Tax Type
Retail Sales and Use Tax
Description
Distributorship Agreement; Underreported Sales; Dealer Responsibilities
Topic
Appropriateness of Audit Methodology
Collection of Tax
Records/Returns/Payments
Date Issued
05-01-2013
May 1, 2013
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This will reply to your letter in which you seek the correction of a retail sales and use tax assessment issued to your client, ***** (the "Taxpayer") for the period September 2006 through October 2010. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer markets and distributes frozen food products that consist primarily of meats such as beef, pork, chicken and seafood. The Taxpayer utilizes a network of individual distributors (the "Distributors") to sell its products utilizing door-to-door sales. The Taxpayer is registered as a dealer with the Department and was reporting and remitting retail sales taxes on behalf of the Distributors. The business relationship between the Taxpayer and the Distributors is governed by a Distributorship Agreement (the "Agreement") that is signed by both parties.
The Department audited and assessed the Taxpayer retail sales tax based on a determination that the Distributors' sales were underreported. The Department's auditor took the position in the audit that the Distributors were the Taxpayer's employees and that the Taxpayer was responsible for reporting and remitting the retail sales taxes due on the Distributors' sales. The Taxpayer uses daily settlement reports to record and maintain a record of each Distributor's product purchases, sales and customer payments. The information on the settlement reports is used to prepare the Taxpayer's monthly sales tax returns. The Taxpayer reported and remitted sales taxes on the Distributors' sales based on customer payment information provided by the Distributors to the Taxpayer, which is recorded on the settlement sheets. For a 3% fee, the Taxpayer processes the Distributors' check and credit card payments. The Taxpayer also processes food stamp vouchers received by the Distributors as payment from their customers.
The Taxpayer did not maintain with its records copies of sales receipts from the Distributors. Thus, the auditor was unable to use sales receipts to verify that the Taxpayer reported and remitted the correct sales figures and sales taxes to the Department. As a result, an estimated sales tax assessment for underreported sales was made. Gross sales for the audit period were estimated using an average of suggested retail sales prices for various product categories as published in the Taxpayer's product brochure. The estimated gross sales amounts were reduced to reflect credits for sales taxes reported and exempt food stamp sales.
DETERMINATION
Taxpayer's Position
The Taxpayer contests the estimated sales tax assessment on several grounds. The Taxpayer maintains that the Distributors are responsible for collecting and remitting retail sales taxes on their sales because the Distributors are independent contractors rather than employees. The Taxpayer states it was advised by the Department to collect and remit sales taxes on the Distributors' sales soon after the business started. Although the Taxpayer complied with the Department's request, the Taxpayer asserts that the Distributors are the dealers making the actual retail sales and are liable for any sales taxes due on their sales. The Taxpayer contends it sells its products to the Distributors for resale and such sales qualify for the resale exemption, provided valid resale exemption certificates are obtained from the Distributors.
The Taxpayer offers several reasons that support treating the Distributors as independent contractors rather than employees. The Taxpayer notes that the Agreement provides that the Distributors are independent contractors who determine the "time, method and manner" of selling the Taxpayer's products. The Distributors do not receive wages, salaries, benefits or other forms of compensation from the Taxpayer. The Distributors establish their own work schedules, use their own sales methods and set their own prices for the products they sell. The Agreement states that the Distributors assume the risk for any damaged, thawed, stolen or lost products obtained from the Taxpayer for resale. The Taxpayer maintains that the Virginia Employment Commission agrees that the Distributors are independent contractors.
The Taxpayer also disputes the methodology used to calculate the audit's taxable sales measure. The Taxpayer asserts that the auditor's use of average sales prices to calculate estimated taxable sales grossly overstates the actual sales for the audit period. The Taxpayer contends the taxable sales measure in the audit erroneously includes out-of-state sales, and exempt food stamp sales are not properly credited in the calculation of taxable sales. The Taxpayer provided the auditor with the actual food stamp sales for each month of the audit period. These amounts were credited against the taxable sales measure. The Taxpayer suggests that a larger credit is due because the sales measure was estimated by extrapolating sales based on average sales prices while the food stamp credit is based on actual sales. Further, the Taxpayer contests the assessment of sales tax on the 3% processing fees charged the Distributors for processing check and credit card transactions.
Dealer Collection Responsibilities
The Taxpayer maintains that the Distributors are not employees or agents under its direct control, and the Distributors are responsible for collecting and remitting sales taxes on retail sales of the Taxpayer's products. I agree with the Taxpayer that the Distributors are selling the Taxpayer's products on a consignment basis. Title 23 of the Virginia Administrative Code (VAC) 10-210-390 states, in part, that "[t]angible personal property consigned, delivered or entrusted to a dealer for the purpose of sale is taxable at the time of sale at retail." Title 23 VAC 10-210-2020 addresses the application of the tax to peddlers and street vendors and states, "Any person engaged in the retail selling of tangible personal property, whether through stores, from private residences, from trucks or wagons, by house-to-house canvass, or in any other manner, is required to file an application for a Certificate of Registration and to collect and pay the tax due the state."
Title 23 VAC 10-210-2020 also states that the Department can decline to issue a Certificate of Registration to peddlers, street vendors and other persons that make retail sales from other than an established place of business due to the transient nature of the business. In such cases, vendors must collect the tax on sales for resale of property to peddlers, street vendors and others because the resale exemption is not applicable. This provision of the regulation is consistent with the definition of "retail sale" in Va. Code § 58.1-602, which provides that a retail sale shall include:
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- sales of tangible personal property to persons for resale when because of the operation of the business, or its very nature, or the lack of a place of business in which to display a certificate of registration, or the lack of a place of business in which to keep records, or the lack of adequate records, or because such persons are minors or transients, or because such persons are engaged in essentially service businesses, or for any other reason there is likelihood that the Commonwealth will lose tax funds due to the difficulty of policing such business operations....
The Taxpayer states that it was instructed by the Department to collect and remit sales taxes on the Distributors' sales based on the statutory definition of sales price and the provisions of Title 23 VAC 10-210-2020. The fact that the Taxpayer is registered with the Department and reports and remits sales taxes is not in dispute.
The Taxpayer is clearly a dealer as defined in Va. Code § 58.1-612 B. The Taxpayer meets several of the dealer criteria set out in the statute. The Taxpayer meets some of the nexus criteria in Va. Code § 58.1-612 C that requires dealers to register and collect the tax. The Taxpayer has physical business locations in the Commonwealth and solicits business in the Commonwealth through a network of distributors. Further, by previously registering with the Department, the Taxpayer effectively consented to the jurisdiction of the state and is required to report and remit the proper amounts of Virginia retail sales and use tax in accordance with Virginia law. In Public Document (P.D.) 93-141 (6/7/93), the Tax Commissioner ruled that a furniture retailer that had voluntarily registered with the Department to collect and remit Virginia use taxes was subject to the state's filing and reporting requirements and was liable for unreported taxes that were assessed by the Department. This policy is also discussed in P.D. 97-440 (10/31/97) and P.D. 00-137 (7/31/00).
Dealer Records
As a registered dealer, there are certain record keeping requirements that apply to the Taxpayer. Virginia Code § 58.1-633 A states:
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- Every dealer required to make a return and pay or collect any tax under this chapter shall keep and preserve suitable records of the sales, leases, or purchases, as the case may be, taxable under this chapter, and such other books of account as may be necessary to determine the amount of tax due hereunder, and such other pertinent information as may be required by the Tax Commissioner.
Based on this statute, the Taxpayer must maintain adequate records for the Department to determine if the correct amounts of sales tax have been reported and paid on the Distributors' sales. While it may be true that the Taxpayer maintains adequate records of its sales to the Distributors, the auditor was unable to verify if the Distributors' sales were properly reported by the Taxpayer because there were no sales receipts.
The provisions of Va. Code § 58.1-625 further concern me. This statute requires dealers to separately state the amount of sales tax and add the tax to the sales price or charge. Title 23 VAC 10-210-340 interprets this statute and states, in part, "[i]dentification of the tax by a separate writing or symbol is not required provided the amount of the tax is shown as a separate item on the record of the transaction." (Emphasis added.) The regulation clearly contemplates the use by dealers of an invoice, receipt or other form of documentation as a record of sales transactions. A record of the transaction is important to both the seller and the purchaser because it contains a breakdown of the various charges in the transaction, including the sales price of the product sold, shipping and handling charges and applicable sales or use tax charges. This enables the purchaser to prove that sales or use tax was paid on the property purchased, and the proper amount of tax was charged. It also creates a record of each transaction for the dealer's use in reporting the tax and proving the proper amount of tax was collected and paid to the Department. Thus, the absence from the Taxpayer's records of sales receipts or some other form of documentation for the Distributors' sales transactions makes it difficult for the Department to determine if the Taxpayer is in compliance with Virginia's statutory reporting and payment requirements for sales and use taxes.
3% Processing Fee
The Taxpayer contests the assessment of sales tax on the fees it charges the Distributors for processing check and credit card sales transactions. The fee is 3% of each check amount or credit card charge processed by the Taxpayer. The fee is listed on the daily settlement sheets and is deducted from the total sales reported for the day by each Distributor. The fee was treated in the audit as part of the taxable sales price of the Taxpayer's products based on the definition of "sales price" in Va. Code § 58.1-602. Sales price is defined, in part, as "the total amount for which tangible personal property or services are sold, including any services that are a part of the sale ...."
The Taxpayer reported and remitted Virginia sales taxes based on the Distributors' taxable retail sales transactions with their customers. The Distributors did not bill their customers a separate charge for the processing fee. Because the 3% processing fee is billed by the Taxpayer to the Distributors with other daily charges, it is likely that the Distributors include the 3% fee in the sales price of the products sold to their customers. The Taxpayer did not deduct the 3% processing fee from the sales reported on its sales tax returns. Based on the Taxpayer's current method of reporting the sales tax, the 3% processing fee is not billed in connection with the Distributors' sales of tangible personal property. The Taxpayer bills the fee in separate transactions with the Distributors. These daily charges are not includable in the taxable sales amounts upon which the Taxpayer calculates and remits Virginia sales taxes. The 3% processing fee is not taxable.
CONCLUSION
A review of the facts of this case and of the relevant information on the employee versus independent contractor issue shows that there are factors that support the positions taken by both the Taxpayer and the Department. However, there is considerable evidence that supports treating the Distributors as independent contractors that sell the Taxpayer's products on a consignment basis. There is also sufficient basis to require the Taxpayer to report and remit the tax for the Distributors in accordance with Title 23 VAC 10-210-2020. I understand the Taxpayer's concerns with respect to requiring the Distributors to provide sales receipts. However, as a registered dealer that is subject to the reporting requirements set out above, the Taxpayer must obtain copies of sales receipts from the Distributors and maintain these copies with its sales records. Otherwise, the Taxpayer is not meeting the statutory record keeping requirements set out in the Code of Virginia. Without adequate supporting sales documentation, the Department has no alternative but to estimate the Taxpayer's sales in the event of another audit.
If some of the Distributors refuse to provide the Taxpayer with sales receipts, those Distributors must register as dealers and begin collecting and remitting the sales tax on their Virginia sales directly to the Department. After registering with the Department, the Distributors can then purchase the Taxpayer's products for resale exempt of the tax. The Distributors should issue the Taxpayer a valid Form ST-10, which is the Department's resale exemption certificate. The Taxpayer should ensure that the Form ST-10 is valid on its face. The exemption certificate should be fully completed and must contain the Distributor's Virginia registration number. Title 23 VAC 10-210-280 and P.D. 97-95 (2/21/97) discuss in more detail the Department's requirements for valid exemption certificates. The Taxpayer should maintain copies of the exemption certificates in its files to support the exempt sales made to those Distributors that are registered with the Department to collect the retail sales tax.
Based on a review of the audit information and the Taxpayer's documentation, I am concerned that the Taxpayer underreported the Distributors' sales made during the audit period. Under the Taxpayer's current system of sales and use tax reporting, there is no record of cash transactions and no way to verify that cash sales have been reported to the Department. Likewise, customers can write checks made payable to the Distributors and the Taxpayer will likely have no record of these sales transactions. The Distributors only need to submit to the Taxpayer sufficient funds to cover their itemized costs for the settlement that is done at the end of the day. For the reasons stated in this determination, it is imperative that the Taxpayer maintain complete records for all of its business transactions. The findings in this determination are based on the specific facts of this case. The final resolution of this case is being addressed as an offer in compromise. A letter that outlines the terms of the offer in compromise will be sent to the Taxpayer under separate cover.
The Code of Virginia sections, regulations and public documents cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions, please contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
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- Sincerely,
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Craig M. Burns
Tax Commissioner
AR/1-4702888185.S
Rulings of the Tax Commissioner