When a business sells products that are subject to sales tax in California, we typically associate the tax liability with the business, itself. But when the company engaged in business ceases operations and closes up shop, who is left holding the bag? A recent opinion issued by California’s Office of Tax Appeals sought to answer that question.
The facts of Garcia are relatively straightforward. Rolando Garcia, the appellant in this case, and his wife, owned Caribbean BBQ Islands, Inc. (“Caribbean”). Garcia acted as the Chief Financial Officer and his wife held all of the company’s shares and served as Caribbean’s President. Pedro Tariche, and Raymond Simpson also worked at Caribbean and served as the company’s Vice President and Business Manager, respectively. Caribbean sold custom barbecue islands from July 2006 through the end of the 2007 calendar year.
Garcia and his wife testified at trial that their involvement in Caribbean was minimal, even though the President and Chief Financial Officer roles that they held would seem to indicate an increased level of involvement. Garcia was involved in other companies, namely a trucking business, that occupied a greater portion of his time.
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In August of 2007, another employee of Caribbean contacted Garcia after a purported customer reached out to the company for a service request. The customer believed they had purchased a fire pit from Caribbean, but the employee could not locate a record of such sale. The customer produced an invoice that differed from the standard invoices typically used by Caribbean and after further investigation, Garcia learned that the customer had been instructed to pay a company that was controlled by Caribbean’s Vice President, Pedro Tariche.
An internal investigation by Garcia uncovered embezzlement by both Pedro Tariche and Raymond Simpson, among other Caribbean employees. Garcia estimated that over $200,000 in profits had been diverted away from Caribbean to benefit Tariche and Simpson. Garcia understandably fired Tariche and Simpson and shut down the Caribbean as of December 31, 2007.
The CDTFA performed a standard close-out audit of Caribbean’s tax compliance upon the cessation of business and discovered that the company substantially underreported its sales and thus, underpaid its true tax liability. Calculations initially performed by the CDTFA estimated that sales were underreported by $1.9 million. The CDTFA issued a Notice of Deficiency to Caribbean, which went unpaid and un-petitioned.
California law provides that when a business shuts down, is abandoned, or otherwise ceases to operate, any person having control or supervision of, or who was charged with the responsibility for the filing of returns or the payment of tax, or who was under a duty to act for the corporation in complying with any requirement of the Sales and Use Tax Law can be held personally liable for any underpaid tax. Accordingly, the CDTFA issued a Notice of Deficiency to Garcia, as he was the Chief Financial Officer, was the sole signatory on the checks of the business and was the only individual who signed the company’s annual tax returns. Garcia appealed the Notice of Deficiency, and although the CDTFA made some minor concessions, the CDTFA’s appeals bureau sustained the lion’s share of the tax due according to the original Notice of Deficiency. Garcia appealed to the Office of Tax Appeals (“OTA”).
A three-judge OTA panel heard Garcia’s case and in ruling in his favor, cited his lack of involvement with the company, as well as the behavior of his former associates. California law provides, among other things, that in order to find an individual liable for the tax of a company, they must have known of the tax liability and willfully failed to pay over the taxes. The OTA’s opinion went on to define the term willful, according to California law, means that the failure to pay was the result of a voluntary, conscious, and intentional course of action.
Although the CDTFA argued that Garcia, being the Chief Financial Officer, having access to the Caribbean bank account, and being the sole signatory on the company’s tax returns, knew or should have known of Caribbean’s true sales figures for the year, the OTA acknowledged that Garcia had a set of sufficient explanations as to why he did not.
First and foremost, the OTA recognized that Garcia had limited English-speaking ability and had not had any prior experience in selling tangible goods. Because Garcia spent the majority of his time working on his trucking business, he relied heavily on Tariche and Simpson to run the day-to-day operations of the business.
The CDTFA acknowledged that Tariche and Simpson had embezzled hundreds of thousands of dollars from Caribbean, but nonetheless persisted that Garica would have at least known of the additional sales and tax liability upon his investigation into the theft by his Vice President and Sales Manager. The OTA disagreed and indicated that although Garcia may have conducted his own investigation into Tariche and Simpson, he most certainly did not perform a detailed sales tax reconciliation. The above, coupled with the fact that Caribbean was, in actuality, operated almost completely by Tariche and Simpson, led the OTA to agree with Garcia, relieving him of personal liability for the underpayment of tax by Caribbean.
This case helps taxpayers in California understand the OTA’s position on personal liability for sales and use taxes of a business when the owner has very little oversight. The OTA was sure to indicate that typically, ignorance of the facts is not a defense. For instance, if Garcia had had access to all of the pertinent information needed to determine tax liability, but simply chose not to review or otherwise take responsibility for it, the disposition of this case would likely have been different. But the unique set of circumstances in this case, particularly Garcia’s language barrier, inexperience in selling goods subject to sales tax, and the potentially criminal activity of his business partners persuaded the OTA to acknowledge that Garcia’s actions were not willful.
This case is a reminder that nearly all tax disputes are unique and may have fact patterns that could alter the outcome. If you have received a Notice of Deficiency by the CDTFA, are facing an audit, or under investigation, it is in your best interest to contact an experienced tax defense attorney who can work with you to understand your set of facts and circumstances and help you determine the correct next steps.
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