23VAC10-210 Retail Sales and Use Tax

REGULATIONS

Vol. 25 Iss. 12 - February 16, 2009

TITLE 23. TAXATION

DEPARTMENT OF TAXATION

Chapter 210

Proposed Regulation

Title of Regulation: 23VAC10-210. Retail Sales and Use Tax (amending 23VAC10-210-2032).

Statutory Authority: § 58.1-203 of the Code of Virginia.

Public Hearing Information:

March 25, 2009 - 10 a.m. - 2200 West Broad Street, Multipurpose Room, Rear Entrance, Richmond, VA

Public Comments: Public comments may be submitted until 5 p.m. on April 17, 2009.

Agency Contact: Bland Sutton, Analyst, Department of Taxation, 600 East Main Street, Richmond, VA 23219, telephone [phone], FAX [phone], or email [e-mail].

Basis: Section 58.1-203 of the Code of Virginia provides that the "Tax Commissioner shall have the power to issue regulations relating to the interpretation and enforcement of the laws of this Commonwealth governing taxes administered by the Department." The authority for the current regulatory action is discretionary.

Purpose: Businesses and various industry groups have always advocated that TAX’s method of calculating use tax compliance in audit situations unfairly omits sales taxes paid to vendors, a component they believe more accurately reflects their compliance efforts to comply with the sales and use tax statutes. This regulation has been amended to allow an alternative method for computing use tax compliance that does include sales taxes paid to vendors on taxable purchases. It is anticipated that this amendment will reduce the assessments of audit penalty as it relates to use tax compliance and reduce the number of appeals and offers in compromise submitted to TAX.

Substance: This regulation has been amended to reflect an administrative change allowing sales and use tax audit candidates an alternative method to calculate their use tax compliance to include sales taxes paid to vendors. The regulation has also been amended to expand the definitions section to define terms used in calculating the alternative use tax compliance. This change was instituted at the request of businesses and various industry groups.

During sales and use tax audits, TAX calculates the use tax compliance of a business. The use tax compliance measures the business's compliance in accruing and remitting the Virginia use tax on untaxed purchases. The level of the use tax compliance ratio, calculated as a percentage, determines the application of audit penalty to use tax liabilities resulting from audit. TAX’s use tax compliance calculation does not include taxes paid to vendors. This regulation has been amended to allow an alternative method for calculating use tax compliance that does include sales taxes paid to vendors.

Issues: The assessment of penalty in audit situations is determined based on an established level of compliance as computed by the sales and use tax compliance ratio. For use tax compliance (the level in which a business self-assesses use tax on untaxed purchases), TAX’s audit program does not include sales taxes paid to vendors in its calculation. The alternative method of computing use tax compliance proposed in this regulation allows businesses the option of calculating their use tax compliance to include sales taxes paid to vendors. The alternative method will increase businesses likelihood that they will meet the tolerances established by TAX and avoid the assessment of use tax penalty in audit situations. This alternative method is also advantageous to TAX as it will reduce the number of audit appeals and offers in compromises as they relate to audit penalty.

The regulatory action poses no disadvantages to the public or the Commonwealth.

The Department of Planning and Budget's Economic Impact Analysis:

Summary of the Proposed Amendments to Regulation. Effective October 1, 1999, the Department of Taxation (Department) allowed the use of an alternative method of computing the use tax compliance ratio in audit situations. This alternative method is an administrative change for the Department and is not reflected in statute. The Department proposes to amend these regulations to delineate the alternative method for computing use tax compliance, and to specify that taxpayers may use the alternative method if desired.

Result of Analysis. The benefits likely exceed the costs for all proposed changes.

Estimated Economic Impact. During sales and use tax audits, the Department calculates the use tax compliance of businesses. Use tax compliance measures business's compliance in accruing and remitting the Virginia use tax on purchases where the vendor does not collect sales tax. As delineated in the current regulations the use tax compliance ratio does not include taxes paid to vendors. It is calculated as follows:

Compliance Ratio = (Measure Reported) / (Measure Reported + Measure Found),

where Measure Reported means the dollar amounts of taxable sales or the dollar amounts of purchases reported on a return for the entire audit period, and Measure Found means the dollar amounts of additional sales deficiency or dollar amounts of additional use deficiency disclosed by the audit.

The compliance ratio determines the application of audit penalty to use tax liabilities resulting from audit.

As stated earlier, the Department has allowed the use of an alternative method of computing the use tax compliance ratio since October 1, 1999. Under the alternative method the compliance ratio is calculated as follows:

Compliance Ratio = (Measure Reported + Measure Paid to Vendors) /

(Measure Reported + Measure Paid to Vendors + Measure Found),

where Measure Paid to Vendors means the dollar amounts of purchases on which the purchaser paid the Virginia sales or use tax to the vendor.

The alternate method increases the compliance ratio where sales taxes have been paid to vendors. Consequently since October 1, 1999 some firms have avoided audit penalties who would have been subject to penalties under the original compliance ratio formula. The alternative method also reduces costs for the Department since it reduces the number of audit appeals and offers in compromises as they relate to the audit penalty.

Since the proposal under consideration is to place in regulations policy that has been applied since 1999, no businesses other than those who may have been unaware of the opportunity to use the alternative method of calculating the use tax compliance ratio will be significantly affected. Delineating the alternative method for computing use tax compliance, and specifying that taxpayers may use the alternative method if desired is beneficial in that some firms that would not otherwise been aware of the opportunity to potentially avoid the audit penalty may became aware of the opportunity and thus save costs.

Businesses and Entities Affected. These regulations on computing the use tax compliance ratio in audit situations can potentially affect any in business in the Commonwealth since all businesses are potentially subject to such audits. Since the proposal under consideration is to place in regulations policy that has been applied since 1999, no businesses other than those who may have been unaware of the opportunity to use the alternative method of calculating the use tax compliance ratio will be significantly affected.

Localities Particularly Affected. The proposed amendments do not disproportionately affect particular localities.

Projected Impact on Employment. The proposal amendments do not significantly affect employment.

Effects on the Use and Value of Private Property. The proposal to amend these regulations to delineate the alternative method for computing use tax compliance, and to specify that taxpayers may use the alternative method if desired may moderately increase the value of a small number of firms if they would have otherwise been unaware of the opportunity to use the alternative method and are able to avoid the audit penalty by doing so.

Small Businesses: Costs and Other Effects. The proposal to amend these regulations to delineate the alternative method for computing use tax compliance and to specify that taxpayers may use the alternative method if desired may moderately reduce costs for a small number of small businesses if they would have otherwise been unaware of the opportunity to use the alternative method and are able to avoid the audit penalty by doing so.

Small Businesses: Alternative Method that Minimizes Adverse Impact. The proposed amendments do not adversely affect small business.

Real Estate Development Costs. The proposed amendments do not significantly affect real estate development costs.

Legal Mandate. The Department of Planning and Budget (DPB) has analyzed the economic impact of this proposed regulation in accordance with § 2.2-4007.04 of the Administrative Process Act and Executive Order Number 36 (06). Section 2.2-4007.04 requires that such economic impact analyses include, but need not be limited to, the projected number of businesses or other entities to whom the regulation would apply, the identity of any localities and types of businesses or other entities particularly affected, the projected number of persons and employment positions to be affected, the projected costs to affected businesses or entities to implement or comply with the regulation, and the impact on the use and value of private property. Further, if the proposed regulation has adverse effect on small businesses, § 2.2-4007.04 requires that such economic impact analyses include (i) an identification and estimate of the number of small businesses subject to the regulation; (ii) the projected reporting, recordkeeping, and other administrative costs required for small businesses to comply with the regulation, including the type of professional skills necessary for preparing required reports and other documents; (iii) a statement of the probable effect of the regulation on affected small businesses; and (iv) a description of any less intrusive or less costly alternative methods of achieving the purpose of the regulation. The analysis presented above represents DPB’s best estimate of these economic impacts.

Agency's Response to the Department of Planning and Budget's Economic Impact Analysis: The agency agrees with the Department of Planning and Budget's economic impact analysis.

Summary:

The proposed amendments reflect an administrative change allowing sales and use tax audit candidates an alternative method to calculate their use tax compliance to include sales taxes paid to vendors on taxable purchases. The proposed amendments also define terms used in calculating the alternative use tax compliance. This change was instituted at the request of businesses and various industry groups.

23VAC10-210-2032. Penalties and interest; audits.

A. Definitions. The following words and terms when used in this section shall have the following meanings unless the context clearly indicates otherwise:

"Compliance ratio" means the percentage figure used by the department to determine a taxpayer's effort to comply with the retail sales and use tax laws of the Commonwealth.

"Measure found" means the dollar amounts of additional sales deficiency or dollar amounts of additional use deficiency disclosed by the audit. Separate compliance ratios for sales and use taxes will be necessary if the audit contains deficiencies in both areas.

"Measure paid to vendor" means the dollar amounts of purchases on which the purchaser paid the Virginia sales or use tax to the vendor.

"Measure reported" means the dollar amounts of taxable sales or the dollar amounts of purchases reported on a return for the entire audit period.

"Net underpayment" means use tax deficiency for each month determined by the audit.

"Net understatement" means sales tax deficiency determined by the audit less allowable credits, such as the sales price of tangible personal property returned by the purchaser, repossessed, or charged off as bad debts for each month during the period of the audit.

B. Penalty.

1. 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. The compliance ratio for the sales or use tax may be computed by using the following ratio:

Measure Reported	= Compliance Ratio
Measure Reported + Measure Found

This method is to be used by the auditor in separately computing the compliance ratio on both the sales portion of the audit and the purchases portion of the audit.

2. If the auditor's computation indicates that a taxpayer has failed to meet the required compliance ratio for the accrual of use tax on the purchases portion of the audit, the taxpayer may, at its option, compute a separate compliance ratio by including the measure on which tax was paid to its vendors, as follows:

Measure Reported + Measure Paid to Vendors	= Compliance Ratio
Measure Reported + Measure Paid to Vendors + Measure Found

It is the taxpayer's responsibility to compute the above compliance ratio (hereinafter referred to as the "alternative method") and provide the auditor with documentation supporting the computation. The taxpayer must compute the ratio based on a review of purchases for the same period used by the auditor to compute the compliance ratio. Use tax penalty will not be assessed if the taxpayer's tax compliance ratio falls within the required tolerances.

Measure Reported
--------------------------------	= Compliance Ratio
Measure Reported + Measure Found

"Measure reported" means dollar amounts of gross sales or the cost price of purchases reported on returns for the audit period.

"Measure found" means dollar amounts of additional sales deficiency or dollar amounts of additional use deficiency disclosed by the audit. Separate ratios for sales and use taxes will be necessary if the audit contains deficiencies in both areas. Tax paid to vendors will not be included in the computation of the compliance ratio.

1. 3. First generation audits. Generally, penalty will be waived for first generation audits. First generation audit penalty cannot be waived if any of the following conditions exist:

a. The taxpayer has been previously notified in writing by the Department of Taxation to collect tax on sales or to pay tax on purchases, but has failed to follow instructions; or

b. The taxpayer has collected the sales tax, but failed to remit it to the Department of Taxation; or

c. The taxpayer has willfully evaded reporting and remitting the tax to the Department of Taxation and indications of fraud exist.

The audit of a business which that has experienced a name change, a change in responsible partners or officers or the addition of new locations, and where the business is conducted in the same manner and for the same purposes as during a prior audit, will not be considered a first audit for purposes of this subsection.

Similarly, audits performed for periods subsequent to the institution of reorganization plans, where during such reorganizations, the continuity of the business was not affected and the business entity maintained operations for the purpose of producing the same product(s) or rendering the same service(s), will not qualify for first generation audit status. In addition, audits performed for periods subsequent to business mergers, absorptions and like ventures, where the intent is to diversify or expand, will not qualify for first generation audit status. However, penalty generally will not be applied to audit deficiencies occurring in new areas not covered in prior audit(s) as set forth in subdivision 6 8 of this subsection.

In the event that a business should undergo a reorganization, restructuring, acquisition, merger, diversification of product line or process, or any other event that would subject the business to a different sales tax application than its normal course of business, it is recommended that the business request a written ruling from the department as to the proper sales and use tax application. See 23VAC10-210-20.

2. 4. Second generation audits. Penalty will generally be applied unless the taxpayer's compliance ratios meet or exceed 85% for sales tax and 60% for use tax, as computed by the auditor or under the alternative method.

3. 5. All subsequent generation audits. Penalty 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.

4. 6. Taxable sales. Penalty, based on the compliance ratio, will generally be applied to the net understatement of the sales tax. "Net understatement" means sales tax deficiency determined by the audit less allowable credits, such as the sales price of tangible personal property returned by the purchaser, repossessed, or charged off as bad debts during the period of the audit.

5. 7. Taxable purchases. Penalty, based on the compliance ratio calculated by either the auditor or under the alternative method, will generally be applied to the net underpayment of the use tax on recurring purchases of tangible personal property used regularly in the business. "Net underpayment" means use tax deficiency determined by the audit.

a. Withdrawals from inventory. Withdrawals of tangible personal property are subject to the use tax on a cost basis (or fabricated cost basis in the case of a fabricator/manufacturer) and should be added to taxable recurring purchases for purposes of computing the compliance ratio.

b. Fixed assets. The tax applies to purchases of fixed assets used in the business and such purchases should be added to taxable recurring purchases and taxable withdrawals from inventory for purposes of computing the compliance ratio.

6. 8. Exceptions. Penalty generally will not be applied to audit deficiencies occurring in new areas not covered by prior audit(s), provided the application of the tax is not clearly established under existing law, regulations or other published documents of which the taxpayer reasonably should have had knowledge, or areas where the taxpayer has relied on prior correspondence with the department that has not been superseded by a law change, a change in regulations, or other published documents of which the taxpayer reasonably should have had knowledge. Deficiencies in these areas will not be included in compliance ratio computations. Notwithstanding the above, items of like class or similar nature may be subject to penalty even though the specific item was not addressed in the previous audit(s) if the general class of items was held taxable in previous audit(s). The application of penalty to audit deficiencies will not be waived on second and subsequent audits for other than exceptional mitigating circumstances.

B. C. Interest. The application of interest to all audit deficiencies is mandatory and accrues as set forth in 23VAC10-210-2030 C.

VA.R. Doc. No. R07-252; Filed January 26, 2009, 1:24 p.m.