The California Department of Tax and Fee Administration auditor will always make sure to distinguish between sales and use tax. Generally, the sales tax is the liability of the seller, whereas the use tax is the liability of the purchaser. A retailer who consumes merchandise purchased for resale under a valid resale certificate or any person who consumes merchandise purchased from a retailer, the sale of which is exempt from sales tax (in contrast to CDTFA sales tax audits), is liable for the use tax on the cost of the property purchased.
In the case of a use tax, purchaser is liable until he or she paid the tax to the state or to a vendor who is authorized or required to collect the use tax and who must issue a receipt to the purchaser. If the purchaser certifies in writing to a seller that the property purchased will be used in a manner as to entitle the seller to treat gross receipt form the sale as exempt from the sales tax, but purchaser actually uses the property in some other manner and for some other purpose, then the purchaser will be liable for sales tax as if purchaser was the seller in the original transaction.
Because many purchasers do not report taxable purchasers, during CDTFA sales tax audits, the CDTFA auditor will carefully examine purchase orders, purchase invoices, journal entries, general ledger accounting and so on. Based on the type of business and the condition of the records, there are three general procedures used during CDTFA sales tax audits in establishing purchases subject to use tax:
• Examination of purchase invoices, requisitions, journal entries and inventory credits
• Examination of debits to selected general ledger accounts and tracing the entries back to the purchase invoices or other documents of original entry
• In some businesses such as small bars and small grocery stores, a reasonable estimate may be used.
In contrast to CDTFA sales tax audits, for use tax, the auditor, however, is not going to wait and see if purchaser becomes liable on the tax, and will assess the seller. To avoid a duplicate assessment of use tax on the same transaction, the auditor completes Form CDTFA-1164, Memorandum of Possible Tax Liability, and makes a notation whether use tax was assessed on the seller/purchaser. Generally, in a simultaneous audit of the seller and purchaser, the use tax is assessed on the purchaser.
Invoices for a representative period, depending on the volume, will be examined and compared with the purchase record to determine that all invoices are on hand. If initial investigation shows that taxpayer is reporting all items correctly, auditor may stop further investigation. If auditor reveals some improper reporting, auditor may continue auditing the whole period initially contemplated.
The examination of invoices sometimes will be made regarding invoices from those who supply the taxpayer with resale merchandise and those vendors who consistently charge tax on consumable items as well as those vendors who do not charge tax on consumable items. The monthly amounts of merchandise so consumed are determined by an examination of several months’ purchase invoices. When this method is used, the taxpayer generally should be consulted and approval secured, if possible.
Generally, the taxpayer may be able to avoid paying tax by proving that the questioned items were not subject to the tax or were reported in another quarter. This is one of the critical thing you need to prove during CDTFA Sales Tax Audits.