The Department's audit used a sample year to estimate my sales/use tax liability across a six-year period -- can I challenge the sample year, and does new documentation I've since found reduce my bill?

Plain-English summary

A fiber optic cable network installation and repair contractor had a use tax account with the Department but hadn't filed returns, and had never had a sales tax account at all. A "first-generation audit" (a business's first audit) selected calendar year 2015 as an average, representative year based on the company's purchases and payroll, then reviewed that year in detail to find an error rate for untaxed purchases. Because that sample year revealed liability, the audit period was expanded forward to 2019 (with the taxpayer's signed agreement waiving the normal time limitations). The error factor found in the 2015 sample was then applied ("extrapolated") across the entire multi-year period to calculate the total assessment. The taxpayer appealed, arguing the methodology overstated its liability and that new documentation had since surfaced.

Why sampling is used, and how it's supposed to work. Sampling is a well-established, valuable audit technique used when a full transaction-by-transaction audit would be too burdensome for either the taxpayer or the Department. The idea is straightforward: pick a representative sample period, determine an error rate within it through detailed review, then apply (extrapolate) that rate across the full audit period to estimate what a complete audit would have found. When done properly, sampling results should land within a narrow range of what a full audit would show, and the Department makes every effort to choose sample periods objectively.

Challenging the sample year isn't enough on its own -- you have to show it was actually flawed. The taxpayer wanted to replace the 2015 sample year with 2018 (which it said would produce a lower error rate) and apply THAT rate to the whole period instead. The Department rejected this: simply preferring a different, more favorable year doesn't demonstrate that the ORIGINAL sample selection was unrepresentative or that the methodology was flawed. Since the taxpayer couldn't show the 2015 sample year was actually a bad choice (as opposed to just less favorable than 2018 would have been), the Department upheld the original sample year and error factor.

But new evidence of actual payments still counts. Separately, the taxpayer had located additional invoices after the audit closed, showing tax had actually been paid on some transactions the audit had flagged as untaxed exceptions. Unlike the methodology challenge, this wasn't an attack on the sampling technique itself -- it was concrete proof relevant to specific transactions. The Department forwarded this new documentation to the original auditor, who agreed it warranted adjustments to the audit.

Result. The sample year and extrapolation method stand as originally used, but the case goes back to audit staff to incorporate the newly found invoices and any other corrections, with a revised audit report and bill to follow. The taxpayer will get another 90-day window to appeal the revised numbers if it still disagrees.

What this means for you

Businesses facing a sampling-based audit assessment

To successfully challenge a sample YEAR or period, you need to show the sample itself was actually unrepresentative or the methodology was flawed -- simply pointing to a different year that would produce a more favorable result generally isn't enough on its own.

Taxpayers who find additional records after an audit closes

Submitting genuine new documentation (like invoices proving tax was actually paid on flagged transactions) is a different, and often more successful, path than challenging the sampling method itself -- the Department will route specific new evidence back to the auditor for review even while upholding the overall methodology.

Businesses undergoing their first ("first-generation") audit

If you've never had a sales tax account and lack complete historical records, expect the Department to select a representative sample period based on available data (purchases, payroll) rather than reviewing every transaction -- and expect the audit period to expand if that sample reveals a liability.

Common questions

Q: Can I challenge an audit's sample year just because a different year would produce a lower liability?
A: Not on its own. You need to show the original sample was actually unrepresentative or the sampling methodology was flawed -- wanting a more favorable year isn't enough by itself.

Q: I found new invoices after my audit closed showing I actually paid tax on some flagged transactions -- is it too late to use them?
A: No. New documentation on specific transactions can still be submitted with an application for correction and forwarded to the auditor for review, separate from any challenge to the overall sampling methodology.

Q: Why did my audit period get extended beyond the original years reviewed?
A: When a sample period reveals a tax liability, the Department may expand the audit into additional years -- but doing so typically requires the taxpayer's agreement (a signed waiver of the normal time limitations) so the audit work can be completed.

Citations and references

Statutes:

• Va. Code § 58.1-1821 -- application for correction of an assessment

Related concept: The Department's use of representative sampling and error-factor extrapolation in sales and use tax audits, described in guidance available on the Department's website (referenced in this ruling, not separately cited by public document number). This ruling is a companion to this corpus's broader audit-sampling family (including P.D. 24-115, P.D. 25-35, and P.D. 24-98), which similarly examine what does and doesn't undermine a properly selected sample period.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 24-72

Original ruling text

August 5, 2024

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

Dear * :

This will respond to your letter in which you seek correction of the retail sales and use tax assessment issued to * (the “Taxpayer”) for the period April 2013 through March 2019. I apologize for the delay in responding to your request.

FACTS

The Taxpayer is a communications contractor, providing fiber optic cable network installation and repair services in Virginia. The Taxpayer had a use tax account with the Department but did not file returns for periods at issue. The Taxpayer did not have a sales tax account prior to the audit. Under a first-generation audit, the 2015 calendar year was selected as an average year based on the Taxpayer’s expense purchases and material purchases less payroll. The Taxpayer was unable to provide sufficient records to show that it properly paid sales or use tax on numerous purchases for the sample period. Purchase invoices were listed as exceptions where tax was not charged, or the invoice was not provided.

Because use tax liability was found in the initial three-year period reviewed, the audit period was extended to include additional proceeding periods and brought forward to 2019. The Taxpayer signed a waiver of time limitations agreement for the entire extended audit period so the audit work could be completed. The exceptions found during the sample period were used to calculate an error factor, which was applied to the total expenses by month to determine the Taxpayer’s liability. The Department issued an assessment for the unpaid tax liability, penalty, and interest. The Taxpayer filed an application for correction, contending that the Department’s methodology in calculating its tax liability overstated the liability, and alleging it had found additional documentation that was not available when the audit was conducted.

DETERMINATION

Methodology

The Taxpayer asserts that the methodology used to calculate the tax deficiency is inaccurate because enough information is available to calculate a lower error factor for the 2018 calendar year. The Taxpayer believes the lower error factor should be applied to the entire audit period rather than the 2015 error factor.

Sampling is an audit technique of significant value that is widely used in both the public and private sectors. The Department uses sampling in sales and use tax audits where a detailed audit would be administratively burdensome to the taxpayer or the Commonwealth. When sampling techniques are properly applied, the final results should be within a narrow percentage range of the actual amount that would have been determined by a detailed audit. The purpose of the audit sample is to determine a factor for errors within a representative select 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 select objectively the sample periods that are representative of the period being audited.

For this audit, the sample was selected because it represented an average range within the initial audit period. The auditor then conducted a detailed review of the sample period to determine the error factor.

The Taxpayer believes the audit liability is overstated and seeks to replace the selected sample period with a period that was unilaterally selected after errors were found in the initial audit period. After reviewing the audit report and the information presented, the auditor’s use of the one-year sample period was proper. Although it contends that the audit sample is not representative of the entire audit period, the Taxpayer has not demonstrated that the sampling methodology was flawed or unrepresentative of the audit period.

Additional Documentation

The Taxpayer asserts that the liability should be reduced because it discovered additional invoices showing tax was paid on certain transactions included on the audit’s exceptions lists. It also now claims to have evidence indicating that several errors were made in calculating the sample amount. The additional documentation provided on appeal was forwarded to the auditor for review. Based on the auditor’s evaluation, the audit should be adjusted to reflect the additional information provided.

Based on the audit report and information presented, the Department finds no basis to invalidate the sample and extrapolation. Accordingly, the selection of the 2015 calendar year and the resulting error factor is upheld.

The case, however, will be returned to the audit staff to make adjustments based on the new information provided during the application for correction. The auditor may also request additional information from the Taxpayer, if needed, to verify the proper treatment of a transaction. For requests of additional information, the Taxpayer and audit staff will decide on a mutually agreed upon time to provide requested records. Once the auditor’s review is complete, an updated audit report, a written explanation of any changes or lack thereof, and an updated bill with accrued interest to date will be mailed to the Taxpayer. If the Taxpayer continues to disagree with revised assessment, it will be given 90 days from the issuance of the revised assessment to file an application for correction pursuant to Virginia Code § 58.1-1821.

Additional information concerning retail sales and use tax audit sampling is available online at www.tax.virginia.gov in the Laws, Rules, and Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at , or via email at **.

Sincerely,

James J. Alex

Tax Commissioner

Commonwealth of Virginia

AR/2218.C