Should a one-time end-of-lease equipment purchase be removed from a Virginia audit sample when the taxpayer cannot identify the property on the lease or invoice?

Plain-English summary

A medical practice leased equipment, then exercised a taxable purchase option without paying sales or use tax. Virginia included the transaction in a three-month sample projected across a six-year audit. The practice said it was a one-time computer purchase unlike normal operations.

Virginia kept it in the sample because the documents did not identify the property. The lease said only “equipment,” and the invoice only “lessee purchase price.”

Two rules the Department clarified

First, a genuinely isolated, nonrepresentative transaction should not be projected through a sample. Virginia was inclined to agree that a one-time purchase after a history of leasing could fit that principle.

Second, the auditor was wrong to suggest that removal required the taxpayer to book the property as an asset. Prior policy imposed no such accounting-label requirement; identifiable property could be removed and audited in detail.

Why the taxpayer still lost

The taxpayer had to prove that the assessed purchase was the claimed computer equipment and was nonrepresentative. Generic contract and invoice descriptions did not make that connection.

Under Va. Code § 58.1-205.1, the assessment was presumed correct. With no clear property identification, the burden was not met.

What this means for you

• Isolated purchases can come out of a sample if you prove they are not representative.
• Fixed-asset accounting treatment is not the legal test.
• Preserve serial numbers, equipment schedules, invoice descriptions, and lease exhibits.
• A taxable lease-end purchase still owes tax even if it is removed from projection.

Common questions

Q: Did Virginia agree the purchase option was taxable?

A: Yes. The dispute concerned projection through the sample, not transaction taxability.

Q: Must the item be capitalized to remove it from a sample?

A: No. The ruling rejected that requirement.

Q: What proof was missing?

A: Documents identifying the generic leased/purchased equipment as the computers claimed by the taxpayer.

Citations and references

• Va. Code § 58.1-205.1 — assessment presumption and burden
• Related Virginia rulings cited: P.D. 93-198, P.D. 98-94, P.D. 16-168

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 19-47

Original ruling text

May 1, 2019

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

Dear *:

This replies to your letter in which you seek correction of the retail sales and use tax assessment issued to the * (the “Taxpayer”) for the period September 2008 through April 2014. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer operates a medical practice providing obstetric, gynecological and surgical services. Because a liability was found in the initial three-year audit period and the Taxpayer had not filed any returns, the audit period was expanded to six years. The Department’s audit disclosed that the Taxpayer leased equipment during the audit period and exercised an end of lease option to purchase the leased equipment. The Taxpayer purchased the equipment without payment of the sales tax to the vendor or accrual and remittance of the use tax to the Department. The Department’s auditor held that the Taxpayer was liable for the payment of the tax on the end of lease purchase option. Because the Taxpayer could not identify the equipment purchase as an asset, the auditor included the equipment in the development of a sample error factor and extrapolated the factor over the entire audit period.

The Taxpayer asserts that the equipment purchase consists of computers, and the inclusion of the one-time purchase in the extrapolation of the deficiency is not representative of the Taxpayer’s normal business purchases. The Taxpayer states that no similar transactions have occurred in the past and will not occur in the future. The Taxpayer seeks an adjustment of the Department’s assessment by removal of the computer equipment from the sample computation.

DETERMINATION

Sampling is an audit technique of significant value that is widely used in both the public and private sectors for all types of audits where a detailed audit would not prove beneficial either to the auditor or the client. When sampling techniques are understood and properly applied, the final result should be within a narrow percentage range of the actual amount that would be determined by a detailed audit. The purpose of the audit sample is to determine a factor for errors within a representative selected 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.

The Department conducted an audit of the Taxpayer using three months (February 2011, September 2012 and June 2013) as sample periods. The auditor determined that four purchases in those months were subject to sales tax and the vendor failed to collect the tax. In accordance with the Department’s audit procedures, the auditor computed error factors and extrapolated them over the entire audit period.

The Taxpayer contends that the computer equipment purchase found in September 2012 should be removed from the sample and the extrapolation. The Taxpayer references several public documents in support of its position. There is a common premise in each of the public documents referenced by the Taxpayer. i.e., the inclusion of a specific sale or purchase in a sample extrapolation that is not representative of the operations of a taxpayer’s audit period should not be included in the extrapolation.

The Taxpayer leased equipment and at the end of the lease exercised its option to purchase the equipment. The Department’s auditor relied on P.D. 98-94 (5/19/98), stating that the end of lease purchase option is a taxable event. The auditor included the equipment purchase in the sample computation and applied the resulting error factor to the entire audit period. Relying on P.D. 93-198 (9/23/93), the auditor contends that the Taxpayer could not prove that the equipment purchase was not a normal part of the Taxpayer’s operations.

The Equipment Lease Agreement provides the lease terms and pricing. The agreement also provides the end of lease purchase option. I am inclined to agree that the Taxpayer’s exercise of a purchase option at the end of a lease is not representative of its operations given that the Taxpayer’s historical practice has been the leasing of equipment only. However the problem here is that the Taxpayer’s lease agreement uses the term “equipment” generally to apply to the property that is the subject of the lease. There is no mention of computers or any other specific type of equipment with regard to the purchase option. Also, the invoice identifies the transaction as “lessee purchase price” and there is no descriptive information regarding the subject of the purchase. Based on all of the information presented, there is no clear evidence to support the Taxpayer’s contention that the equipment purchased at the end of the lease, which the Taxpayer asserts are computers, is in fact the equipment that has been assessed in the audit.

The auditor maintains that had the Taxpayer provided information showing that the equipment purchases were deemed to be assets, the auditor would have removed the purchases from the sample computation and included them as part of the detailed assets. The auditor’s position that the transactions at issue could not be removed from the sample because the property is not an asset is without basis. In P.D. 16-168, the Tax Commissioner concluded that prior public documents set forth no requirement that a taxpayer treat property as an asset in order for the property to be removed from the sample and audited on a detailed basis. The same applies in this instance, and had the Taxpayer been able to identify the property as stated above, the transaction would have been removed from the sample consistent with established policy on this issue. The Department’s field audit procedures require that the audit of the fixed asset category of purchases be performed on a detailed basis. However, that procedure is an audit process guideline and has no bearing on the policy application regarding sampling.

Virginia Code § 58.1-205.1 provides that any assessment of tax issued by the Department shall be deemed prima facie correct. The burden of proving that the tax assessment is incorrect is upon the taxpayer. In this instance, the Taxpayer has not met that burden of proof. Therefore, I find no basis for removal of the transaction from the audit sample and the contested assessment, bill number *, is upheld. The Taxpayer will receive an updated bill with interest accrued to date. The bill should be paid within 30 days of the bill date to avoid the accrual of additional interest.

The Code of Virginia section and public documents cited are available on-line in the Laws, Rules and Decisions section of the Department’s website located at www.tax.virginia.gov . If you have any questions regarding this matter, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/642.L

Related Documents

93-198

98-94

16-168