A claimed sale for resale will be allowed in a CDTFA audit if it is supported by a resale certificate that is proper in form and is timely taken in good faith from a person who is engaged in the business of selling tangible personal property and who holds a California seller’s permit.
If the purchaser is not required to hold a permit because the purchaser sells only property of a kind, the retail sale of which is not taxable, (e.g., food products for human consumption) or because the purchaser makes no sales in California, an appropriate notation to that effect will be entered in lieu of a seller’s permit number on the resale certificate under Regulation 1667 governing exemption certificate requirements.
A certificate will be considered timely if it is taken at any time before the seller bills the purchaser for the property, or any time within the seller’s normal billing and payment cycle, or any time at or prior to delivery of the property to the purchaser. CFA auditors can be stringent when enforcing the resale certificate requirement.
In an CDTFA audit, any document, such as a letter or purchase order, timely provided by the purchaser to the seller will be regarded as a resale certificate with respect to the sale of the property described in the document if it contains all of the essential elements in Regulation 1668.
A signed resale certificate that has been scanned and transmitted electronically or via a facsimile machine (faxed) is acceptable provided that it contains all of the information required by Regulation 1668, is timely and accepted in good faith, and contains the date and time of transmission and telephone number of the sender either on the document itself, or on the proof of transmission such as a copy of the email, or on the standard fax cover sheet.
One of the most common targets in a California sales tax audit is sales for resale. Sales for resale is the most common deduction claimed by California taxpayers and one of the most common targets of the CDTFA.
CDTFA sales tax auditors are especially careful in examining accounting methods used by taxpayers and use various procedures to verify amounts. Often, California taxpayers will estimate this deduction and will get tripped up in a sales tax audit when the CDTFA auditor uses their verification procedures.
Normally, there are two ways that a CDFA auditor will verify sales for resale. First, if the claimed deduction consists of relatively few items so that all transactions can be examined in a reasonable amount of time, the California sales tax auditor will audit every item in detail. Consequently, if sales for resale are numerous and of a reasonably similar unit value, the verification will be made on a test or sample basis.
The auditor will develop perimeters for their test, such as a time period and a method for screening data. This test will then be imputed to the rest of the audit period.
California sales tax audits for sales for resale generally are broken down into three classification categories:
- Detailed audit — lists of claimed sales for resale available
- Detailed audit — lists of claimed sales for resale not available
- Audit on test basis
California Procedures for Detailed Sales Tax Audits Where Resale Data is Available
In the case of a detailed audit, and when a list of claimed resales is available, claimed resales will be summarized by months or by quarters in accordance with the taxpayer’s listings and records. The taxpayer’s detailed schedules will be used as a basis for the verification.
The auditor will examine sales invoices and other documentary evidence of the non-taxability of the sales, such as resale certificates, purchase orders, correspondence, or contracts. The nature of transactions and the type and number of items purchased will be scrutinized to determine whether resale certificates appear to have been taken in good faith.
All sales questioned by the auditor for any reason will be listed on a subsidiary schedule. A copy of this schedule will be given to the taxpayer as an aid in attempting to support the exempt status of the questioned items.
A reasonable period of time must be given to the taxpayer to obtain this information before closing the audit. If a list of claimed resales is not available, then the auditor will request the taxpayer to prepare a detailed listing of all claimed sales for resale and the taxpayer must be allowed a reasonable amount of time to do so.
If questioned resales are not supported by the taxpayer to the auditor’s satisfaction during a California sales tax audit, then those sales will be disallowed.
One special item of note. Sales to Mexican merchants for resale are allowable if certain requirements are met. For example, a Mexican Merchant Identification Card must be valid and not expired at the time of the sale and the merchandise purchased for resale must be related to the special business classification codes on the card.
What Can be Considered a Resale Certificate in a CDTFA Audit
The CDFA provides detailed guidelines for CDTFA audits about what can be considered as a resale certificate.CDTFA provides following examples:
- A purchase order that contains all the elements of a valid resale certificate, containing words “for resale”
- A valid qualified resale certificate taken timely and in good faith, combined with a purchase order that contains any of the following phrases or similar terminology to indicate that tax or tax reimbursement should not be added to the sales invoice.
- • “for resale”
- • “resale = yes”
- • “taxable = no”
- • “nontaxable”
- • “exempt”
- If the purchase order includes both items to be resold and items to be used, the purchase order must specify which items are purchased for resale and which items are purchased for use. A seller must retain copies of the purchase orders along with the qualified resale certificates in order to support sales for resale.
- A letter covering a specific purchase from an out-of-state retailer or from a California purchaser if all the elements of a resale certificate are shown.
- Contracts of sale where all the essential elements of a resale certificate are included.
Other evidence of the validity of a claimed sale for resale may be accepted by the California Department of Tax and Fee Administration too in a CDFA audit.
Use of Form CDTFA-504 – Proving That a Sale was Not a Resale
In a CDFA audit, taxpayers should keep in mind that any of the evidence other than the actual resale certificate, by itself, is not the equivalent of a resale certificate timely taken in good faith and may not relieve the seller of the liability for the tax.
In absence of any valid resale documentation, in a California Department of Tax and Fee Administration audit, the auditor may determine that it is appropriate for a seller to use the Form CDTFA–504 series of forms (called “XYZ” Letters) procedure to help satisfy burden of proving that a sale was not at retail even though a valid resale certificate was not obtained or to substantiate a claim that taxpayer’s customer paid the tax directly to the state.
When it is appropriate to use the “XYZ” Letter process, the auditor will provide the taxpayer with a copy of forms CDTFA–504–A, B and C, or other type, if applicable. Various types of this letter are described on CDTFA’s website.
A response to an “XYZ” Letter inquiry alone is not necessarily enough to support a sale for resale. Generally, the “XYZ” Letter is not a substitute for a timely resale certificate, additional documentation or information may be required by the auditor.
CDTFA Audit – XYZ Letter Procedure
A period of four weeks will be allowed by the CDTFA for the taxpayer to prepare and send the “XYZ” statements and for the customer to reply. It is recommended that the “XYZ” statements be returned directly to the CDTFA.
Auditor will provide the taxpayer with appropriate forms and return envelopes. If the taxpayer elects to have the “XYZ'' statements returned to them instead of the CDTFA, then the likelihood of having CDFA staff contact the customer or sending an additional mailing is greater. Generally, in a CDFA audit, you would not want the auditor contacting the taxpayer’s customers.
The taxpayer may customize the “XYZ” cover letter. However, the use of a standardized “XYZ” statement will reduce any possible controversy over whether the proof provided is satisfactory.
The taxpayer may ask their customers to forward payment of tax reimbursement if the transaction is identified as taxable. The statement should clearly state that the payment of tax be forwarded to the taxpayer and not the CDTFA.
All modifications to the cover letter must be approved by the auditor’s supervisor. The “XYZ” statement must be used as provided by the auditor. The taxpayer’s customer is requested to return the completed “XYZ” statement within 10 days. The CDTFA auditor may request a second XYZ letter to be sent, depending on circumstances. All customers’ responses are part of the audit working papers and will be used in the audit.
When XYZ responses are not returned, the California Department of Tax and Fee Administration audit staff will make every effort, if not already done, to determine the taxability of the questioned sale by alternative methods.
The auditor can examine the customer’s seller’s permit registration to determine whether or not the purchaser had a permit at the time of purchase, can review the quantity and type of items sold, review a subsequent resale certificate and can contact the customer over the phone.
Please note that the CDTFA auditor is allowed to accept or deny support contained in documents based on personal knowledge the auditor gained from prior audits or other sources.
There are occasions when the taxpayer is unable to obtain an XYZ letter response because the customer is no longer in business due to a bankruptcy or another reason. In this situation only (but not in cases of corporate changes or reorganizations of customers) the sale will be considered a sale for resale if the property purchased by the customer is consistent with the type of sales the business makes.
If the sale appears to be of a type that could be consumed, the taxpayer is unable to obtain a proper XYZ letter response, and the auditor is unable to determine the exempt status of the sale by alternative means, the non-response will be treated by the California Department of Tax and Fee Administration auditor as an error.