Can a cigarette wholesaler avoid use tax on resale purchases when its exemption certificates are incomplete or belong to another supplier?

Plain-English summary

A cigarette wholesaler bought cigarettes tax-free "for resale" from two distributors. Under Virginia's cigarette-compliance program, the Department matched the distributors' sales records and assessed consumer use tax, penalty, and interest on cigarettes the wholesaler couldn't show it had actually resold tax-exempt. The wholesaler had missed the auditor's original request for documentation, then appealed after the assessment, offering sales invoices and customer resale exemption certificates.

The Department gave partial relief: it accepted the invoices and removed sales backed by valid certificates, but upheld the tax on sales that were poorly documented or undocumented. It waived the penalty but not the interest, and — because the business had closed — invited an offer in compromise.

What the wholesaler had to prove

Virginia puts the burden of proving a sale is exempt on the dealer (Va. Code § 58.1-623 A; 23 VAC 10-210-280 A). Wholesalers and jobbers must keep records of every sale — buyer name and address, registration number, date, item, and price (Va. Code § 58.1-633 B) — and keep exemption/resale certificates and purchase records for three years (23 VAC 10-210-470). An assessment is prima facie correct, so the taxpayer must prove it wrong (Va. Code § 58.1-205).

What the Department accepted — and rejected

The ruling sorted the wholesaler's transactions into buckets:

• Sales invoices — accepted. The auditor had rejected the invoices for lacking a customer signature, but the Commissioner found the invoices otherwise valid and held that the taxpayer met its statutory recordkeeping obligation. Those sales were allowed.
• Valid exemption certificates — removed from the assessment. Sales supported by complete, good-faith resale certificates were taken out of the audit.
• Defective certificates — tax upheld. Certificates that bore another supplier's name (a wholesaler can't use someone else's certificate), or that were missing the supplier name, complete registration numbers, or a description of the property, were incomplete and invalid. A certificate that is "incomplete, invalid, infirm or inconsistent on its face is never acceptable."
• Undocumented sales — tax upheld. Where the taxpayer had no resale documentation at all, the distributors' purchase data was the best information available, and the tax stood.

Penalty, interest, and hardship

• Penalty removed. Under Va. Code § 58.1-635 and 23 VAC 10-210-2032, penalty is generally not assessed on a first-generation audit absent fraud — so it was waived.
• Interest kept. Interest is mandatory (Va. Code § 58.1-1812) and is not a penalty; it's a charge for the use of money owed, so it can't be waived unless the underlying tax changes.
• Offer in compromise offered. With the business closed and hardship claimed, the Commissioner invited an offer in compromise based on doubtful collectibility (Va. Code § 58.1-105 B) — but the taxpayer must submit the required Business Offer in Compromise financial statements within 30 days, or the assessment becomes immediately due.

What this means for you

• Keep resale documentation as you go. After-the-fact invoices help, but missing or defective certificates will leave you owing the tax.
• A certificate must be complete and yours. It needs the supplier's name, full registration number, and a description of the property — and you can't rely on a certificate issued to a different supplier.
• Respond to the auditor the first time. This dispute grew partly because the taxpayer missed the initial documentation request.
• First-audit penalties are often waivable, but interest is not. Expect to pay interest on any tax that ultimately stands.
• If you truly can't pay, an offer in compromise based on doubtful collectibility is available — but only if you file the financial statements on time.

Common questions

Q: I'm a wholesaler — do I really have to prove my resale sales were exempt?

A: Yes. The burden is on the dealer. If you can't document a tax-exempt resale with valid records and certificates, the Department can assess use tax on the purchase.

Q: My auditor rejected invoices for having no customer signature. Is that required?

A: The Commissioner here found otherwise-valid invoices acceptable despite the missing signature. A signature is not what makes the sales record valid.

Q: Can I use an exemption certificate that names a different supplier?

A: No. A certificate issued to another supplier is invalid for your sales, and an incomplete certificate is never acceptable.

Q: The penalty was waived — why do I still owe interest?

A: Interest is mandatory by statute and isn't a penalty; it compensates the Commonwealth for the delayed payment and can't be waived unless the tax itself is reduced.

Citations and references

• Va. Code § 58.1-623 A — exemption burden; use tax on untaxed purchases
• Va. Code § 58.1-633 B — wholesaler/jobber recordkeeping requirement
• 23 VAC 10-210-470 — three-year recordkeeping duty
• 23 VAC 10-210-280 — exemption certificates; incomplete certificate never acceptable
• Va. Code § 58.1-205 — assessment is prima facie correct
• Va. Code § 58.1-635 and 23 VAC 10-210-2032 — penalty; first-generation-audit waiver
• Va. Code § 58.1-1812 — mandatory interest
• Va. Code § 58.1-105 B — offer in compromise based on doubtful collectibility

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 19-101

Original ruling text

September 4, 2019

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

Dear *:

This is in response to your letter on behalf of * (the “Taxpayer”) in which you seek correction of the retail sales and use tax assessment for the period April 2013 through May 2014. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer is wholesale dealer. As a result of the Department’s compliance program to verify retail sales tax compliance on purchases of cigarettes by retail and wholesale dealers, the Taxpayer was issued an assessment for consumer use tax, penalty and interest on untaxed cigarettes purchased from * and ***, collectively (the “Distributors”) pursuant to Virginia Code § 58.1-623 A.

The assessment is based on sales information provided by the Distributors identifying the Taxpayer’s purchase of cigarettes exempt of the tax for resale. A notice was sent to the Taxpayer on July 9, 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. Because the Taxpayer failed to respond to the Department’s request for documentation within the allotted time, an assessment was issued for the tax, interest and penalty on the untaxed cigarette purchases. The Taxpayer contacted the auditor and provided sales invoices and customer resale exemption certificates.

The Taxpayer contests the sales tax assessment and claims that, as a wholesaler, it is not required to collect the sales tax on cigarettes sold to retail dealers for resale. The Taxpayer further maintains that all exempt sales are supported by customer resale exemption certificates. In addition, the Taxpayer argues that the audit was conducted as a desk audit and no contact was made with the Taxpayer. Therefore, the Taxpayer was not given a fair opportunity to challenge the audit findings. Lastly, the Taxpayer claims that the audit liability will cause a severe financial burden on the Taxpayer.

DETERMINATION

Records

Virginia Code § 58.1-633 B provides that:

All wholesalers and jobbers in this Commonwealth shall keep a record of all sales of tangible personal property, whether such sales be for cash or on terms of credit. Such records shall include the name and address of the purchaser, the number of the certificate of registration issued to the purchaser, the date of the purchase, the article purchased, and the price at which the article is sold to the purchaser. . . Any person who is both a retailer and a wholesaler or jobber and who fails to keep proper records showing wholesale sales and retail sales separately shall pay the tax as a retailer on both classes of his business.

The record keeping requirement is further explained in Title 23 of the Virginia Administrative Code (VAC) 10-210-470 as following:

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. The dealer may maintain such records on microfilm.

The above authorities state that the Taxpayer clearly has an obligation to maintain sufficient records of all sales of tangible personal property and substantiate sales of tangible personal property that are made exempt from the tax. This is a responsibility shared by all dealers who sell tangible personal property.

It is my understanding that the auditor’s attempt to contact the Taxpayer to perform a retail inspection was unsuccessful. It was only after the assessment was issued that the Taxpayer contacted the Department about the documentation required by the auditor to support exempt sales. As a result, a meeting was scheduled and the Taxpayer provided the auditor sales invoices and customer exemption certificates. The auditor reviewed the invoices and deemed them invalid because they had no customer signature on the invoice. Therefore, the auditor made no adjustment to the assessment based on the documentation provided by the Taxpayer.

Based on the above cited authorities and a review of the documentation provided by the Taxpayer, I find that the Taxpayer fulfilled its statutory obligations and the sales invoices are valid.

Certificates of Exemption

Title 23 VAC 10-210-280 A provides that:

All sales, leases and rentals of tangible personal property are subject to the tax until the contrary is established. The burden of proving that the tax does not apply rests with the dealer unless he takes, in good faith from the purchaser or lessee, a certificate of exemption indicating that the property is exempt under the law. The certificate will remain in effect except upon notice from the Department of Taxation that it is no longer acceptable. However, a certificate that is incomplete, invalid, infirm or inconsistent on its face is never acceptable, either before or after notice.

Subsection B of the regulation states that:

Legitimate use of exemption certificates is vital. Reasonable care and judgment must be exercised by all concerned to prevent the giving or receiving of false, fraudulent or bad faith exemption certificates. An exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate.

Based on a review of the exemption certificates provided, the audit will be adjusted to remove the sales supported by valid exemption certificates. However, the auditor found exemption certificates presented by the Taxpayer bearing the name of another supplier (*). These exemption certificates are not valid because the Taxpayer cannot accept another supplier’s exemption certificate to sell cigarettes exempt of the tax. In addition, some certificates presented by the Taxpayer lack the name of the supplier, complete tax registration numbers, or descriptions of the type and use of the property being purchased. These certificates presented by the Taxpayer during the appeal are incomplete and, therefore, invalid. As properly completed exemption certificates have not been provided by the Taxpayer to substantiate these protested sales, I find these sales were correctly assessed.

Undocumented Sales

A comparison of the sales provided by the Taxpayer to the cigarette purchases from the Distributors show that the Taxpayer purchased * in tax exempt cigarettes not supported by resale documentation. Lacking documentation to support the exempt sale of such cigarettes, the auditor held the purchases in the audit.

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. Because the Taxpayer provided no records, the sales information provided by the Distributors was the best information available to assess the audit liability. As such, the tax liability was calculated based on purchase price of the cigarettes. Accordingly, the assessment is correct with respect to these purchases.

Penalty

Virginia Code § 58.1-635 mandates the application of penalty to sales and use tax deficiencies. Title 23 VAC 10-210-2032 B 3 generally provides that penalty will not be assessed in first generation audits. Because this is a first generation audit and there are no indications of fraud, I find 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.

Financial Hardship

The Taxpayer indicates that the assessment will cause a financial burden. The Taxpayer, however, has not submitted the required financial statements that reflect or verify an inability to pay the assessment. The Taxpayer must present evidence of doubtful collectability to support a claim of financial hardship. Without such information, the Department is unable to consider an offer in compromise based on doubtful collectability.

Virginia Code § 58.1-105 B authorizes the Tax Commissioner to compromise and settle a tax liability of doubtful collectibility. It is my understanding that the Taxpayer’s business is closed, and there continues to remain an issue of financial hardship if the Taxpayer be required to pay the assessment. As such, the Taxpayer may wish to request an offer in compromise based on doubtful collectibility. The Taxpayer must present evidence of doubtful collectibility to support a claim of financial hardship. If the Taxpayer wishes to pursue a settlement based on doubtful collectibility, please complete and return the Business Offer in Compromise.

Upon completion of the Department's review, a response will be issued based upon the information provided. The completed forms should be sent to: Tax Commissioner, Virginia Department of Taxation, P. O. Box 2475, Richmond, VA 23218-2475. If the Department does not receive the completed forms within 30 days of the date of this letter, it will be presumed that the Taxpayer will not submit an offer in compromise based upon doubtful collectibility. In that case, the assessment as issued will become immediately due and payable.

The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s web site. The Business Offer in Compromise: Doubtful Collectibility Package can also be found, completed and printed on the website in the Miscellaneous Forms section.

If you have any questions about this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/569.T