Could a cigarette retailer defeat a reconstructed sales-tax assessment by claiming that distributor purchases were fraudulent?

Plain-English summary

Virginia upheld a reconstructed sales-tax assessment against a cigarette retailer. Distributor records showed that the retailer bought cigarettes tax-free for resale, but the retailer's records did not show the resale exemption or sales tax collected and remitted on those cigarettes.

The retailer denied authorizing the purchases and cited a police report alleging fraud and identity theft. The report had been closed after the investigating officer found no evidence of fraudulent activity. Without supporting records, the retailer did not overcome the presumption that the Department's assessment was correct.

Virginia calculated the assessment from the distributor's cost-price records as the best information available. It also retained the penalty because the retailer showed no good cause for noncompliance and retained interest because interest compensated the Commonwealth for the use of money due.

Common questions

Could Virginia use distributor records? Yes. When the retailer lacked adequate records, the Department could reconstruct liability from the best information available.

Did the fraud allegation overturn the assessment? No. The police report was closed without evidence of fraud, and the retailer supplied no other proof.

Why was the penalty retained? The retailer did not show good cause for failing its tax-compliance duties.

Could interest be waived as a penalty? No. The ruling treated interest as compensation for use of the Commonwealth's money, not as a penalty.

Citations and references

• Va. Code §§ 58.1-602, 58.1-623, 58.1-633, and 58.1-618
• 23 VAC 10-210-280 and 10-210-470
• Va. Code §§ 58.1-205, 58.1-635, 58.1-1812, and 58.1-1821

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 18-183

Original ruling text

October 30, 2018

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

Dear *:

This is in response to your letter in which you seek correction of the retail sales tax assessment issued to * (the “Taxpayer”) for the period January 2013 through August 2013. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer is a retailer of cigarettes and other tobacco products. The Department utilizes a compliance program that verifies retail sales and use tax compliance regarding cigarettes purchased for resale and sales of cigarettes by a retail or wholesale dealer. As a result of the compliance program, the Taxpayer was issued an assessment for tax, penalty and interest on untaxed cigarettes purchased from * (the “Distributor”). The assessment is based on sales information provided by the Distributor identifying the Taxpayer’s purchases of cigarettes exempt of the tax for resale.

It is the Department’s position that the cigarettes purchased by the Taxpayer for resale would have been sold to the Taxpayer’s customers and, therefore, the sales tax should have been collected and remitted to the Department on such sales. Based on the sales information provided by the Distributor, it was determined that the Taxpayer underreported sales of cigarettes, by the amount of the cigarettes purchased from the Distributor for resale. On June 23, 2014, the Department sent the Taxpayer a summary of the findings and the proposed tax liability. The Taxpayer was allowed 14 days to provide documentation to substantiate whether the Taxpayer’s purchases from the Distributor qualified for the resale exemption or whether the Taxpayer collected and remitted the sales tax on the sale of those purchases. The Taxpayer failed to respond to the Department’s request for documentation within the allotted time and the assessment was issued.

The Taxpayer contests the sales tax assessment and claims that any purchase of cigarettes from the Distributor was made without the Taxpayer’s knowledge or permission. The Taxpayer states that it filed a police report regarding the alleged fraudulent purchases and requests that the Department place the assessment on hold until the police investigation is complete and resolved.

DETERMINATION

Purchases/Sales

The resale exemption provided under the Virginia retail sales and use tax is found in Virginia Code § 58.1-602. This code section excludes a sale for resale from the definition of a “retail sale,” which is defined as “a sale to any person for any purpose other than for resale in the form of tangible personal property or services taxable under this chapter.”

Virginia Code § 58.1-623 sets forth the requirements for the proper use of exemption certificates and, in section A, provides that “[a]ll sales or leases are subject to the tax until the contrary is established. The burden of proving that a sale, distribution, lease, or storage of tangible personal property is not taxable is upon the dealer unless he takes from the taxpayer a certificate to the effect that the property is exempt under this chapter.”

Title 23 of the Virginia Administrative Code (VAC) 10-210-280 provides further explanation of the proper use of exemption certificates. Subsection A states that a certificate that is incomplete, invalid, infirm or inconsistent on its face is never acceptable, either before or after notice.

Virginia Code § 58.1-633 A provides that every dealer required to make a return and collect sales tax "shall keep and preserve suitable records of the sales, leases, or purchases . . . taxable under this chapter, and such other books of account as may be necessary to determine the amount of tax due hereunder, and such other pertinent information as may be required by the Tax Commissioner."

The 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 deductions and exemptions claimed in filing sales or use tax returns., including exemption and resale certificates, returned or repossessed goods, and bad debts. . .A record of all tangible property used or consumed in the conduct of the business. . .A true and complete inventory of the stock on hand and its value, taken at least once each year. Records must be open for inspection and examination at all reasonable hours of the business day by the Department of Taxation.

When a dealer fails to maintain adequate records, the Department is authorized by Virginia 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.

In this instance, the documentation provided by the Distributor shows that the Taxpayer purchased cigarettes exempt of the tax for resale. The cigarette sales provided by the Distributor show that the Taxpayer made cigarette purchases totaling * exempt of the tax that are not supported by any resale exemption or tax reporting documentation.

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

The assessment is calculated on the cost price of the cigarettes based on the sales documentation provided by the Distributor, as this was the best information available. A notice was sent to the Taxpayer on June 23, 2014 of the Department’s findings regarding the Taxpayer’s exempt purchases of cigarettes and a request for documentation to substantiate the exempt resale of such cigarettes. While the Taxpayer denies that it purchased such cigarettes, the information provided by the Distributor shows that the Taxpayer purchased the contested cigarettes exempt of the tax for resale from the Distributor. Further, it is my understanding that the police report filed by the Taxpayer claiming fraud and identity theft in connection with the purchase of cigarettes from the Distributor was closed in May 2015 because the officer found no evidence of fraudulent activity. Lacking supporting documentation that the contested cigarettes were purchased fraudulently, the Taxpayer has not met the burden of proof that the assessment is erroneous. Accordingly, I find that the audit assessment is correct.

Penalty

Virginia Code § 58.1-635 mandates the application of penalty to tax deficiencies and provides that:

When any dealer fails to make any return and pay the full amount of the tax required by this chapter, there shall be imposed, in addition to other penalties provided herein, a specific penalty to be added to the tax in the amount of six percent if the failure is for not more than one month, with an additional six percent for each additional month, or fraction thereof, during which the failure continues, not to exceed thirty percent in the aggregate. . .If such failure is due to providential or other good cause shown to the satisfaction of the Tax Commissioner, such return with or without remittance may be accepted exclusive of penalties. [Emphasis added.]

As the Taxpayer has not shown good cause for its failure to properly comply with its tax compliance responsibilities as a retailer of cigarettes, I find no basis to remove the assessed penalty.

Interest

Virginia Code § 58.1-1812 mandates the application of interest to any tax assessment. Interest is not assessed as a penalty for noncompliance with the tax laws. Rather, it simply represents a fee for the use of money over a period of time. In this case, the Taxpayer had the use of the money that was properly due the Commonwealth. Therefore, I find no basis to waive the interest assessed as a result of the Department's audit.

CONCLUSION

The assessment is upheld as issued. I note that a payment in the amount of * has been applied to the bill. An updated bill, with interest accrued to date, will be sent to the Taxpayer. The outstanding balance should be paid within 30 days of the bill date to avoid additional interest charges. The Taxpayer should remit its payment to: Virginia Department of Taxation, 600 East Main Street, 15th Floor, Richmond, Virginia 23219, Attn: . If you have any questions concerning payment of the assessment, you may contact at ***.

The Code of Virginia sections and regulations 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 response, you may contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/562.T