Saturday, March 23, 2013

Revenue Finds Taxpayer Failed to Sufficiently Show What Part of "Lot" Purchases Were Incorporated into Manufactured Products

Excerpts of Revenue's Determination follow:


Taxpayer is an Indiana business which manufactures "vibratory feeding" equipment. The Indiana Department of Revenue ("Department") conducted an audit review of Taxpayer's business records. The audit resulted in the assessment of sales/use tax.
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Taxpayer purchased items from a particular on-line vendor. This particular vendor sold it supplies in various mixed "lots." Each particular "lot" contained more than item.

Taxpayer paid a single price for each purchase invoice even though the purchase invoice represented the purchase of multiple items contained in a single "lot."

Some of the items in a particular "lot" were purchased and incorporated into one of Taxpayer's manufactured products. The other items in that particular "lot" were discarded because they could not be incorporated into one of Taxpayer's manufactured products.

For example, Taxpayer might purchase a particular "lot" from the on-line vendor. The total price of the "lot" was $100 but the "lot" consisted of three items; the first item cost $10, the second item cost $30, and the third item cost $60. However, Taxpayer purchased the $100 "lot" with the intention of discarding the first two items.

In reviewing the invoices from this particular on-line vendor, the audit found that "[T]axpayer failed to keep some of the invoices documenting purchases made from this vendor." The audit concluded that without the invoices, "[T]he taxability of the purchases could not be verified."

The audit assessed use tax on the total price for each invoice issued by this particular on-line vendor. In the example cited above, the audit assessed use tax on the entire $100 charge because Taxpayer did not maintain or retain record of which items were incorporated into one of Taxpayer' s manufactured products and which items were discarded. There is no disagreement that items incorporated into one of Taxpayer's products would have been exempt but that the discarded items were subject to Indiana's use tax.

Taxpayer disagrees with the audit's conclusion taxing the full price on each invoice stating that approximately 80 percent of the purchases consisted of items incorporated into Taxpayer's manufactured products and that the tax should only have been assessed against the 20 percent of the purchases which were discarded.
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There is no dispute that Taxpayer is in the business of manufacturing "vibratory feeding" equipment and that it sells this equipment to its customers. There is no dispute that items purchased and incorporated into this equipment are exempt pursuant to IC § 6-2.5-5-6. There is also no dispute that it is likely some of the items purchased from the on-line vendor were actually incorporated into Taxpayer's products because the on-line vendor sold Taxpayer such mundane items as cylinders, valves, and electrical components which are just the sort of items a manufacturer might typically purchase for use in the production of its manufactured goods.

The issue is whether Taxpayer has established that 80 percent of the items were used in an exempt fashion. As with any "proposed assessment," it is the Taxpayer's responsibility to establish that the existing tax assessment is incorrect. As stated in IC § 6-8.1-5-1(c), "The notice of proposed assessment is prima facie evidence that the department's claim for the unpaid tax is valid. The burden of proving that the proposed assessment is wrong rests with the person against whom the proposed assessment is made."

Taxpayer explains that it arrived at its determination in the following manner:

The [vendor's] invoices placed a value on every item within the package and the sum of the individual values totaled the total purchase price for the package. We have randomly selected three test months from each year to review the invoices in detail. [] Our review entailed looking at each package to determine the useful and unwanted items. We then used the [vendor's] value on the invoice to allocate the purchase price to the useful and unwanted items within the package. The allocated cost for the three months was then added together. The total of the useful items were divided by the total of all the items to determine a percentage for the three months.

Taxpayer explained that its representative chose the three sample months by randomly drawing selections "out of a hat" and that its methodology reduces the proposed assessment by approximately $2,800.

Indiana law imposes on Taxpayer a requirement to maintain adequate, source documentation. IC § 6-8.1-5-4(a) states:

Every person subject to a listed tax must keep books and records so that the department can determine the amount, if any, of the person's liability for that tax by reviewing those books and records. The records referred to in this subsection include all source documents necessary to determine the tax, including invoices, register tapes, receipts, and canceled checks.

As noted above, the Department concedes that it is reasonably certain that items purchased from the on-line vendor were incorporated into Taxpayer's equipment but the issue is whether Taxpayer's calculation is correct and the Department's is wrong. In this case, Taxpayer must resort to an "after-the-fact" calculation because Taxpayer did not maintain the required source documentation conclusively establishing what items were entitled to the exemption and what items were not. As such, the Department is unable to sustain Taxpayer's protest. Taxpayer's "back-of-the-envelope" calculation may be valid but it is does not meet the standard establishing that the audit assessment was wrong.
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