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© Avalara Sales Tax Audit and Appeals Joseph N. Endres , Esq. Hodgson Russ LLP [email protected] Sponsored by
© Avalara
Sales Tax Audit and Appeals
Joseph N. Endres, Esq.Hodgson Russ LLP
Sponsored by
Making sales tax less taxing
Summary of Topics
• Section 1: The Lay of the Land - Overview of Issues that
Typically Arise during An Audit
• Section 2: The Sales Tax Audit – Process and
Procedures
• Section 3: Appealing an Adverse Assessment
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Making sales tax less taxing
OVERVIEW OF ISSUES THAT TYPICALLY ARISE DURING AN AUDIT
Section 1
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Making sales tax less taxing
Section 1: Typical Audit Issues
• When does a company have to comply with a state’s tax
laws?
• In other words, when does a company have to worry
about an audit?
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Making sales tax less taxing
Section 1: Typical Audit Issues
• Nexus, what is it?
– Nexus is a fancy word for “connection.” In order for a state to require an
out-of-state seller to collect its sales tax, there must be a requisite level
of connection between the state and the seller.
• Quill v. North Dakota, 504 U.S. 298 (1992)
• The “Bright Line” Test: Physical Presence
• Do you have any people or property in the state?
– Offices
– Employees or independent contractors
– Inventories
– Other property – servers and Texas
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Making sales tax less taxing
Section 1: Typical Audit Issues
• Can a third party’s activity in a state confer nexus on an
out-of-state seller?
– Yes. Affiliate or Click-Through Nexus!
– Scripto, Inc. v. Carson, 362 U.S. 207 (1960)
– Tyler Pipe Industries, Inc. v. Washington Dep’t of Revenue, 483 U.S.
232 (1987)
– Several states now impose some sort of click-through or affiliate
nexus, including Arkansas, California, Colorado, Connecticut,
Georgia, Illinois (currently unconstitutional), Kansas, Minnesota,
Missouri, New York, North Carolina, Oklahoma, Pennsylvania,
Rhode Island, Texas and Vermont.
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Making sales tax less taxing
Section 1: Typical Audit Issues
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NY’s Amazon Litigation
1. Two out-of-state sellers with no physical presence in New York (no
offices, employees, or property), Amazon.com and Overstock.com,
challenged the constitutionality of New York’s law.
2. Nearly five years after the initial challenge, New York’s highest appellate
court, the Court of Appeals, issued a decision on March 28, 2013. See,
20 N.Y.3d 586.
3. In late 2013, the Supreme Court refused to hear a challenge to New
York’s Affiliate Nexus laws.
Making sales tax less taxing
Section 1: Typical Audit Issues
• Sales Tax is Considered a “Transaction Tax” and a
“Destination Tax”
– Liability for the tax occurs at the time of the transaction, not when
the debt is paid.
– The transaction occurs when:
• there is a transfer of title or possession (or both) of TPP.
• a service is rendered.
– Location of change of possession or rendering or service
determines both the incident and rate of tax.
• Auditors should not use out of state sales to determine in-state
liability.
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Making sales tax less taxing
POLLING QUESTION
• What is your primary concern around sales tax
compliance?
A. Staying up to date on rate and rule changes.
B. Changing/new nexus laws.
C. Adapting compliance to new business operations.
D. The burden to accurately prepare and file returns.
E. Other
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Making sales tax less taxing
Section 1: Typical Audit Issues
• Sales Tax is a “Form Over Substance” Tax
– This can work both for and against taxpayers.
• Separate corporations (even if related) are treated as separate
taxpayers under the sales tax law.
• Work performed by one corporation for another may be taxable.
• But this does allow for structuring opportunities!
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Making sales tax less taxing
Section 1: Typical Audit Issues
• Bundled Transactions
– If you bundle taxable items together with nontaxable items for
one charge, the taxable items taint the nontaxable items and
cause the entire charge to be taxable.
• Most state taxing authorities take the position that it’s not their job to
determine what’s taxable from what’s nontaxable.
• Some auditors will allow allocation.
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Making sales tax less taxing
Section 1: Typical Audit Issues
• States maintain various exemption certificates, including
the following primary forms:
– Exempt Organization Exempt Purchase Certificate
– Resale Certificates
– Contractor Exempt Purchase Certificate
– Certificate of Capital Improvement
– Exempt Use Certificate
• You have to keep an exemption certificate on file for as
long as an audit risk exists and some states (e.g., FL)
require that certificates be updated periodically.
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Making sales tax less taxing
Section 1: Typical Audit Issues
• Exemption Certificate Issues – an exemption certificate
will shield the seller from potential liability if the certificate
is valid!
• A certificate will be considered valid if:
– It is timely received (typically 45 to 90 days from the transaction)
– It is properly competed (all required entries were made)
– It is accepted in good faith (no actual knowledge to the contrary)
• But lack of a certificate does not turn an exempt
transaction into a taxable one.
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Making sales tax less taxing
POLLING QUESTION
• How does your company handle exemption certificate
compliance?
A. Maintains a paper copy of all exemption certificates.
B. Maintains a digital copy of all exemption certificates
C. Maintains a paper and digital copy of all exemption certificates.
D. What’s an exemption certificate?
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Making sales tax less taxing
Section 1: Typical Audit Issues
• Asset Sales – 2 Primary Issues:
– Is the Asset Sale Subject to Tax?
• In most states, no. There is an “isolated” or “occasional” sale
exemption.
• But in some states, such as NY, YES!! If tangible assets are
transferred and no exemption applies, the assets will be subject to
tax.
– Does the sale expose the purchaser to successor liability?
• Yes! In most states, the purchaser may be held liable for the seller's
outstanding sales tax liability up to the selling price of the assets or
their fair market value, whichever is greater.
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Making sales tax less taxing
Section 1: Typical Audit Issues
• What Qualifies as an Asset Sale?
– In many states, any transfer of assets outside the normal course
of business will trigger a bulk sale filing. In others, a specific
amount of the business assets have to be sold.
• Note that a purchase or the transfer of consideration is not required.
• Successor liability can be imposed even in instances in which the
assets are gifted.
• Successor liability applies regardless of whether the assets
purchased are tangible personal property (whether taxable or
exempt), intangible property, or real property. In other words, even
if the transaction is a nontaxable one, the bulk sale rule still applies.
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Making sales tax less taxing
Section 1: Typical Audit Issues
• Asset Sales: to avoid successor liability, the purchaser
must comply with various notice requirements:
• This notice allows the state taxing authorities to
determine, before the assets are sold, whether the seller
has any unpaid sales or use tax liabilities.
• Purchasers are typically required to withhold or escrow
the purchase money until the taxing authority has issued
a certification that the seller does not have any
outstanding liability and the sale can proceed.
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Making sales tax less taxing
Section 1: Typical Audit Issues
• Asset Sales: Practical Considerations
– Private Indemnifications and Escrow Accounts.
• Is this really a solution?
• Applications to escrow can be difficult and time consuming.
• The application might be contested = litigation.
• It can be difficult to estimate a “safe” escrow amount.
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Making sales tax less taxing
POLLING QUESTION
• Has your business ever bought or sold business assets
outside the normal course of business?
A. No, never.
B. Yes, frequently.
C.Yes, but rarely.
D.Yes, once. And now that I know these rules, I have to go call my
accountant/lawyer.
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Making sales tax less taxing
THE SALES TAX AUDIT –PROCESS AND PROCEDURE
Section 2
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Making sales tax less taxing
Section 2: The Sales Tax Audit –Process and Procedure• How does a business get chosen for audit?
– Audits of other taxpayers
– Whistleblower Issues
– Technology!!
• Corporate tax return sales v. sales tax return sales
• Consistent taxable percentage
• Drastic changes in filing pattern
• New “self-audit” letters based on ratios and “typical” use tax liabilities.
• Information from more sources (franchisers, insurance companies, liquor
distributors, and financial institutions)
• Compare returns of similar businesses operating within the same geographic
areas
• lottery traffic vs. low sales
• cash/credit card ratio out of sync with similar businesses
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Making sales tax less taxing
Section 2: The Sales Tax Audit –Process and Procedure• Auditors look at a few key areas:
– Tax reconciliation
– Expenses - usually recurring - use of test period or statistic
sample preferred.
– Sales - usually sampled, depends on level of sales activity:
guest checks - register tapes - taxable ratio.
– Capital acquisitions - full detail usually preferred, items usually
reconciled with cash disbursements journal and federal
depreciation schedule.
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Making sales tax less taxing
Section 2: The Sales Tax Audit –Process and Procedure• Major Audit Issues:
– Where to hold audit
– Responsible officer questionnaire
– Access to information
• LLCs be especially careful in NY
– Consent to extend
– Statute of Limitations
– Timing Issues
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Making sales tax less taxing
POLLING QUESTION
• Most audits result in some liability, even if just a small
amount. If your company has been audited in the past,
where did the auditors find most of the liability?
A. Tax Account Reconciliation.
B. Sales – we didn’t know our sales were subject to tax.
C.Sales – we didn’t know we had nexus in a state.
D.Disallowed exempt sales (problems with exemption certificates).
E. Expense purchases where tax wasn’t paid.
F. Capital purchases where tax wasn’t paid.
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Making sales tax less taxing
Section 2: The Sales Tax Audit –Process and Procedure• Audit Methodology
– Direct Audit
• What qualifies as “adequate records?”
• Typical for non-cash businesses
• Test Period Consent
– Indirect or Estimated Audit Methodologies
• Records must be requested and deemed inadequate
• Observation Test
• Purchase Markup Test
• Cash to Credit Card Test
• Industry Indices Test (e.g., rent to sales ratio)
• Beware income tax issues!
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Making sales tax less taxing
Section 2: The Sales Tax Audit –Process and Procedure• Concluding an Audit
– Audit Work Papers
– Overlapping Audit Policy
– Collecting Tax from Customers
– Presumption of Correctness and Burden of Proof Issues
– Penalties and Interest
– Closing Agreements
– Follow-Up Audits
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Making sales tax less taxing
APPEALING AN ADVERSE ASSESSMENT
Section 3
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Making sales tax less taxing
Section 3: Appealing an Adverse Assessment• Immediately Following the Audit
– The Use of FOIL
– Taxpayer Rights Advocate’s Office
– Review Consents to Extend the Period for Assessment
– Mailing Rules – assessment must follow certain procedures
• Timely and Proper Mailing
• Last Known Address
• Proof of Mailing
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Making sales tax less taxing
Section 3: Appealing an Adverse Assessment• Informal Protest
– Courtesy Conferences
– Mediation
• Still working with the auditors
• Can be binding on the taxing authority
• Usually not binding on the taxpayer
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Making sales tax less taxing
POLLING QUESTION
• If your company has gone through a sales tax audit,
which one of the following statements best describes
your experience?
A. The auditors were fair and reasonable and concluded the
audit in a timely manner.
B. The auditors were hyper aggressive and used a methodology
that artificially inflated the liability.
C.The rules and record keeping requirements are so onerous
it’s impossible for businesses to fully comply with the law.
D. I loved our sales tax audit and can’t wait for the next one!
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Making sales tax less taxing
Section 3: Appealing an Adverse Assessment• Formal Protests
– Administrative Hearings
• Still within the taxing authority
• May or may not be binding on the taxing authority
• No longer working directly with the auditors
• Before an Administrative Law Judge
• Quasi Trial - Usually sworn testimony with transcript
• May provide for a further internal appeal
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Making sales tax less taxing
Section 3: Appealing an Adverse Assessment• Formal Protests (con’t)
– State Court Proceeding
• Full legal procedures, rules of evidence, etc.
• May go right to appellate level court
• Costly and Time Consuming
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Making sales tax less taxing
If you have further questions or if you need additional assistance, please
feel free to contact:
Thank You forAttending Today’s Seminar
Joseph N. Endres
HODGSON RUSS LLP
716.848.1504
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Making sales tax less taxing
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