TAPROOT ADMINISTRATIVE SERVICES, INC. v. COMM., Cite as 109 AFTR 2d 2012-XXXX, 03/21/2012
Taproot Administrative Services, Inc., Petitioner-Appellant, v. Commissioner of Internal Revenue, Respondent-Appellee.
Case Information:
Code Sec(s):
Court Name: UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT,
Docket No.: No. 10-70892; Tax Ct. No. 15396-07,
Date Decided: 03/21/2012Argued and Submitted November 9, 2011—Pasadena, California.
Prior History:
Disposition:
HEADNOTE
.
Reference(s):
OPINION
Steven R. Mather (argued), Kajan Mather and Barish, Beverly Hills, California, for the petitioner-appellant.
John A. DiCicco, Acting Assistant Attorney General; Richard Farber and John A. Dudeck (argued), Attorneys; U.S. Department of Justice, Tax Division, Washington, D.C., for the respondent-appellee.
UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT,
Appeal from a Decision of the United States Tax Court
Before: Mary M. Schroeder and Stephen Reinhardt, Circuit Judges, and Henry E. Hudson, District Judge. *
Opinion by Judge Hudson
OPINION
Judge: HUDSON, District Judge:
FOR PUBLICATION
Under the Internal Revenue Code, certain eligible corporations may elect S corporation status, thereby acting as pass-through entities for federal taxation purposes. The rules governing eligibility to elect S corporation status restrict various attributes those corporations may have, including the number of shareholders, the classes of stock issued, and the types of shareholders. The single question presented is whether a corporate taxpayer is ineligible for S corporation status, and therefore must be taxed as a C corporation, because its sole shareholder is a custodial Roth Individual Retirement Account (Roth IRA). Taproot Administrative Services, Inc. (Taproot) contends that a Roth IRA cannot be distinguished from its individual owner under a reasonable interpretation of the governing statute. Adhering to this construction, Taproot thus argues that it satisfies the S corporation requirements. For the reasons that follow, we disagree with Taproot and affirm the decision of the Tax Court.
I.
Qualifying small business corporations may affirmatively elect S corporation status for federal income tax purposes. I.R.C. §§ 1361(a), 1362(a)(1) (2006). Under I.R.C. §§ 1363(a) and 1366(a)(1)(A), an S corporation's “profits pass through directly to its shareholders on a pro rata basis and are reported on the shareholders' individual tax returns.” Gitlitz v. Comm'r, 531 U.S. 206, 209 [87 AFTR 2d 2001-417] (2001) (citing I.R.C. § 1366(a)(1)(A)). In this way, an S corporation serves as a conduit through which income flows to its shareholders. Id.(“Subchapter S allows shareholders of qualified corporations to elect a “pass-through” taxation system under which income is subjected to only one level of taxation.”);see also Bufferd v. Comm'r , 506 U.S. 523, 525 [71 AFTR 2d 93-573] (1993).
To receive such favorable tax treatment under the statute, a small business corporation must first meet all of the eligibility requirements before electing S corporation status. 1 Eligibility turns on three characteristics: (1) the number of shareholders, (2) the class of stock, and (3) the types of shareholders. I.R.C. § 1361(b). 2 In pertinent part, the statute limits eligible types of shareholders to domestic individuals, estates, certain trusts, and certain tax-exempt entities. I.R.C. § 1361(b)(1)(B), (c)(2), (c)(6). As of the 2003 tax year, § 1361(c)(2)(A) permitted the following trusts to be eligible shareholders:
((i)) A trust all of which is treated (under subpart E of part I of subchapter J of this chapter) as owned by an individual who is a citizen or resident of the United States.
((ii)) A trust which was described in clause (i) immediately before the death of the deemed owner and which continues in existence after such death, but only for the 2-year period beginning on the day of the deemed owner's death.
((iii)) A trust with respect to stock transferred to it pursuant to the terms of a will, but only for the 2-year period beginning on the day on which such stock is transferred to it.
((iv)) A trust created primarily to exercise the voting power of stock transferred to it.
((v)) An electing small business trust. 3
Taxpayer Paul Di Mundo (Di Mundo) incorporated Taproot Administrative Services, Inc. in the state of Nevada on October 2, 2002. Taproot elected S corporation status effective as of the date of incorporation and filed its 2003 tax return on a Form 1120S, U.S. Income Tax Return for an S Corporation. On January 2, 2003, Taproot issued all outstanding shares of its stock to a custodial Roth IRA account held at the First Trust Co. of Onaga, in Onaga, Kansas, for the benefit of Di Mundo. 4 The custodial Roth IRA 5 account remained Taproot's sole shareholder during the 2003 tax year. According to its 2003 tax return, Taproot earned a total income of $322,420. Taproot reported total deductions of $320,191, resulting in a net ordinary income of $2,229. Taproot also reported interest income totaling $8,549.
On April 10, 2007, the Commissioner of the Internal Revenue Service (I.R.S.) issued a notice of deficiency to Taproot for the 2003 tax year. Among other findings, 6 the Commissioner determined that a Roth IRA did not qualify as an eligible shareholder of an S corporation. Consequently, Taproot was deemed taxable as a C corporation for the 2003 tax year.
II.
In response to the Commissioner's notice of deficiency, Taproot filed a petition with the U.S. Tax Court arguing that the individual beneficiary of a custodial account also qualifying as a Roth IRA should be considered the shareholder for purposes of the S corporation statute, or, in the alternative, a Roth IRA should be treated as a grantor trust pursuant to § 1361(c)(2)(A). Specifically, Taproot contended that as the sole beneficiary of the DiMundo Roth IRA, DiMundo should be considered the shareholder and, thus a qualifying individual for the purposes of the statute. According to Taproot, DiMundo's eligibility as such is governed by § 1.1361-1(e)(1) of the Treasury Regulations. In relevant part, the regulation provides that “[t]he person for whom stock of a corporation is held by a nominee, guardian, custodian, or an agent is considered to be the shareholder of the corporation for purposes of [the S corporation statute].” Treas. Reg. § 1.1361-1(e)(1). Taproot further supported this conclusion by citing Revenue Ruling 66-266, 1966-2 C.B. 356, and I.R.S. Priv. Ltr. Rul. 86-05-028 (Nov. 4, 1985) for the propositions that S corporation stock held in a custodial account for a disabled person or by a custodian under the Uniform Gifts to Minors Act, respectively, should be treated as held by the disabled person or child individually.
In the alternative, Taproot argued that a Roth IRA should be classified as a grantor trust, which qualifies as an eligible S corporation shareholder. Specifically, § 1361(c)(2)(A)(i) extends shareholder eligibility to any grantor trust 7 “all of which is treated ... as owned by an individual who is a citizen or resident of the United States.”
The Tax Court rejected Taproot's arguments, holding that a Roth IRA could not be an S corporation shareholder under the eligibility rules in place during 2003. As a result, Taproot was ineligible for S corporation status in 2003 and was therefore a C corporation for federal income tax purposes. In articulating its reasoning, the Tax Court first acknowledged that “no statute or regulation in effect during 2003 explicitly prohibited a traditional or Roth IRA from owning S corporation stock.”Taproot Admin. Serv. v. Comm'r , 133 T.C. 202, 208 (2009). The Tax Court then identified Revenue Ruling 92-73, as providing the only guiding legal authority on the issue.Id. Examining this ruling, in which the Commissioner held that a trust that qualifies as an IRA is not a permitted shareholder of an S corporation, the Tax Court concluded that the underlying rationale was sound and comported with the apparent intent of Congress, thus providing a compelling reason for its decision. The Tax Court was also mindful that under Taproot's theory of statutory construction, DiMundo would avoid virtually all taxation on his S corporation profits.
In determining the requisite deference owed to a revenue ruling, the Tax Court noted that it was not bound by the official interpretations of the I.R.S., which “are published for the information and guidance of taxpayers, I.R.S. officials, and others concerned.” Id. (quoting Treas. Reg. 601.601(d)(2)(i)(a)). Rather, “applying the standard enunciated by the Supreme Court in Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944), the weight (if any) that [the court must] afford them depends upon their persuasiveness and the consistency of the Commissioner's position over time.” Id. at 208–09.
Extending Skidmore deference to Revenue Ruling 92-73, the Tax Court found the ruling to “sensibly distinguish[ ] IRAs from grantor trusts.”Id. at 210. In making that determination, the Tax Court relied in part on the rationale of Revenue Ruling 92-73, stating that:
[T]raditional IRAs are not eligible S corporation shareholders because the beneficiary of a traditional IRA is not taxed currently on the IRA's share of the S corporation's income whereas the beneficiaries of the permissible S corporation shareholder trusts listed in section 1361(c)(2)(A) are taxed currently on the trust's share of such income.
Id. The Tax Court also noted the functional difference between IRAs and grantor trusts. Governed by distinct code sections, traditional and Roth IRAs exist separately from their owners for federal taxation purposes, while grantor trusts do not. 8
Turning to the second factor set forth inSkidmore , the Tax Court also found that the Commissioner had applied the revenue ruling consistently. In particular, the Tax Court cited the Commissioner's uniform citation to Revenue Ruling 92-73 in private letter rulings addressing automatic terminations of S corporation status upon stock acquisition by IRAs. Id.
Finally, the Tax Court shifted its attention to the legislative intent behind the S corporation statute, finding the only available evidence to suggest that Congress did not intend to allow IRAs to own S corporation stock. Id.Although at the time Congress initially drafted the S corporations statute, both traditional and Roth IRAs had yet to be created, 9 the Tax Court reasoned that “had Congress intended to render IRAs eligible S corporation shareholders, it could have done so explicitly,” as it did with the narrow 2004 amendment allowing banks with IRA shareholders to elect S status in specific circumstances. 10 Id. at 213.
Noting the fact that Congress passed the 2004 amendment after the tax year at issue, the Tax Court posited that Congress would not have “engaged in a useless act.” Id. at 214. This was especially true in light of Congress's 1999 directive to “the Comptroller General of the United States to conduct a study of possible revisions to the rules governing S corporations including “permitting shares of such corporations to be held in individual retirement accounts.””Id. at 213 (quoting Gramm-Leach-Bliley Act, Pub. L. No. 106-102, 113 Stat. 1470 (1999)). Subsequently, the Tax Court voiced its reluctance to find that Congress had sent the Comptroller General on a “fool's errand,” inviting it to reach a conclusion that would have rendered “an entire clause of section 1361 mere surplusage.” Id. at 214. For these reasons, the Tax Court concluded that traditional and Roth IRAs were not eligible shareholders under § 1361(b).
III.
We review the Tax Court's grant of summary judgment de novo.Miller v. Comm'r , 310 F.3d 640, 642 [90 AFTR 2d 2002-7159] (9th Cir. 2002). The record is reviewed in the light most favorable to the appellant “to determine whether there is a genuine issue of fact and whether the tax court applied the substantive law correctly.” Sierra Club Inc. v. Comm'r, 86 F.3d 1526, 1530 [78 AFTR 2d 96-5005] (9th Cir. 1996) (internal quotation marks and citation omitted). This appeal does not involve any disputed issues of fact. Rather, the central question for review turns solely on whether a custodial Roth IRA qualifies as an eligible shareholder for the purpose of assessing S corporation taxation.
At the outset, we adopt the Tax Court's reasoning; however, as observed in Judge Halpern's concurring opinion, 11 the analysis requires further elaboration. In particular, the Tax Court cabined its focus to the applicability of the statutory provision recognizing grantor trusts as eligible shareholders to Roth IRAs. This narrow perspective fails, however, to squarely address Taproot's alternative argument for eligibility as the legal owner of the individual shares of stock comprising the IRA. 12 On appeal, Taproot therefore appears to concentrate the bulk of its argument on the contention that IRAs and Roth IRAs as investment instruments are indistinguishable from their individual owners—in this case, Di Mundo. Taproot maintains that the Di Mundo Roth IRA, which held all of Taproot's outstanding shares during the 2003 tax year, functioned merely as the form of Di Mundo's individual investment account. Thus, under Taproot's logic, the shares were owned by an eligible shareholder within the meaning of the S corporation statute. At minimum, Taproot claims that the plain language of Treasury Regulation § 1.1361-1(e)(1) explicitly authorizes those IRAs and Roth IRAs created as custodial accounts to be shareholders of S corporations. In the following part, we review the broader issue of IRA and Roth IRA eligibility under the statute, and then address Treasury Regulation § 1.1361-1(e)(1).
A.
Grounding its argument in statutory construction and legislative history, Taproot first claims that both forms of IRAs and Roth IRAs—trusts and custodial accounts—lack the essential characteristics of a separate taxpayer and should therefore be treated as indistinguishable from the individual owners. Consequently, Taproot maintains that IRAs and Roth IRAs should be deemed domestic individuals under the S corporation eligibility rules. This argument, however, flounders in a number of ways.
In support of its position, Taproot contends that because IRAs and Roth IRAs do not file separate tax returns they should not be considered separate taxpayers. Taproot cites to statutory provisions merging IRAs with their individual owners for excise tax purposes as further evidence that the I.R.S. intended for IRAs and Roth IRAs to share the identity of their individual owners for S corporation purposes. See, e.g., I.R.C. § 408(o)(4). Additionally, Taproot notes the ability of the I.R.S. to levy against IRA funds to satisfy the tax liabilities of the underlying owner. 13 See, e.g., Ameritrust Co. v. Derakshan, 830 F. Supp. 406, 410 [72 AFTR 2d 93-6486] (N.D. Ohio 1993).
We begin our analysis of this strand of Taproot's argument by identifying the level of deference to which an agency's statutory interpretation is entitled. As both parties concede, I.R.S. revenue rulings are entitled to the degree of deference articulated by the Supreme Court in Skidmore, 323 U.S. at 140, and United States v. Mead Corp., 533 U.S. 218, 228 (2001). 14 Under Skidmore, the weight given to an agency's interpretation depends on (1) the thoroughness and validity of the agency's reasoning; (2) the formality of the agency's interpretation; (3) the formality of the agency's action; and (4) all of those factors giving it the power to persuade, if lacking power to control.Mead , 533 U.S. at 228.
In finding persuasive the I.R.S.'s interpretation of “individual” as excluding IRA and Roth IRA accounts, we employ the familiar principle that “the words of statutes—including revenue acts—should be interpreted where possible in their ordinary, everyday senses.”Hanover Bank v. Comm'r , 369 U.S. 672, 687 [9 AFTR 2d 1492] (1962) (quoting Crane v. Comm'r, 331 U.S. 1, 6 [35 AFTR 776] (1947));see also De Ganay v. Lederer , 250 U.S. 376, 381 [3 AFTR 3007] (1919) (“[S]tatutory words are presumed to be used in their ordinary and usual sense and with the meaning commonly attributable to them.”). Here, the Internal Revenue Code does not define the word “individual”; therefore, we interpret it in accordance with its ordinary, everyday usage. Black's Law Dictionary defines the term “individual” as “1. Existing as an indivisible entity. 2. Of or relating to a single person or thing, as opposed to a group.” Black's Law Dictionary (9th ed. 2009). More instructively, Webster's Dictionary defines the term “individual” as “a single human being as contrasted with a social group or institution.” Webster's Ninth New Collegiate Dictionary 615 (1987); see also Johnson v. Comm'r, 353 F.3d 1181, 1184 [93 AFTR 2d 2004-323] (10th Cir. 2003) (“When the word “individual” is used elsewhere in the Internal Revenue Code, the context almost always compels it to be construed to mean a human being.”) (citing I.R.C. § 1(a), (c)).
Taproot claims that both forms of IRAs—trusts and custodial accounts—lack the essential attributes of a separate tax-paying entity and consequently should be treated as legally indistinguishable from their individual owners. Yet, it provides neither persuasive reasoning nor convincing authority for this conclusion. To the contrary, the reasoning behind Revenue Ruling 92-73 unequivocally supports the opposite result. As relied on by the Tax Court, this revenue ruling specifies that a trust is a permitted shareholder only in cases where the trust is described in § 1361(c)(2)(A)(i), or is a qualified subchapter S trust (QSST) that is treated as a trust under § 1361(c)(2)(A)(i) pursuant to the election of the beneficiary. Consequently, this excludes IRAs and Roth IRAs from eligibility. The I.R.S. notes in its analysis that the beneficiary of either a grantor trust or a QSST is taxed currently on the trust's share of S corporation income, deductions, and credits. In contrast, the beneficiary of an IRA trust does not pay taxes on income until distributions are made from the trust. Thus, the IRA taxation rules are incompatible with the rules applying to § 1361(c)(2)(A)(i) or a QSST. Implicit in Revenue Ruling 92-73 is the I.R.S.'s classification of IRAs and Roth IRAs as trusts rather than individuals.
Applying Skidmore deference, we agree with the conclusion of the Tax Court that Revenue Ruling 92-73 provides persuasive guidance that IRAs are ineligible for S corporation shareholders. The distinguishing feature is the deferred income tax treatment, which differentiates IRAs from beneficiaries listed in § 1361(c)(2)(A) who are taxed currently on the trust's share of income. This revenue ruling turns on sound reasoning. As noted by the Commissioner, the I.R.S. has also applied Revenue Ruling 92-73 consistently since its adoption, including in a host of private letter rulings that rely upon the revenue ruling to address inadvertent termination waiver requests under I.R.C. § 1362(f). P8P8 15See, e.g., I.R.S. Priv. Ltr. Rul. 2009-15-020 (Dec. 19, 2008); I.R.S. Priv. Ltr. Rul. 2005-01-013 (Sept. 29, 2004).
Furthermore, despite Taproot's argument to the contrary, the legislative history of the S corporation statute favors limited eligibility. Taproot suggests that the Congressional history reflects a narrow intent to merely preserve the integrity of the statute's limitation on the number of S corporation shareholders. In Taproot's opinion, Congress's overriding concern has always been restricted to limiting the number of S corporation shareholders, rather than thetype . 16 To support this position, Taproot cites the extension of the statute to grantor trusts and voting trusts, as well as the 1997 amendments adding employee stock ownership plans (ESOPs) and charitable organizations to the list of permitted shareholders. In Taproot's view, the expansion in eligibility evidences Congress's intent to include IRAs as eligible shareholders.
According to the legislative history of the ESOP eligibility amendment, however, Congress did not envision IRAs as permissible shareholders at the time of enactment. In detailing the reasons for the amendment, the Joint Committee for Taxation stated that “the provisions of subchapter S were enacted in 1958 and substantially modified in 1982 on the premise that all income of the S corporation (including all gains on the sale of the stock) would be subject to a shareholder-level income tax.” S. Rep. No. 104-281, at 61 (1996). Thus, in enacting the statute, Congress did not contemplate or intend eligibility for IRAs and other entities entitled to deferred taxation.
Moreover, as noted by the Tax Court, there is no other indication that “Congress ever intended to allow IRAs to own S corporation stock.” 133 T.C. at 213. In fact, the “only available evidence suggests otherwise.” Id. IRAs or Roth IRAs were not explicitly listed in § 1361 as eligible S corporation shareholders in 2003 or in any year prior. If at any point Congress had intended IRA eligibility, it could have amended the statute. In fact, in 2004 Congress explicitly extended shareholder eligibility to IRAs in the limited case of bank corporations. See supra n. 3.
Although this 2004 IRA eligibility amendment occurred after the tax year at issue, and is therefore not controlling,see United States v. Phila. Nat'l Bank , 374 U.S. 321, 348–49 (1963), the Commissioner argues that it should not be disregarded. Indeed, if IRAs and Roth IRAs qualified as eligible shareholders in 2003, then the subsequent amendment would have been completely unnecessary. As the Tax Court's majority opinion points out, this Court, as well as the Supreme Court, see, e.g., Seatrain Shipbuilding Corp. v. Shell Oil Co., 444 U.S. 572, 596 (1980), have held that a succeeding view of Congress is certainly entitled to consideration in ascertaining legislative intent. See, e.g., United States v. Hecla Mining Co., 302 F.2d 204, 211 [8 AFTR 2d 5784] (9th Cir. 1961). Here, the 2004 amendment, coupled with the prior legislative history, unequivocally supports the I.R.S.'s interpretation of the S corporation statute and promulgation of Revenue Ruling 92-73.
B.
Turning next to Treasury Regulation § 1.1361-1(e), Taproot argues that this provision, which offers guidance on assessing the number of shareholders for purposes of the S corporation statute, directly authorizes ownership of S corporation stock by IRAs and Roth IRAs created as custodial accounts. Furthermore, Taproot contends that the unambiguous meaning of the regulation should be authoritative in this matter over any informal agency guidance or policy interpretations. In pertinent part, the regulation specifies that:
A corporation does not qualify as a small business corporation if it has more than 75 shareholders (35 for taxable years beginning prior to January 1, 1997). Ordinarily, the person who would have to include in gross income dividends distributed with respect to the stock of the corporation (if the corporation were a C corporation) is considered to be the shareholder of the corporation. For example, if stock (owned other than by a husband and wife) is owned by tenants in common or joint tenants, each tenant in common or joint tenant is generally considered to be a shareholder of the corporation .... The person for whom stock of a corporation is held by a nominee, guardian, custodian, or an agent is considered to be the shareholder of the corporation for purposes of this paragraph (e) and paragraphs (f) and (g) of this section. 17 For example, a partnership may be a nominee of S corporation stock for a person who qualifies as a shareholder of an S corporation. However, if the partnership is the beneficial owner of the stock, then the partnership is the shareholder, and the corporation does not qualify as a small business corporation. In addition, in the case of stock held for a minor under a uniform gifts to minors act or similar statute, the minor and not the custodian is the shareholder.
Treas. Reg. § 1.1361-1(e). As stated, the regulatory provision also governs whether a stockholder qualifies as an individual for purposes of the S corporation statute.
In Taproot's opinion, the present case turns largely on the construction of this regulation because the Di Mundo Roth IRA was created as a custodial account. According to Taproot, under the plain language of the regulation, the Di Mundo Roth IRA serves as a custodial account for the benefit of Di Mundo, who is then treated as the shareholder for purposes of S corporation eligibility. As noted by Taproot, prior to the promulgation of this regulation, the I.R.S. issued a revenue ruling and a private letter ruling concluding that S corporation stock held in a custodial account for a disabled person or by a custodian under the Uniform Gifts to Minors Act should be treated as held by the disabled person or child, individually. See, e.g., Rev. Rul. 66-2666, 1966-2 C.B. 356 (stating that the disabled beneficiary of a custodial arrangement is treated as the shareholder); I.R.S. Priv. Ltr. Rul. 86-05-028 (Nov. 4, 1985) (holding that the individual beneficiary is considered the shareholder under the Uniform Gifts to Minors Act).
The Commissioner argues in response that the language of the regulation requires consideration of who ultimately bears the tax responsibility from its application. Specifically, the Commissioner finds instructive the regulatory provision stating that the shareholder of a corporation is “[o]rdinarily, the person who would have to include in gross income dividends distributed with respect to the stock of the corporation.” Treas. Reg. § 1.1361-1(e). Accordingly, the current taxation of income derived from the corporation to the beneficiary provides the rationale for treating the beneficiary of a custodial account that holds S corporation stock as the shareholder.
Applying this logic, custodial IRAs and Roth IRAs are different in kind and therefore distinguishable from other custodial accounts, such as those involving minors or disabled individuals. The latter form of custodial account functions to hold shares for a person who cannot otherwise legally hold them. In such cases, income is taxed currently to that person, in contrast to IRAs and Roth IRAs, where individuals who could legally hold the underlying assets instead choose to place them in such accounts, thereby deferring or exempting taxation of any current income. This subverts the rationale for the attribution rule in the regulation, and in the Commissioner's opinion, forecloses any extension of the regulation to IRAs and Roth IRAs.
Furthermore, the I.R.S. has consistently adopted this interpretation in various private letter rulings by applying Revenue Ruling 92-73 to custodial IRAs in the same manner as trust IRAs. See, e.g., I.R.S. Priv. Ltr. Rul. 2002-42-024 (Oct. 18, 2002) (finding S corporation status terminated at the time shareholder transferred shares of the company's stock to a bank as custodian of another individual's IRA); I.R.S. Priv. Ltr. Rul. 96-44-030 (Nov. 1, 1996); I.R.S. Priv. Ltr. Rul. 95-28-008 (Apr. 12, 1995); I.R.S. Priv. Ltr. Rul. 95-02-014 (Jan. 13, 1995). 18 Although private letter rulings may not be used or cited as precedent under I.R.C. § 6110(k)(3), they may be used as evidence of an administrative practice of the Commissioner. See, e.g., American Ass'n of Christian Schools Voluntary Employees Beneficiary Ass'n Welfare Plan Trust v. United States, 850 F.2d 1510, 1515 [62 AFTR 2d 88-5366] n.6 (11th Cir. 1988) (citing Rowan Companies, Inc. v. United States, 452 U.S. 247, 261 [48 AFTR 2d 81-5115] n.17 (1981)). In the instant case, therefore, this pattern of private letter rulings provides evidence of the agency's uniform classification of custodial IRAs as identical to those created as trusts for the purpose of applying Revenue Ruling 92-73. Basic logic dictates that through the coalescence of custodial IRAs with trust IRAs under Revenue Ruling 92-73, the I.R.S. necessarily excludes custodial IRAs from the purview of Treasury Regulation §1.1361-1(e).
In the final analysis, Taproot's argument founders on the shoals of logic and well-settled rules of regulatory interpretation. To adopt the position Taproot urges, this Court must conclude that Congress consciously crafted a legislative scheme enabling shareholders to employ Roth IRAs to perpetually avoid any taxation on S corporation profits. 19 The legislative history and regulatory record foreclose this conclusion.
As Judge Halpern sagely noted in his concurring opinion below, “the critical attributes of an IRA — i.e., deferral of or exemption from taxation — are antithetical to the rationale for permitting custodial accounts to be shareholders of S corporations.” 133 T.C. at 216 (emphasis in original). This Court embraces the I.R.S.'s narrow interpretation of Treasury Regulation § 1.1361-1(e)(1), restricting its application to custodial accounts in which corporate dividends are taxed in the same year received.
Moreover, for the reasons discussed above, we find persuasive the agency's opinion that ownership of custodial IRAs and Roth IRAs should not be attributed to the underlying individual for purposes of S corporation eligibility. To hold otherwise would undermine the entire taxation structure underlying individual retirement accounts.
Accordingly, the decision of the United States Tax Court is
AFFIRMED.
*
The Honorable Henry E. Hudson, United States District Judge for the Eastern District of Virginia, sitting by designation.
1
Furthermore, any subsequent violation of one or more of the eligibility rules automatically terminates a corporation's S status. I.R.C. § 1362(a), (d)(2). For example, if an eligible S corporation shareholder sells or otherwise transfers his shares to an ineligible shareholder, the corporation's status as an S corporation terminates immediately as a matter of law on the date of the transfer. I.R.C. § 1362(d)(2); Treas. Reg. § 1.1362-2(b)(2).
2
Section 1361(b)(1)(A) limits the total number of shareholders to 100 (during the 2003 tax year, however, § 1361(b)(1)(A) limited the total number of shareholders to seventy-five). See American Jobs Creation Act of 2004, Pub. L. 108-357 § 232(a), 118 Stat. 1434 (2004). Additionally, the statute permits eligible S corporations to issue only one class of stock.
3
The categories of eligible Subchapter S shareholders, as originally envisioned, have morphed considerably in passing years. At the time Congress first added Subchapter S in 1958, the list of permissible shareholders was limited to domestic individuals and estates. Over the years, Congress has gradually expanded the limits of eligibility to include some trusts and tax-exempt entities. In the Tax Reform Act of 1976, Congress extended Subchapter S to certain trusts, Pub. L. No. 94-455, § 902(f), 90 Stat. 1609, including what is commonly referred to as a grantor trust, “which is treated as owned by an individual who is a citizen or resident of the United States.” I.R.C. § 1361(c)(2)(A)(i). The amendment also granted eligibility to voting trusts and electing small business trusts, among others. In 1996, Congress amended the statute through the Small Business Job Protection Act to permit certain tax-exempt organizations to own S corporation stock. Pub. L. No. 104-188, § 1316(a), 110 Stat. 1785. Most notably, a 2004 amendment extended the types of eligible trusts to banks whose stock is held in a trust qualifying as an IRA or a Roth IRA. American Jobs Creation Act of 2004, Pub. L. No. 108-357, § 233(a), 118 Stat. 1434 (2004). That amendment, however, was enacted after the tax year here at issue.
4
Under I.R.C. § 408(a) and § 408A(a), the terms IRA and Roth IRA generally refer to “a trust created or organized in the United States for the exclusive benefit of an individual or his beneficiaries.” I.R.C. §§ 408(a), 408A(a). Both IRAs and Roth IRAs allow earnings on contributions to accrue tax-free. The basic tax characteristics of a traditional IRA are (1) deductible contributions, (2) the accrual of tax-free earnings (except with respect to § 511 unrelated business income), and (3) the inclusion of distributions in gross income. I.R.C. §§ 219(a), ,,408(a), (d)(1), (e). More recently, Congress created Roth IRAs as part of the Taxpayer Relief Act of 1997. Pub. L. No. 105-34, § 302, 111 Stat. 788, 825. Roth IRAs differ from traditional IRAs in that contributions may not be deducted, and future distributions are not taxable. I.R.C. § 408A(a), (c)(1), (d)(1), (2)(A).
5
Sections 408(h) and 408A(a) permit a custodial account to be treated as an IRA or Roth IRA trust. In such cases, “[f]or purposes of [the statutory] section, a custodial account shall be treated as a trust if the assets of such account are held by a bank ... and if the custodial account would, except for the fact that it is not a trust, constitute an [IRA].” I.R.C. § 408(h);see also id. § 408A(a) (“[A] Roth IRA shall be treated for purposes of this title in the same manner as an [IRA].”). Furthermore, the “custodian of such an account shall be treated as the trustee thereof” for the purposes of the statutory title.Id. § 408(h).
6
The I.R.S. also challenged the income and expenses reported by Taproot. The parties settled these issues. Thus, the only issue before this Court on appeal is whether Taproot was eligible for S corporation status during the 2003 tax year.
7
Section 1361(c)(2)(A)(i) specifically references the sections of the I.R.C. governing grantors and others treated as substantial owners of trusts. SeeI.R.C. §§ 671–79.
8
The Tax Court further noted the irrationality of imparting grantor status to a traditional or Roth IRA. Particularly, because grantor trusts are simply conduits through which income and gains pass to the grantor, the grantor must account for any income and deductions pertaining to the trust. 133 T.C. at 212. Income attributable to a traditional or Roth IRA, on the other hand, does not pass to the beneficiary for tax purposes. Moreover, the tax-free accrual of income allowed at the IRA level is “one of the cornerstones of traditional and Roth IRAs.” Id. Treating IRAs as grantor trusts would eliminate that quintessential benefit. Id.
9
It was not until 1974, as part of the Employee Retirement Income Security Act, that Congress enacted the original provisions creating IRAs. Pub. L. No. 93-406, § 408, 88 Stat. 959.
10
Congress added § 1361(c)(2)(A)(vi) to the S corporation statute in 2004, permitting traditional and Roth IRAs to be shareholders of banks or depository institution holding companies. However, this eligibility only extends to stock held by IRAs on or before October 22, 2004.
11
Judge Halpern, of the Tax Court, concluded that the plain meaning of the regulation served only as a “starting point for an analysis of the interaction between the rules governing S corporations and those governing IRAs.” 133 T.C. at 216 (Halpern, J., concurring). His concurrence then noted that IRAs violate the general rule of custodial accounts requiring “flowthrough taxation of the beneficiary.”Id. According to the concurrence, the tax treatment is “the rationale for considering the beneficiary of a custodial account that holds S corporation stock to be a shareholder of the S corporation.” Id.
12
The Tax Court's majority opinion merely references Treasury Regulation § 1.1361-1(e)(1) in a footnote, concluding that Taproot's reliance on the regulation is misplaced. Specifically, the court observed that IRAs differ from the examples provided in the regulation in that the income attributable to the S corporation does not flow through to the beneficiary. Rather, the IRA exists on its own, separate from the beneficiary, and any income consequently belongs to the IRA. 133 T.C. at 211 n.20.
13
Pursuant to I.R.C. § 6331, “[i]f any person liable to pay any tax neglects or refuses to pay the same within 10 days after notice and demand, it shall be lawful for the Secretary to collect such tax ... by levy upon all property and rights to property ... belonging to such person” unless an exemption applies under § 6334. There is no exemption for IRA or Roth IRA accounts under § 6334.
14
The Tax Court applied the less stringent Skidmore factors in its analysis of Revenue Ruling 92-73, and both parties concede it is the appropriate standard. This Court, however, has not definitely resolved the issue of whether revenue rulings are entitled toSkidmore deference or the deference articulated by the Supreme Court in Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 843–844 (1984). See Tualatin Valley Builders Supply, Inc. v. United States, 522 F.3d 937, 941 [101 AFTR 2d 2008-1697], 941–42 (9th Cir. 2008) (stating that the “case law leaves unresolved the question whether a revenue procedure should receiveChevron or Skidmore deference” and declining to resolve the matter). We, too, decline to resolve this question, as we conclude that the I.R.S.'s position is persuasive without affording Chevron deference to Revenue Ruling 92-73.
15
Commissioner admits that private letter rulings may not be used or cited as precedent under I.R.C. § 6110(k)(3); however, they may be used as evidence of an administrative practice of the Commissioner. Thus, the weight we accord Revenue Ruling 92-73 is further supported by the number of subsequent private letter rulings citing the revenue ruling as controlling. Indeed, forty-two private letter rulings have cited Revenue Ruling 92-73 for the proposition that IRAs are ineligible shareholders, thirty-two of which occurred during or before the tax year at issue. See, e.g., I.R.S. Priv. Ltr. Rul. 2003-16-012 (Apr. 18, 2003); I.R.S. Priv. Ltr. Rul. 2003-09-018 (Feb. 28, 2003); I.R.S. Priv. Ltr. Rul. 2002-25-009 (Dec. 13, 2002).
16
At the time the S Corporation statute was enacted in 1958, the maximum number of shareholders was capped at ten. Additionally, only individuals and estates were permitted as shareholders. Technical Amendments Act of 1958, Pub. L. 85-866 § 64(a), 72 Stat. 1650 (1958). In 1977, the total number of shareholders was increased to fifteen following a five-year waiting period. The statute also extended eligibility to grantor trusts. Tax Reform Act of 1976, Pub. L. 94-455 § 902, 90 Stat. 1609 (1976). Two years later, Congress abolished the five-year waiting period and universally capped the number of shareholders at fifteen. Eligibility was expanded to bankruptcy estates, and Congress clarified that husband, wife and heirs would be treated as one shareholder. Revenue Act of 1978, Pub. L. 95-600 § 341(a), 92 Stat. 2843 (1978). In 1982, Congress increased the shareholder maximum to twenty-five and added certain trusts as eligible shareholders. Economic Recovery Tax Act of 1981, Pub. L. 97-34 § 233(a), 95 Stat. 250 (1981). Just one year later Congress again increased the cap to thirty-five. Subchapter S Revision Act of 1982, Pub. L. 97-354 § 2, 96 Stat. 1669 (1982). Congress then increased the maximum number of shareholders to seventy-five in 1997. At that time, Congress also extended eligibility to employee stock ownership plans (ESOPs) and affiliated group members. Small Business Job Protection Act of 1996, Pub. L. 104-188 § 1301, 110 Stat. 1777 (1996). Following the tax year at issue, Congress expanded the total number of shareholders to 100. American Jobs Creation Act of 2004, Pub. L. 108-357 § 232(a), 118 Stat. 1434 (2004).
17
Paragraph (f) provides guidance on the terms “individual” and “estate.” It explicitly indicates that the provision of paragraph (e) which clarifies ownership by a nominee, guardian, custodian or agent also applies to the definition of an individual for purposes of the statute. According to the paragraph, “[e]xcept as otherwise provided in paragraph (e)(1) (relating to nominees), paragraph (h) (relating to certain trusts) of this section, a corporation in which any shareholder is a corporation, partnership, or trust does not qualify as a small business corporation.” Treas. Reg. § 1.1361-1(f)(2003).
18
Without specifically referencing Revenue Ruling 92-73, the I.R.S. has concluded in other private letter rulings that status as an S corporation terminates at the time a custodial IRA acquires stock in that corporation. See I.R.S. Priv. Ltr. Rul. 2000-31-046 (May 9, 2000); I.R.S. Priv. Ltr. Rul. 94-51-055 (Dec. 23, 1994).
19
On appeal Taproot contends that the Tax Court's underlying policy concerns provided the true impetus for its decision. Particularly, the Tax Court observed in a footnote that “tax alchemy” could be effectuated if Roth IRAs qualified as eligible shareholders. This would enable S corporations to achieve an overwhelming benefit over C corporation competitors which are subject to two levels of taxation. In drawing this conclusion, the Tax Court expressed its skepticism that the Unrelated Business Income Tax (UBIT) could adequately mitigate this tax advantage. In general, the UBIT subjects the business earnings of tax-exempt organizations to taxation, thereby functioning to prevent them “from unfairly using their tax-exempt status to compete with commercial businesses.”Alumni Ass'n of the Univ. of Or., Inc. v. Comm'r , T.C. Memo. 1996-63 [1996 RIA TC Memo ¶96,063], aff'd. 193 F.3d 1098 [84 AFTR 2d 99-6515] (9th Cir. 1999). Although Taproot contends that the UBIT negates the Tax Court's policy concerns, the Commissioner correctly observes that I.R.C. § 512 generally excludes passive investment income, such as interest income, from application of the UBIT. Thus, in this case, the interest income at issue would not be subject to the UBIT.
Sunday, March 25, 2012
Thursday, March 15, 2012
Chinese Restaurant
In the Matter of the Petitions of JING FONG RESTAURANT, INC. SHUI LING LAM AND CHUN TSUI, AS OFFICERS for Revision of Determinations or for Refund of Sales and Use Taxes under Articles 28 and 29 of the Tax Law for the Period June 1, 2003 through February 28, 2005.
Case Information:
Docket/Court: 822939; 822940; 822941; 822942; 822943; 822944; 822945, New York Tax Appeals Tribunal
Date Issued: 02/23/2012
Tax Type(s): Sales and Use Tax
OPINION
DECISION
Petitioners, Jing Fong Restaurant, Inc., Shui Ling Lam and Chun Tsui, as officers, filed an exception to the determination of the Administrative Law Judge issued on January 6, 2011. Petitioners appeared by Miu & Co. (Louis Miu, CPA). The Division of Taxation appeared by Mark Volk, Esq. (Lori Antolick, Esq., of counsel).
Petitioners filed a brief in support of their exception. The Division of Taxation filed a brief in opposition. Petitioners filed a reply brief. Oral argument, at petitioners' request, was heard on September 14, 2011 in New York, New York.
After reviewing the entire record in this matter, the Tax Appeals Tribunal renders the following decision.
ISSUES
I. Whether the Division of Taxation correctly determined that additional sales and use taxes were due from petitioners.
II. Whether petitioners have established any facts or circumstances warranting the reduction or abatement of penalties.
FINDINGS OF FACT
We find the facts as determined by the Administrative Law Judge except for findings of fact “2” and “9,” which have been modified. The Administrative Law Judge's findings of fact and the modified findings of fact are set forth below.
Petitioner Jing Fong Restaurant, Inc. (Jing Fong) is a large restaurant that offers on-premises dining and also provides a catering service. The serving area is approximately one-half the size of a football field. 1
We modify finding of fact “2” of the Administrative Law Judge's determination to read as follows:
The Division's auditor, Renel Saint-Amour, conducted the relevant audits of petitioner and testified at the hearing. On June 22, 2006, the Division of Taxation (Division) mailed a letter to Jing Fong that scheduled a field audit on July 11, 2006 for the period June 1, 2003 through May 31, 2006. The letter stated that “[a]ll books and records pertaining to the sales and use tax liability, for the audit period, must be available on the appointment date.” A schedule of books and records to be produced was attached to the letter. The Division did not receive a reply to this letter, and on the date of the proposed appointment, the auditor went to petitioner's place of business and was greeted by a manager. At the restaurant, the auditor received the name and telephone number of petitioner's representative. Later in the afternoon, the auditor received a telephone call from an individual in the representative's office stating that they could not meet at the scheduled time. 2
On September 19, 2006, the auditor received a waiver of the statute of limitations from petitioner's representative. The audit period was then extended through August 31, 2006.
On October 20, 2006, the representative's office asked to postpone the appointment scheduled for October 26, 2006 because the date was not convenient for him. The appointment was rescheduled to December 14, 2006.
On December 19, 2006, the Division was required to reschedule the appointment because of a mandatory meeting. The appointment was rescheduled for January 11, 2007, and the audit period was extended through November 30, 2006. On December 21, 2006, the Division made an additional written request for records. On December 26, 2006, petitioner's representative asked to postpone the audit until after the tax season. On April 13, 2007, a member of the representative's staff requested that the audit be postponed until July 2007.
On May 14, 2007, the Division prepared estimated assessment information for processing. On May 29, 2007, the Division issued a Notice of Determination to Jing Fong (assessment # L-028625181), which assessed sales and use tax for the period June 1, 2003 through August 31, 2004 in the amount of $182,935.07 plus penalty and interest for a balance due of $356,071.13. The notice stated that, since Jing Fong did not submit adequate records for an audit, the Division determined that it owed tax, penalties and interest based upon available records and information. The notice was based on the disallowance of exempt sales and the conclusion that certain purchases were subject to tax. This notice was challenged by the filing of a request for a conciliation conference and later, the filing of a petition with the Division of Tax Appeals. The Division also issued Notices of Determination, dated May 29, 2007, to Shui Ling Lam and Chun Tsui, as responsible officers of Jing Fong, which assessed sales and use taxes for the period March 1, 2004 through August 31, 2004. To the extent that the notices overlap tax periods, the assessments are premised upon the same findings as used in the assessment against Jing Fong in the notice dated May 29, 2007.
On June 18, 2007, the Division and petitioner's representative discussed the status of the audit and scheduled an appointment for July 18, 2007. The representative was also advised that the audit period would be extended through May 31, 2007.
On July 5, 2007, the Division, among other things, issued an additional request for records. On July 18, 2007, an auditor went to petitioner's representative's office and was advised that the representative had not arrived and was instructed to wait. Shortly thereafter, a member of the representative's staff led the auditor to a desk that contained the following: a copy of the federal income tax return for the fiscal year ended November 30, 2005, a power of attorney, copies of sales tax returns for the period September 2003 through May 2007, a spreadsheet of the sales journal for the entire audit period and some bank statements. This was the first time the Division was provided with any records.
We modify finding of fact “9” of the Administrative Law Judge's determination to read as follows:
On July 18, 2007, the Division mailed petitioner's representative a list of additional records needed for the audit for the period September 1, 2006 through November 30, 2006. The list included: cash register tapes and guest checks for the test period, sales invoices or documents for banquets for the test period, sales invoices and related exemption documents for the test period, purchase invoices or documents relating to assets, purchase invoices or documents relating to recurring expenses, federal income tax returns for the fiscal years ended November 30, 2004 and November 30, 2006, and the sales journal worksheet for December 2006. 3
On August 31, 2007, the Division scheduled an appointment for October 10, 2007 in order to continue the audit. On September 13, 2007, at the request of petitioner's representative, the appointment was rescheduled to October 15, 2007. On October 15, 2007, the Division received: an updated power of attorney, copies of cash register tapes and guest checks, copies of sales invoices, the sales journal worksheet for December 2006 through May 2007, and copies of the most recent utility bills.
On October 18, 2007, the Division completed the transcript of the available guest checks and cash register receipts for September 2006. On this date, petitioner's representative promised to provide the auditor with the additional information needed to complete the audit. The auditor attempted to schedule the next meeting but petitioner's representative declined because he wanted to review the list of missing information or information needed with petitioner before scheduling the next meeting.
On November 1, 2007, the Division faxed petitioner's representative another list of records needed for the audit. This list included credit card statements, purchase invoices or documents pertaining to assets, purchase invoices or documents regarding recurring expenses and copies of the federal income tax returns that had previously been requested.
The Division issued a Notice of Determination, dated November 23, 2007, (assessment # L029458681), to Jing Fong, which assessed sales and use tax for the period September 1, 2004 through November 30, 2004 in the amount of $52,307.90 plus penalty and interest for a balance due of $99,676.98. The assessment was based upon the disallowance of exempt sales and the conclusion that there were purchases that were subject to tax. The Division also issued a notice dated December 6, 2007 to petitioner Shui Ling Lam (assessment # L029482822), which assessed sales and use tax for the period September 1, 2004 through November 30, 2004 for the same amount of tax, penalty and interest as that assessed against Jing Fong.
On January 15, 2008, the Division scheduled a meeting to be held on January 31, 2008. On this date, an assistant to petitioner's representative showed the auditor into a conference room with two piles of invoices. Except for three invoices, all of the invoices were for recurring purchases outside of the test period of September 1, 2006 through November 30, 2006. No other records were presented.
On February 8, 2008, the auditor was directed to issue an assessment for the period that would expire. On February 21, 2008, the Division issued a Notice of Determination (assessment number L029729328) to Jing Fong that assessed sales and use tax for the period December 1, 2004 through February 28, 2005 in the amount of $17,891.17 plus penalty and interest for a balance due of $32,303.99. As was the case with the prior notices, the assessment was premised upon the disallowance of exempt sales and the sales and use tax due on Jing Fong's recurring purchases. The Division also issued a Notice of Determination, dated February 25, 2008, to Chun Tsui, as a responsible officer of Jing Fong, which assessed the same quarterly period for the same amount of sales and use tax plus penalty and interest for a balance due of $32,435.35.
On May 6, 2008, the auditor met with petitioner's representative. During the meeting, the representative presented the auditor with certain recurring expense invoices that were found to be the same invoices that were presented on January 31, 2008. He also offered to fax the auditor copies of the federal income tax returns for the fiscal years ended November 30, 2004 and November 30, 2006. In addition, petitioner's representative presented credit card statements, which the auditor transcribed.
On April 7, 2008, the Division sent a letter requesting the production of the following documents for the period June 1, 2003 through May 31, 2007: credit card statements; purchase invoices or documents relating to purchases of furniture and fixtures, equipment, computer, software, leasehold improvement and other assets; purchase invoices or documents relating to garbage removal, office expenses, storage, supplies and linen expenses; and copies of federal returns for the fiscal years ended November 30, 2004 and November 30, 2006. On October 15, 2008, the auditor sent an additional letter requesting certain documents for the entire audit period, including: cash register tapes and guest checks, payroll records, bank statements, banquet records, sales invoices, cash receipts journal, exemption documents, fixed asset purchase invoices, expense invoices, computer generated files, copies of leases for the audit period and financial statements.
On November 19, 2008, the auditor went to petitioner's representative's office to complete the audit. However, none of the records requested in the letter of October 15, 2008 were available. Petitioner's representative promised to have the records available for the audit in two weeks and an appointment was scheduled for December 18, 2008.
Upon returning to the office, the section head directed the auditor to cancel the appointment scheduled for December 18, 2008. On December 15, 2008, the audit team leader and the section head held a conference with the representative wherein they discussed the status of the audit, the records needed for the audit and an appointment for the next field meeting. On March 9, 2009, the auditor, among other things, drafted another letter requesting all records needed for the audit. On March 25, 2009, the auditor attended a meeting with petitioner's representative. After, some initial confusion over whether there was an appointment, petitioner's representative made a presentation for nearly a half-hour. However, none of the records that were previously requested were made available. Petitioner's representative declined to discuss the audit or schedule an appointment to continue the audit but promised to contact the Division after “tax season.”
When the Division completed its review of the available records, it had obtained sales tax returns for the period in issue, the 2005 federal income tax return, the general ledger, an incomplete set of cash register tapes and guest checks for the period September 2006 through November 2006 and bank statements. The Division opined that Jing Fong's records were inadequate for conducting an audit because, even with the assistance of petitioner's representative, it could not reconcile what the taxpayer reported on the sales tax return with the records that were made available. For instance, the Division could not reconcile the documentation on exempt sales with the amounts reported on the sales tax returns. Further, the Division prepared a transcript of the cash register tapes and guest checks. The net total of the guest checks for September 2006 was $4,300.00. This month was chosen as part of the block sample. The auditor observed that there were only nine guest checks for September 1, 2006, no guest checks for September 2, 2006 through September 4, 2006, six guest checks for September 5, 2006 and no guest checks for September 6, 12, 14, 24 and 25. A number of boxes with documents were presented, but all of the boxes presented were incomplete. Although bank statements were provided, they were not used because they could not be tied into the general ledger or the tax returns. In order to perform an audit, the Division felt that it needed a complete set of cash register tapes and guest checks, that is, any kind of record that Jing Fong used to record sales.
The Division utilized several approaches in order to determine the amount of sales and use taxes due. The Division disallowed the exempt sales claimed by petitioner on its sales tax returns for which the Division did not receive documentation. 4 In order to determine the amount of tax due, the auditor divided the average of the total exempt sales claimed by petitioner on its sales tax returns during the audit period by the number of quarters in the audit period. The applicable sales tax rate was then applied to each quarter. The amount of additional sales tax found due on this portion of the audit was $210,121.24.
The auditor also examined the amount of tax due on recurring purchases. In furtherance of this task, the auditor requested a “block sample” of documentation for the period September 1, 2006 through November 30, 2006. In response, the Division received a portion of the general ledger that contained information regarding fixed assets, leasehold improvements and general administrative expenses. Since no documentation was provided to substantiate the entries on the general ledger for the test period, the purchases recorded on the general ledger were held subject to tax. The amount of tax due during the test period was $4,966.66. This amount was applied to the entire audit period resulting in tax due on recurring purchases in the amount of $79,466.56.
Following a review of the general ledger, the auditor found that petitioner owed tax on capital expenditures. Although requested, petitioner did not provide any invoices to substantiate the information found on the general ledger for items such as leasehold improvements. The Division imposed tax on each item for which petitioner could not substantiate the payment of tax. The total amount of tax found due on capital expenditures during the audit period was $74,542.89.
On the basis of the forgoing, the total amount of tax found due from Jing Fong during the period June 1, 2003 through May 31, 2007 was $364,130.69. Nevertheless, the amount of tax assessed by the Division and challenged by Jing Fong, through the filing of petitions, was $448,052.10 computed as follows:
-----------------------------------------------------------------------------
Notice Assessment Period Tax
Date Number Assessed
-----------------------------------------------------------------------------
06/19/07 L-028625181 06/01/03 - 08/31/04 $182,953.07
-----------------------------------------------------------------------------
11/23/07 L-029458681 09/01/04 - 11/30/04 52,307.90
-----------------------------------------------------------------------------
02/21/08 L-029729328 12/01/04 - 02/28/05 17,891.17
-----------------------------------------------------------------------------
TOTAL: $253,152.14
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Notice Interest Penalty Total
Date Assessed Assessed Assessed
-----------------------------------------------------------------------------
06/19/07 $102,690.52 $70,427.54 $356,071.13
-----------------------------------------------------------------------------
11/23/07 26,446.10 20,922.98 99,676.98
-----------------------------------------------------------------------------
02/21/08 9,045.51 5,367.31 32,303.99
-----------------------------------------------------------------------------
TOTAL $138,182.13 $96,717.83 $448,052.10
-----------------------------------------------------------------------------
Similarly, the amount of tax challenged by Ling Lam Shui through the filing of petitions was $230,198.04 computed as follows:
-----------------------------------------------------------------------------
Notice Assessment Period Tax
Date Number Assessed
-----------------------------------------------------------------------------
05/29/07 L-028632040 03/01/04 - 08/31/04 $69,356.93
-----------------------------------------------------------------------------
12/06/07 L-029482822 09/01/04 - 11/30/074 52,307.90
-----------------------------------------------------------------------------
TOTAL: $121,664.83
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Notice Interest Penalty Total
Date Assessed Assessed Assessed
-----------------------------------------------------------------------------
05/29/07 $33,027.95 $27,742.58 $130,127.46
-----------------------------------------------------------------------------
12/06/07 26,839.70 20,922.98 100,070.58
-----------------------------------------------------------------------------
TOTAL: $59,867.65 $48,665.56 $230,198.04
-----------------------------------------------------------------------------
The amount of tax challenged by Chun Tsui through the filing of petitions was $162,472.81 determined as follows:
-----------------------------------------------------------------------------
Notice Assessment Period Tax
Date Number Assessed
-----------------------------------------------------------------------------
05/29/07 L-028632039 03/01/04 - 08/31/04 $69,356.93
-----------------------------------------------------------------------------
02/25/08 L-029748998 12/01/04 - 02/28/05 17,891.17
-----------------------------------------------------------------------------
TOTAL: $87,248.10
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Notice Interest Penalty Total
Date Assessed Assessed Assessed
-----------------------------------------------------------------------------
05/29/07 $33,027.95 $27,742.58 $130,127.46
-----------------------------------------------------------------------------
02/25/08 9,086.87 5,367.31 32,345.35
-----------------------------------------------------------------------------
TOTAL: $42,114.82 $33,109.89 $162,472.81
-----------------------------------------------------------------------------
This matter is the third sales tax audit of Jing Fong. The first audit resulted in an assessment of sales and use tax that was calculated utilizing a ratio of gratuities to sales. Thereafter, the Division utilized a rent factor to calculate the amount of tax due. However, this assessment was cancelled at a conciliation conference. The second audit assessed sales and use tax upon gratuities received by the waiters and waitresses. This assessment was cancelled by the Tax Appeals Tribunal.
THE DETERMINATION OF THE ADMINISTRATIVE LAW JUDGE
The Administrative Law Judge first found that since petitioners had not filed a petition challenging the assessments for the periods after February 28, 2005, the Division of Tax Appeals did not have jurisdiction to rule on such assessments.
Next, the Administrative Law Judge concluded that petitioner Jing Fong was a vendor under the Tax Law and, as such, was required to maintain complete, adequate and accurate books and records regarding its sales tax liability and, upon request, to make the same available for audit by the Division. The Administrative Law Judge found that the Division had requested the relevant books and records from petitioners, but that petitioners failed to provide the Division with all of the relevant documents requested. Thus, the Administrative Law Judge determined that the Division properly estimated petitioners' tax liability. The Administrative Law Judge noted that after the Division estimates a taxpayer's tax liability, the burden then rests upon the taxpayer to demonstrate that the audit methodology or the amount of the assessment was erroneous. The Administrative Law Judge explained that if the testimony or analysis provided by the auditor at the hearing presented an incorrect perspective, it was incumbent upon petitioners to come forward with evidence refuting the matter in dispute. The Administrative Law Judge found that petitioners did not present sufficient evidence challenging the findings of the auditor. Furthermore, the Administrative Law Judge found that petitioners had not met their burden of proof to abate the applicable penalties. Thus, the Administrative Law Judge upheld the relevant Notices of Determination with an adjustment for an exempt sale to a group named Engineers Without Borders USA, Inc.
ARGUMENTS ON EXCEPTION
Petitioners raise the same arguments on exception as they did below. Specifically, petitioners argue that: a) adequate books and records were provided to the auditor and that the use of an estimation of tax liability was not justifiable; b) even though they provided the auditors with various books and records during the audit, throughout the process the auditor kept issuing demand letters for certain records that had already been provided by them; and c) there was no rationale behind the auditor's calculation of additional tax due.
The Division argues that the Administrative Law Judge correctly upheld the relevant Notices of Determination (as modified) and correctly determined that petitioners failed to show that reasonable cause existed for the abatement of penalties. The Division reiterates that, although requested by the auditor, petitioners failed to provide significant supporting records to substantiate petitioners' accounting of certain transactions.
OPINION
As Jing Fong is a “vendor” under Tax Law § 1101(b)(8), petitioners were “required to maintain complete, adequate and accurate books and records regarding its sales tax liability and, upon request, to make the same available for audit by the Division” (Matter of AGDN, Inc., Tax Appeals Tribunal, February 6, 1997 ). The records required to be maintained “include a true copy of each sales slip, invoice, receipt, statement or memorandum” (Tax Law § 1135[a]; 20 NYCRR 533.2 [b][1]).
Tax Law § 1138(a)(1) provides, in relevant part, that if a sales tax return is not filed, “or if a return when filed is incorrect or insufficient, the amount of tax due shall be determined [by the Division of Taxation] from such information as may be available.” (Tax Law § 1138[a][1]). When acting pursuant to section 1138(a)(1), the Division is required to select an audit methodology reasonably calculated to reflect the tax due. The burden then rests upon the taxpayer to demonstrate that the audit methodology or the amount of the assessment was erroneous (Matter of Your Own Choice, Tax Appeals Tribunal, February 20, 2003 ). In the case at hand, petitioners have failed to provide certain necessary documentary evidence to support the accounting positions taken in their books and records and presumably on their tax returns. Petitioners have failed to show that the Division's approach was unreasonable.
As the Administrative Law Judge noted, the Division made repeated requests for petitioners' records. When a particular request was not completely satisfied, the Division made additional requests for the same records. Petitioners' representative asserted that the Division continued to mail one letter after another requesting documents after those documents had already been submitted to the Division. The tax field audit record shows that while many records were eventually provided, there still remained a series of unfulfilled requests for documents by the auditor. We do note that although petitioners failed to provide all of the necessary documentation requested, at various times throughout the audit, petitioners did provide certain documentation that the auditor requested; however, even after receiving such information, the auditor issued additional document requests to petitioners, which included therein demands for documentation already provided by petitioners. Such was inappropriate and not in conformity with the appropriate professional practice standards. Moreover, the Division inappropriately attempted to use the reissuance of the same demand lists as proof that none of the items listed on the earlier lists were provided to the Division. Petitioners' representative stresses his valid criticism that, although the auditor was provided with numerous documents that were responsive to the auditor's demands, the subsequent demand lists were never changed to reflect what had already been delivered. The problem magnified itself when petitioners submitted documents that they thought were responsive to a number of items on the demand list; however, the auditor determined that the submission was only sufficiently responsive to a lesser number of items from the list. That fact would not have been problematic had the auditor indicated to petitioners which items were determined to have been sufficiently responded to. Instead, the auditor continued to issue to petitioners the entire list again with no indication (on the list itself or otherwise) of exactly which documents were outstanding. As such, petitioners were left in the unfortunate position of not knowing what items were sufficiently addressed. The record in this case is not clear enough to determine exactly when and what documents were supplied to the auditor, although such may have been useful in addressing the level of competency of the audit performed. Ultimately, however, the Division's behavior in this regard did not relieve petitioners of their obligation to present all of the relevant documentation.
Petitioners correctly note that on the transcript of cash register tapes for September 2006, the auditor mistakenly entered the total net cash amount for September 2006. However, the error is of no consequence because this speadsheet was not utilized in his final audit calculations.
Petitioners focus on the alleged contradictory conclusions in the audit workpapers regarding taxable sales and exempt sales. Petitioners note that the schedule of returns filed shows different amounts of taxable and exempt sales than on the worksheets prepared by the auditor. Petitioners assert that this difference shows that the worksheets are contradictory and confusing. This argument is misguided. The difference in the amounts stated on the different documents is attributable to the fact that one set of amounts was based on what Jing Fong reported and the second set of amounts was based on a review of the general ledger, taking into consideration that certain entries lacked any supporting documentation.
Petitioners have established that one adjustment to the audit warrants a modification. During the audit of exempt transactions, petitioners presented an invoice for a banquet sale to a group named Engineers Without Borders USA, Inc., to show that the sale should be accounted for as exempt from tax. Petitioners offered into evidence a letter from the Internal Revenue Service stating that the organization was exempt from federal income tax pursuant to Internal Revenue Code (IRC) § 501(c)(3). Since Tax Law § 1116(a)(4) is similar to IRC § 501(c)(3), it is appropriate to look to federal law for guidance (see Matter of Great Neck-Port Washington, Tax Appeals Tribunal, September 5, 1991 ). We agree with the Administrative Law Judge that under the circumstances, it was an error to impose tax on this sale and that the portion of the assessment premised upon sales to unsubstantiated exempt organizations should be revised to reflect that this sale should be accounted for as exempt from sales tax.
The Division asserted a penalty pursuant to Tax Law § 1145(a)(1)(i)states that any person failing to file a return or to pay over any sales or use tax shall be subject to a penalty. This penalty may be cancelled if the failure was “due to reasonable cause and not due to willful neglect” (Tax Law § 1145[a][1][iii]). Consistent with this statute, the Division's regulations provide that penalty imposed under Tax Law § 1145(a)(1)(i) “must be imposed unless it is shown that such failure was due to reasonable cause and not due to willful neglect” ( 20 NYCRR 2392.1 [a][1]). In the case at hand, the records provided by petitioners were insufficient and petitioners have not established that the failure to pay sales tax was due to reasonable cause and not willful neglect.
Finally, we note that a proceeding before the Division of Tax Appeals is commenced by the filing of a petition protesting a written notice of the Division of Taxation (Tax Law § 2008 [1]). Petitioners did not file a petition challenging the assessments for periods after February 28, 2005. Therefore, the Division of Tax Appeals lacks jurisdiction to rule on the merits of such assessments.
Accordingly, it is ORDERED, ADJUDGED and DECREED that:
1. The exception of Jing Fong Restaurant, Inc., Shui Ling Lam and Chun Tsui, as officers, is denied;
2. The determination of the Administrative Law Judge is affirmed;
3. The petitions of Jing Fong Restaurant, Inc., Shui Ling Lam and Chun Tsui, as officers, are granted to the extent indicated in conclusion of law “P” of the Administrative Law Judge's determination, but in all other respects are denied; and
4. The Notices of Determination, dated May 29, 2007, November 23, 2007, December 6, 2007, February 21, 2008 and February 25, 2008, as modified in paragraph “3” above, together with penalty and interest, are sustained.
DATED: Albany, New York, February 23, 2012
/s/ James H. Tully, Jr.
James H. Tully, Jr.
President
/s/ Charles H. Nesbitt
Charles H. Nesbitt
Commissioner
1
The liability asserted against the individual petitioners was based upon their status as responsible officers of Jing Fong and is derived from the audit of the restaurant. Accordingly, a reference to petitioner is a reference to Jing Fong.
2
We modify this fact to more accurately reflect the record.
3
We modify this fact to more accurately reflect the record.
4
Documentation was provided to support some exempt sales. One invoice, for a sale made to Engineers Without Borders USA, Inc., was disregarded because it was purportedly written in a foreign language and the auditor could not discern who was the customer. Although there were invoices that were written in Chinese, this particular invoice was written in both Chinese and English. Petitioner also submitted a letter from the Internal Revenue Service to substantiate this organization's tax exempt status as an IRC § 501(c)(3) organization.
Case Information:
Docket/Court: 822939; 822940; 822941; 822942; 822943; 822944; 822945, New York Tax Appeals Tribunal
Date Issued: 02/23/2012
Tax Type(s): Sales and Use Tax
OPINION
DECISION
Petitioners, Jing Fong Restaurant, Inc., Shui Ling Lam and Chun Tsui, as officers, filed an exception to the determination of the Administrative Law Judge issued on January 6, 2011. Petitioners appeared by Miu & Co. (Louis Miu, CPA). The Division of Taxation appeared by Mark Volk, Esq. (Lori Antolick, Esq., of counsel).
Petitioners filed a brief in support of their exception. The Division of Taxation filed a brief in opposition. Petitioners filed a reply brief. Oral argument, at petitioners' request, was heard on September 14, 2011 in New York, New York.
After reviewing the entire record in this matter, the Tax Appeals Tribunal renders the following decision.
ISSUES
I. Whether the Division of Taxation correctly determined that additional sales and use taxes were due from petitioners.
II. Whether petitioners have established any facts or circumstances warranting the reduction or abatement of penalties.
FINDINGS OF FACT
We find the facts as determined by the Administrative Law Judge except for findings of fact “2” and “9,” which have been modified. The Administrative Law Judge's findings of fact and the modified findings of fact are set forth below.
Petitioner Jing Fong Restaurant, Inc. (Jing Fong) is a large restaurant that offers on-premises dining and also provides a catering service. The serving area is approximately one-half the size of a football field. 1
We modify finding of fact “2” of the Administrative Law Judge's determination to read as follows:
The Division's auditor, Renel Saint-Amour, conducted the relevant audits of petitioner and testified at the hearing. On June 22, 2006, the Division of Taxation (Division) mailed a letter to Jing Fong that scheduled a field audit on July 11, 2006 for the period June 1, 2003 through May 31, 2006. The letter stated that “[a]ll books and records pertaining to the sales and use tax liability, for the audit period, must be available on the appointment date.” A schedule of books and records to be produced was attached to the letter. The Division did not receive a reply to this letter, and on the date of the proposed appointment, the auditor went to petitioner's place of business and was greeted by a manager. At the restaurant, the auditor received the name and telephone number of petitioner's representative. Later in the afternoon, the auditor received a telephone call from an individual in the representative's office stating that they could not meet at the scheduled time. 2
On September 19, 2006, the auditor received a waiver of the statute of limitations from petitioner's representative. The audit period was then extended through August 31, 2006.
On October 20, 2006, the representative's office asked to postpone the appointment scheduled for October 26, 2006 because the date was not convenient for him. The appointment was rescheduled to December 14, 2006.
On December 19, 2006, the Division was required to reschedule the appointment because of a mandatory meeting. The appointment was rescheduled for January 11, 2007, and the audit period was extended through November 30, 2006. On December 21, 2006, the Division made an additional written request for records. On December 26, 2006, petitioner's representative asked to postpone the audit until after the tax season. On April 13, 2007, a member of the representative's staff requested that the audit be postponed until July 2007.
On May 14, 2007, the Division prepared estimated assessment information for processing. On May 29, 2007, the Division issued a Notice of Determination to Jing Fong (assessment # L-028625181), which assessed sales and use tax for the period June 1, 2003 through August 31, 2004 in the amount of $182,935.07 plus penalty and interest for a balance due of $356,071.13. The notice stated that, since Jing Fong did not submit adequate records for an audit, the Division determined that it owed tax, penalties and interest based upon available records and information. The notice was based on the disallowance of exempt sales and the conclusion that certain purchases were subject to tax. This notice was challenged by the filing of a request for a conciliation conference and later, the filing of a petition with the Division of Tax Appeals. The Division also issued Notices of Determination, dated May 29, 2007, to Shui Ling Lam and Chun Tsui, as responsible officers of Jing Fong, which assessed sales and use taxes for the period March 1, 2004 through August 31, 2004. To the extent that the notices overlap tax periods, the assessments are premised upon the same findings as used in the assessment against Jing Fong in the notice dated May 29, 2007.
On June 18, 2007, the Division and petitioner's representative discussed the status of the audit and scheduled an appointment for July 18, 2007. The representative was also advised that the audit period would be extended through May 31, 2007.
On July 5, 2007, the Division, among other things, issued an additional request for records. On July 18, 2007, an auditor went to petitioner's representative's office and was advised that the representative had not arrived and was instructed to wait. Shortly thereafter, a member of the representative's staff led the auditor to a desk that contained the following: a copy of the federal income tax return for the fiscal year ended November 30, 2005, a power of attorney, copies of sales tax returns for the period September 2003 through May 2007, a spreadsheet of the sales journal for the entire audit period and some bank statements. This was the first time the Division was provided with any records.
We modify finding of fact “9” of the Administrative Law Judge's determination to read as follows:
On July 18, 2007, the Division mailed petitioner's representative a list of additional records needed for the audit for the period September 1, 2006 through November 30, 2006. The list included: cash register tapes and guest checks for the test period, sales invoices or documents for banquets for the test period, sales invoices and related exemption documents for the test period, purchase invoices or documents relating to assets, purchase invoices or documents relating to recurring expenses, federal income tax returns for the fiscal years ended November 30, 2004 and November 30, 2006, and the sales journal worksheet for December 2006. 3
On August 31, 2007, the Division scheduled an appointment for October 10, 2007 in order to continue the audit. On September 13, 2007, at the request of petitioner's representative, the appointment was rescheduled to October 15, 2007. On October 15, 2007, the Division received: an updated power of attorney, copies of cash register tapes and guest checks, copies of sales invoices, the sales journal worksheet for December 2006 through May 2007, and copies of the most recent utility bills.
On October 18, 2007, the Division completed the transcript of the available guest checks and cash register receipts for September 2006. On this date, petitioner's representative promised to provide the auditor with the additional information needed to complete the audit. The auditor attempted to schedule the next meeting but petitioner's representative declined because he wanted to review the list of missing information or information needed with petitioner before scheduling the next meeting.
On November 1, 2007, the Division faxed petitioner's representative another list of records needed for the audit. This list included credit card statements, purchase invoices or documents pertaining to assets, purchase invoices or documents regarding recurring expenses and copies of the federal income tax returns that had previously been requested.
The Division issued a Notice of Determination, dated November 23, 2007, (assessment # L029458681), to Jing Fong, which assessed sales and use tax for the period September 1, 2004 through November 30, 2004 in the amount of $52,307.90 plus penalty and interest for a balance due of $99,676.98. The assessment was based upon the disallowance of exempt sales and the conclusion that there were purchases that were subject to tax. The Division also issued a notice dated December 6, 2007 to petitioner Shui Ling Lam (assessment # L029482822), which assessed sales and use tax for the period September 1, 2004 through November 30, 2004 for the same amount of tax, penalty and interest as that assessed against Jing Fong.
On January 15, 2008, the Division scheduled a meeting to be held on January 31, 2008. On this date, an assistant to petitioner's representative showed the auditor into a conference room with two piles of invoices. Except for three invoices, all of the invoices were for recurring purchases outside of the test period of September 1, 2006 through November 30, 2006. No other records were presented.
On February 8, 2008, the auditor was directed to issue an assessment for the period that would expire. On February 21, 2008, the Division issued a Notice of Determination (assessment number L029729328) to Jing Fong that assessed sales and use tax for the period December 1, 2004 through February 28, 2005 in the amount of $17,891.17 plus penalty and interest for a balance due of $32,303.99. As was the case with the prior notices, the assessment was premised upon the disallowance of exempt sales and the sales and use tax due on Jing Fong's recurring purchases. The Division also issued a Notice of Determination, dated February 25, 2008, to Chun Tsui, as a responsible officer of Jing Fong, which assessed the same quarterly period for the same amount of sales and use tax plus penalty and interest for a balance due of $32,435.35.
On May 6, 2008, the auditor met with petitioner's representative. During the meeting, the representative presented the auditor with certain recurring expense invoices that were found to be the same invoices that were presented on January 31, 2008. He also offered to fax the auditor copies of the federal income tax returns for the fiscal years ended November 30, 2004 and November 30, 2006. In addition, petitioner's representative presented credit card statements, which the auditor transcribed.
On April 7, 2008, the Division sent a letter requesting the production of the following documents for the period June 1, 2003 through May 31, 2007: credit card statements; purchase invoices or documents relating to purchases of furniture and fixtures, equipment, computer, software, leasehold improvement and other assets; purchase invoices or documents relating to garbage removal, office expenses, storage, supplies and linen expenses; and copies of federal returns for the fiscal years ended November 30, 2004 and November 30, 2006. On October 15, 2008, the auditor sent an additional letter requesting certain documents for the entire audit period, including: cash register tapes and guest checks, payroll records, bank statements, banquet records, sales invoices, cash receipts journal, exemption documents, fixed asset purchase invoices, expense invoices, computer generated files, copies of leases for the audit period and financial statements.
On November 19, 2008, the auditor went to petitioner's representative's office to complete the audit. However, none of the records requested in the letter of October 15, 2008 were available. Petitioner's representative promised to have the records available for the audit in two weeks and an appointment was scheduled for December 18, 2008.
Upon returning to the office, the section head directed the auditor to cancel the appointment scheduled for December 18, 2008. On December 15, 2008, the audit team leader and the section head held a conference with the representative wherein they discussed the status of the audit, the records needed for the audit and an appointment for the next field meeting. On March 9, 2009, the auditor, among other things, drafted another letter requesting all records needed for the audit. On March 25, 2009, the auditor attended a meeting with petitioner's representative. After, some initial confusion over whether there was an appointment, petitioner's representative made a presentation for nearly a half-hour. However, none of the records that were previously requested were made available. Petitioner's representative declined to discuss the audit or schedule an appointment to continue the audit but promised to contact the Division after “tax season.”
When the Division completed its review of the available records, it had obtained sales tax returns for the period in issue, the 2005 federal income tax return, the general ledger, an incomplete set of cash register tapes and guest checks for the period September 2006 through November 2006 and bank statements. The Division opined that Jing Fong's records were inadequate for conducting an audit because, even with the assistance of petitioner's representative, it could not reconcile what the taxpayer reported on the sales tax return with the records that were made available. For instance, the Division could not reconcile the documentation on exempt sales with the amounts reported on the sales tax returns. Further, the Division prepared a transcript of the cash register tapes and guest checks. The net total of the guest checks for September 2006 was $4,300.00. This month was chosen as part of the block sample. The auditor observed that there were only nine guest checks for September 1, 2006, no guest checks for September 2, 2006 through September 4, 2006, six guest checks for September 5, 2006 and no guest checks for September 6, 12, 14, 24 and 25. A number of boxes with documents were presented, but all of the boxes presented were incomplete. Although bank statements were provided, they were not used because they could not be tied into the general ledger or the tax returns. In order to perform an audit, the Division felt that it needed a complete set of cash register tapes and guest checks, that is, any kind of record that Jing Fong used to record sales.
The Division utilized several approaches in order to determine the amount of sales and use taxes due. The Division disallowed the exempt sales claimed by petitioner on its sales tax returns for which the Division did not receive documentation. 4 In order to determine the amount of tax due, the auditor divided the average of the total exempt sales claimed by petitioner on its sales tax returns during the audit period by the number of quarters in the audit period. The applicable sales tax rate was then applied to each quarter. The amount of additional sales tax found due on this portion of the audit was $210,121.24.
The auditor also examined the amount of tax due on recurring purchases. In furtherance of this task, the auditor requested a “block sample” of documentation for the period September 1, 2006 through November 30, 2006. In response, the Division received a portion of the general ledger that contained information regarding fixed assets, leasehold improvements and general administrative expenses. Since no documentation was provided to substantiate the entries on the general ledger for the test period, the purchases recorded on the general ledger were held subject to tax. The amount of tax due during the test period was $4,966.66. This amount was applied to the entire audit period resulting in tax due on recurring purchases in the amount of $79,466.56.
Following a review of the general ledger, the auditor found that petitioner owed tax on capital expenditures. Although requested, petitioner did not provide any invoices to substantiate the information found on the general ledger for items such as leasehold improvements. The Division imposed tax on each item for which petitioner could not substantiate the payment of tax. The total amount of tax found due on capital expenditures during the audit period was $74,542.89.
On the basis of the forgoing, the total amount of tax found due from Jing Fong during the period June 1, 2003 through May 31, 2007 was $364,130.69. Nevertheless, the amount of tax assessed by the Division and challenged by Jing Fong, through the filing of petitions, was $448,052.10 computed as follows:
-----------------------------------------------------------------------------
Notice Assessment Period Tax
Date Number Assessed
-----------------------------------------------------------------------------
06/19/07 L-028625181 06/01/03 - 08/31/04 $182,953.07
-----------------------------------------------------------------------------
11/23/07 L-029458681 09/01/04 - 11/30/04 52,307.90
-----------------------------------------------------------------------------
02/21/08 L-029729328 12/01/04 - 02/28/05 17,891.17
-----------------------------------------------------------------------------
TOTAL: $253,152.14
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Notice Interest Penalty Total
Date Assessed Assessed Assessed
-----------------------------------------------------------------------------
06/19/07 $102,690.52 $70,427.54 $356,071.13
-----------------------------------------------------------------------------
11/23/07 26,446.10 20,922.98 99,676.98
-----------------------------------------------------------------------------
02/21/08 9,045.51 5,367.31 32,303.99
-----------------------------------------------------------------------------
TOTAL $138,182.13 $96,717.83 $448,052.10
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Similarly, the amount of tax challenged by Ling Lam Shui through the filing of petitions was $230,198.04 computed as follows:
-----------------------------------------------------------------------------
Notice Assessment Period Tax
Date Number Assessed
-----------------------------------------------------------------------------
05/29/07 L-028632040 03/01/04 - 08/31/04 $69,356.93
-----------------------------------------------------------------------------
12/06/07 L-029482822 09/01/04 - 11/30/074 52,307.90
-----------------------------------------------------------------------------
TOTAL: $121,664.83
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Notice Interest Penalty Total
Date Assessed Assessed Assessed
-----------------------------------------------------------------------------
05/29/07 $33,027.95 $27,742.58 $130,127.46
-----------------------------------------------------------------------------
12/06/07 26,839.70 20,922.98 100,070.58
-----------------------------------------------------------------------------
TOTAL: $59,867.65 $48,665.56 $230,198.04
-----------------------------------------------------------------------------
The amount of tax challenged by Chun Tsui through the filing of petitions was $162,472.81 determined as follows:
-----------------------------------------------------------------------------
Notice Assessment Period Tax
Date Number Assessed
-----------------------------------------------------------------------------
05/29/07 L-028632039 03/01/04 - 08/31/04 $69,356.93
-----------------------------------------------------------------------------
02/25/08 L-029748998 12/01/04 - 02/28/05 17,891.17
-----------------------------------------------------------------------------
TOTAL: $87,248.10
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Notice Interest Penalty Total
Date Assessed Assessed Assessed
-----------------------------------------------------------------------------
05/29/07 $33,027.95 $27,742.58 $130,127.46
-----------------------------------------------------------------------------
02/25/08 9,086.87 5,367.31 32,345.35
-----------------------------------------------------------------------------
TOTAL: $42,114.82 $33,109.89 $162,472.81
-----------------------------------------------------------------------------
This matter is the third sales tax audit of Jing Fong. The first audit resulted in an assessment of sales and use tax that was calculated utilizing a ratio of gratuities to sales. Thereafter, the Division utilized a rent factor to calculate the amount of tax due. However, this assessment was cancelled at a conciliation conference. The second audit assessed sales and use tax upon gratuities received by the waiters and waitresses. This assessment was cancelled by the Tax Appeals Tribunal.
THE DETERMINATION OF THE ADMINISTRATIVE LAW JUDGE
The Administrative Law Judge first found that since petitioners had not filed a petition challenging the assessments for the periods after February 28, 2005, the Division of Tax Appeals did not have jurisdiction to rule on such assessments.
Next, the Administrative Law Judge concluded that petitioner Jing Fong was a vendor under the Tax Law and, as such, was required to maintain complete, adequate and accurate books and records regarding its sales tax liability and, upon request, to make the same available for audit by the Division. The Administrative Law Judge found that the Division had requested the relevant books and records from petitioners, but that petitioners failed to provide the Division with all of the relevant documents requested. Thus, the Administrative Law Judge determined that the Division properly estimated petitioners' tax liability. The Administrative Law Judge noted that after the Division estimates a taxpayer's tax liability, the burden then rests upon the taxpayer to demonstrate that the audit methodology or the amount of the assessment was erroneous. The Administrative Law Judge explained that if the testimony or analysis provided by the auditor at the hearing presented an incorrect perspective, it was incumbent upon petitioners to come forward with evidence refuting the matter in dispute. The Administrative Law Judge found that petitioners did not present sufficient evidence challenging the findings of the auditor. Furthermore, the Administrative Law Judge found that petitioners had not met their burden of proof to abate the applicable penalties. Thus, the Administrative Law Judge upheld the relevant Notices of Determination with an adjustment for an exempt sale to a group named Engineers Without Borders USA, Inc.
ARGUMENTS ON EXCEPTION
Petitioners raise the same arguments on exception as they did below. Specifically, petitioners argue that: a) adequate books and records were provided to the auditor and that the use of an estimation of tax liability was not justifiable; b) even though they provided the auditors with various books and records during the audit, throughout the process the auditor kept issuing demand letters for certain records that had already been provided by them; and c) there was no rationale behind the auditor's calculation of additional tax due.
The Division argues that the Administrative Law Judge correctly upheld the relevant Notices of Determination (as modified) and correctly determined that petitioners failed to show that reasonable cause existed for the abatement of penalties. The Division reiterates that, although requested by the auditor, petitioners failed to provide significant supporting records to substantiate petitioners' accounting of certain transactions.
OPINION
As Jing Fong is a “vendor” under Tax Law § 1101(b)(8), petitioners were “required to maintain complete, adequate and accurate books and records regarding its sales tax liability and, upon request, to make the same available for audit by the Division” (Matter of AGDN, Inc., Tax Appeals Tribunal, February 6, 1997 ). The records required to be maintained “include a true copy of each sales slip, invoice, receipt, statement or memorandum” (Tax Law § 1135[a]; 20 NYCRR 533.2 [b][1]).
Tax Law § 1138(a)(1) provides, in relevant part, that if a sales tax return is not filed, “or if a return when filed is incorrect or insufficient, the amount of tax due shall be determined [by the Division of Taxation] from such information as may be available.” (Tax Law § 1138[a][1]). When acting pursuant to section 1138(a)(1), the Division is required to select an audit methodology reasonably calculated to reflect the tax due. The burden then rests upon the taxpayer to demonstrate that the audit methodology or the amount of the assessment was erroneous (Matter of Your Own Choice, Tax Appeals Tribunal, February 20, 2003 ). In the case at hand, petitioners have failed to provide certain necessary documentary evidence to support the accounting positions taken in their books and records and presumably on their tax returns. Petitioners have failed to show that the Division's approach was unreasonable.
As the Administrative Law Judge noted, the Division made repeated requests for petitioners' records. When a particular request was not completely satisfied, the Division made additional requests for the same records. Petitioners' representative asserted that the Division continued to mail one letter after another requesting documents after those documents had already been submitted to the Division. The tax field audit record shows that while many records were eventually provided, there still remained a series of unfulfilled requests for documents by the auditor. We do note that although petitioners failed to provide all of the necessary documentation requested, at various times throughout the audit, petitioners did provide certain documentation that the auditor requested; however, even after receiving such information, the auditor issued additional document requests to petitioners, which included therein demands for documentation already provided by petitioners. Such was inappropriate and not in conformity with the appropriate professional practice standards. Moreover, the Division inappropriately attempted to use the reissuance of the same demand lists as proof that none of the items listed on the earlier lists were provided to the Division. Petitioners' representative stresses his valid criticism that, although the auditor was provided with numerous documents that were responsive to the auditor's demands, the subsequent demand lists were never changed to reflect what had already been delivered. The problem magnified itself when petitioners submitted documents that they thought were responsive to a number of items on the demand list; however, the auditor determined that the submission was only sufficiently responsive to a lesser number of items from the list. That fact would not have been problematic had the auditor indicated to petitioners which items were determined to have been sufficiently responded to. Instead, the auditor continued to issue to petitioners the entire list again with no indication (on the list itself or otherwise) of exactly which documents were outstanding. As such, petitioners were left in the unfortunate position of not knowing what items were sufficiently addressed. The record in this case is not clear enough to determine exactly when and what documents were supplied to the auditor, although such may have been useful in addressing the level of competency of the audit performed. Ultimately, however, the Division's behavior in this regard did not relieve petitioners of their obligation to present all of the relevant documentation.
Petitioners correctly note that on the transcript of cash register tapes for September 2006, the auditor mistakenly entered the total net cash amount for September 2006. However, the error is of no consequence because this speadsheet was not utilized in his final audit calculations.
Petitioners focus on the alleged contradictory conclusions in the audit workpapers regarding taxable sales and exempt sales. Petitioners note that the schedule of returns filed shows different amounts of taxable and exempt sales than on the worksheets prepared by the auditor. Petitioners assert that this difference shows that the worksheets are contradictory and confusing. This argument is misguided. The difference in the amounts stated on the different documents is attributable to the fact that one set of amounts was based on what Jing Fong reported and the second set of amounts was based on a review of the general ledger, taking into consideration that certain entries lacked any supporting documentation.
Petitioners have established that one adjustment to the audit warrants a modification. During the audit of exempt transactions, petitioners presented an invoice for a banquet sale to a group named Engineers Without Borders USA, Inc., to show that the sale should be accounted for as exempt from tax. Petitioners offered into evidence a letter from the Internal Revenue Service stating that the organization was exempt from federal income tax pursuant to Internal Revenue Code (IRC) § 501(c)(3). Since Tax Law § 1116(a)(4) is similar to IRC § 501(c)(3), it is appropriate to look to federal law for guidance (see Matter of Great Neck-Port Washington, Tax Appeals Tribunal, September 5, 1991 ). We agree with the Administrative Law Judge that under the circumstances, it was an error to impose tax on this sale and that the portion of the assessment premised upon sales to unsubstantiated exempt organizations should be revised to reflect that this sale should be accounted for as exempt from sales tax.
The Division asserted a penalty pursuant to Tax Law § 1145(a)(1)(i)states that any person failing to file a return or to pay over any sales or use tax shall be subject to a penalty. This penalty may be cancelled if the failure was “due to reasonable cause and not due to willful neglect” (Tax Law § 1145[a][1][iii]). Consistent with this statute, the Division's regulations provide that penalty imposed under Tax Law § 1145(a)(1)(i) “must be imposed unless it is shown that such failure was due to reasonable cause and not due to willful neglect” ( 20 NYCRR 2392.1 [a][1]). In the case at hand, the records provided by petitioners were insufficient and petitioners have not established that the failure to pay sales tax was due to reasonable cause and not willful neglect.
Finally, we note that a proceeding before the Division of Tax Appeals is commenced by the filing of a petition protesting a written notice of the Division of Taxation (Tax Law § 2008 [1]). Petitioners did not file a petition challenging the assessments for periods after February 28, 2005. Therefore, the Division of Tax Appeals lacks jurisdiction to rule on the merits of such assessments.
Accordingly, it is ORDERED, ADJUDGED and DECREED that:
1. The exception of Jing Fong Restaurant, Inc., Shui Ling Lam and Chun Tsui, as officers, is denied;
2. The determination of the Administrative Law Judge is affirmed;
3. The petitions of Jing Fong Restaurant, Inc., Shui Ling Lam and Chun Tsui, as officers, are granted to the extent indicated in conclusion of law “P” of the Administrative Law Judge's determination, but in all other respects are denied; and
4. The Notices of Determination, dated May 29, 2007, November 23, 2007, December 6, 2007, February 21, 2008 and February 25, 2008, as modified in paragraph “3” above, together with penalty and interest, are sustained.
DATED: Albany, New York, February 23, 2012
/s/ James H. Tully, Jr.
James H. Tully, Jr.
President
/s/ Charles H. Nesbitt
Charles H. Nesbitt
Commissioner
1
The liability asserted against the individual petitioners was based upon their status as responsible officers of Jing Fong and is derived from the audit of the restaurant. Accordingly, a reference to petitioner is a reference to Jing Fong.
2
We modify this fact to more accurately reflect the record.
3
We modify this fact to more accurately reflect the record.
4
Documentation was provided to support some exempt sales. One invoice, for a sale made to Engineers Without Borders USA, Inc., was disregarded because it was purportedly written in a foreign language and the auditor could not discern who was the customer. Although there were invoices that were written in Chinese, this particular invoice was written in both Chinese and English. Petitioner also submitted a letter from the Internal Revenue Service to substantiate this organization's tax exempt status as an IRC § 501(c)(3) organization.
Chinese buffet
In the Matter of the Petition of BEIJING CHINA BUFFET, INC. for Revision of a Determination or Refund of Sales and Use Taxes under Articles 28 and 29 of the Tax Law for the Period September 1, 2004 through February 28, 2007.
In the Matter of the Petition of PING DI CHEN for Revision of a Determination or Refund of Sales and Use Taxes under Articles 28 and 29 of the Tax Law for the Period December 1, 2004 through February 28, 2007.
In the Matter of the Petition of YONG LI for Revision of a Determination or Refund of Sales and Use Taxes under Articles 28 and 29 of the Tax Law forthe Period December 1, 2004 through February 28, 2007.
Case Information:
Docket/Court: 822635; 822636; 822637, New York Tax Appeals Tribunal
Date Issued: 02/23/2012
Tax Type(s): Sales and Use Tax
OPINION
DECISION
Petitioners, Beijing China Buffet, Inc., Ping Di Chen and Yong Li, filed an exception to the determination of the Administrative Law Judge issued on September 23, 2010. Petitioners appeared by the Law Offices of Stephen K. Seung (Stephen K. Seung Esq. and Robert Nizewiz, Esq., of counsel). The Division of Taxation appeared by Mark Volk, Esq. (Michael Hall, of counsel).
Petitioners filed a brief in support of their exception. The Division of Taxation filed a brief in opposition. Petitioners filed a reply brief. Oral argument, at petitioners' request, was heard on September 14, 2011 in New York, New York.
After reviewing the entire record in this matter, the Tax Appeals Tribunal renders the following decision.
ISSUES
I. Whether the Division of Taxation properly determined additional sales and use taxes due from Beijing China Buffet, Inc., Ping Di Chen and Yong Li for the period September 1, 2004 through February 28, 2007 using an estimated audit methodology. 1
II. Whether the estimated audit methodology utilized by the Divison of Taxation was rational and reasonably calculated to reflect the taxes due.
FINDINGS OF FACT
We find the facts as determined by the Administrative Law Judge. These facts are set forth below.
Petitioner, Beijing China Buffet, Inc. (Beijing), 2 operated a Chinese buffet-style restaurant at 2429 Military Road, Niagara Falls, New York, between September 1, 2004 and February 28, 2007 (the audit period) making sales of food and drink.
An audit appointment letter, dated March 5, 2007, was mailed to petitioner's representative, Shiugeen Chin, CPA, to review petitioner's sales and use tax records for the period September 1, 2004 through February 28, 2007. The appointment was scheduled for April 30, 2007 and requested that specific records pertinent to the audit period be made available at that time, including: sales tax returns; federal income tax returns; New York State corporation tax returns; the general ledger; general journal and closing entries; all exemption documentation to support nontaxable sales; chart of accounts; fixed asset purchase and sales invoices for the audit period; expense purchases; merchandise purchases; bank statements and canceled checks and deposit slips for all bank accounts maintained by petitioner; cash receipts journal; cash disbursement journal; the corporate book; depreciation schedules for the audit period; State Liquor Authority license in effect for the audit period; utility bills; guest checks; and cash register tapes for the audit period.
On March 27, 2007, the auditor received a power of attorney from petitioner's new representative, Evelyn Kung, CPA, and traveled to her office to review petitioner's records, which consisted of federal income tax returns, bank statements, canceled checks, wage reporting statements, sales summaries, purchase records for food and beverages and utility bills. At this time, the auditor informed Ms. Kung that petitioner did not have adequate sales and purchase records.
The auditor performed a detailed review of petitioner's fixed asset or capital accounts and determined that tax had not been paid on some assets valued at $19,984.00, which resulted in additional tax due of $1,629.23. Petitioner provided no documentation to demonstrate that sales tax had been paid on these asset purchases.
Since petitioner did not maintain a general ledger, cash register tapes or guest checks, there was no source documentation for sales. Additionally, the purchase records maintained by petitioner along with information the Division of Taxation (Division) received from vendors indicated purchases for the fiscal year ended October 31, 2005 of $92,508.45, while the federal income tax returns filed for the same period stated purchases (cost of goods sold) of $76,995.00. A similar discrepancy was found for the fiscal year ended October 31, 2006, where petitioner's records indicated purchases of $125,275.28, but the federal tax return recorded only $98,799.00. Given the lack of source documentation for sales and the unreliability of the purchase information available, the Division concluded that it would be impossible to perform a detailed audit of petitioner's records to determine petitioner's tax liability for the audit period and resorted to an indirect audit methodology.
In choosing a methodology, the Division rejected a markup test due to the lack of reliable purchase information and the fact that petitioner operated a buffet style restaurant that prevented an accurate determination of the quantities of food sold. Instead, it was decided to do a cash-tocredit card sales analysis, utilizing the results of a one-day observation test and petitioner's own records of credit card sales as disclosed in banking records.
The Division's investigators conducted an observation at petitioner's restaurant, the Beijing China Buffet, on Thursday, November 8, 2007 from 10:30 A.M. to 8:00 P.M. The restaurant was located on a high volume traffic road close to the Niagara Prime Outlet Mall. There was seating for approximately 240 patrons. Customers pay for their meals upon entering regardless of whether they are eating in or taking the food out.
Between 11:00 A.M. and 8:00 P.M., there were 96 transactions, 16 of which were take-outs. The total value of all the transactions was $1,454.91, of which 14 were credit card transactions totaling $238.80, or 16.41% of the total. The amounts reported by the investigators from the observation were inclusive of sales tax. However, when the tax was backed out of the sales total, it amounted to $1,347.14. Credit card sales exclusive of tax amounted to $221.11 and cash sales totaled $1,126.03. Based on these figures, the resulting cash-to-credit card sales ratio was 5.093.
The total amount of cash sales could not be determined from petitioner's records. In fact, petitioner's Key Bank monthly bank statements from December 2004 through February 2007 indicated that there were no cash deposits at all for the months of January, April and August 2006 and nine other months with cash deposits of $100.00 or less.
Of the ten vendor/suppliers that appeared in petitioner's records for the period September 2004 through October 2005, only one was paid by check, with all others compensated in cash.
Because credit card deposits were made directly into petitioner's bank account by the credit card companies, credit card sales could be tracked and substantiated by the Division. The Division took the credit card deposits that were made into petitioner's bank account for the audit period, 3 $453,319.78, and applied the cash-to-credit card ratio determined in the observation test, 5.0923, to said figure (on a quarterly basis) to arrive at a projection of cash sales for the audit period, $2,360,128.7. The appropriate tax rate was applied for each quarter to arrive at total audited tax due on sales of $189,884.98. After giving credit for tax reported of $52,195.68, the additional tax on sales due per the audit was determined to be $137,689.30.
Based upon the audit findings, the Division issued to Beijing China Buffet, Inc., a Statement of Proposed Audit Change, dated November 21, 2007, which set forth additional sales and use tax due of $139,318.52, plus penalty and interest for the period September 1, 2004 through February 28, 2007. The additional tax due was comprised of the additional tax due on capital asset purchases for which petitioner did not offer any substantiation and the additional tax on sales as projected from the observation test and petitioner's books and records.
On or about January 11, 2008, petitioner's representative, Evelyn Kung, CPA, sent the Division a calculation of the cash-to-credit ratio based upon petitioner's records for the months of August through December 2007. 4 According to the calculations, petitioner recorded 4,540 sales during these five months with $113,882.00 in cash sales and $93,734.00 in credit card sales. These figures yielded a cash-to-credit card sales ratio of 1.215.
Petitioner took the credit card deposits for all the months of the audit period, netted the deposits of 15% to allow for tips, and then applied its own cash-to-credit card ratio (1.215) to determine cash sales and then total sales. Petitioner then backed out sales tax to determine sales net of tax, applied the sales tax rates used by the Division in its analysis to arrive at its own sales tax liability. Reported sales were subtracted to determine additional tax due. For the period December 2004 through February 2007, petitioner estimated additional tax due on sales of $ 19,061.05.
Upon review of petitioner's calculations, the auditor concluded that he could not accept petitioner's projections based upon a cash-to-credit card sales ratio of 1.215 since it did not take into account the months during the audit period where there were no cash deposits to the bank account and many others less than $100.00. The auditor believed that failing to recognize such data made the projections “self-serving” and eroded any credibility that could be ascribed to petitioner's conclusions drawn therefrom. The auditor believed that the data used by petitioner in its calculations was not indicative of the circumstances that presented themselves during the audit period.
Petitioner Ping Di Chen was the vice-president of Beijing China Buffet, Inc., during the period in issue. He came to the United States in 1998 from China and began working at the Beijing China Buffet sometime prior to October 2004 as a cook. He does not speak or read the English language and has little formal education.
In October 2004, Mr. Ping Di Chen and Mr. Yong Li took over the restaurant from the prior owner. Mr. Chen continued to work in the kitchen, cooking and ordering food. He was a signatory on the corporate bank account and did sign checks, including at least one for the payment of sales tax with the return for the quarter ended February 28, 2007 and others for expense purchases. He also signed sales tax returns filed during the audit period. He was listed on, and executed, the Application for Registration as a Sales Tax Vendor as an officer (vice-president) of the corporation in November 2004. In addition, Mr. Chen was listed as an officer on both the 2005 and 2006 federal income tax returns.
Mr. Yong Li was also listed as an officer, president, on the Application for Registration as a Sales Tax Vendor, was a signatory on the corporation's bank account, signed most of the sales tax returns filed during the audit period, and was listed as an officer on the federal income tax returns for the fiscal years ended October 31, 2005 and 2006. The auditors also observed checks issued by Mr. Li for the corporation's expense purchases. Mr. Chen stated that Mr. Li had acted as manager for an undisclosed period, but that they delegated that responsibility to persons they hired for most of the audit period. Managers were hired to bridge the language barrier and generally help them with the operation of the business. Mr. Chen also stated that Mr. Li helped their accountant to prepare tax returns.
Mr. Yong Li left the business sometime in January 2007.
THE DETERMINATION OF THE ADMINISTRATIVE LAW JUDGE
The Administrative Law Judge analyzed the statute and case law regarding sales tax audits. After reviewing the record, the Administrative Law Judge found that the Division made proper records requests and that petitioner failed to produce adequate books and records for the audit period. As such, the Administrative Law Judge concluded that the Division was properly entitled to estimate petitioner's sales tax liability.
The Administrative Law Judge observed that Courts have found it reasonable for the Division to extrapolate the results of a one-day observation test over a multi-year audit period. In the instant matter, the Administrative Law Judge found the Division's use of the cash-to-credit card sales ratio to be reasonable because it addressed major discrepancies in petitioner's records. The Administrative Law Judge observed that a taxpayer challenging an audit bears the burden of proving, by clear and convincing evidence, that the audit results were either unreasonably inaccurate or clearly erroneous.
The Administrative Law Judge determined that petitioner failed to carry its burden in this regard. Upon review, the Administrative Law Judge rejected petitioner's arguments based upon Matter of Cjefa Pizza, Inc. (Division of Tax Appeals, January 8, 2009 ) because Administrative Law Judge determinations lack precedential value and petitioner inaccurately interpreted that determination. The Administrative Law Judge also rejected petitioner's attacks on the audit methodology utilized, because speculation about possible alternative audit methods does not meet the standard of clear and convincing evidence. Having addressed the arguments regarding the underlying deficiency, the Administrative Law Judge turned to whether the individual petitioners were responsible persons.
The Administrative Law Judge observed the relevant statutes for determining whether an individual is a responsible person for sales tax. Upon reviewing the record and briefs, the Administrative Law Judge found that Ping Di Chen conceded liability for the assessed taxes and that Yong Li failed to raise a valid defense. However, the Administrative Law Judge directed the Division to adjust the period to December 1, 2004 through January 31, 2007 for Yong Li because the record shows that he left the corporation as of January 2007.
The Administrative Law Judge sustained the assessed penalties because petitioner failed to adduce evidence showing reasonable cause for abatement of such penalties.
ARGUMENTS ON EXCEPTION
Petitioner raises arguments that are substantially similar to those argued before the Administrative Law Judge. While petitioner does not argue against utilizing a one-day observation test, petitioner contends that it is unreasonable for the Division to use the cash-tocredit card sales ratio from a one-day observation test and apply it to petitioner's records.
Petitioner contends that the cash-to-credit card ratio is too inaccurate and resulted in a deficiency that is not reasonably related to the amount due. Petitioner supports its position with testimonial evidence and a report generated by its accountant. Petitioner disagrees with the Division's decision to estimate cash sales by applying a cash-to-credit card sales ratio to petitioner's credit card sales, which were derived from petitioner's records. Petitioner argues that the Division cannot use the cash-to-credit ratio and, instead, must apply total sales from the one-day observation test to the entire audit period. Petitioner Ping Di Chen and Yong Li raised no argument on exception regarding their status as responsible persons.
The Division argues that the Administrative Law Judge properly concluded that petitioner failed to meet its burden of proof and sustained the subject Notices. The Division distinguishes this matter from those cited by petitioner based on the fact that the subject audit was based upon petitioner's own records, as opposed to an external index. Further, the Division argues that the auditor fully articulated the reasoning behind each step of the audit and why the cash-to-credit card sales ratio was utilized. As such, the Division submits that it has established a rational basis for the audit and that it was incumbent upon petitioner to introduce evidence that the results were either clearly erroneous or unreasonably inaccurate. The Division contends that petitioner failed to introduce sufficient evidence to prove either proposition and that, at best, petitioner's argument amounts to an alternative methodology, not proof that the utilized method was unreasonably inaccurate or clearly erroneous.
OPINION
We affirm the determination of the Administrative Law Judge.
This Tribunal has often articulated the standard for reviewing a determination based on an estimated audit methodology. In Matter of AGDN, Inc. (Tax Appeals Tribunal, February 6, 1997) , we stated as follows:
a vendor ... is required to maintain complete, adequate and accurate books and records regarding its sales tax liability and, upon request, to make the same available for audit by the Division (see, Tax Law §§ 1138[a]; 1135; 1142[5]; see, e.g., Matter of Mera Delicatessen, Tax Appeals Tribunal, November 2, 1989 ). Specifically, such records required to be maintained 'shall include a true copy of each sales slip, invoice, receipt, statement or memorandum' ( Tax Law § 1135 ). It is equally well established that where insufficient records are kept and it is not possible to conduct a complete audit, 'the amount of tax due shall be determined by the commissioner of taxation and finance from such information as may be available. If necessary, the tax may be estimated on the basis of external indices...' (Tax Law § 1138[a]; see, Matter of Chartair, Inc. v. State Tax Commn., 65 AD2d 44, 411 NYS2d 41, 43 ).
When estimating sales tax due, the Division need only adopt an audit method reasonably calculated to determine the amount of tax due (Matter of Grant Co. v. Joseph, 2 NY2d 196, 159 NYS2d 150, cert denied 355 US 869 ); exactness is not required (Matter of Meyer v. State Tax Commn., 61 AD2d 223, 402 NYS2d 74, lv denied 44 NY2d 645, 406 NYS2d 1025 ; Matter of Markowitz v. State Tax Commn., 54 AD2d 1023, 388 NYS2d 176, affd 44 NY2d 684, 405 NYS2d 454 ). The burden is then on the taxpayer to demonstrate, by clear and convincing evidence, that the audit method employed or the tax assessed was unreasonable (Matter of Meskouris Bros. v. Chu, 139 AD2d 813, 526 NYS2d 679 ; Matter of Surface Line Operators Fraternal Org. v. Tully, 85 AD2d 858, 446 NYS2d 451 ).
Our review of the records reveals that the Division made a clear and unequivocal written request for petitioner's books and records. Petitioner introduced no source documents, such as sales invoices, complete purchase invoices or cash register tapes, that would permit the Division to conduct a complete audit for the entire period (see Matter of Vebol Edibles v. Tax Appeals Trib., 162 AD2d 765 [1990], lv denied 77 NY2d 803 [1991] ; Matter of Club Marakesh v. State Tax Commn., 151 AD2d 908 [1989], lv denied 74 NY2d 616 [1989] ). Accordingly, we hold that the Division was entitled to resort to external indices to estimate the amount of taxes due (see Matter of Urban Liqs. v. State Tax Commn., 90 AD2d 576 [1982] ).
The primary issue presented in this case is whether petitioner established that the selected audit method resulted in either unreasonably inaccurate or clearly erroneous amount of tax due (Matter of Scarpulla v. State Tax Commn., 120 AD2d 842 [1986] ; Matter of Surface Line Operators Fraternal Org. v. Tully, supra).
We note that “[c]onsiderable latitude is given an auditor's method of estimating sales under such circumstances as exist in [each] case” (Matter of Grecian Sq. v. State Tax Commn., 119 AD2d 948, 950 [1986] ). Whether the audit method used was “reasonably calculated to reflect the taxes due” (Matter of W.T. Grant Co. v. Joseph, supra at 206 ) can only be determined based on information made available to the auditor before the assessment is issued (see e.g. Matter of Queens Discount Appliances, Tax Appeals Tribunal, December 30, 1993 ; Matter of House of Audio of Lynbrook, Tax Appeals Tribunal, January 2, 1992 ).
We find that it was reasonable for the Division to estimate petitioner's liability by utilizing petitioner's records and a cash-to-credit card ratio generated from a one-day observation test. During the audit, petitioner provided the Division with bank statements for the entire period. These documents indicated deposits from major credit card vendors, which allowed the auditor to compute the amount of credit card sales for the entire period. Petitioner's actual cash sales remained an unknown, which is critical since a significant portion of petitioner's business was cash sales. To determine cash sales, the Division monitored petitioner's sales during a one-day field audit and generated a cash-to-credit card sales ratio. The Division then estimated cash sales by applying this ratio to credit card sales, and assessed petitioner based on the total underreported amount.
Upon review, we find that the Administrative Law Judge properly rejected petitioner's challenges to the accuracy of the audit method. As a general proposition, any imprecision in the results of an audit arising by reason of a taxpayer's own failure to keep and maintain records of all of its sales as required by Tax Law § 1135(a)(1) must be borne by that taxpayer (Matter of Markowitz v. State Tax Commn., supra; Matter of Meyer v. State Tax Commn., supra). Petitioner specifically complains that the cash-to-credit card sales ratio resulted in a larger number of total sales than those actually generated by petitioner. However, petitioner failed to adduce any source documentation that would support that conclusion. We also agree with the conclusion that the test period audit, conducted by petitioner's accountant, merited little consideration because the results did not appear to be an accurate reflection of the business during the audit period.
We find petitioner's challenge to be without merit because it provided no source documentation, such as sales invoices, complete purchase invoices or cash register tape records, either on audit or at hearing, that would establish the actual amount of petitioner's sales. Absent any records, petitioner's arguments do not provide any grounds for changing the Division's audit results. As such, we conclude that petitioner failed to carry its burden of showing the audit to be unreasonably inaccurate or clearly erroneous.
Petitioner asserts that Matter of 33 Virginia Place (Tax Appeals Tribunal, December 23, 2009) requires a reversal or modification of the Administrative Law Judge's determination. In Matter of 33 Virginia Place, the Division estimated the taxpayers' liability using an external index because the petitioners failed to maintain adequate books and records. However, in that case, at hearing, the auditor could not articulate a rational basis for the selected audit methodology. The taxpayers submitted expert testimony and evidence showing that the Division misapplied its selected audit methodology. As such, we cancelled the notices therein because the taxpayers met their burden of proof.
This matter is distinguishable from Matter of 33 Virginia Place. Herein, the Division estimated petitioner's tax liability from petitioner's own records and from data gathered from an observation test at petitioner's place of business. At the hearing, the auditor repeatedly provided the rationale for choosing to apply the cash-to-credit card sales ratio to the estimated credit card sales. Moreover, petitioner introduced no persuasive evidence challenging the audit methodology or its rationale. As noted by the Administrative Law Judge, we find petitioner's arguments to be insufficient to meet its burden of proof. Accordingly, we conclude that petitioner failed to provide any grounds for either modifying or canceling the Notice of Determination issued to Beijing China Buffet, Inc.
We also find that the Administrative Law Judge properly sustained the penalties assessed against petitioner. In establishing reasonable cause for the abatement of penalties, the taxpayer faces an onerous task (see Tax Law § 1145[a][1][iii]; Matter of Philip Morris, Tax Appeals Tribunal, April 29, 1993 ). Petitioner bears the burden of showing reasonable cause such that the nonpayment of taxes was beyond the control of petitioner and due to no fault of its own (Matter of F & W Oldsmobile v. State Tax Commn., 106 AD2d 792 [1984] ). Herein, petitioner advanced no argument that would permit the abatement of penalties. Accordingly, the penalties assessed against petitioner are sustained.
Petitioner raised no argument challenging the determination that Ping Di Chen and Yong Li were responsible persons under the Tax Law. However, we agree that the record supports the Administrative Law Judge's conclusion that Yong Li left the corporation as of January 2007 and that this petitioner should be liable only for the period December 1, 2004 through January 31, 2007.
We have reviewed and considered petitioner's remaining arguments, and we find them without either support or merit.
Accordingly, it is ORDERED, ADJUDGED and DECREED that:
1. The exception of Beijing China Buffet, Inc., Ping Di Chen, and Yong Li is denied;
2. The determination of the Administrative Law Judge is affirmed;
3. The petitions of Beijing China Buffet, Inc., and Ping Di Chen are denied; the petition of Yong Li is granted to the extent indicated in conclusion of law “F” of the Administrative Law Judge's determination, but in all other respects is denied;
4. The Notices of Determination, dated March 3, 2008, issued to Beijing China Buffet, Inc. and Ping Di Chen are sustained and the Notice of Determination, March 3, 2008, issued to Yong Li, as modified in paragraph “3” above, is sustained.
DATED: Albany, New York, February 23, 2012
/s/ James H. Tully, Jr.
James H. Tully, Jr.
President
/s/ Charles H. Nesbitt
Charles H. Nesbitt
Commissioner
1
The officers were not assessed for the quarter ended November 30, 2004.
2
Herein, references to the three petitioners together will be singular (i.e. petitioner).
3
The Division explained in its workpapers that the bank records with which it was presented showed a balance of $10,273.20 for the period ended December 2004. This presumably came from the January statement as a carry forward or starting balance. The Division's bank deposit analysis disclosed that, on average, 92.83% of the account balance was the result of credit card deposits. It concluded from the balance of $10,273.20 that 92.83%, or $9,536.61, represented credit card sales for December 2004.
4
In its brief, the Division asserted that the letter from Ms. Kung with the attachments was not admitted into evidence. At hearing, petitioner had the document identified and marked as Petitioner's Exhibit 1. After being marked, the document became the focal point of several pages of questioning. There is no indication in the record that the Division objected, or would have objected, to its introduction given the extensive discussion and the assumed inclusion of the letter and its attachments in the official audit file. By oversight, the Administrative Law Judge did not formally receive these documents in evidence. Under these circumstances, it is reasonable to expressly state here that the letter from Ms. Kung, identified as Exhibit 1 in the record, has been admitted into evidence (see also State Administrative Procedure Act § 306 [1]; 20 NYCRR 3000.15 [d][1]).
In the Matter of the Petition of PING DI CHEN for Revision of a Determination or Refund of Sales and Use Taxes under Articles 28 and 29 of the Tax Law for the Period December 1, 2004 through February 28, 2007.
In the Matter of the Petition of YONG LI for Revision of a Determination or Refund of Sales and Use Taxes under Articles 28 and 29 of the Tax Law forthe Period December 1, 2004 through February 28, 2007.
Case Information:
Docket/Court: 822635; 822636; 822637, New York Tax Appeals Tribunal
Date Issued: 02/23/2012
Tax Type(s): Sales and Use Tax
OPINION
DECISION
Petitioners, Beijing China Buffet, Inc., Ping Di Chen and Yong Li, filed an exception to the determination of the Administrative Law Judge issued on September 23, 2010. Petitioners appeared by the Law Offices of Stephen K. Seung (Stephen K. Seung Esq. and Robert Nizewiz, Esq., of counsel). The Division of Taxation appeared by Mark Volk, Esq. (Michael Hall, of counsel).
Petitioners filed a brief in support of their exception. The Division of Taxation filed a brief in opposition. Petitioners filed a reply brief. Oral argument, at petitioners' request, was heard on September 14, 2011 in New York, New York.
After reviewing the entire record in this matter, the Tax Appeals Tribunal renders the following decision.
ISSUES
I. Whether the Division of Taxation properly determined additional sales and use taxes due from Beijing China Buffet, Inc., Ping Di Chen and Yong Li for the period September 1, 2004 through February 28, 2007 using an estimated audit methodology. 1
II. Whether the estimated audit methodology utilized by the Divison of Taxation was rational and reasonably calculated to reflect the taxes due.
FINDINGS OF FACT
We find the facts as determined by the Administrative Law Judge. These facts are set forth below.
Petitioner, Beijing China Buffet, Inc. (Beijing), 2 operated a Chinese buffet-style restaurant at 2429 Military Road, Niagara Falls, New York, between September 1, 2004 and February 28, 2007 (the audit period) making sales of food and drink.
An audit appointment letter, dated March 5, 2007, was mailed to petitioner's representative, Shiugeen Chin, CPA, to review petitioner's sales and use tax records for the period September 1, 2004 through February 28, 2007. The appointment was scheduled for April 30, 2007 and requested that specific records pertinent to the audit period be made available at that time, including: sales tax returns; federal income tax returns; New York State corporation tax returns; the general ledger; general journal and closing entries; all exemption documentation to support nontaxable sales; chart of accounts; fixed asset purchase and sales invoices for the audit period; expense purchases; merchandise purchases; bank statements and canceled checks and deposit slips for all bank accounts maintained by petitioner; cash receipts journal; cash disbursement journal; the corporate book; depreciation schedules for the audit period; State Liquor Authority license in effect for the audit period; utility bills; guest checks; and cash register tapes for the audit period.
On March 27, 2007, the auditor received a power of attorney from petitioner's new representative, Evelyn Kung, CPA, and traveled to her office to review petitioner's records, which consisted of federal income tax returns, bank statements, canceled checks, wage reporting statements, sales summaries, purchase records for food and beverages and utility bills. At this time, the auditor informed Ms. Kung that petitioner did not have adequate sales and purchase records.
The auditor performed a detailed review of petitioner's fixed asset or capital accounts and determined that tax had not been paid on some assets valued at $19,984.00, which resulted in additional tax due of $1,629.23. Petitioner provided no documentation to demonstrate that sales tax had been paid on these asset purchases.
Since petitioner did not maintain a general ledger, cash register tapes or guest checks, there was no source documentation for sales. Additionally, the purchase records maintained by petitioner along with information the Division of Taxation (Division) received from vendors indicated purchases for the fiscal year ended October 31, 2005 of $92,508.45, while the federal income tax returns filed for the same period stated purchases (cost of goods sold) of $76,995.00. A similar discrepancy was found for the fiscal year ended October 31, 2006, where petitioner's records indicated purchases of $125,275.28, but the federal tax return recorded only $98,799.00. Given the lack of source documentation for sales and the unreliability of the purchase information available, the Division concluded that it would be impossible to perform a detailed audit of petitioner's records to determine petitioner's tax liability for the audit period and resorted to an indirect audit methodology.
In choosing a methodology, the Division rejected a markup test due to the lack of reliable purchase information and the fact that petitioner operated a buffet style restaurant that prevented an accurate determination of the quantities of food sold. Instead, it was decided to do a cash-tocredit card sales analysis, utilizing the results of a one-day observation test and petitioner's own records of credit card sales as disclosed in banking records.
The Division's investigators conducted an observation at petitioner's restaurant, the Beijing China Buffet, on Thursday, November 8, 2007 from 10:30 A.M. to 8:00 P.M. The restaurant was located on a high volume traffic road close to the Niagara Prime Outlet Mall. There was seating for approximately 240 patrons. Customers pay for their meals upon entering regardless of whether they are eating in or taking the food out.
Between 11:00 A.M. and 8:00 P.M., there were 96 transactions, 16 of which were take-outs. The total value of all the transactions was $1,454.91, of which 14 were credit card transactions totaling $238.80, or 16.41% of the total. The amounts reported by the investigators from the observation were inclusive of sales tax. However, when the tax was backed out of the sales total, it amounted to $1,347.14. Credit card sales exclusive of tax amounted to $221.11 and cash sales totaled $1,126.03. Based on these figures, the resulting cash-to-credit card sales ratio was 5.093.
The total amount of cash sales could not be determined from petitioner's records. In fact, petitioner's Key Bank monthly bank statements from December 2004 through February 2007 indicated that there were no cash deposits at all for the months of January, April and August 2006 and nine other months with cash deposits of $100.00 or less.
Of the ten vendor/suppliers that appeared in petitioner's records for the period September 2004 through October 2005, only one was paid by check, with all others compensated in cash.
Because credit card deposits were made directly into petitioner's bank account by the credit card companies, credit card sales could be tracked and substantiated by the Division. The Division took the credit card deposits that were made into petitioner's bank account for the audit period, 3 $453,319.78, and applied the cash-to-credit card ratio determined in the observation test, 5.0923, to said figure (on a quarterly basis) to arrive at a projection of cash sales for the audit period, $2,360,128.7. The appropriate tax rate was applied for each quarter to arrive at total audited tax due on sales of $189,884.98. After giving credit for tax reported of $52,195.68, the additional tax on sales due per the audit was determined to be $137,689.30.
Based upon the audit findings, the Division issued to Beijing China Buffet, Inc., a Statement of Proposed Audit Change, dated November 21, 2007, which set forth additional sales and use tax due of $139,318.52, plus penalty and interest for the period September 1, 2004 through February 28, 2007. The additional tax due was comprised of the additional tax due on capital asset purchases for which petitioner did not offer any substantiation and the additional tax on sales as projected from the observation test and petitioner's books and records.
On or about January 11, 2008, petitioner's representative, Evelyn Kung, CPA, sent the Division a calculation of the cash-to-credit ratio based upon petitioner's records for the months of August through December 2007. 4 According to the calculations, petitioner recorded 4,540 sales during these five months with $113,882.00 in cash sales and $93,734.00 in credit card sales. These figures yielded a cash-to-credit card sales ratio of 1.215.
Petitioner took the credit card deposits for all the months of the audit period, netted the deposits of 15% to allow for tips, and then applied its own cash-to-credit card ratio (1.215) to determine cash sales and then total sales. Petitioner then backed out sales tax to determine sales net of tax, applied the sales tax rates used by the Division in its analysis to arrive at its own sales tax liability. Reported sales were subtracted to determine additional tax due. For the period December 2004 through February 2007, petitioner estimated additional tax due on sales of $ 19,061.05.
Upon review of petitioner's calculations, the auditor concluded that he could not accept petitioner's projections based upon a cash-to-credit card sales ratio of 1.215 since it did not take into account the months during the audit period where there were no cash deposits to the bank account and many others less than $100.00. The auditor believed that failing to recognize such data made the projections “self-serving” and eroded any credibility that could be ascribed to petitioner's conclusions drawn therefrom. The auditor believed that the data used by petitioner in its calculations was not indicative of the circumstances that presented themselves during the audit period.
Petitioner Ping Di Chen was the vice-president of Beijing China Buffet, Inc., during the period in issue. He came to the United States in 1998 from China and began working at the Beijing China Buffet sometime prior to October 2004 as a cook. He does not speak or read the English language and has little formal education.
In October 2004, Mr. Ping Di Chen and Mr. Yong Li took over the restaurant from the prior owner. Mr. Chen continued to work in the kitchen, cooking and ordering food. He was a signatory on the corporate bank account and did sign checks, including at least one for the payment of sales tax with the return for the quarter ended February 28, 2007 and others for expense purchases. He also signed sales tax returns filed during the audit period. He was listed on, and executed, the Application for Registration as a Sales Tax Vendor as an officer (vice-president) of the corporation in November 2004. In addition, Mr. Chen was listed as an officer on both the 2005 and 2006 federal income tax returns.
Mr. Yong Li was also listed as an officer, president, on the Application for Registration as a Sales Tax Vendor, was a signatory on the corporation's bank account, signed most of the sales tax returns filed during the audit period, and was listed as an officer on the federal income tax returns for the fiscal years ended October 31, 2005 and 2006. The auditors also observed checks issued by Mr. Li for the corporation's expense purchases. Mr. Chen stated that Mr. Li had acted as manager for an undisclosed period, but that they delegated that responsibility to persons they hired for most of the audit period. Managers were hired to bridge the language barrier and generally help them with the operation of the business. Mr. Chen also stated that Mr. Li helped their accountant to prepare tax returns.
Mr. Yong Li left the business sometime in January 2007.
THE DETERMINATION OF THE ADMINISTRATIVE LAW JUDGE
The Administrative Law Judge analyzed the statute and case law regarding sales tax audits. After reviewing the record, the Administrative Law Judge found that the Division made proper records requests and that petitioner failed to produce adequate books and records for the audit period. As such, the Administrative Law Judge concluded that the Division was properly entitled to estimate petitioner's sales tax liability.
The Administrative Law Judge observed that Courts have found it reasonable for the Division to extrapolate the results of a one-day observation test over a multi-year audit period. In the instant matter, the Administrative Law Judge found the Division's use of the cash-to-credit card sales ratio to be reasonable because it addressed major discrepancies in petitioner's records. The Administrative Law Judge observed that a taxpayer challenging an audit bears the burden of proving, by clear and convincing evidence, that the audit results were either unreasonably inaccurate or clearly erroneous.
The Administrative Law Judge determined that petitioner failed to carry its burden in this regard. Upon review, the Administrative Law Judge rejected petitioner's arguments based upon Matter of Cjefa Pizza, Inc. (Division of Tax Appeals, January 8, 2009 ) because Administrative Law Judge determinations lack precedential value and petitioner inaccurately interpreted that determination. The Administrative Law Judge also rejected petitioner's attacks on the audit methodology utilized, because speculation about possible alternative audit methods does not meet the standard of clear and convincing evidence. Having addressed the arguments regarding the underlying deficiency, the Administrative Law Judge turned to whether the individual petitioners were responsible persons.
The Administrative Law Judge observed the relevant statutes for determining whether an individual is a responsible person for sales tax. Upon reviewing the record and briefs, the Administrative Law Judge found that Ping Di Chen conceded liability for the assessed taxes and that Yong Li failed to raise a valid defense. However, the Administrative Law Judge directed the Division to adjust the period to December 1, 2004 through January 31, 2007 for Yong Li because the record shows that he left the corporation as of January 2007.
The Administrative Law Judge sustained the assessed penalties because petitioner failed to adduce evidence showing reasonable cause for abatement of such penalties.
ARGUMENTS ON EXCEPTION
Petitioner raises arguments that are substantially similar to those argued before the Administrative Law Judge. While petitioner does not argue against utilizing a one-day observation test, petitioner contends that it is unreasonable for the Division to use the cash-tocredit card sales ratio from a one-day observation test and apply it to petitioner's records.
Petitioner contends that the cash-to-credit card ratio is too inaccurate and resulted in a deficiency that is not reasonably related to the amount due. Petitioner supports its position with testimonial evidence and a report generated by its accountant. Petitioner disagrees with the Division's decision to estimate cash sales by applying a cash-to-credit card sales ratio to petitioner's credit card sales, which were derived from petitioner's records. Petitioner argues that the Division cannot use the cash-to-credit ratio and, instead, must apply total sales from the one-day observation test to the entire audit period. Petitioner Ping Di Chen and Yong Li raised no argument on exception regarding their status as responsible persons.
The Division argues that the Administrative Law Judge properly concluded that petitioner failed to meet its burden of proof and sustained the subject Notices. The Division distinguishes this matter from those cited by petitioner based on the fact that the subject audit was based upon petitioner's own records, as opposed to an external index. Further, the Division argues that the auditor fully articulated the reasoning behind each step of the audit and why the cash-to-credit card sales ratio was utilized. As such, the Division submits that it has established a rational basis for the audit and that it was incumbent upon petitioner to introduce evidence that the results were either clearly erroneous or unreasonably inaccurate. The Division contends that petitioner failed to introduce sufficient evidence to prove either proposition and that, at best, petitioner's argument amounts to an alternative methodology, not proof that the utilized method was unreasonably inaccurate or clearly erroneous.
OPINION
We affirm the determination of the Administrative Law Judge.
This Tribunal has often articulated the standard for reviewing a determination based on an estimated audit methodology. In Matter of AGDN, Inc. (Tax Appeals Tribunal, February 6, 1997) , we stated as follows:
a vendor ... is required to maintain complete, adequate and accurate books and records regarding its sales tax liability and, upon request, to make the same available for audit by the Division (see, Tax Law §§ 1138[a]; 1135; 1142[5]; see, e.g., Matter of Mera Delicatessen, Tax Appeals Tribunal, November 2, 1989 ). Specifically, such records required to be maintained 'shall include a true copy of each sales slip, invoice, receipt, statement or memorandum' ( Tax Law § 1135 ). It is equally well established that where insufficient records are kept and it is not possible to conduct a complete audit, 'the amount of tax due shall be determined by the commissioner of taxation and finance from such information as may be available. If necessary, the tax may be estimated on the basis of external indices...' (Tax Law § 1138[a]; see, Matter of Chartair, Inc. v. State Tax Commn., 65 AD2d 44, 411 NYS2d 41, 43 ).
When estimating sales tax due, the Division need only adopt an audit method reasonably calculated to determine the amount of tax due (Matter of Grant Co. v. Joseph, 2 NY2d 196, 159 NYS2d 150, cert denied 355 US 869 ); exactness is not required (Matter of Meyer v. State Tax Commn., 61 AD2d 223, 402 NYS2d 74, lv denied 44 NY2d 645, 406 NYS2d 1025 ; Matter of Markowitz v. State Tax Commn., 54 AD2d 1023, 388 NYS2d 176, affd 44 NY2d 684, 405 NYS2d 454 ). The burden is then on the taxpayer to demonstrate, by clear and convincing evidence, that the audit method employed or the tax assessed was unreasonable (Matter of Meskouris Bros. v. Chu, 139 AD2d 813, 526 NYS2d 679 ; Matter of Surface Line Operators Fraternal Org. v. Tully, 85 AD2d 858, 446 NYS2d 451 ).
Our review of the records reveals that the Division made a clear and unequivocal written request for petitioner's books and records. Petitioner introduced no source documents, such as sales invoices, complete purchase invoices or cash register tapes, that would permit the Division to conduct a complete audit for the entire period (see Matter of Vebol Edibles v. Tax Appeals Trib., 162 AD2d 765 [1990], lv denied 77 NY2d 803 [1991] ; Matter of Club Marakesh v. State Tax Commn., 151 AD2d 908 [1989], lv denied 74 NY2d 616 [1989] ). Accordingly, we hold that the Division was entitled to resort to external indices to estimate the amount of taxes due (see Matter of Urban Liqs. v. State Tax Commn., 90 AD2d 576 [1982] ).
The primary issue presented in this case is whether petitioner established that the selected audit method resulted in either unreasonably inaccurate or clearly erroneous amount of tax due (Matter of Scarpulla v. State Tax Commn., 120 AD2d 842 [1986] ; Matter of Surface Line Operators Fraternal Org. v. Tully, supra).
We note that “[c]onsiderable latitude is given an auditor's method of estimating sales under such circumstances as exist in [each] case” (Matter of Grecian Sq. v. State Tax Commn., 119 AD2d 948, 950 [1986] ). Whether the audit method used was “reasonably calculated to reflect the taxes due” (Matter of W.T. Grant Co. v. Joseph, supra at 206 ) can only be determined based on information made available to the auditor before the assessment is issued (see e.g. Matter of Queens Discount Appliances, Tax Appeals Tribunal, December 30, 1993 ; Matter of House of Audio of Lynbrook, Tax Appeals Tribunal, January 2, 1992 ).
We find that it was reasonable for the Division to estimate petitioner's liability by utilizing petitioner's records and a cash-to-credit card ratio generated from a one-day observation test. During the audit, petitioner provided the Division with bank statements for the entire period. These documents indicated deposits from major credit card vendors, which allowed the auditor to compute the amount of credit card sales for the entire period. Petitioner's actual cash sales remained an unknown, which is critical since a significant portion of petitioner's business was cash sales. To determine cash sales, the Division monitored petitioner's sales during a one-day field audit and generated a cash-to-credit card sales ratio. The Division then estimated cash sales by applying this ratio to credit card sales, and assessed petitioner based on the total underreported amount.
Upon review, we find that the Administrative Law Judge properly rejected petitioner's challenges to the accuracy of the audit method. As a general proposition, any imprecision in the results of an audit arising by reason of a taxpayer's own failure to keep and maintain records of all of its sales as required by Tax Law § 1135(a)(1) must be borne by that taxpayer (Matter of Markowitz v. State Tax Commn., supra; Matter of Meyer v. State Tax Commn., supra). Petitioner specifically complains that the cash-to-credit card sales ratio resulted in a larger number of total sales than those actually generated by petitioner. However, petitioner failed to adduce any source documentation that would support that conclusion. We also agree with the conclusion that the test period audit, conducted by petitioner's accountant, merited little consideration because the results did not appear to be an accurate reflection of the business during the audit period.
We find petitioner's challenge to be without merit because it provided no source documentation, such as sales invoices, complete purchase invoices or cash register tape records, either on audit or at hearing, that would establish the actual amount of petitioner's sales. Absent any records, petitioner's arguments do not provide any grounds for changing the Division's audit results. As such, we conclude that petitioner failed to carry its burden of showing the audit to be unreasonably inaccurate or clearly erroneous.
Petitioner asserts that Matter of 33 Virginia Place (Tax Appeals Tribunal, December 23, 2009) requires a reversal or modification of the Administrative Law Judge's determination. In Matter of 33 Virginia Place, the Division estimated the taxpayers' liability using an external index because the petitioners failed to maintain adequate books and records. However, in that case, at hearing, the auditor could not articulate a rational basis for the selected audit methodology. The taxpayers submitted expert testimony and evidence showing that the Division misapplied its selected audit methodology. As such, we cancelled the notices therein because the taxpayers met their burden of proof.
This matter is distinguishable from Matter of 33 Virginia Place. Herein, the Division estimated petitioner's tax liability from petitioner's own records and from data gathered from an observation test at petitioner's place of business. At the hearing, the auditor repeatedly provided the rationale for choosing to apply the cash-to-credit card sales ratio to the estimated credit card sales. Moreover, petitioner introduced no persuasive evidence challenging the audit methodology or its rationale. As noted by the Administrative Law Judge, we find petitioner's arguments to be insufficient to meet its burden of proof. Accordingly, we conclude that petitioner failed to provide any grounds for either modifying or canceling the Notice of Determination issued to Beijing China Buffet, Inc.
We also find that the Administrative Law Judge properly sustained the penalties assessed against petitioner. In establishing reasonable cause for the abatement of penalties, the taxpayer faces an onerous task (see Tax Law § 1145[a][1][iii]; Matter of Philip Morris, Tax Appeals Tribunal, April 29, 1993 ). Petitioner bears the burden of showing reasonable cause such that the nonpayment of taxes was beyond the control of petitioner and due to no fault of its own (Matter of F & W Oldsmobile v. State Tax Commn., 106 AD2d 792 [1984] ). Herein, petitioner advanced no argument that would permit the abatement of penalties. Accordingly, the penalties assessed against petitioner are sustained.
Petitioner raised no argument challenging the determination that Ping Di Chen and Yong Li were responsible persons under the Tax Law. However, we agree that the record supports the Administrative Law Judge's conclusion that Yong Li left the corporation as of January 2007 and that this petitioner should be liable only for the period December 1, 2004 through January 31, 2007.
We have reviewed and considered petitioner's remaining arguments, and we find them without either support or merit.
Accordingly, it is ORDERED, ADJUDGED and DECREED that:
1. The exception of Beijing China Buffet, Inc., Ping Di Chen, and Yong Li is denied;
2. The determination of the Administrative Law Judge is affirmed;
3. The petitions of Beijing China Buffet, Inc., and Ping Di Chen are denied; the petition of Yong Li is granted to the extent indicated in conclusion of law “F” of the Administrative Law Judge's determination, but in all other respects is denied;
4. The Notices of Determination, dated March 3, 2008, issued to Beijing China Buffet, Inc. and Ping Di Chen are sustained and the Notice of Determination, March 3, 2008, issued to Yong Li, as modified in paragraph “3” above, is sustained.
DATED: Albany, New York, February 23, 2012
/s/ James H. Tully, Jr.
James H. Tully, Jr.
President
/s/ Charles H. Nesbitt
Charles H. Nesbitt
Commissioner
1
The officers were not assessed for the quarter ended November 30, 2004.
2
Herein, references to the three petitioners together will be singular (i.e. petitioner).
3
The Division explained in its workpapers that the bank records with which it was presented showed a balance of $10,273.20 for the period ended December 2004. This presumably came from the January statement as a carry forward or starting balance. The Division's bank deposit analysis disclosed that, on average, 92.83% of the account balance was the result of credit card deposits. It concluded from the balance of $10,273.20 that 92.83%, or $9,536.61, represented credit card sales for December 2004.
4
In its brief, the Division asserted that the letter from Ms. Kung with the attachments was not admitted into evidence. At hearing, petitioner had the document identified and marked as Petitioner's Exhibit 1. After being marked, the document became the focal point of several pages of questioning. There is no indication in the record that the Division objected, or would have objected, to its introduction given the extensive discussion and the assumed inclusion of the letter and its attachments in the official audit file. By oversight, the Administrative Law Judge did not formally receive these documents in evidence. Under these circumstances, it is reasonable to expressly state here that the letter from Ms. Kung, identified as Exhibit 1 in the record, has been admitted into evidence (see also State Administrative Procedure Act § 306 [1]; 20 NYCRR 3000.15 [d][1]).
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