- Safeguard Records
Vendors who sell items that are subject to California sales tax are required to keep records of those sales. These records can include such things as sales slips, receipts, invoices, or even other memos documenting an exchange. The vendor is typically required to keep and preserve these records until the assessment statute of limitations has run. The purpose behind this rule is to better enable the State to track the vendor’s sales—and to unearth and assess any tax liabilities that may exist.
- Sales Tax Audit Goals
There is often very specific information that an auditor wants during a sales tax audit. The Board of Equalization helpfully identifies several objectives of an auditor:
- Did the taxpayer report all gross receipts from sales of tangible personal property and taxable labor and services?
- Did the taxpayer report the cost of all business equipment and supplies that they purchased without tax either from out- of-state vendors or for resale for thier business or personal use?
- Did the taxpayer properly claim deductions?
- Did the taxpayer properly allocate tax?
- Did the taxpayer use the correct rate of tax when reporting sales in special tax districts?
- Did the taxpayer properly apply tax to their sales and self-use of merchandise (tangible personal property)?
In attempting to answer these questions, the auditor will seek to review various kinds of records, documents, and electronic files, such as the following:
- Books of account including the taxpayer’s income statements, balance sheets, general ledgers, and other summary records of the business operations, including state and federal income tax returns.
- Original documents that support the entries to the taxpayer’s books, such as sales and purchase invoices, purchase orders, contracts, bank statements, cash register tapes, and any other documents that result from the business operations.
- Resale certificates, exemption certificates, bills of lading, or other documents supporting claimed exempt sales.
- Copies of the taxpayer’s returns filed with the State and the working papers and schedules used to prepare those returns.
For more on California audits, see the Board of Equalization’s Publication 76 (2013), accessible here: https://www.cdtfa.ca.gov/formspubs/pub76.pdf
- Subpoenas—Generally
Most taxpayers simply acquiesce and comply with the government’s request for documents, books, and records. But some prefer to resist until the Board of Equalization issues a subpoena. Pursuant to 15613 of the Government Code, the Board has the power to “issue subpoenas for the attendance of witnesses or the production of books, records, accounts, and papers . . .”
Sections 441 to 470 of the Rev. & Tax Code give the assessor much authority to obtain information from the taxpayer.
Surprisingly, the State has the power to subpoena a corporation’s books and records, even when the corporation itself owns no property subject to assessment by the Board. This was one of the holdings of Redding Pine Mills, Inc. v. State Board of Equalization, 157 Cal.App.2d 40, cert. denied 358 U.S. 818. The court reasoned that the State should be able to subpoena the corporation’s ledgers and books for the purpose of gathering facts for an investigation as to whether sales or income tax should have been applied.
- Limits on Subpoena Power
While the State’s subpoena power is broad, it is not unlimited. Taxpayers are still protected by California’s Constitution, and the Fourth Amendment of the U.S. Constitution, which give citizens the right to be free from unreasonable searches and seizures. To non infringe upon a taxpayer’s Forth Amendment rights, the Board’s subpoena must relate to an “inquire [that the tax] agency is authorized to make” and that its demands for information and documents not be “too indefinite, and the information sought be reasonably relevant.” Roberts v. Gulf Oil Corp., 195 Cal. Rptr. 393, 405 (1983). Case law also explains that a subpoena is valid only if the sought “information [were] reasonably relevant to the proposed tax.” Union Pacific R.R. v. State Board of Equalization, 776 P.2d 267, 271 (1989). Rev. & Tax. Code § 452 also imposes this relevance criterion.
In Union Pacific, the State Board of Equalization requested with a subpoena part of the railroad’s confidential business plan for future acquisitions. The taxpayer agreed to produce portions of this plan, but it refused to produce detailed information about future property acquisitions and projected income therefrom. With a strategic legal theory, the Board argued that the court could not even decide in favor of the taxpayer (even if the court were to agree with Union Pacific) until it paid its tax and filed for a refund, exhausting all administrative remedies.
Fortunately for the taxpayer, the court disagreed and held that Union Pacific did not need to do that, and it held that the railroad did not need to produce its confidential business acquisition plans because such information was “not reasonably relevant to the board’s assessment function.” The court could not find any reason why the Board would need information for the taxpayer’s “mere hopes and plans for possible future acquisitions of additional property [that might] affect the fair market value of the corporation’s existing property.”
Instructively, the court distinguished between a taxpayer’s future income—which is often used in the income/ capitalization approach to valuing a business—from its future property. The court correctly noted that only existing property is capitalized for valuation purposes—not mere hopes and plans of future income.
- Practical effect of not furnishing requested information
As a practical matter, if a taxpayer fails to produce information that the assessor or Board requests, then the tax agency will likely just make an arbitrarily high assessment, forcing the taxpayer to correct it and prove up documentation to fight the overreaching tax assessment. For example, Section 480 of the Rev. & Tax Code provides that the assessor will “promptly assess the property” in question, based on his (arbitrary) estimate, if the taxpayer “fails to comply with any provision of law for furnishing” the relevant information. Moreover, the assessor may also impose a penalty pursuant to Section 501.
