Rulings of the Tax Commissioner

August 17, 2023

Re: § 58.1-1821 Application: Retail Sales and Use Tax        
    
Dear *****:

This is in response to your letter submitted on behalf of *****. (the “Taxpayer”), in which you seek correction of the retail sales and use tax assessment issued for the period February 2015 through January 2018.  I apologize for the delay in responding to your request.

FACTS

The Taxpayer is a wholesaler of clothing and other apparel products. Under first generation audit, the Taxpayer did not provide sufficient documentation to verify taxable and exempt sales and an assessment was issued for Virginia retail sales and use tax. The Taxpayer appeals, contending that valid exemption certificates were provided for the customers at issue and the related transactions should be removed from the assessment. The Taxpayer further contests the extrapolation of the error ratio over the audit period and asserts that it resulted in an incorrectly large assessment of tax and requests that 50% of the assessed interest be waived because of delays in completing the audit.

DETERMINATION

Exemption Certificates 

Virginia Code § 58.1-623 A provides “[a]ll sales or leases are subject to the tax until the contrary is established.” Virginia Code § 58.1-623 B then states, in part: 

The certificate mentioned in this section shall relieve the person who takes such certificate from any liability for the payment or collection of the tax, except upon notice from the Tax Commissioner that such certificate is no longer acceptable. Such certificate shall be signed by and bear the name and address of the taxpayer; shall indicate the number of the certificate of registration, if any, issued to the taxpayer; shall indicate the general character of the tangible personal property sold, distributed, leased, or stored, or to be sold, distributed, leased, or stored under a blanket exemption certificate; and shall be substantially in such form as the Tax Commissioner may prescribe. 

Title 23 of the Virginia Administrative Code (VAC) 10-210-280 A interprets Virginia Code § 58.1-623 and states that “a certificate that is incomplete, invalid, infirm or inconsistent on its face is never acceptable, either before or after notice”. Title 23 VAC 10-210-280 B then states that “[r]easonable care and judgment must be exercised by all concerned to prevent the giving or receiving of false, fraudulent or bad faith exemption certificates. An exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate.”

The reasonable care and judgement standard is addressed in International Paper Company v. Virginia Department of Taxation, CL-2009-360, Circuit Court of Fairfax County, July 29, 2010. See Public Document (P.D.) 10-258 (10/25/2010). The Court held that a dealer could satisfy the good faith and reasonable care and judgment standards in taking a certificate to the effect that the acceptance is exempt if: 

Upon a facial examination of the certificate, a dealer could reasonably conclude that the items purchased could potentially be used for any of the exempt purposes claimed on the certificate of exemption; or 

Based upon the dealer’s actual knowledge of the business of its purchaser, the dealer could reasonably determine in good faith that the specific purchaser intended to use the items purchased for one or more of the exempt purposes claimed on the certificate of exemption. 

It is important to note that the standard addressed in International Paper Company is applicable only when a valid certificate is received and retained at the time of sale and can be produced by the taxpayer at the time of an audit. In P.D. 04-75 (8/25/2004), the Tax Commissioner cited longstanding policy as set out in P.D. 98-29 (2/20/1998) that the absence of a valid exemption certificate at the time of a sales transaction indicates that the certificate was never accepted in good faith. 

When a dealer fails to receive a valid certificate at the time of sale, the “good faith acceptance” privilege is invalidated and the dealer becomes subject to the tax that was not applied to the transaction. While the dealer has the responsibility to prove the transaction is exempt, the Department also applies “greater scrutiny” to determine whether the transaction is exempt in order to avoid collecting tax when it is not due. In doing so, the Department may perform a search of its records to determine if the customer has a registration number, as well as a sales and use tax return filing history. Once this search is performed, the Department can reasonably conclude whether the purchase made by the customer would qualify for an exemption, in this case a resale exemption. The Department takes these additional steps because dealers do not have access to the registration and filing histories of their customers and, therefore, cannot reasonably be expected to provide such scrutiny regarding the acceptance of exemption certificates. 

Keeping this in mind in addition to the cited authorities, the exemption certificates furnished by the Taxpayer have been received and the use of such certificates evaluated. 

Certificates on File at Audit 

During the audit, the Taxpayer furnished resale exemption certificates that were on file at the time of the audit to the auditor for four customers: ***** (Customer 1), ***** (Customer 2), ***** (Customer 3), ***** (Customer 4). The auditor concluded that the certificates for their customers were completed incorrectly and disallowed the exemptions. 

After reviewing the documentation provided by the Taxpayer, the audit file, and exemption certificates, the Department now finds that it was reasonable for the Taxpayer to rely on the exemption certificates based on their actual knowledge of the business of the purchaser. Exceptions as they relate to Customers 1, 2, 3, and 4 will be removed from the audit. 

Certificates Not on File at Audit 

At the time of the audit, the Taxpayer did not have exemption certificates on file for four customers: ***** (Customer 5), ***** (Customer 6), ***** (Customer 7), and ***** (Customer 8). The Taxpayer was unable to provide the certificates during the audit and has not provided them with its appeal. As stated above, the absence of a valid exemption certificate at the time of a sales transaction indicates that the certificate was never accepted in good faith. Therefore, the exemptions for Customers 5, 6, 7, and 8 were appropriately denied and the transactions associated with these customers were properly included as exceptions in the audit. 

In addition to the above, the Taxpayer did not have exemption certificates on file, but was able to obtain them during the audit, for three customers: ***** (Customer 9), ***** (Customer 10), and ***** (Customer 11). Because these certificates were not on file at the outset of the audit, they are subject to greater scrutiny by the Department. Upon review of the Department’s records, none of these customers were registered with the Department to collect Virginia retail sales and use tax. Under these facts, certificates from Customers 9, 10, and 11 were not acceptable for any purchases occurring during the audit period and were properly included as exceptions. 

Audit Sample

The Taxpayer argues that the small sample size, less than one week, cannot be representative of a 156 week audit period. Sampling is an audit technique of significant value that is widely used in both the public and private sectors for all types of audits where a detailed audit would not prove beneficial to either the auditor or the client. When sampling techniques are properly applied, the final results are usually within a narrow percentage range of the actual amount that would have been determined by a detailed audit. The purpose of the audit sample is to determine a factor for errors within a representative selected period. Once the error factor is determined, the factor is extrapolated over the entire audit period. The purpose of the projection is to account for likely similar transactions on which Virginia tax has not been paid. Every effort is made to select objectively the sample periods that are representative of the period being audited.

Upon review of the audit report and the information presented, I find no basis to invalidate the sample and extrapolation. The auditor used a sample period pursuant to request by the Taxpayer and the Taxpayer has not asserted that the selected sample period was unreasonable or contained unusual business transactions. The sample and error factor were applied in accordance with established audit procedures. 

Partial Interest Abatement

The Taxpayer contends the length of time taken to complete the audit was unreasonable and, therefore, one-half of the interest should be abated. However, the Taxpayer’s difficulty in gathering the necessary documents and exemption certificates from the customers resulted in the delays in the audit. The Department records show that the auditor provided the Taxpayer ample time to obtain and update incomplete details. Even with the additional time permitted, the Taxpayer was unable to provide satisfactory exemption certificates for all of its customers. Additionally, Virginia Code § 58.1-1812 mandates the application of interest to any tax assessment. Interest is not assessed as a penalty for noncompliance with the tax laws. Rather, it represents a fee for the use of money over a period of time. In this instance, the Taxpayer had the use of money that was properly due to the Commonwealth. 

CONCLUSION 

Based on this determination, the audit will be returned to the appropriate field audit staff to remove the transactions related to Customers 1, 2, 3 and 4. After the revision of the audit is complete, the Taxpayer will be issued a revised audit report and revised bill, with interest accrued to date. No further interest will accrue provided the outstanding bill is paid within 60 days of the date of the bill. 

The Code of Virginia sections, regulation, and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at (804) *****.

Sincerely,

Craig M. Burns
Tax Commissioner

                        
AR/3605.F