How could Virginia estimate taxable complimentary restaurant meals when records were missing, and did the first-audit penalty apply?

Subject

Complimentary-meal estimate reduced and first-audit penalty waived

Plain-English summary

Virginia allowed an estimate of taxable complimentary meals because the restaurants did not keep records showing why each meal was given, but it reduced the taxable percentage from 65% to 35%. A free-meal ticket issued because of poor food quality did not create additional tax. A meal given for poor service, public relations, or another reason required use tax on the cost of the property furnished.

The restaurants did not produce daily, weekly, or monthly support separating those categories. The auditor therefore used a prior ruling's 65%-35% split, but applied the wrong side of it. In that precedent, 65% represented exempt poor-food-quality meals and 35% represented taxable meals.

Discounted employee meals and other discounted sales were not included in the audit. The penalty was also waived because this was a first-generation audit and the record did not show prior written notice, collected-but-unremitted tax, or willful evasion with signs of fraud.

Result: taxable complimentary meals were estimated at 35% of the total, the audit was revised, and the penalty was removed.

What this means for you

• Record why each complimentary meal was issued.
• Separate poor-food-quality remedies from poor-service and public-relations meals.
• Missing records allow Virginia to use the best available information to estimate liability.
• Do not assume the 35% estimate applies outside these audit facts.
• First-audit penalty relief can be lost when a regulatory exception is present.

Common questions

Q: Are all free restaurant meals exempt?

A: No. The cited rule protected a redeemed free meal ticket issued for poor food quality, not meals given for poor service or public relations.

Q: Did the audit tax discounted employee meals?

A: No. The ruling states that discounted employee meals and discounted sales were not included.

Citations and references

• Va. Code §§ 58.1-205, 58.1-633(A), and 58.1-618.
• 23 VAC 10-210-930(E), 10-210-470, and 10-210-2032(B)(3).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 15-150

Original ruling text

July 7, 2015

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 assessments issued to * (collectively the "Taxpayer), for the period July 2008 through December 2012 and September 2008 through December 2012, respectively. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer operates two restaurants in Northern Virginia. As a result of the Department's audits, assessments were issued for taxable complementary meals. Because the Taxpayer did not provide the necessary documentation to verify taxable and exempt complementary meals, the auditor relied on Public Document (P.D.) 05-169 (12/13/05) to estimate the liability for taxable complementary meals based upon a percentage of the total complementary meals. The Department's audits also disclosed that the Taxpayer failed to file returns for multiple periods outside the audit periods. The auditor extended the audit periods to include these returns that were not filed.

The Taxpayer contests the audit methodology for determining taxable complementary meals and claims that it was erroneously assessed the tax on complementary, discounted and employee meals. In addition, the Taxpayer requests that penalties be reduced from 30% to 10% on the basis that the Taxpayer was dealing with the repercussions of a significant data breach that affected its point of sale systems and credit card information. Further, the Taxpayer contends that some of the returns filed with the auditor were less than 30 days late but were included in the audit and erroneously assessed penalty.

DETERMINATION

Complementary Meals

Title 23 of the Virginia Administrative Code (VAC) 10-210-930 E states, "A dealer who has collected the tax from a customer but subsequently issues a ticket which is redeemable for a free meal will not be liable for any additional tax on the free meal provided the redeemable ticket was issued to the customer as a result of poor food quality. ” [Emphasis added]. When a redeemable free meal ticket is issued to a customer as the result of poor service, for public relations purposes or for any reason other than poor quality food, the dealer must report use tax on the cost price of all tangible personal property furnished in providing the free meal at the time the ticket is redeemed.

In P.D. 05-169, the taxpayer requested a refund for tax paid on exempt complementary meals. The Tax Commissioner agreed that the taxpayer's 65%-35% split between complementary meals for poor quality food and taxable poor quality service, respectively, was reasonable for calculating the tax paid on exempt complementary meals due to poor food quality.

In this instance, the auditor requested daily, weekly or monthly reports from the Taxpayer on several occasions to determine what complementary meals were provided for poor quality food and what complementary meals were provided for poor quality services or for public relations purposes. The information was not provided. The auditor denied the one-month summary of complementary meals provided by the Taxpayer because there was no supporting documentation to verify the breakout of taxable complementary meals. Further, the monthly summary was for a period outside the audit. Therefore, to estimate the audit liability for taxable complementary meals, the auditor relied on the percentages established in P.D. 05-169 for taxable and exempt complementary meals.

Based on the foregoing and absent evidence to the contrary, I find that the audit methodology is reasonable with one exception. The auditor erroneously applied 65% to the Taxpayer's total complementary meals figures to estimate the audit liability for taxable complementary meals but should have applied 35% as established in P.D. 05-169. Therefore, the audit will be adjusted to estimate taxable complementary meals based on 35% of the total complementary meals.

It is my understanding that discounted employee meals and discounted sales were not included in the audit and, therefore, are not an issue.

Virginia Code § 58.1-205 sets out that any assessment of a tax by the Department is deemed prima fade correct. This means that the burden of proving that the assessment is erroneous is upon the Taxpayer. Based on the available information, the Taxpayer has not met this burden.

Regarding the Taxpayer's lack of records, Va. Code § 58.1-633 A, every dealer required to file a retail sales and use tax return and pay or collect such tax must keep and preserve suitable records of the sales, leases, or purchases, as the case may be, subject to the retail sales and use tax. The dealer must also maintain such other books of account as may be necessary to determine the amount of tax due, and "such other pertinent information as may be required by the Tax Commissioner." This record keeping requirement is further explained in Title 23 VAC 10-210-470 as follows:

Every person who is liable for collection of sales tax or remittance of use tax or both is required to keep and preserve for three years adequate and complete records necessary to determine the amount of tax liability. Such records must include . . . a daily record of all cash and credit sales, including sales under any type of financing or installment plan in use. . . A record of the amount of all merchandise purchased, including a bill of lading, invoice, purchase order or other evidence to substantiate each purchase. . . A record of all tangible property used or consumed in the conduct of the business... Records must be open for inspection and examination by the Department of Taxation. [Emphasis added].

When a dealer fails to maintain adequate records, as is the case here, 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.

Penalty

Title 23 VAC 10-210-2032 B 3 addresses penalty on first generation audits and provides that:

Generally, penalty will be waived for first generation audits. First generation audit penalty cannot be waived if any of the following conditions exist:

a. The taxpayer has been previously notified in writing by the Department of Taxation to collect tax on sales or to pay tax on purchases, but has failed to follow instructions;

b. The taxpayer has collected the sales tax, but failed to remit it to the Department of Taxation; or

c. The taxpayer has willfully evaded reporting and remitting the tax to the Department of Taxation and indications of fraud exist.

In this instance, none of the conditions cited above exist that would warrant penalty on this first generation audit. Accordingly, the audit penalty will be waived.

CONCLUSION

The audit will be adjusted based on this determination. After the audit is revised and the assessment is adjusted by the Department's audit staff, an updated bill with accrued interest will be issued to the Taxpayer. The bill should be paid within 30 days of the bill date to avoid the accrual of additional interest. The Taxpayer should remit its payment to: Virginia Department of Taxation, 600 East Main Street, 23rd Floor, Richmond, Virginia 23219, Attn: *. If you have any questions concerning payment of the assessment, you may contact at **.

The Code of Virginia , regulation sections and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions about this determination, please contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-5611645966.T