New York: Sales Tax Audit Thrown Out
- Jul 13, 2012 | Steven Dunston
In 2009, the New York Division of Taxation performed a tax audit on Richmond Deli & Bagels Inc., a ". . . deli grocery store in Staten Island, New York, selling soda, beer, cigarettes, sandwiches, prepared foods, coffee, detergent and other similar grocery items." The auditors requested all books and records ". . . pertaining to the sales and use tax liability . . ." for the eleven sales tax periods, from June 1, 2005 to February 29, 2008.
However, the auditors determined that records returned by Richmond Deli were inadequate. This was largely ". . . due to the fact that when [the auditor] attempted to reconcile the bank statements for the audit period to the gross sales reported by Richmond Deli, he found that there were more than $2 million worth of reported sales not deposited into the corporation’s bank account."
Since they found the records inadequate, and Richmond Deli could not produce adequate records, the auditors opted to calculate additional tax due based on ". . . an indirect audit methodology that relied on prepaid cigarette credits claimed by Richmond Deli on its returns for the period."
The auditors determined that cigarette sales represented 22% of the Deli's reported gross sales. Based on prior experience with similar businesses, the auditors estimated that the cigarette sales should represent only 15% of the Deli's reported gross sales. Therefore, in their view, the business had under-reported their gross sales, making the percentage of cigarette sales appear larger than it actually was. The auditors thus reported that the Deli owed $247,119.71 in additional taxes.
Richmond Deli petitioned the audit findings to the New York State Division of Tax Appeals on the grounds that the auditors did not use a reasonable audit method for determining the tax owed. The court ruled in favor of the Deli, stating that while the indirect audit method used was appropriate, the auditors did not calculate the tax owed based on any of the business' actual activities. In fact, the auditors never set foot in the Deli, and did not use its real operations to estimate the Deli's gross sales. They estimated that cigarette sales should represent 15% of reported sales based purely on prior experience.
The court concluded "By clear and convincing evidence, petitioners have shown that the audit method employed was unreasonable and lacks any rational basis. Accordingly, the assessments derived from a method lacking a rational basis are erroneous and must be cancelled, and consequently, no penalties will ensue."