What is the Difference between Sales Tax vs Use Tax

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Sales Tax and Use Tax Audits

Use tax bears repeating because it can create so many headaches and it is an area where the CDTFA is really digging in their heels.  In fact, use tax is one of the most miscalculated and unpaid taxes found during audits.

The use tax is a tax on the use of tangible personal property not otherwise subject to sales tax. Use tax is typically owed when someone purchases a product while paying less than the applicable sales tax or paying no sales tax at all. 

Unless that buyer has an exemption, use tax is owed to the government. Use tax is also due when a product is purchased from outside the state for use within the state when the seller is not registered for, nor collects sales tax in that state.

Use tax in the past has not been the purview of the seller; the buyer owes the use tax. However, state governments are beginning to hold sellers responsible for it when it is not paid.

What to Do:

  • Learn the difference between sales tax and use tax
  • Write a use tax policy for your business
  • Review all your non-resale purchase invoices and determine consumer use tax where is applicable
  • Properly track and account for any withdrawals made from your resale inventory

Use tax is a counterpoint to sales tax. For example, if I buy a car in Arizona, I can ship it to California because California is not charging me sales tax on that transaction because it is not occurring within the state. Instead, they charge me a use tax.

Use tax is levied on consumers of merchandise used, consumed or stored in the State of California. It does not matter where it was purchased. If you buy something from an online source that is not registered to collect California sales tax or else does not collect it, you are on the hook for paying the tax, which is the same rate as the sales tax.

Use tax is also imposed on leased merchandise such as cars, boats and planes. If you make a purchase in a foreign country and hand-carry it through U.S. customs into California, you must pay the use tax.

Use tax is the tax that I pay for importing goods into California. In situations where there is no sales tax, I pay use tax. 

Sales and use taxes are mutually exclusive. You cannot be required to pay both sales tax and use tax for the same merchandise.

 

Special Issues in California Use Tax Audits

Tax Auditor Treatment of Use Tax on Leases

In general, during California use tax audits, use tax will only be asserted against the lessor since it is difficult to determine from the lessee’s records whether the lease is a “sale” under the Sales and Use Tax Law. Therefore, a review of the lessor’s records will be made to determine if any tax liability exists.

Whenever the audit of a lessee reveals that tax has not been collected by the lessor, and the auditor cannot determine that tax was properly due, an audit memorandum (Form CDTFA–1164) will be prepared and sent to the lessor’s district. During use tax audits, the auditor will not assert tax against the lessee. 

An exception to the above general policy is that tax may be assessed against the lessee if the lessor is located out-of-state, and the property being leased is not mobile transportation equipment (MTE). If tax is assessed, Form CDTFA–1164 will be sent to the lessor’s current district showing the amount of tax assessed and the applicable periods.

Use of Form CDTFA-1164 by the Tax Auditor

In California use tax audits, taxpayers should be careful with resale certificates by the purchaser, because the auditor will pay attention to the nature of the goods to determine if a transaction was done in bad faith. 

For example, if a jewelry store obtains janitorial equipment, and obtains certificates, the auditor will review this transaction very carefully, and may determine lack of good faith by the taxpayer, leading to serious consequences. 

The auditor may contact the vendor to determine whether the vendor holds a valid resale certificate. In the event the vendor does not have a valid resale certificate, the tax generally will not be determined against the purchaser unless the sale occurred outside of California or is otherwise a transaction subject to use tax. 

Form CDTFA–1164 will be prepared by the auditor setting forth the pertinent facts about the transaction. This form, along with any supporting documents, will be used as basis for investigation in California use tax audits.

The auditor will also prepare Form CDTFA–1164 if in the examination of sales invoices the auditor finds that the seller did not charge tax and has accepted a properly executed resale or exemption certificate in good faith and the auditor questions whether the buyer has in fact purchased the merchandise for resale or in fact an exemption applies. 

The auditor should also prepare Form CDTFA–1164 where it is determined that a vendor is improperly computing tax on its invoices. 

For example:

  • Is not charging tax
  • Charges tax on repair labor or other exempt items
  • Does not charge tax on fabrication labor, trade-ins, or other components of the sale which should be included in the measure of the tax

Unsupported sales for resale to Mexican migrants which are discovered during audits of California sellers will be disallowed against the seller. The auditor also will prepare Form CDTFA–1164 for such sales, which then will be forwarded to San Diego District Office.

 

Treatment of Storage of Property Intended for Resale in Use Tax Audits

Please note that if a purchaser who timely gives a resale certificate or purchases property for the purpose of reselling it makes any storage or use of the property other than retention, demonstration or display while holding it for sale in the regular course of business, the storage or use measured by the purchase price is taxable as of the time the property is first so stored or used. 

Sections 6094 and 6244 provide that for property used under the following conditions the measure of the tax is the fair rental value of the property for the period of such other use:

  • Loan of property to customers as an accommodation while awaiting delivery of property purchased or leased from the lender, or the loan of property to a customer while the customer’s property is being repaired by the lender, provided it is not a loan of property pursuant to a mandatory warranty.

During California use tax audits, if a specific charge is made for use of the property, this may be used as the measure of tax provided the charge is consistent with the fair rental value. Property used frequently for purposes of demonstration or display and used partly for other purposes.