If I submit exemption certificates for the first time on appeal (not during the audit itself), will they be accepted, and can I get compliance penalty waived on a repeat sales tax audit?

Plain-English summary

A corrugated packaging manufacturer with several Virginia locations was audited for sales and use tax and assessed additional tax on sales to two customers the auditor found lacked valid exemption support, plus a compliance penalty. The taxpayer appealed on two fronts: that both customers' sales were actually exempt (it had certificates, just not in the auditor's hands at the time), and that penalty and interest should be abated because it made a good-faith effort to comply.

On the exemption certificates, Virginia law puts the burden on the seller to prove a sale is exempt, generally by holding a valid exemption certificate from the buyer at the time of sale. An incomplete certificate is never acceptable, even after the fact. For the first customer, the certificate on file during the audit was missing the customer's registration number and didn't check the box identifying the claimed exemption -- and the version submitted on appeal was still just as incomplete, so it couldn't be accepted. For the second customer, no certificate existed at all during the audit; the taxpayer submitted one on appeal (a Form ST-11, used for manufacturing/processing/mining exemptions), but that certificate didn't identify the customer's type of business, and the Department couldn't even locate the customer in its own records to verify the exemption was being used properly. Because certificates provided only with an appeal -- rather than taken in good faith at the time of sale -- get greater scrutiny and must be affirmatively confirmed as valid for the specific transactions, both contested sales categories stayed in the audit.

On penalty, this was the taxpayer's FIFTH consecutive audit (a "fifth generation audit"), and Virginia's compliance-penalty rule for third-and-later audits applies penalty unless the taxpayer's compliance ratio meets or exceeds 85% for BOTH sales tax and use tax. The taxpayer's use tax compliance ratio came in at 83% -- just under the threshold -- so the penalty was mandatory, with no discretion to waive it based on good faith. A separate 20% tax amnesty penalty (for liability that was eligible for the state's 2017-18 amnesty program but went unpaid) was also left in place, since none of the recognized waiver circumstances applied. Interest, which Virginia law treats as a mandatory fee for the use of money rather than a punitive penalty, could not be waived either since the underlying tax itself wasn't waived. The assessment -- already paid in full by the time of this ruling -- was upheld across the board.

What this means for you

Sellers relying on customer exemption certificates

Get complete, valid exemption certificates AT THE TIME OF SALE, not after. A certificate produced for the first time on appeal faces heightened scrutiny and must affirmatively establish the customer's proper use for that specific transaction -- an incomplete certificate (missing a registration number, unchecked exemption box) is never acceptable, before or after the fact.

Businesses facing a repeat ("generation 3+") sales/use tax audit

Know your compliance ratio requirement: 85% for BOTH sales tax and use tax on third-and-later audits. Falling even slightly short (83% here) triggers a MANDATORY penalty with no good-faith exception -- there's no discretion to waive it based on effort or intent.

Anyone with unpaid liability from an amnesty-eligible period

If tax liability was eligible for Virginia's Tax Amnesty program (a 2017-18 initiative) but went unpaid, expect an additional 20% amnesty penalty stacked on top of ordinary penalties, waivable only under the specific circumstances described in the amnesty guidelines (P.D. 17-156) -- routine "good faith effort" arguments won't qualify.

Common questions

Q: Can I submit exemption certificates for the first time on appeal if I didn't have them during the audit?
A: You can try, but they'll be subject to greater scrutiny than certificates taken in good faith at the time of sale, and the Department must be able to affirmatively confirm the customer's use was valid for the specific transactions -- an incomplete or unverifiable certificate still won't be accepted.

Q: What compliance ratio do I need to avoid a mandatory penalty on a repeat sales tax audit?
A: For a third-generation audit or later, you need a compliance ratio of at least 85% for BOTH sales tax and use tax; falling short of either triggers a mandatory penalty with no good-faith exception.

Q: Can penalty or interest be waived if I made a good-faith effort to comply?
A: The compliance-ratio penalty on repeat audits is mandatory once you're below the threshold, regardless of good faith. Interest is not a penalty at all -- it's a fee for the use of money -- and can't be waived unless the underlying tax itself is waived.

Q: What is the tax amnesty penalty, and can it be waived?
A: A 20% penalty on tax liability that was eligible for Virginia's Tax Amnesty program but remained unpaid; it can only be waived under the specific conditions set out in the amnesty program guidelines (P.D. 17-156), which weren't met in this case.

Citations and references

• Va. Code § 58.1-623 A (burden of proving exemption; certificate requirement)
• 23 VAC 10-210-280 A, B (exemption certificate good-faith and completeness requirements)
• 23 VAC 10-210-2032 B (compliance-ratio penalty for repeat/generation audits)
• Va. Code § 58.1-1812 (mandatory interest on assessments)
• Va. Code § 58.1-205 1 (assessment presumed prima facie correct)
• P.D. 11-8 (1/20/2011) (good-faith exemption certificate acceptance standard)
• P.D. 17-156 (9/5/2017) (Virginia Tax Amnesty Program guidelines)

Subject

Exemption: Certificates - Provided with Appeal Subject to Greater Scrutiny Penalty: Compliance - 5th Generation Audit Requires Ratio in Excess of 85% for Both Sales And Use Tax

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 23-40

Original ruling text

April 12, 2023

Re: § 58.1-1821 Application: 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 November 2015 through September 2018. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer, a producer of corrugated packaging with several locations in Virginia, was audited for the period at issue. The Taxpayer appeals the assessment, contending that sales made to two customers are exempt because it had valid exemption certificates on file for both sales. In addition, the Taxpayer requests an abatement of assessed penalty and interest because it made a good faith effort to file and pay its tax liability.

DETERMINATION

Exemption Certificates

Virginia Code § 58.1-623(A) provides that “All 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 A states, in part, 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. . . However, a certificate that is incomplete, invalid, infirm or inconsistent on its face is never acceptable, either before or after notice.

Title 23 VAC 10-210-280 B requires legitimate use of an exemption certificate and provides that:

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.

Public Document (P.D.) 11-8 (1/20/2011) sets forth the Department’s good faith requirement and its application to the acceptance of exemption certificates. As outlined in P.D. 11-8 and Title 23 VAC 10-210-280 A, dealers cannot accept incomplete exemption certificates in good faith. In cases where a taxpayer accepts an exemption certificate that is incomplete, the claim for exemption is subject to greater scrutiny by the Department. Under these circumstances, the exemption certificate will only be accepted if the Department can confirm the customer’s use of the certificate was valid and proper for the specific sales transaction as reviewed in the audit.

During the audit, the Taxpayer provided an incomplete exemption certificate for sales made to * (“Customer 1”) and failed to provide an exemption certificate for sales made to *** (“Customer 2”). The certificate provided for Customer 1 was deemed invalid by the auditor because it lacked the customer’s registration number and a box was not checked to determine the exemption claimed by the customer. The Taxpayer’s claims for exemption for the sales made to these customers are subject to greater scrutiny due to the absence of a valid exemption certificate for both customers at the time of the transaction or sale. Upon appeal, the Taxpayer submits exemption certificates for review.

Customer 1: The exemption certificate provided with the appeal is incomplete. The certificate is missing the customer’s registration number and a box is not checked to indicate the customer’s use of the certificate. Based on the aforementioned authorities, an incomplete certificate is not valid and cannot be used to confirm that the customer’s use of the certificate was proper for these transactions. Accordingly, the contested sales exception for Customer 1 will remain in the audit.

Customer 2: The exemption certificate provided with the appeal was not presented to the auditor during the audit. Thus, the claim for exemption is subject to greater scrutiny because an exemption certificate was not taken in good faith at the time of the sale. The Taxpayer presents Form ST-11, which is used by manufacturing, processing, or mining businesses to make exempt purchases of certain tangible personal property used directly in the manufacturing process. The certificate does not contain information regarding the kind of business engaged by the purchaser and the company could not be located in the Department’s records to determine if the customer’s use of the exemption certificate was proper. Accordingly, the contested sales exception for Customer 2 will remain in the audit.

Compliance Penalty

This was a fifth generation audit for this Taxpayer. Title 23 VAC 10-210-2032 B 1 provides that “[t]he 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.” Further, section B 5 of the same regulation provides that for third and subsequent generation audits, “[p]enalty will generally be applied unless the taxpayer's compliance ratios meet or exceed 85% for sales tax and 85% for use tax, as computed by the auditor or under the alternative method.”

Based upon the compliance ratio computations in the audit, the Taxpayer’s use tax compliance ratio is 83% for the audit period at issue. In accordance with Title 23 VAC 10-210-2032, the penalty is properly applied in the audit to the use tax liability because the Taxpayer’s use tax compliance ratio did not meet or exceed 85%. Accordingly, the Taxpayer’s request for abatement of the penalty assessed in the audit cannot be granted.

Amnesty Penalty

The 2017 General Assembly enacted legislation establishing a Tax Amnesty program, spanning a 60-75 day period that was administered by the Department. The Guidelines for the Virginia Tax Amnesty Program are addressed in Public Document 17-156 (9/5/2017). Taxpayers with delinquent returns for amnesty-eligible periods qualified for amnesty benefits. Any tax liability that was eligible for amnesty benefits but remained unpaid is subject to a 20% amnesty penalty in addition to all other penalties. This post-amnesty penalty can be waived under certain circumstances; however, none of the conditions set forth in P.D. 17-156 exist in this case. Accordingly, I do not find cause to waive amnesty penalty in this instance.

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. Interest cannot be waived unless the associated tax is waived. Accordingly, the assessed interest will remain in the audit.

CONCLUSION

Virginia Code § 58.1-205 1 provides that, in any proceeding relating to the interpretation of the tax laws of Virginia, an “assessment of a tax by the Department shall be deemed prima facie correct.” This means that the burden of proving an error in the assessment is upon the Taxpayer. Convincing evidence must be provided to the Department in support of any exemption claim. In this case, the Taxpayer has not met its burden of proving the sales at issue are exempt. Accordingly, the assessment is upheld. The assessment at issue has been paid in full; therefore, no further action is required.

The Code of Virginia sections, regulation, and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s website. 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/4001.G

Related Documents

20-121

17-156

11-8