors' individual income-tax returns.

The taxpayer's appeal supplied receipt-based sales figures that differed from the figures examined during the audit. Because the Commissioner could not resolve that conflict without checking the invoices, the ruling required the auditor to review the new documentation. The compliance ratio, fraud penalties, amnesty penalties, older assessment periods, and individual-income-tax liabilities all remained subject to adjustment after that review.

If the taxpayer failed to provide the supporting invoices on time, the Department would issue consolidated bills using the original audit figures.

What this means for you

• Severe underreporting can support fraud penalties and extend Virginia's audit period.
• Sales-tax audit adjustments can also increase an owner's individual taxable income.
• Alternative summaries of receipts are not enough by themselves; the auditor may require the underlying invoices.
• This ruling was procedural and documentation-dependent, not a final holding that every assessed amount was correct.

Common questions

Did Virginia waive the fraud and amnesty penalties?

No. It left them in place pending review and allowed adjustment only if the supporting invoices changed the underlying sales findings.

Why were the proprietors' income-tax returns affected?

The Department used the additional business sales identified in the sales-tax audit to recalculate the proprietors' individual income.

Citations and references

• Va. Code §§ 58.1-635(A)-(B), 58.1-1840.1(F)(1), 58.1-634, 58.1-308, and 58.1-312(A).
• 23 VAC 10-210-2032(A).
• The source discusses P.D. 04-64.

Subject

Assessed tax, penalty and interest on underreported sales of automotive parts

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 06-128

Original ruling text

October 25, 2006

Re: § 58.1-1821 Application

* - Retail Sales and Use Tax

* - Individual Income 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 November 1998 through September 2004. You also seek correction of the individual income tax assessments issued to *** (the "Proprietors") for the taxable years 1998 through 2003. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer sells automotive parts at retail. As the result of an audit by the Department, the Taxpayer was assessed tax, penalty and interest on underreported sales. In addition the Proprietors, owners of the Taxpayer, were assessed tax, penalty and interest with regard to their individual income tax returns filed for the forementioned periods. With regard to both the retail sales and use tax assessment and the individual income tax assessments, you request the abatement of all fraud penalties assessed, the abatement of all amnesty penalties assessed, and the abatement of all taxes, penalties and interest assessed for periods prior to November 2001.

DETERMINATION

Retail Sales and Use Tax Assessment

Compliance Ratio

Title 23 of the Virginia Administrative Code 10-210-2032 A provides that "[t]he application of penalty to audit deficiencies is mandatory and its application is generally based on the percentage of compliance determined by computing the dealer's compliance ratio."

The compliance ratio computed in the audit is based on the sales and use tax returns filed by the Taxpayer with the Department and the invoices reviewed during the audit. Based on the auditor's review, it was determined that the Taxpayer was significantly underreporting its sales. You represent that you have reviewed the Taxpayer's invoices for 2001, 2002 and 2003, and believe that your review is sufficient to prove that the compliance ratio indicated by the sample is not indicative of the population and is therefore incorrect.

The documentation provided with the appeal to support the Taxpayer's position sets out sales figures based on the Taxpayer's receipts. This data is different than the data reviewed in the audit. Because the figures differ, I am unable to make a determination regarding your contention without further review by the auditor of the documentation presented. After the auditor has reviewed the documentation provided, a determination will be made regarding the compliance ratio calculation.

Fraud Penalty

Virginia Code § 58.1-635 A provides that when a dealer fails to make any return and pay the full amount of the tax due, there shall be imposed a 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, or in the 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 states, "It 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."

You maintain that there is no evidence of any attempt by the Taxpayer to defraud the Commonwealth. Based on the documentation reviewed during the audit, it was determined that the Taxpayer had consistently reported its gross sales at 50 percent of the actual amount. In accordance with Va. Code § 58.1-635 B, the underreporting of sales by 50 percent by the Taxpayer is considered prima facie evidence of intent to defraud, and the auditor was justified in imposing the fraud penalty. Pending the review of the sales documentation provided with the appeal, the application of the fraud penalty will be reexamined and adjusted if warranted.

Amnesty Penalty

Virginia Code § 58.1-1840.1 F 1 provides that "[i]f any taxpayer eligible for amnesty under this section and under the rules and guidelines established by the Tax Commissioner retains any outstanding balance after the close of the Virginia Tax Amnesty Program because of the nonpayment, underpayment, nonreporting or underreporting of any tax liability eligible for relief under the Virginia Tax Amnesty Program, then such balance shall be subject to a 20 percent penalty on the unpaid tax. This penalty is in addition to all other penalties that may apply to the taxpayer."

You maintain that the Taxpayer was not aware of the Virginia Tax Amnesty Program, and that the Taxpayer was also unaware that all sales and use tax due to the Department had not been paid. There were sufficient resources available to the Taxpayer to be properly apprised of its eligibility for amnesty. Concurrent with the release of the Department's web site (www.VaTaxAmnesty.com) on August 1, 2003, the Department issued a media release outlining the terms of Amnesty. In addition, the Taxpayer was under a duty to ensure that the proper amount of tax was remitted to the Department, and should have been aware of the discrepancy in the amount of the tax remitted prior to the amnesty period. Because the Taxpayer retained an outstanding balance at the close of the Amnesty Program, amnesty penalty was imposed in accordance with Va. Code § 58.1-1840.1 F 1. Pending a review of the documentation provided with the appeal, the application of the amnesty penalty will be reexamined and adjusted if warranted.

Statute of Limitations

Virginia Code § 58.1-634 requires that the retail sales and use tax be assessed within three years from the date on which such tax became due and payable. However, in the case of a false or fraudulent return with intent to evade payment of the tax or a failure to file a return, the taxes may be assessed at any time within six years from such date. The Tax Commissioner cannot examine any person's records beyond the three­year period of limitations unless there is reasonable evidence of fraud, or reasonable cause to believe that such person was required by law to file a return and failed to do so.

As previously mentioned, there is prima facie evidence of fraud in this case based on the documentation reviewed during the audit and the provisions in Va. Code § 58.1-635 B. Virginia Code § 58.1-634 supports the Department's examination of the Taxpayer's records and assessment of the tax beyond the three-year limitations period.

Pending a review of the documentation provided with the appeal, the statute of limitations extension will be reexamined and adjusted if it is determined that there was no intent on the part of the Taxpayer to defraud the Commonwealth.

Individual Income Tax Assessments

Underreported Income

The documentation reviewed during the audit indicates that the Taxpayer had underreported sales, resulting in the retail sales and use tax assessment. The individual income tax assessments for additional tax and interest were issued to the Proprietors as a result of the additional sales identified in the retail sales and use tax audit of the Taxpayer.

In Public Document 04-64 (8/24/04), the taxpayer, a restaurant, was owned and operated by the proprietor. An audit by the Department showed that the taxpayer had underreported sales. The additional sales figures that formed the basis for the tax assessed by the auditor for retail sales and use tax purposes were also used to adjust sales on the proprietor's individual income tax returns, resulting in assessments of additional individual income tax and interest.

In the Taxpayer's case, the use of the additional sales figures from the retail sale and use tax audit to recalculate the Proprietors' individual income tax liability is proper. Pending the review of the sales documentation provided with the appeal, the individual income tax liabilities for the periods at issue will be reexamined and adjusted if warranted.

Fraud Penalty

Virginia Code § 58.1-308 provides that if the understatement of individual income tax liability is false or fraudulent with the intent to evade the tax, "a penalty of 100 percent shall be added together with interest on the tax at a rate determined in accordance with § 58.1-15, from the time the return was required by law to be filed until paid."

In this instance, the gross sales reported on the Proprietors' individual income tax returns were underreported in an amount equal to the underreported sales for retail sales and use tax purposes. Pending the review of the documentation provided with the appeal, the application of the fraud penalty will be reexamined and adjusted if warranted.

Amnesty Penalty

As discussed previously, the application of the amnesty penalty will be reexamined following a review of the documentation provided with the appeal.

Statute of Limitations

Virginia Code § 58.1-312 A authorizes the assessment of the individual income tax at any time if a false or fraudulent return is filed with intent to evade tax. As stated previously, based on the documentation reviewed during the audit, the auditor determined that the Proprietors filed false or fraudulent returns with intent to evade tax. As a result, the Department was authorized to expand the taxable years under review and assess tax. Pending a review of the documentation provided with the appeal, this issue will be reexamined and adjusted if it is determined that there was no intent on the part of the Taxpayer to defraud the Commonwealth.

CONCLUSION

The documentation provided with the appeal will be forwarded to the auditor for review. The auditor will contact the Taxpayer shortly. The Taxpayer should be prepared to provide to the auditor the invoices supporting the sales listed in the documentation presented. Should the Taxpayer fail to provide the invoices within the time allotted by the auditor, the Taxpayer and the Proprietors will be issued a consolidated bill based on the figures used in the initial audit. Those bills will be immediately due and payable.

The Code of Virginia sections, regulations and public documents cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions about this determination, you may contact * in the Department's Office of Policy and Administration, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/54958P