Can a Virginia sales tax auditor keep an unusually large month in the audit sample if it skews the error rate applied to the whole audit period?

Plain-English summary

An out-of-state contractor that sells and installs non-monitored fire alarm and security systems for Virginia customers was audited. Rather than run a line-by-line review, the auditor used sampling — pulling a set of months, measuring the tax "error factor" in them, and projecting that rate across the whole audit period (March 2013–February 2016). The dispute was narrow: the taxpayer objected that September 2014 was not representative and shouldn't be extrapolated over the rest of the population.

The Tax Commissioner explained that sampling is a valid, widely used audit technique, but its entire purpose depends on the sample being representative of normal business. Here the taxpayer showed that September 2014's sales were more than 50% of the combined sales of the other five sample months — a single outlier large enough to distort the projected error rate. On that showing, the Commissioner agreed the month skewed the projection, removed it from the sample computation, and directed that the September 2014 sales be taxed separately on their actual amounts instead of extrapolated. The audit will be revised and the taxpayer will receive a corrected bill with interest.

What this means for you

Businesses under a Virginia sales tax audit

Sampling projections are not set in stone. If one month or transaction in the sample is abnormally large or otherwise unlike your normal operations, it can inflate the error rate applied to years of sales. The way to fight it is with numbers: show concretely that the item is not representative — here, that one month dwarfed the others. When that's shown, the remedy is usually to pull the outlier out of the projection and tax it directly, not to discard the whole sample.

Accountants and auditors

The decision marks when the Department will disturb its own sample: a representativeness challenge succeeded because the taxpayer quantified the distortion (one month exceeding half the total of the other five). Keep the underlying monthly detail so an outlier can be identified and, if appropriate, carved out and taxed on its actual figures.

Common questions

Q: Can Virginia really project one sample's error rate over my entire audit period?
A: Yes. Sampling and extrapolation are accepted audit techniques. The projection stands as long as the sample fairly represents the period being audited.

Q: How did the taxpayer get a month removed from the sample?
A: By showing it wasn't representative — the September 2014 sales were more than 50% of the combined sales in the other five sample months, enough to skew the projected error rate. The Commissioner removed that month and taxed those sales separately.

Q: Does this ruling apply to my audit?
A: Not automatically. It resolves one taxpayer's appeal on its facts. It shows how the Department evaluates a sampling challenge, but you would need your own evidence that a sample item is not representative.

Citations and references

Statutes:

• § 58.1-1821 (application to the Tax Commissioner for correction of an assessment)

The determination applies the Department's general audit-sampling methodology rather than a specific exemption statute; the key principle is that a sample must be representative before its error factor is extrapolated over the audit period.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-111

Original ruling text

June 30, 2020

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 * (the “Taxpayer”) for the period March 2013 through February 2016. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer is located in another state and is primarily engaged in the sale and installation of non-monitored security and fire alarm systems to Virginia customers. As a result of the Department’s audit, the auditor found that the Taxpayer did not charge its customers sales tax on the sale and installation of non-monitored fire alarm and security systems. Rather, the Taxpayer purchased all the materials used in the installation of the non-monitored systems exempt of the tax and remitted the use tax to the Department on the cost price of the materials. The auditor assessed the sales tax on mark-up charges and service and other fees in connection with the sale and installation of non-monitored systems.

During the audit, the auditor sampled three months of exempt sales (high, low, and average). The Taxpayer disagreed with the inclusion of September 2014 sales in the sample and claimed that those sales were not representative of the sales population. The auditor agreed to expand the sample to include an additional three months. The Taxpayer, however, continues to contest the inclusion of the September 2014 sales in the sample and argues that the sales be removed from the computation of the error factor and taxed separately.

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. Every effort is made to objectively select the sample periods that are representative of the period being audited and to reach a consensus with the taxpayer concerning the validity of the sample.

After reviewing the information provided in your letter, I agree that the September 2014 sales may not be representative of the Taxpayer's normal business activity during the audit period. The Taxpayer has demonstrated that the inclusion of the September 2014 sales represents over 50% of the total sales for the remaining five sample months. Therefore, I agree that the inclusion of the September 2014 sales in the sample skews the error rate projection over the population. Accordingly, I find basis to remove the September 2014 sales from the Department’s sample computations and to tax the sales separately.

CONCLUSION

The audit will be returned to the appropriate field audit staff for revision. Once the revision is completed, the Taxpayer will receive a revised bill with interest accrued to date. The bill should be paid within 30 days of the date of the bill to avoid the accrual of additional interest. If you have any questions concerning this determination, please contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1320.T