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All About Sales Tax

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Sales tax is one of the most interesting, and challenging, taxes. It’s interesting because it involves clients in every possible industry. Every active business has potential sales tax exposure, no exceptions!  And unfortunately sales tax compliance is particularly difficult for two, specific reasons.  First, the tax is perhaps the most fact-dependent – seemingly inconsequential changes in the underlying facts can transform a nontaxable sale into a taxable one.  Second, these rules are constantly changing.  It’s tough enough to keep up with these changes in just one state.  But many vendors, especially those selling over the internet, have to keep abreast of these changes in multiple states.  So it’s easy to fall behind on sales tax compliance. 

With this blog, we hope to keep you up to date on impactful changes in the sales tax compliance, especially in New York State.  We’ll review legislative and administrative changes in the sales tax; we’ll discuss new sales tax case law; and we’ll highlight the enforcement initiatives and tactics we’re seeing while defending businesses in sales tax audits.  We hope you find this content as interesting as we do.  Please contact us with any questions. 

Matters of Hotel Depot, Inc. and Parikh – Deep Dive

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Every now and then, we’re going to do a deep dive into a sales tax case that we previously reported on in the TiNY Blog.  We keep the more abridged version in the TiNY Blog because, according to Chris Doyle, “Joe, your interest in the sales tax is at best annoying, and at worst pathological.”

So with that resounding vote of confidence, in this post we take a closer look at Matters of Hotel Inc. and Parikh.  My previous TiNY post on the case is available here.  In this decision, the Tribunal was asked whether the Division had a rational basis for taxing the sales to New York customers of a New Jersey hotel furniture supplier, and, if so, whether the Petitioners proved that the audit methodology used by the Division was not “reasonably calculated to reflect tax due.”  We previously reviewed the ALJ determination here and our basic assessment of the case from that post still stands.  The case basically boils down to one sentence in both the determination and the decision: “Petitioner did not present any witnesses or exhibits at hearing.”  The likelihood of a petitioner’s success in a DTA sales tax case is directly proportionate to the amount of good evidence the petitioner provides: When the evidence is nil, the likelihood of success is nil.

Considering that this appears to be a pretty straightforward case of petitioners failing to satisfy their burdens of proof, why did we decide to do a deeper dive?  Well, we think this case provides an excellent opportunity to discuss three interesting topics: (1) how the burden of proof works in sales tax cases; (2) prospective sales tax compliance following a history of noncompliance; and, perhaps most important, (3) the use of computers to conduct an audit (maybe a sign of things to come). 

Burden of Proof

As a preliminary matter, when analyzing sales tax assessments, the first question that needs to be answered is whether the Division has a rational basis for issuing an assessment.  In other words, the Division is obligated to demonstrate, as an initial matter, that its assessment is not irrational. If its assessment is not based on a rational methodology, it will be set aside. 

Here, the Tribunal determined that the Division reasonably concluded that the invoices at issue were taxable despite being made by an out-of-state vendor because the invoices contained a “ship to” address in NY.  The Tribunal did not further obligate the Division to provide evidence that the material was, in fact, delivered to the customers in NY.  Rather, in the absence of evidence to the contrary, it was reasonable for the Division to assume these transactions were taxable NY sales. 

Having determined that the Division’s assessment had a rational basis, the inquiry and burden shifted to the taxpayer to prove, with “clear and convincing evidence,” that the taxpayer was not a “vendor” under the sales tax law or that the methodology was not “reasonably calculated to reflect tax due.”  In other words, even if the Division had a rational basis to issue its assessment, that doesn’t mean that the assessment must be sustained.  Though the Division is given considerable leeway, some assessments are so wrong that they cannot be sustained. 

Here, the Petitioners advanced a few different factual scenarios that, if true, could support the conclusion that tax should not be charged on the transactions at issue.  Of course, the Petitioners failed to provide even a shred of evidence to support these allegations.  And with the burden on the Petitioners, and a high burden at that (“clear and convincing evidence”), their argument went down in flames.

Prospective Compliance

One of the things that I found most interesting about this case is that it appears to have been initiated as a result of the business trying to actually come into compliance with NY sales tax law.  According to the very first finding of fact, the business filed a DTF-17, Application to Register for a Certificate of Authority on March 30, 2011 (the process is now done electronically through the Department’s website here).  A mere four months later, in July 2011, the Division opened a sales tax audit of the taxpayer.  In other words, filing a form so that the business could start collecting NY sales tax seems to have caused the Division to open an audit of the business.  But the truly scary thing is that this audit covered a six-year period, from June 1, 2005 through May 31, 2011 (the last full sales tax quarter to date). 

This is an alarming reminder that putting your business on the Division’s radar must be done with extreme caution and care.  Apparently this business thought it didn’t have a previous collection and remittance obligation in NY because it had no nexus (i.e., physical presence) in the state.  But upon review, the taxpayer was not able to provide any evidence to support this position; it could not demonstrate how its sales of property and services got to its NY customers without the company coming into the state.  And this led to a six-year audit.  It’s a stark reminder that businesses with past liabilities cannot simply register to begin collecting taxes on a going forward basis.  At least once a month I hear a business owner say, “can’t I just begin filing on a going-forward basis and hope the Tax Department doesn’t find out about past liabilities?”  This case shows why that may not be a great strategy.

So what could this taxpayer have done, instead?  Well, after a sober and honest review of its past activities, if it came to the conclusion that it had nexus with NY, it probably would have been better for it to participate in NY’s voluntary disclosure program.  This likely would have conferred the benefit of limiting the past liability to just three years.  In other words, the tax liability would have been cut in half!  Perhaps more importantly, given how old the liability was, it would have also limited the oldest interest calculations.  Finally, though it does not appear that the Division imposed penalties, it certainly could have done so.  The voluntary disclosure program would have eliminated this concern. 

Use of Computers

This case proceeded in a somewhat unusual manner.  In most audits, to determine a business’s sales tax liability, auditors will review a month or a quarter in detail (i.e., they will review every sales invoice for a month or quarter) and then project whatever liability they find to the rest of the audit period.  But the auditors in this audit appear to have used computer technology to help calculate the audit liability instead.  According to the decision, “[t]he auditor reviewed petitioner’s invoices in detail with the help of the Division’s Technology Assist Audit Unit….”  This Unit is usually used to audit the largest of taxpayers using a statistical sampling methodology to determine the tax liability.  But here, it appears that the Unit reviewed every sale made by the taxpayer looking for invoices with a “ship to” address in NY.  Of the thousands (perhaps hundreds of thousands) of invoices issued by the business, the Division’s computers found 1,675 potentially subject to New York’s sales tax.  In my experience, this is an extremely high number of invoices to review.  As software and technology become faster and more capable, we think detailed computer review of a large pool of transactions is going to become the norm rather than the exception.  This could be good news for taxpayers because it will eliminate unfair or unrepresentative test period projections.  But it will also likely mean that auditors are going to find more issues.  In other words, it’s going to be significantly less likely that auditors will simply miss issues when conducting their review. 

Finally, it’s important to note that computers probably played a role in picking this taxpayer for audit.  At the start of the audit, the business’s representative tried to forestall the audit before providing any evidence by arguing that the NJ business did not have nexus with NY.  But the auditor responded with examples of invoices that the Division already had in its files of sales made by the Petitioner to NY customers.  All sales have two parties, the seller and the purchaser.  Apparently the Division already audited one of the NY customers of the NJ business and was able to immediately contest its nexus position.  Thus, when the business submitted for its sales tax vendor registration request, the Division’s computers likely matched the business’s name or ID to information that the Division already had in its system regarding sales made to customers in NY.  Thus, the auditor was ready to contest any nexus argument advanced by the business. 

The Division now receives an incredible amount of information from numerous sources, some of which are:

  • the audits it conducts;
  • the tax returns filed by taxpayers (sales tax, income tax, real property taxes, withholding, employment taxes, etc.);
  • the informational returns filed by credit/debit card companies;
  • the informational returns filed by insurers of motor vehicles;
  • the informational returns filed by alcoholic beverage wholesalers;
  • the informational returns filed by franchisors;
  • the informational shared with the IRS and other states; and
  • the information auditors can find using services like Lexis/Nexis and simple Google searches. 

At this point, the Division has access to so much information that if a taxpayer is not properly handling its sales tax obligations, there’s an ever-increasing likelihood that the Division is going to find out about it. 

Sorry for ending on such an ominous note, but we’re now living in the digital/information age and the NYS Tax Department is at the forefront of using such technologies and information to find audit targets and conduct audits. 

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