Did accounting-personnel changes justify splitting a Virginia audit into two periods with separate error factors?

Plain-English summary

Virginia refused to divide the audit period and apply a second, lower error factor after the company's accounting-personnel change. The original 2002 sample remained representative of the full March 2001-February 2004 audit.

The sample already included three months after the staffing change, and those months produced 23% of all sampled exceptions. After the change, returns for the company's two locations also repeatedly reported exempt sales exceeding gross sales. Those records did not demonstrate a significant improvement in compliance.

Because tax assessments are presumed correct and the taxpayer did not prove the sample invalid, Virginia upheld the extrapolation and assessment.

What this means for you

• Operational changes do not automatically invalidate an existing audit sample.
• To obtain separate error factors, a taxpayer needs evidence that compliance materially changed.
• Post-change errors can support using one factor across the full audit period.
• The taxpayer bears the burden of overcoming the assessment's presumed correctness.

Subject

Partitioning an audit period to apply two separate error factors is not warranted

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-83

Original ruling text

May 25, 2007

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

Dear *:

This will reply to your letter in which seek reconsideration of the Department's determination of May 9, 2005, issued to * (the "Taxpayer"). I apologize for the delay in responding to your letter.

FACTS

The Department audited the Taxpayer for the period March 2001 through February 2004. The auditor chose the year 2002 as the sample period and extrapolated the error factor for this period over the entire audit. The Taxpayer agrees to the results of the extrapolation for 2001, but disagrees with extrapolating the results for the period 2002 through 2004. In the Department's May 9, 2005 letter, it was determined that partitioning the audit period for purposes of applying two separate error factors was not warranted.

The Taxpayer states that it initiated changes in its accounting department during 2002 in order to improve tax compliance. The Taxpayer contends that a separate error factor should be computed and applied to periods in 2002 and after to account for the change in personnel.

DETERMINATION

The purpose of an 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 the sample periods that are representative of the period being audited and to reach a consensus with the taxpayer concerning the validity of the sample.

Upon review of the audit report and the information presented, I find no basis to invalidate the sample and extrapolation. While the Taxpayer claims that the error factor used by the auditor does not take into account the improved compliance as a result of the change in personnel, I do not agree with the Taxpayer's claim. The sample includes a three-month period after the change in personnel. In reviewing this three-month period, the Department's auditor found that 23% of the total number of exceptions found in the sample period occurred during this period. This suggests that the compliance level did not improve significantly as a result of the new personnel. Furthermore, after the change in personnel, the Virginia sales and use tax returns were filed claiming exempt sales in excess of gross sales. This occurred 10 out of the 14 months for the Taxpayer's Chantilly location and 5 months out of 14 months for the Taxpayer's Richmond location. This also suggests that the Taxpayer's compliance level did not improve significantly as a result of the change in personnel. Based on the above, an adjustment of the extrapolation and error factor is not warranted.

The courts have held that a tax assessment issued by the proper assessing authorities is prima facie correct, and the burden is upon the taxpayer to prove otherwise. The Taxpayer has not met this burden. Accordingly, the assessment is upheld as issued.

A revised bill, with interest accrued to date, will be mailed shortly to the Taxpayer. No additional interest will accrue provided the assessment is paid within 30 days from the date of the updated bill. If you have any questions about this determination, you may contact * in the Office of Policy and Administration, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/56015.i