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Penalties and Interest; Audits
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23VAC10-210-2032

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.