DECISIONS
Matter of Apple Inc.; Division’s Rep: David Gannon; Taxpayer’s Rep: Peter Faber and Mark Yopp; Articles 28 and 29 (by Joe Endres).
Before delving into the substantive issues in this case, I would like to thank the powers-that-be at TiNY for allowing me to report on sales tax cases. I will endeavor to uphold TiNY’s strong analytical tradition while also maintaining its somewhat irreverent, yet respectful, tone.
By way of introduction, let me begin by saying that sales tax is, by far, my favorite tax. This is because it is the meanest and most persnickety of all New York taxes. And the lone sales tax case this week illustrates these points perfectly.
In Matter of Apple Inc., the Tax Appeals Tribunal reviewed Judge Law’s determination that Petitioner under-collected tax on its 2011 and 2012 “Back to School” (BTS) promotion sales made in its retail stores. TiNY previously reviewed the Judge’s determination here. This decision highlights numerous interesting issues, including: structuring issues, burden of proof issues, audit methodology issues and compliance concerns in New York’s broader tax enforcement climate.
Structuring Issues
Pursuant to Petitioner’s BTS promotions, customers who purchased certain qualifying computers or iPads received gift cards for either $100 or $50 depending on the product purchased. Let’s say I paid $1,000 for an iPad. Under the BTS promotion, I received the iPad and a $100 gift card. The question in this case was whether I paid for a discounted iPad (i.e., a $900 iPad and a $100 gift card) or a full-price iPad and a free gift card (i.e., $1,000 iPad and no charge for the gift card). As the Judge and the Tribunal noted, these distinct scenarios have very different tax consequences. In the former, sales tax is due on only the $900 iPad, while in the latter, sales tax is due on the full $1,000.
The Tribunal ultimately concluded that, based on the facts of the transactions at issue (more on this later), tax was due on the full $1,000 and upheld the ALJ determination. But Petitioner could have easily accomplished its goal of selling discounted hardware and full-priced gift cards if it just made the facts surrounding the transaction clearer, i.e. by changing how the receipt given to customers was structured. And that’s why sales tax is a particularly persnickety tax. Absent unusual circumstances, taxpayers live or die by the form of the transactions they create and the tax consequences that flow from them. Properly structured transactions may reduce the tax vendors are required to collect and remit. Poorly structured transactions may result in a hefty and unexpected tax bill.
Burden of Proof
But did Petitioner really structure poorly here? That statement seems a bit harsh. Certainly the company could have made the underlying facts clearer so as to leave the Division with no basis for an assessment. But there were facts that supported Petitioner’s treatment and the Tribunal acknowledged this. For example, Petitioner categorized the revenue from the gift cards for accounting purposes as “deferred revenue.” Moreover, when hardware was returned by a customer, Petitioner also required the contemporaneous return of the unused gift card, otherwise only the discounted price of the hardware would be refunded. Petitioner also never used the word “free” when referring to the gift card and its POS system was not capable of discounting the price of the gift card. These facts supported Petitioner’s treatment of the BTS transactions.
But there were also unhelpful facts for Petitioner. For example, its online sales during the BTS promotions correctly (in the Division’s view) computed and collected tax on the full $1,000. Moreover, if a customer declined the gift card as part of the BTS promotion, the full price of the qualifying device with applicable tax would have been charged.
What’s important to recognize here is that the applicable burden of proof puts taxpayers at a severe disadvantage when confronted with competing factual scenarios. Unfortunately for Petitioner, it had the burden of proving, by clear and convincing evidence, that its position was correct. It had numerous helpful facts. In my opinion, a preponderance of the facts supported Petitioner’s position. But a “preponderance of evidence” is not necessarily “clear and convincing evidence.” Taxpayers should recognize that the rules of the game are tilted heavily in favor of the government, as borne out annually in the published DTA statistics.
Audit Methodology
Just a quick note on sales and use tax audit methodology (for an overview of the steps in a NY sales and use tax audit, click here). Many taxpayers forget that sales and use tax audits examine three distinct areas:
- Did the taxpayer collect the proper amount of sales tax on its sales;
- Did the taxpayer pay the proper amount of tax on its purchases (capital and expense); and
- Do the taxpayer’s numbers reconcile?
The last inquiry, which usually occurs first in an audit, was central in this case. Had the Division not thoroughly reviewed Petitioner’s sales and tax figures, it’s likely that this issue would not have been spotted on audit. As part of all audits, auditors are instructed to review the taxpayer’s taxable sales figures and confirm that they reconcile with the amount of tax paid to the state. Similarly, auditors are instructed to review the amount of tax collected by the taxpayer from customers to confirm that it reconciles to the amount of tax actually paid to the state.
In this case, the liability resulted from a one-day test period wherein customer invoices from Petitioner’s retail stores were reviewed, with the subtotal on the invoice being multiplied by the applicable tax rate. This review led to a discrepancy between the amount of tax the auditors determined should have been collected and the amount actually collected by Petitioner for sales subject to the BTS promotion. Again, this issue could have easily been missed by less-diligent auditors. And it’s a warning to taxpayers to conduct internal reconciliations prior to meeting with auditors. Surprises are great for birthday parties and Christmas gifts, not so much for sales tax audits.
Compliance Environment
We at TiNY have a bias in favor of taxpayers. But even if we didn’t, it would be tough not to feel sympathy for the Petitioner. As noted above, it could have structured its BTS transactions to avoid paying tax on the value of the gift cards. But what’s particularly startling is the amount of effort Petitioner exerted to properly account for BTS sales. The Tribunal details how Petitioner’s point-of-sale, tax, accounting and legal teams all worked on the promotions. And if a behemoth like Apple can’t get it right, with all its resources and expertise, what hope does a little mom-and-pop retailer have of correctly navigating New York’s confusing and counterintuitive sales tax law?
At one point in the decision, the Tribunal notes that one of Petitioner’s employees voiced concern over over-collecting tax, which, she posited, could happen if Petitioner gave the gift card away “for free” (leading to the collection of full tax on the $1,000 charge that included both the value of the taxable hardware and the value of the non-taxable gift card) and then charging tax again when the gift card was redeemed for taxable products. The Tribunal noted that Petitioner had been subject to “over-collection” suits in the past. One can imagine the competing considerations that Petitioner faced.
Conclusion
Ok, so I geeked out a bit on sales tax, and this summary got a bit long. What can I say? I was excited to join the TiNY blog, I love sales tax and this case raised a bunch of juicy issues. I realize that we probably lost half of our readership due to that last sentence, but somehow we’ll manage to carry on with the remaining six readers. I look forward to contributing every time the DTA issues a sales tax order, determination or decision. Until then….
