As California grows more desperate for revenues, we can expect to see an increase in sales tax audits. Moreover, California was recently rated the most aggressive state in sales tax auditing according to a survey of 400 corporate financial managers done by Vertex, a tax software company.

Fight Back!!

How can taxpayers fight back when it comes to unreasonable and uncompromising positions taken by state sales tax auditors? In answering this question, we need to understand both the legal issues and the audit issues involved in any particular sales tax audit. A successful protester will first need to identify what legal basis the auditor has for asserting his position. Secondly, he needs to fully understand the method used to quan¬tify the tax deficiency. We have had much experience with sales tax auditors and have been surprised at the number of times they replace the law and regulations with their own version. In fair¬ness to the Board of Equalization auditors, we can understand when they interpret a gray area in favor of the state but we do not understand how they can be allowed to disregard the code and statue.

War Stories

The following war stories come to mind:

Currently we have a case where a State Board of Equalization auditor is taking the position that a portion of printed sales messages are taxable. He is basing his decision on the fact that the taxpayer, in his own records, attempted to identify the com¬ponents of the sale by allocating part of the sales price to various categories. There was no corresponding breakdown on the sales invoice. The auditor says that by identifying the com¬ponents of the sales price we effectively have a “service in con¬nection with a sale.” The scary part is that four months after the office hearing the supervisor wrote us back saying there is no apparent reason to change the audit. The legal issues involve include Regulation 1541.5 and the definition of gross receipts. The auditor agrees that the printed sales messages are exempt but thinks only the amount categorized in the books as the printing portion should be exempt. He feels other amounts should be taxed.

What is the legal authority for taxing the components of gross receipts when the sale itself is exempt? There is none. In fact, the definition of gross receipts would dictate the exact opposite effect. 6012(b)(1). Furthermore, there is no legal authority that an internal breakdown of the sales amount has any significance. Certainly it should not be escalated above the sales invoice itself which has only one lump sum charge. In other instances auditors have chosen to ignore valid (timely, signed, taken in good faith, etc.) resale certificates and assert tax on the seller.

In one case the auditor “felt” that the description of the property on the resale card (which was furniture) did not cover the item purchased (antique furniture). Regulation 1668(b)(2)(B), provides that a general description is acceptable. However, the auditor chose to trust his own feelings instead since he was convinced the buyer didn’t resell this particular item. In another case, the auditor took the position that the taxpayer must have purchase orders in addition to resale cards. This again is contrary to Regulation 1668.

In the audit of a printer, the auditor asserted tax on miscel¬laneous charges when the printed matter was exempt. For example, the printer made separate charges to stop the press change the plate and turn the press back on. The auditor thought this sounded like a service in connection with a sale so drew the con¬clusion it was taxable. The fact that it was a service in con¬nection with a sale is why it was exempt. (The gross receipts of a sale include all services in connection with that sale so that those extra charges take on the same tax character as the sale.)

In another example, a district principal auditor took the posi¬tion that the transportation of landfill material (after 1 1 89) was taxable since the taxpayer sold the material rather than merely acted as broker. This is in direct opposition to Regula¬tion 1628(C) but evidently this principal auditor did not think 1628(C) was written for this taxpayer.

In still another case, a retailer did not charge tax on an item that was clearly exempt. His customer, however, added $4,000 tax to the invoice and remitted this amount to the retailer. Later, the retailer explained the mistake to his customer and credited the overpaid tax off a future sale. The credit was given by reducing the sales price of the next sale rather than clearly showing a credit against accounts receivable. The auditor took the position that this was excess tax reimbursement and since the taxpayer could not clearly show this was credited to the customer he owed it to the state. Regulation 1700, defines excess tax reimbursement as an amount represented by a person to a customer computed upon an amount not subject to tax or in excess of the taxable amount. The point here is that this case did not con¬stitute excess tax reimbursement. The taxpayer did not compute any tax and even though the customer remitted the tax it does not meet the definition. It, therefore, is irrelevant as to whether or not the customer was somehow refunded the overpaid tax.

Recently I got a call from a CPA who stated a sales tax auditor asserted tax on helicopters sold in this state to nonresidents. She was told by the auditor that Regulation 1620 required that to be exempt items must be shipped out of this state by the retailer. The auditor in this case was correct about his inter¬pretation of 1620, however, failed to point out that Regulation 1593(a)(3) provides an exception to this rule for aircraft (which include helicopters). The other conditions for that exemption were met and the auditor has reversed his position.

We could go on and on with other examples but hope these il¬lustrate our point.

Question Authority

To succeed in reducing sales tax audits, it is imperative that the auditor is questioned as to his authority. Next, no matter how assertive, confident, or sometimes arrogant the auditor portrays himself, never assume they must know what they are doing. There is no substitute for independent analysis of the legal issues involved. Finally, once you have done the research, hold your ground and appeal to higher levels.

To Come

Next month we will discuss audit methods and issues, and common errors made.