My use tax compliance ratio came out to 0% on a second sales tax audit because of heavy employee turnover during the audit period -- does that turnover excuse the penalty?

Plain-English summary

A company providing utility inspection services in and outside Virginia was audited for the period July 2015 through December 2019. Virginia's auditor found untaxed general expense and fixed-asset purchases and assessed sales and use tax on them, along with a penalty. The penalty was mandatory because this was the company's second-generation audit -- meaning it had already been audited once before -- and its use tax compliance ratio came out to 0%, well below the 60% ratio a second audit requires to avoid the penalty (85% for sales tax).

On appeal, the company raised two separate arguments. First, it said sales tax had actually been paid on a number of the disputed furniture and fixture purchases, and it provided an asset listing from its personal property tax return along with invoices showing tax paid. Virginia Code § 58.1-633 requires dealers to keep suitable records of their taxable purchases, and when a taxpayer submits new documentation on appeal, the original auditor gets a chance to review it and adjust the assessment where the records check out. The Department sent the case back to the field audit staff to verify the new documentation and revise the bill accordingly.

Second, the company asked Virginia to waive the compliance penalty altogether, pointing to high employee turnover during the audit period as the reason its recordkeeping and tax payment had slipped. Virginia's regulation makes the audit penalty mandatory based on the compliance ratio, and the Department has consistently held -- citing two of its own prior published rulings on the same point -- that corporate restructuring and employee turnover are normal business conditions within a taxpayer's own control, not the kind of unusual, extraordinary circumstance that justifies a penalty waiver. Because the company's use tax compliance ratio was 0% on a second-generation audit, and employee turnover didn't count as an exceptional mitigating circumstance, the penalty stayed in place even though part of the underlying tax bill was reduced.

What this means for you

Businesses appealing an audit assessment with new documentation

If you have invoices, asset listings, or other records showing tax was actually paid on items in an audit's exception list, submit them on appeal. Virginia will route the new documentation back to the original auditor to verify and adjust the assessment for confirmed items -- but this only affects the underlying tax, not any separately assessed penalty.

Businesses facing a penalty on a second-generation (repeat) audit

The penalty is mandatory once your compliance ratio falls short of the threshold (85% for sales tax, 60% for use tax on a second audit), and Virginia has repeatedly found that ordinary business disruptions -- employee turnover, corporate restructuring -- don't qualify as the extraordinary circumstances needed to waive it. Don't count on turnover alone as grounds for relief; you'll need something genuinely unusual, not just typical staffing changes.

Common questions

Q: Can employee turnover during an audit period excuse a compliance penalty?
A: No. Virginia treats employee turnover and corporate restructuring as normal business conditions within a taxpayer's control, not extraordinary circumstances -- the Department has reached this same conclusion in multiple prior published rulings.

Q: If I submit new invoices or records on appeal, will the assessment be reduced?
A: Possibly. New documentation submitted on appeal goes back to the original auditor to review and verify; the assessment can be adjusted for items the records support, even though this is separate from any compliance penalty.

Q: What compliance ratio do I need to avoid a penalty on a repeat (second-generation) sales and use tax audit?
A: Generally 85% for sales tax and 60% for use tax; falling short of either makes the penalty mandatory absent an extraordinary circumstance.

Citations and references

• Va. Code § 58.1-633 (dealers must keep suitable records of taxable sales, leases, and purchases, and other information the Tax Commissioner requires)
• Va. Code § 58.1-618 (Department may use best available information to reconstruct sales and purchases when a dealer's records are inadequate)
• 23 VAC 10-210-470 (dealer recordkeeping requirements)
• 23 VAC 10-210-2032 (audit penalty is mandatory based on compliance ratio; second-generation audits require 85% sales tax / 60% use tax compliance to avoid penalty)
• P.D. 00-115 (6/23/2000) and P.D. 97-31 (1/31/1997) (Virginia has previously held that corporate restructuring and employee turnover are normal business conditions, not grounds to waive an audit compliance penalty)

Subject

Audit: Dealer Records - Documentation, Compliance Penalty: Second Audit- Employee Turnover

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-151

Original ruling text

December 14, 2021

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

Dear *:

This is in response to your letter submitted on behalf of * (the “Taxpayer”) in which you seek correction of the retail sales and use tax assessment issued for the period July 2015 through December 2019. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer provides various utility inspection services in and outside of Virginia. An audit by the Department resulted in an assessment for untaxed general expense and fixed asset purchases. During the audit, the Taxpayer did not provide to the auditor documentation showing that taxes were paid on its expense and fixed asset purchases. Penalty was assessed because this was a second generation audit and the Taxpayer failed to meet the use tax compliance ratio.

The Taxpayer appeals the assessment contending the sales tax was paid on a number of the furniture and fixture purchases. Documentation was provided with the appeal, including an asset listing from its personal property tax return and invoices showing taxes paid. The Taxpayer also requests the abatement of the assessed penalty based on high employee turnover during the audit period.

DETERMINATION

Documentation

Virginia Code § 58.1-633 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 requirements are set out in Title 23 of the Virginia Administrative Code 10-210-470. 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 and purchases to determine whether a tax liability exists.

When a taxpayer files an appeal, which includes additional information, the auditor is provided with the opportunity to review and comment on the new documents. After reviewing the additional documentation, the auditor was able to confirm the information was related to items on the exceptions list and will make adjustments, as appropriate.

Penalty Waiver

Title 23 VAC 10-210-2032 provides that the application of penalty to audit deficiencies is mandatory and its application is generally based on the percentage of compliance determined by computing the dealer’s compliance ratio. In second generation audits, the penalty will generally be applied unless the taxpayer’s compliance ratios meet or exceed 85% for sales tax and 60% for use tax. In this second generation audit, the Taxpayer’s use tax compliance ratio was 0%.

In Public Document (P.D.) 00-115 (6/23/2000), the taxpayer sought a waiver of penalty assessed in a retail sales and use tax audit. The Department ruled that corporate restructuring and employee turnover are considered normal business conditions, which are generally within a taxpayer’s control and a consequence of a taxpayer’s efforts and actions. The circumstances cited by the taxpayer in that instance were not considered unusual. Rather, the Department ruled that they reflected common business conditions. Accordingly, the Department did not find a basis to waive the penalty. See also P.D. 97-31 (1/31/1997).

Pursuant to the authorities cited above, the Taxpayer’s employee turnover is considered a normal business condition and does not constitute exceptional mitigating circumstances to waive the penalty. In addition, this is a second generation audit and the Taxpayer’s use tax compliance ratio is 0%. Accordingly, there is no basis to waive the penalty.

CONCLUSION

In accordance with this determination, the audit will be returned to the appropriate field audit staff for revision. The audit staff will adjust the audit assessment based on the documentation provided with the Taxpayer's appeal. A revised copy of the audit report and an updated bill will be sent to the Taxpayer. The bill should be paid within 60 days to avoid the accrual of additional interest.

The Code of Virginia section, regulation, and public documents cited, along with other reference documents, 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/3597.G

Related Documents

97-31

00-115