How did Virginia estimate a cash restaurant's taxable sales when it lacked guest checks, Z-tapes, and other supporting records?

Subject

Taxpayer failed to maintain sufficient sales records to verify sales.

Plain-English summary

Virginia could use a gross-profit-markup method because the restaurant did not keep enough records to verify reported sales. The restaurant had not retained guest checks, Z-tapes, or similar support. Its reported gross-profit margin was roughly 20% below comparable restaurants, and the auditor initially increased the margin by 15% after allowing for evidence that the taxpayer's costs were higher.

The taxpayer argued that bank deposits and cash-paid expenses better measured sales. The Department disagreed because an all-cash business could not prove those figures captured every receipt.

The taxpayer did obtain a partial reduction. Later records supported a 51.35% gross-profit margin, 13.03% above the audit-period margin. Although the taxpayer applied that percentage incorrectly in its own calculation, the Department accepted a 13.03% margin increase instead of 15% and reduced taxable sales accordingly.

What this means for you

• Restaurants must preserve records sufficient to verify reported sales.
• When records are inadequate, Virginia may reconstruct sales using the best available information and industry comparisons.
• Bank deposits do not necessarily capture all receipts of a cash business.
• Reliable later-period records can support an audit adjustment, but the calculation must apply the margin correctly.

Common questions

Was the markup method rejected?

No. The Department found it reasonable but reduced the percentage used.

What was the final adjustment?

The gross-profit-margin increase was reduced from 15% to 13.03%, lowering the reconstructed taxable sales.

Citations and references

• Va. Code §§ 58.1-633 and 58.1-618.
• 23 VAC 10-210-470.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-235

Original ruling text

September 29, 2010

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

Dear *:

This will reply to your letter in which you seek correction of the retail sales and use tax assessment issued to * (the "Taxpayer") for the period January 2005 through December 2007. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer operates a restaurant. During the audit period, the Taxpayer failed to maintain sufficient sales records to verify sales as reported to the Department. The Taxpayer did not retain guest checks, Z-tapes or other records to support its sales reported. The auditor attempted to establish reasonable gross sales figures by applying a mark-up of the cost of goods sold. The auditor compared the gross profit margin (GPM) of the Taxpayer to the GPMs of other similar restaurants. The Taxpayer's average GPM for the audit period was approximately 20% lower than that of other comparable restaurants. The Taxpayer did provide some records to show that its costs were 5% higher than other restaurants, and the auditor adjusted the GPM to 15% and assessed tax on the additional sales derived from the increase.

The Taxpayer disagrees with the Department's computations and states that the bank deposit records and cash paid expenses provide documentation of cash received and should be used rather than the method chosen by the auditor. The Taxpayer has also provided an alternative computation that it believes disproves the auditor's gross sales methodology.

DETERMINATION

Records

Virginia Code § 58.1-633 mandates every dealer to keep and preserve suitable records of the sales, leases, or purchases and any, such other books of account that may be necessary to determine the amount of tax due, and other pertinent information as may be required by the Tax Commissioner. This record keeping requirement is further explained in Title 23 of the Virginia Administrative Code 10-210-470.

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. When an assessment is issued under these circumstances, the above cited statute deems such an assessment to be prima facie correct. The burden is upon the Taxpayer to prove that the audit methodology applied is flawed in some mariner as to render the assessment invalid.

Purchase Mark Up

When adequate records are not available, a method used by the Department to determine a reasonable audit deficiency is to utilize industry standards. According to data published by the National Restaurant Association in 1995, GPMs for restaurants similar to that of the Taxpayer range from 60% to 70%. The auditor looked at the GPMs reported by three similar-type restaurants within the same geographical region. GPMs for these restaurants during the audit period ranged from 56% to 65%. The Taxpayer's average GPM during the audit period was approximately 20% lower than the other comparable restaurants. The auditor concluded that the Taxpayer's GPM should be increased by 20%. During the audit, the Taxpayer did provide some records to support that its costs were 5% higher than the other restaurants. In consideration of the information provided, the auditor re-evaluated his figures and increased the Taxpayer's GPM by 15%, assessing tax on the resulting additional sales.

The Taxpayer argues that the bank deposit records and expenses paid by cash provide adequate documentation to determine gross sales more accurately than the methodology used by the auditor. The flaw in the Taxpayer's methodology, however, is that when all the sales of a business are cash sales, it is difficult to verify that the bank deposits plus cash paid expenses represent all of the gross receipts. Based on the information presented, the auditor's increase of the GPM by 15% in order to determine gross sales appears to be fair and reasonable. Accordingly, I do not find sufficient cause to amend the Department's computation based on bank deposits and cash paid expenses.

Alternative Method

After the close of the audit, the Taxpayer provided additional information proposing an alternative method to determine the amount of understated sales. The Taxpayer maintained sufficient records for the period March through December 2008. During that period, the supportable GPM calculated by the Taxpayer was 51.35%, which was 13.03% higher than the GPM reported during the audit period. Based on this computation, the Taxpayer proposed additional taxable sales of *. The Taxpayer's calculations, however, are flawed, in that, the Taxpayer's figures increased gross sales reported during the audit period by 13.03% rather than increasing the average GPM by 13.03%. The Taxpayer's computations should have increased the GPM during the audit period by 13.03%, with the resulting additional taxable sales equaling ***.

Based on the foregoing, while I believe that the Department's computations are reasonable, I will agree to accept the GPM at 13.03% instead of 15% and reduce the taxable sales from * to ***.

The Department's audit has been revised to reflect the adjusted sales. A revised bill will be mailed under separate cover. The outstanding balance must be paid within 30 days from the date of the revised bill to avoid the accrual of additional interest and an additional 20% penalty on the tax due under the terms of Virginia's recent Amnesty program.

The Code of Virginia sections and regulation cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have any questions regarding this determination, please contact * of ***. the Department's Office of Tax Policy, Appeals and Rulings, at

Sincerely,

Linda D. Foster

Deputy Tax Commissioner

AR/1-4096981981.Q