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Devising a Proper Strategy for Sales & Use Tax Audit Defense

Devising a Proper Strategy for Sales & Use Tax Audit Defense

Devising a Proper Strategy for Sales & Use Tax Audit Defense

Auditors are usually trained to do the audits one way. The way that they have been trained is not the fairest way, specifically for the taxpayer, in several cases. Most audits generally require some sort of strategy while delving into the audit defence process. We must perform pre-audit work in the development of a proper sales & use tax audit defence strategy.

We do the Pre-Audit Work For Two Reasons:

1. First Reason is to Get Our Client Ready for the Audit.

What this means is, we must take the time to learn our client’s business. We must familiarize ourselves with their products and services, their taxability and the availability of data and documents. We must ensure that they have all of the documents that may be needed to start the process of audit. We must not confuse this with providing the list of documents that the auditor has summarily requested. In several cases, it is so that the documents they have requested are not necessary for this particular audit, but have been requested anyway, just in case they are needed. If it happens that there are missing documents, in that case our client will have a headache inducing homework even before the audit process starts. So, it is imperative that if there are discrepancies or inconsistencies in the documents that the auditor might question, in that case, we must work with our client to determine the reasons and explanations prior to the instigation of the sales tax audit. We must make the process of sales tax audit defence as efficient as possible for both our client and the auditor.
There is no denying, audits are stressful and time consuming. Most taxpayers want them to be over with as soon as possible. Having a proper strategy and ensuring our client has all the documents that will be needed to start the audit will put us a few steps ahead of the auditor. Afterall, we already know what they want, we also know what they are going to think when they see it and finally, we know what they will ask for next. This will make the whole process flow much more smoothly.

2. The Second Reason is to Exposure.

We must determine if there is any sales & use tax exposure. And if there is, we must develop a strategy to ensure that if the auditor does find the exposure, at least the tax liability is minimized.

That is not to say that we try to hide the issue. However, we do not point it out when the auditor walks in the door either. If the auditor does manage to find the issue then we must ensure that we guide them in a way that our client does not unfairly suffer from sales tax audit penalties and mitigate the liability as much as we possibly can.

One good example is a Houston-based pipe company which inspects every shipment of pipes before it leaves their yard and they bill their customer for the required inspection. Unfortunately, they did not realize that the inspections were taxable to the extent that the pipe itself was taxable. In other words, if the pipe is shipped out of the state, then it is not subject to sales tax audit Texas. Therefore, the inspections will not be taxable. If their customer is direct pay permit holder and they have a certificate
on file, in that case the pipe and inspections will not be taxable. On the other hand, if the sale of the pipe is subject to Texas sales tax, the inspections will also be taxable. They discovered their error about half-way through the four-year audit period. It meant that they had two years of taxing the inspections correctly and two years of taxing the inspections incorrectly. The fee for the inspections was $1,500; a drop in the bucket compared to the pipe sales that could be in the hundreds of thousands of dollars for one shipment.
When creating a transaction sample for an audit, most auditors will just take all of the transactions and throw them into the population before selecting their sample base. Though, in this example’s case, that could have resulted in an over-stated liability. Firstly, the $1,500 errors only existed in the first two years of the audit, and secondly, extrapolating a $1,500 error across the much larger sales invoices would result in an inflated amount of the due tax.
The relevant Defense specialist developed a strategy. The solution was that if the auditor found the issue then those errors must not be unfairly extrapolated across a much larger population. So, the strategy was to pull the data from our client’s accounting software in a way that allowed it to segregate taxable and out-of-state sales out of the data. This left a relatively substantial list of Texas customers for whom tax was not charged. All the certificates were presented to the auditor, who was then able to cull that list down even further by his own hands and detail the remaining sales transactions, thereby not creating a situation where the $1,500 issue could be extrapolated. If the auditor had managed the audit like he was trained and the client did not have the right strategy this audit would have ended very badly for this taxpayer, as they would have been ignorant of there being a better way.

Contact SG Inc. CPA today and get the best service imaginable for devising a good strategy for your sales and use tax audit defense.