A New York State Administrative Law Judge canceled a sales tax assessment against a taxpayer’s restaurant business, finding that the Department’s use of external indices was unreasonable. Matter of A & J Grand Enterprises, Inc., DTA Nos. 822935, 822936 & 822937 (N.Y.S. Div. of Tax App., August 25, 2011).
The audit. The taxpayer, A&J, had during the period in issue operated a restaurant franchise – L & L Hawaiian Barbecue – located in downtown Manhattan. In 2007, A&J agreed to sell the restaurant; in January 2008, a bill of sale was executed. A bulk sale notification was submitted by the purchaser to the Department dated January 3, 2008, and was received by the Department on January 8. The bulk sale notice prompted a sales tax audit, which did not commence until nearly two months later. The auditor immediately prepared a request for all books and records to be made available for a field audit scheduled to begin on March 17, two weeks later.
Although the auditor was aware that A&J no longer conducted business at the restaurant’s location, the auditor took the letter to the restaurant, where the manager of the new business promised to forward it to A&J’s owner. The auditor also called the new business the next day, but did not mail a copy of the letter to A&J until March 7, four days later, when he sent copies of the letter to the owners of A&J at their home addresses, which were addresses used in a 2004 vendor registration application.
Meanwhile, on March 6, the auditor reviewed the case, decided to use a Robert Morris Statement Study Worksheet as a basis to compute tax, and prepared a schedule of tax due based upon his calculations. On March 12, the auditor spoke with the new owner, who claimed to have handed the letter to the seller. On March 13, the auditor met with his supervisor to review the case, decided to estimate the amount of tax due based on external indices, and issued a Statement of Proposed Audit Change, addressed to A&J at the address of the business now operated by the new owner. He relied on computations contained in a study of the restaurant industry to estimate gross sales, the selling prices of business assets, and the value of tangible personal property. On March 27, a Notice of Determination was issued to A&J, and a second Notice of Determination was issued on April 14. Another notice was issued to the owner of A&J as an allegedly responsible person. The ALJ noted that the record was silent on whether the new owner had been timely assessed as a bulk sale purchaser.
The ALJ decision. The ALJ held that the auditor’s resort to external indices was improper. While New York law clearly allows an audit to rely on external indices when necessary, such reliance is permitted only when the taxpayer’s records are determined to be inadequate, after the auditor has requested and examined those records. Here, the ALJ found that the auditor’s requests for A&J’s books and records were “weak and casual.” Although the auditor knew that A&J no longer conducted business at the restaurant’s location, he took the appointment letter there and relied on the new owner to forward it. He waited four more days to mail the letter, by which time he had already decided to use external indices, and then immediately concluded that a detailed audit was not possible because he had received no response. The ALJ found that A&J was not granted a reasonable opportunity to produce its books and records before a determination was made that the records were inadequate, and therefore it was improper for the Department to have resorted to external indices. Accordingly, the ALJ held that the notices of determination should be cancelled.
Additional Insights. Auditors are generally granted great leeway in the basis they use to reach a determination of tax due, and many cases support the proposition that, where the Department demands the taxpayer’s book and records and no records are produced, the auditor may resort to external indices to estimate tax, as long as the estimate methodology is reasonably calculated to reflect the tax due. See, for example, Matter of Your Own Choice, Inc., DTA No. 817104 (N.Y.S. Tax App. Trib., Feb. 20, 2003). Here, however, the ALJ’s concern was the unreasonably short period of time allowed by the auditor for the taxpayer to respond to the request for books and records. The auditor did not take actions reasonably intended to get his request to the attention of the former owners, and then almost immediately decided no records would be produced and jumped right to external indices. The ALJ concluded that this process was not a proper basis for the resort to external indices, and that A&J “was not afforded a reasonable opportunity to produce its books and records” before a determination was made that the records were inadequate to allow the conduct of a complete audit.