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GENERAL AUDIT PROCEDURES Audit Manual Chapter 4 California State
Audit Manual
Chapter 4
GENERAL AUDIT PROCEDURES
Business Tax and Fee Department
California State
Board of Equalization
This is an advisory publication providing direction to staff administering the Sales and Use Tax Law and Regulations. Although
this material is revised periodically, the most current material may be contained in other resources including Operations
Memoranda and Policy Memoranda.
Please contact any Board of Equalization office if there are concerns regarding any section of this publication.
Audit Manual
General Audit Procedures
Table of Contents
GENERAL AUDIT PROCEDURES
0400.00
INTRODUCTION......................................................................................................... 0401.00
Audit Selection.........................................................................................................................0401.01
Form BOE-1164........................................................................................................................0401.02
Public Relations........................................................................................................................0401.03
Money Laundering....................................................................................................................0401.04
Tax Auditing .............................................................................................................................0401.05
Overview - Audit Procedures....................................................................................................0401.06
Audit Plan.................................................................................................................................0401.07
Pre-Audit Conference...............................................................................................................0401.08
Opening Conference ...............................................................................................................0401.09
Status Conferences..................................................................................................................0401.10
Information Document Request (IDR)......................................................................................0401.12
Audit Findings Presentation Sheet (AFPS)..............................................................................0401.14
Exit Conference .......................................................................................................................0401.16
Concurrent Audits.....................................................................................................................0401.18
TEAM AUDITS............................................................................................................ 0402.00
Overview..................................................................................................................................0402.01
Role of the Audit Supervisor.....................................................................................................0402.04
Role of the Lead Auditor...........................................................................................................0402.06
Role of Audit Team Member.....................................................................................................0402.08
Role of the Computer Audit Specialist in a Team Audit............................................................0402.12
PROGRAMMING — AUDIT SURVEY........................................................................ 0403.00
Starting an Assignment — General..........................................................................................0403.05
Transferring an Audit to Another District................................................................................. 0403.07
Preliminary Arrangements........................................................................................................0403.10
Video and Audio Taping............................................................................................................ 0403.11
Role and Responsibilities of Computer Audit Specialist...........................................................0403.12
Contacts with Third Party Representatives..............................................................................0403.14
Power of Attorney.....................................................................................................................0403.15
Written Correspondence...........................................................................................................0403.18
Preliminary Examination...........................................................................................................0403.20
Special Consideration — Fire or Natural Disaster....................................................................0403.23
Preliminary Testing...................................................................................................................0403.25
Survey of Plant.........................................................................................................................0403.30
Receipt for Taxpayer’s Records...............................................................................................0403.35
AUDIT PROGRAM — PROCEDURE TO FOLLOW................................................... 0404.00
Planning the Audit....................................................................................................................0404.05
Exploratory Testing...................................................................................................................0404.15
February 2016
Audit Manual
MAKING THE AUDIT — PROCEDURES AND TECHNIQUES.................................. 0405.00
General.....................................................................................................................................0405.05
Audits on a Taxable Measure Basis.........................................................................................0405.10
Short Tests................................................................................................................................0405.15
Use of Test Basis......................................................................................................................0405.20
Use of Form BOE–472, Audit Sampling Plan...........................................................................0405.23
Bank Deposits..........................................................................................................................0405.25
Obtaining Financial Information................................................................................................0405.27
Mark-Up Methods.....................................................................................................................0405.30
Using Third-Party Proprietary Data in Audits............................................................................0405.32
Use of Prior Audit Percentages of Error in Subsequent Audits................................................0405.33
Use of Successor or Predeccessor Information in an Audit.....................................................0405.34
Cut-Off Techniques...................................................................................................................0405.35
Whole Dollar Auditing...............................................................................................................0405.40
Working Papers........................................................................................................................0405.45
MAKING THE AUDIT —
APPLYING PROCEDURES AND TECHNIQUES................................................. 0406.00
General.....................................................................................................................................0406.05
Examination of General Ledger Accounts................................................................................0406.10
Examination of General Journal...............................................................................................0406.15
Examination of Cash Receipts and Disbursements Records...................................................0406.20
Examination of Accounts Receivable Ledger...........................................................................0406.25
Examination of Purchase Journal.............................................................................................0406.30
Schedule of Total Sales or Revenue........................................................................................0406.35
Gross Profit and Net Worth Analysis........................................................................................0406.40
Mark-Up Based on Income Tax Returns...................................................................................0406.45
Income Tax Returns as Basis of Audit......................................................................................0406.50
Examination of Sales or Revenue Invoices..............................................................................0406.55
Concessionaires.......................................................................................................................0406.60
SPECIALIZED TECHNIQUES — SALES AND USE TAX.......................................... 0407.00
General.....................................................................................................................................0407.05
Mark-Up Methods.....................................................................................................................0407.10
Short Tests................................................................................................................................0407.15
Verification of Recorded Total Sales.........................................................................................0407.20
Cash Register Shortages.........................................................................................................0407.25
PURCHASES SUBJECT TO SALES OR USE TAX.................................................. 0408.00
General.....................................................................................................................................0408.05
Methods of Verification.............................................................................................................0408.10
Audits of Sales Subject to Use Tax...........................................................................................0408.12
Examination of Purchase Invoices...........................................................................................0408.15
Use of Form BOE–503, “ABC” Letter Procedure.....................................................................0408.16
Assertion of Use Tax on Leases...............................................................................................0408.17
Use of Form BOE–1164, Audit Memorandum of Possible Tax Liability....................................0408.18
Information On Out-Of-State Retailers ....................................................................................0408.19
BOE-1164 File and Folder Names............................................................................................0408.20
Processing the BOE-1164........................................................................................................0408.21
California Use Tax Collections by Unregistered Out-of-State Retailers....................................0408.23
July 2016
General Audit Procedures
Examination of Selected General Ledger Accounts.................................................................0408.25
Other Records..........................................................................................................................0408.27
Capitalization of Resale Inventory............................................................................................0408.28
Examinations of Journal Entries and Requisitions...................................................................0408.30
Fungible Goods........................................................................................................................0408.35
Use or Loan of Property Purchased for Resale........................................................................0408.40
AUDIT OF SALES FOR RESALE.............................................................................. 0409.00
General.....................................................................................................................................0409.05
Methods of Reporting Resales.................................................................................................0409.10
Deduction Supported by Actual Lists........................................................................................0409.15
Deduction Calculated...............................................................................................................0409.20
Deduction Estimated................................................................................................................0409.28
Selection of the Basis for the Audit...........................................................................................0409.30
Detailed Audit — List of Claimed Resales Available.................................................................0409.35
Detailed Audit — List of Claimed Resales Not Available..........................................................0409.40
Effect of “Contra” Items on Deductions for Sales for Resale....................................................0409.45
Acceptable Documentary Evidence to Support Sales for Resale............................................0409.50
Use of BOE–504 — XYZ Letter Procedure..............................................................................0409.51
When Good Faith of Seller Is Questioned................................................................................0409.55
Purchase Orders and Resale Certificates................................................................................0409.60
Misuse of Resale Certificate.....................................................................................................0409.62
Tax Assessed On Purchaser....................................................................................................0409.63
Tax Billed by Vendor But Deleted by Purchaser.......................................................................0409.65
Verification of Payment of Use Tax by Purchaser.....................................................................0409.70
Drop Shipments........................................................................................................................0409.75
Multistate Tax Commission Multijurisdiction
Resale Certificate...............................................................................................................0409.80
AUDIT OF SALES TO THE U. S. GOVERNMENT..................................................... 0410.00
General.....................................................................................................................................0410.05
Auditing Procedure...................................................................................................................0410.10
Sales to Federal Employees
Using U.S. Government Bankcards....................................................................................0410.15
UNITED STATES GOVERNMENT SUPPLY CONTRACTS....................................... 0411.00
General .................................................................................................................................... 0411.05
Title Clauses ............................................................................................................................ 0411.10
Types of Contracts................................................................................................................... 0411.15
Types of Costs ......................................................................................................................... 0411.20
Auditing Procedures................................................................................................................. 0411.25
AUDIT OF CASH DISCOUNTS.................................................................................. 0412.00
General.....................................................................................................................................0412.05
Actual Cash Discounts Taken on Taxable Sales......................................................................0412.10
Composite Percentage of Deductions Taken...........................................................................0412.15
Percentage of Total Discounts Taken.......................................................................................0412.20
Trading Stamps........................................................................................................................0412.25
Sales Promotion Plans.............................................................................................................0412.30
Sales Tax Included In Cash Discounts.....................................................................................0412.35
January 2014
Audit Manual
AUDIT OF RETURNED MERCHANDISE................................................................... 0413.00
General.....................................................................................................................................0413.05
Methods of Claiming the Deduction.........................................................................................0413.10
Auditing Procedure — Deduction Claimed...............................................................................0413.15
Auditing Procedure — Deduction Netted from Sales...............................................................0413.20
Shipping and Handling Charges...............................................................................................0413.23
Rehandling and Restocking Charges.......................................................................................0413.25
Return of Tax Reimbursement..................................................................................................0413.26
Examination of Accounts Receivable.......................................................................................0413.30
Defective Merchandise.............................................................................................................0413.35
Price Adjustments.....................................................................................................................0413.40
AUDITS OF SALES IN INTERSTATE OR FOREIGN COMMERCE.......................... 0414.00
General.....................................................................................................................................0414.05
Auditing Procedure — Shipments Out-of-State........................................................................0414.10
Certificate of Verification — Out-of-State Delivery...................................................................0414.12
Audit Procedure — Shipments into the State...........................................................................0414.15
AUDIT OF DEDUCTION FOR LABOR....................................................................... 0415.00
General.....................................................................................................................................0415.05
Auditing Procedure...................................................................................................................0415.10
AUDIT OF SALES TAX INCLUDED IN SALES......................................................... 0416.00
General.....................................................................................................................................0416.05
Auditing Procedure...................................................................................................................0416.10
TREATMENT OF EXCESS TAX REIMBURSEMENT................................................ 0417.00
General.....................................................................................................................................0417.05
Refunds of Excess Tax Reimbursement...................................................................................0417.07
Auditing Procedure...................................................................................................................0417.10
Offsets......................................................................................................................................0417.15
Specific Applications.................................................................................................................0417.20
AUDIT OF PRESCRIPTION MEDICINES................................................................... 0418.00
General.....................................................................................................................................0418.05
Auditing Procedure...................................................................................................................0418.10
AUDIT OF OTHER DEDUCTIONS............................................................................. 0419.00
Audit of Bad Debt Deductions — General................................................................................0419.03
Auditing Procedure...................................................................................................................0419.10
Special Situations.....................................................................................................................0419.15
Bad Debts Incurred by Lenders on Purchased Accounts Receivable......................................0419.17
Credit for Tax Paid to Other States, Section 6406 Credit.........................................................0419.20
Shipment by Mail or Common Carrier to Indian Reservations.................................................0419.22
Property Used in Tribal Self-Governance by Tribes Without Reservation Facilities.................0419.24
Tax Paid Purchases Resold.....................................................................................................0419.25
Audit of Charitable Organizations.............................................................................................0419.30
Auditing Transportation Charges..............................................................................................0419.35
New or Remanufactured Trucks, Truck Tractors, Trailers, or Semitrailers...............................0419.45
Sales Tax Exemption for Foreign Missions and Consuls..........................................................0419.50
Audit of Electronic Benefit Transfer (EBT) Card Purchases.....................................................0419.60
Federal Excise Tax...................................................................................................................0419.65
August 2016
General Audit Procedures
AUDIT OF LEASES.................................................................................................... 0420.00
General.....................................................................................................................................0420.05
Auditing Procedure...................................................................................................................0420.10
Timely Election.........................................................................................................................0420.15
Items Included in Rental Receipts............................................................................................0420.20
Items excluded from rental receipts.........................................................................................0420.25
Sale of Leased Property by Lessor..........................................................................................0420.30
Repair and Maintenance Contracts..........................................................................................0420.35
Fuel Used in Rental Vehicles “Wet Rentals”.............................................................................0420.40
Audit of Sale and Leaseback Transactions..............................................................................0420.45
Audit of Lease Transactions with Governmental Bodies..........................................................0420.50
AUDIT OF NONTAXABLE ELECTRONIC SALES
AND PURCHASES OF COMPUTER SOFTWARE .............................................. 0421.00
Introduction ..............................................................................................................................0421.01
Software Transferred by a Load-and-Leave Process...............................................................0421.02
Sales and Purchases of Software Transferred
Electronically ...........................................................................................................................0421.03
Audit Procedures for Sale........................................................................................................0421.04
Audit Procedures for Purchases...............................................................................................0421.05
Dongles....................................................................................................................................0421.06
Annual Software License Renewals.........................................................................................0421.07
Optional Software Maintenance Contracts...............................................................................0421.08
PARTIAL EXEMPTIONS............................................................................................. 0422.00
Farm Equipment and Machinery..............................................................................................0422.10
Solar Power Facility..................................................................................................................0422.15
Contract Operators Diesel Fuel Partial Exemption...................................................................0422.20
AUDIT OF FRANCHISORS OR LARGE RETAILERS............................................... 0423.00
Third-Party Data Requests to Franchisors and Large Retailers...............................................0423.10
Procedure.................................................................................................................................0423.15
AUDIT OF MOTOR VEHICLE FUEL.......................................................................... 0430.00
General.....................................................................................................................................0430.05
Auditing Procedure...................................................................................................................0430.10
Methods of Verification.............................................................................................................0430.15
Acquisition of Ex-Tax Gasoline.................................................................................................0430.20
AUDIT OF MOTOR VEHICLE FUEL RETAILERS —
PREPAYMENT OF SALES TAX............................................................................ 0431.00
General.....................................................................................................................................0431.05
Reporting Requirements..........................................................................................................0431.10
Auditing Procedures.................................................................................................................0431.15
Procedures Where Retailer is also a Supplier/Wholesaler.......................................................0431.20
Local Tax Allocation..................................................................................................................0431.25
Bad Debts.................................................................................................................................0431.30
Eligibility for Removal from Prepayment Status.......................................................................0431.35
Close-Outs...............................................................................................................................0431.40
Working Papers........................................................................................................................0431.45
October 2015
Audit Manual
SPECIAL MOTOR VEHICLE FUEL TRANSACTIONS.............................................. 0432.00
Retailers Who Premix or Blend Motor Vehicle Fuel and Lube Oil............................................0432.10
Retailers Who Purchase Premix from a Supplier.....................................................................0432.15
Credit Card Sales.....................................................................................................................0432.20
Master Contract Sales..............................................................................................................0432.25
Sales to the U.S. Government..................................................................................................0432.30
Sales to Local Governments....................................................................................................0432.35
Sales of Gasoline for Use in Aircraft.........................................................................................0432.40
Sales to Aircraft Common Carriers and Operators of Waterborne Vessels..............................0432.45
Sales to Auto Leasing Firms.....................................................................................................0432.50
Sales to Lessors of Mobile Transportation Equipment.............................................................0432.55
Refund of Sales Tax on State Motor Vehicle Fuel Tax Refunds...............................................0432.60
Refund of Sales Tax on Federal Excise Tax Refunds...............................................................0432.65
AUDIT OF FUEL DISTRIBUTORS/BROKERS —
PREPAYMENT OF SALES TAX............................................................................ 0433.00
General.....................................................................................................................................0433.05
Prepayment Credits..................................................................................................................0433.10
Auditing Procedure...................................................................................................................0433.15
Reporting Errors.......................................................................................................................0433.20
Audit Working Papers...............................................................................................................0433.25
Bad Debts.................................................................................................................................0433.30
Local Tax Allocation..................................................................................................................0433.35
New Car Dealers......................................................................................................................0433.40
CREDIT OFFSETS...................................................................................................... 0434.00
Claim for Refund Filed While Audit Determination
In Petition Status or Within Six Months of Finality Date.....................................................0434.05
Claim for Refund Filed When Audit Determination Not in
Petition Status or More Than Six Months After Finality Date..............................................0434.10
Split Billings..............................................................................................................................0434.15
Claim for Refund Filed Timely for Audit Determination
But not for Phone-In Determination....................................................................................0434.20
Application of Overpayments to Expired
Liabilities But Within the Claim for Refund Period..............................................................0434.30
Offsetting Interest on Claims for Refund Filed During an Audit ...............................................0434.32
MANAGED AUDIT PROGRAM.................................................................................. 0435.00
Managed Audit Program – General..........................................................................................0435.05
Eligible Accounts......................................................................................................................0435.10
Application of Interest and Penalties........................................................................................0435.15
Audit Procedure........................................................................................................................0435.20
June 2014
GENERAL AUDIT PROCEDURES
ALTERNATIVE METHOD OF REPORTING USE TAX............................................... 0436.00
General.....................................................................................................................................0436.01
Eligibility...................................................................................................................................0436.02
AMRUT Approval Process........................................................................................................0436.03
Taxable Percentage Calculation...............................................................................................0436.04
Term..........................................................................................................................................0436.05
Renewal...................................................................................................................................0436.06
Termination or Cancelation.......................................................................................................0436.07
Revised Percentages...............................................................................................................0436.08
Post Review and Evaluation.....................................................................................................0436.09
APPLICATION OF TAX TO SPECIFIC TRANSACTIONS......................................... 0437.00
Food Sales at Movie Theaters..................................................................................................0437.05
Application of Tax to Multi-Use Containers...............................................................................0437.10
Taxability of Meal Replacement Products................................................................................0437.15
Motion Picture Industry - Release Prints..................................................................................0437.20
Rebates and Incentives............................................................................................................0437.25
REASSIGNMENT / TRANSFER OF AUDIT ASSIGNMENTS.................................... 0442.00
Reassignment of Audits within a District Office........................................................................0442.02
Interdistrict Cooperative Audits.................................................................................................0442.04
Responsibilities of the Controlling District Office......................................................................0442.06
Responsibilities of the Cooperating District Office...................................................................0442.09
GLOSSARY OF TERMS............................................................................................. 0490.00
May 2016
Audit Manual
General Audit Procedures
GENERAL AUDIT PROCEDURES
0400.00
INTRODUCTION0401.00
It is not the purpose of the Audit Manual (AM) to lay down rules so rigid the auditor is precluded
from the exercise of reasonable judgment. Suggested procedures that conform to standard audit
practices are presented with an explanation of the terms frequently used by auditors. The auditor
should recognize, however, that there are many variations necessitated by application of the law,
rules and regulations, taxpayer’s methods of reporting, and types of records encountered. For
these reasons, it is impractical to present procedures that will be applicable to all situations. The
typical flow of the audit process is illustrated in Exhibit 1.
The primary objective of the audit program is to determine, with the least possible expenditure
of time, the correct measure of tax. The audit program provides information and assistance to
taxpayers, enabling them to complete returns and pay taxes correctly and efficiently. Interpretations
of the law and related regulations during the audit process provide taxpayers with proper basis
or method for reporting future tax liabilities.
AM sections 0401.00 and 0402.00 apply to audits, field billing orders and claims for refund.
Completion of Form BOE-414-Z, Assignment Activity History, (BOE-414-Z) using the 414-Z
Program is mandatory for all audit assignments (including reaudits and claims for refund). See
AM section 0221.00.
Specific reference is made to the glossary contained in AM section 0490.00 for terms peculiar
to tax auditing which are used in this chapter. The auditor is expected to have a good working
knowledge of these terms prior to reading this chapter.
AUDIT SELECTION
0401.01
Each district is responsible for determining which accounts are to be audited.
An audit assignment does not always result in a completed audit. Preliminary testing (AM section
0403.25) may disclose that an audit is not warranted, in which case auditors prepare Form
BOE–596, Report on Account Being Waived for Audit (See AM section 0212.00).
When deciding whether to waive or perform an audit, the auditor should consider the following
points:
• Are accurate and complete records kept?
• Does the markup on cost of goods sold appear adequate?
• Are the persons preparing tax returns familiar with the law and the rules and regulations
pertaining to their particular business?
• Are the reported amounts reasonable considering the type of business, nature of the
premises, the location in the community, etc.?
• Do the reported amounts vary materially from period to period?
• Is there a good system of internal control?
• Is the taxpayer’s past reporting record good?
When working on an audit assignment, the auditor may discover other accounts which may not
have reported the correct amount of tax. Such information should be communicated to the audit
supervisor.
February 2016
Audit Manual
FORM BOE-1164
0401.02
The auditor should prepare Form BOE–1164, Audit Memorandum of Possible Tax Liability,
(Exhibit 2) in appropriate circumstances. The information on this form is valuable in audit
selection and may aid in disclosing tax that may otherwise remain unreported. Therefore, the
importance of preparing this form cannot be overemphasized. For information on the use of Form
BOE–1164, see AM section 0408.18.
The auditor should also be alert for activity in other tax and fee programs for which the taxpayer
may not have a permit. See AM sections 0205.51, 0205.53, 0205.55, 0205.56, and 0205.57.
Confidentiality of Form BOE–1164 Information
Current policy allows copies of Form BOE–1164 to be released to a taxpayer if the confidential
information about another taxpayer is redacted. Thus, seller information must be redacted when
the form is provided to the buyer, and buyer information must be redacted when the form is
provided to the seller. Any invoices that are attached to Form BOE–1164 must also be redacted
to remove confidential information.
The information to be redacted includes any information which might lead to the discovery of
confidential taxpayer information such as the taxpayer’s name, permit number, purchase order
number, invoice number, dollar amount of purchase, or comments.
Audit Memorandums Concerning State Agencies The Department of Finance no longer audits state agencies and therefore no longer receives or takes
action on audit memorandums. Therefore, the audit memorandums prepared by auditors which
involve state agencies should be distributed in the same manner as other audit memorandums.
The Out-of-State District in auditing out of state businesses should question any sales or leases
to the State of California. If they find sales or leases subject to use tax in which the tax was not
paid to the state or reported by the retailer, such sales or lease receipts should be assessed in the
audit. Special care should be taken to accurately assess applicable local and district taxes.
PUBLIC RELATIONS
0401.03
It is important that the auditor attempt to establish a good rapport with the taxpayer thereby
encouraging a cooperative attitude. The Board of Equalization (BOE) has established a basic
policy which is clearly stated in AM Chapter 1 — General Information. The complete compliance
with this policy cannot be overemphasized.
The auditor should maintain an objective attitude, tempered by the fact that we are working with
human beings. To the extent possible, the auditor should:
• Encourage a cooperative attitude by being cooperative
• Maintain an “arms-length” relationship with the taxpayer by not becoming personally
involved
• Avoid arguing with the taxpayer
• Avoid “humorous” remarks as they may be misinterpreted by the taxpayer
• Avoid political and religious discussions
February 2016
General Audit Procedures
Public Relations
(Cont.) 0401.03
Public relations are a factor during the entire course of the audit. The auditor should develop a
sense of timing as to when it is best to discuss the various audit phases with the taxpayer; e.g.,
after agreement has been reached regarding appropriate test procedures with the taxpayer, no
further discussion should be required until test findings are established or necessary changes in
agreed procedure are required. On the other hand, many taxpayers prefer to receive schedules
of questioned items as they are completed. This makes it possible for the taxpayer to begin work
on possible exceptions while the auditor continues the test. This method facilitates a more rapid
completion of the audit and makes an early test cutoff possible, if appropriate.
The auditors’ appearance, clothing and conduct should be appropriate to their professional status.
There is one basic difference between tax auditing and public accounting: The public accountant
is serving their client and is on the client’s premises at the request of the client; the tax auditor’s
presence is usually not requested.
MONEY LAUNDERING
0401.04
In cooperation with the Department of Justice, the BOE has agreed to provide assistance in
the enforcement of money laundering violations by reporting suspected violations. If potential
violations of money laundering or monetary instrument transaction reporting laws are suspected,
a report documenting the suspected violation should be prepared and forwarded to the Deputy
Director, Field Operations Department (FOD). FOD will then forward the report to the Department
of Justice. This report should be submitted in a form similar to that shown in Exhibit 3.
The law contains two money laundering offenses the auditor should look for when conducting an
audit. These are referred to as the “facilitation” offense and the “capturing” offense.
The facilitation offense includes conducting or attempting to conduct a transaction involving
a monetary instrument or instruments exceeding $5,000 through a financial institution with
the intent to promote, manage, establish, carry on or facilitate the promotion, management,
establishment or carrying on of any criminal activity.
The capturing offense involves the laundering of illegally derived proceeds. It includes conducting
or attempting to conduct a transaction involving a monetary instrument or instruments exceeding
$5,000 through a financial institution with knowledge that the monetary instrument represents
the proceeds of criminal activity.
Auditors should not spend a significant amount of time investigating potential money laundering
violations. However, any suspected violations discovered in the course of regular auditing
procedures should be reported.
TAX AUDITING 0401.05
Introduction
Tax auditing is defined as an inquiry into all phases of a taxpayer’s business where significant tax
error could occur. Tests are conducted in accordance with generally accepted auditing standards.
They are extensive or comprehensive only to the degree necessary to support a professional audit
opinion as to the accuracy of returns as filed. Tests of records where potential errors are small
are normally not as comprehensive as tests where substantial errors are possible. Expression
of the auditor’s opinion or recommendation concerning all tax-significant phases of a taxpayer’s
business are reflected in the following types of audit reports:
February 2016
Audit Manual
Tax Auditing
(Cont. 1) 0401.05
1. BOE–414–A “Change” reports recommending:
•Deficiency determination per section 6481
•Determination — No returns filed per section 6511
•Refund recommendation per section 6901
2. BOE–414–C “No change” reports
Very limited testing or sampling may be all that is necessary to support a “No Change” report or
“No Change” phase(s) of a “Change” report. Testing to support substantial change recommendations
must include sufficient verification or explanatory comments so that the report is understandable
and can be evaluated by other members of the staff as to the soundness of the auditor’s opinion
or recommendation. (See AM Chapter 2 for Form BOE–414–B, Field Billing Order, and field
waivers (BOE–596) which are short of a full report as contemplated by Form BOE–414–C, Report
of Examination of Records, or Form BOE–414–A, Report of Field Audit.)
Auditors should make the most efficient use of their time by making full use of all available
records and worksheets of the taxpayer. The auditor should schedule exceptions noted. This has
the advantage of aiding the auditor in discussing the direct findings with the taxpayer. This
procedure also helps to clarify the exceptions to the specific law and/or regulations.
Audit Approach Many taxpayers are careful to report taxable transactions accurately, especially after one or more
audits have been made. To make an extensive examination of three years’ operations in these
situations may not be justified. Short tests should be made before starting a complete verification
of three years’ operations.
If these short tests indicate the taxpayer has not properly reported their tax liability, the auditor
should make more extensive tests. The short test should be designed so that the result can be
combined with more extensive tests to determine the proper measure of additional tax.
Approach to Auditing Credits or Refunds
A primary purpose of the BOE’s audit program is to provide reasonable assurance that taxpayers
pay neither more nor less tax than required by law. Consequently, the BOE is just as concerned
with refunding overpayments as with collecting underpayments. If a refund situation is noted in
the course of the audit, the auditor should normally secure a claim for refund from the taxpayer
utilizing Form BOE–101, Claim for Refund or Credit.
Sampling and projection techniques may be used by taxpayers to determine the amount of
overpayment of tax liability using criteria similar to the techniques used by auditors (AM sections
0405.20 and 1302.05). If sampling and projection techniques are not appropriate for some or all
of the transactions, the amount of the refund will be determined on an actual basis.
The preferred method of sampling is statistical sampling, as described in Chapter 13 of this
manual. Claims for refund using statistical sampling methods must meet the BOE’s established
standards for statistical sample evaluation. If statistical sampling is not feasible, non-statistical
sampling procedures, as discussed in this chapter, may be considered.
Once the taxpayer has filed a claim for refund and has requested or suggested determining the
amount of refund by means of sampling, the claim will be assigned to an auditor who will contact
the taxpayer to determine if sampling is feasible and, if so, develop a mutually agreeable sampling
plan. The auditor may choose to consult a Computer Audit Specialist (CAS) on the sampling plan.
Taxpayer requests for CAS consultation are subject to the procedures outlined in AM section
1302.25(h).
February 2016
General Audit Procedures
Tax Auditing
(Cont. 2) 0401.05
During the course of an audit, conducted on an actual or sample basis, the auditor may detect both
underpayments and overpayments. It is very important that the underpayments and overpayments
(credit offsets) be treated equally. When an audit is done on a sample basis, both overpayments (in
certain situations) and underpayments need to be taken into account and treated the same when
examining sample items, analyzing the sample results, and projecting the resulting errors to the
population being tested. Any allowable credit offsets resulting from the sample should be a part
of the calculation of the percentage of error to be applied to the population. See section 1302.25(i)
for additional discussion of tax overpayments (credit offsets) in the sampling plan.
The completion and transmittal of audit reports recommending refunds must be given urgent
priority. Each district must establish procedures for the early identification and control of audits
involving refunds so that such audits are completed and transmitted without unnecessary delay.
Waiver of Credit Interest Policy Claims for Refund
The taxpayer should always be allowed a reasonable time in which to support a claim for refund.
Under most circumstances, ninety days is considered reasonable.
If the taxpayer has been granted a 90 day delay and requests additional time, consideration
should be given to obtaining a waiver of credit interest. The BOE may require a claimant to sign a
Form BOE–146, Waiver of Credit Interest, as a condition to deferring action on a claim for refund
(Revenue and Taxation Code section 6908(b)). In some cases, it may be appropriate to allow up to
an additional ninety days because of the size of the claim and quantity of supporting documentation
required. However, delays beyond six months should not be allowed without a waiver of credit
interest or the approval of the Deputy Director, Business Tax and Fee Department, or designee,
or Deputy Director, Field Operations Department, or designee, as appropriate.
An extension of time beyond twelve months from the date the taxpayer was first notified in writing
to compile the necessary data in support of the claim should not be allowed even if the taxpayer is
willing to sign a waiver of credit interest or an extension to an existing waiver of credit interest. If
the taxpayer does not provide the supporting data within the twelve-month period, the claim for
refund will be denied for failure to support the grounds upon which the claim was based. Exceptions
to this policy must be approved by the Deputy Director, Business Tax and Fee Department, or
designee, Deputy Director, Field Operations Department, or designee, as appropriate.
Deficiency Audits with Credits
If the taxpayer contends that there are other credits which offset or exceed a deficiency disclosed
by an audit in process and requests additional time to obtain information supporting such credits,
completion of the audit may be delayed for up to 90 days. A notation should be made on the
BOE–414–Z of the date and reason for the delay. Should the taxpayer request a further delay, the
deficiency audit should be completed as a non-concurred audit and processed in the usual manner.
With regard to the credits in question, it is critical that the auditor obtain a timely claim for refund
which includes the taxpayer’s specific contentions. The claim for refund, and when appropriate
a waiver of credit interest, should be forwarded to the Audit Determination and Refund Section
(ADRS) with all pertinent information concerning the credits and the waiver of credit interest.
Subsequent action by the district office, if needed, will be requested by Headquarters.
It should be noted that refunds are to be considered priority assignments. In those cases where
a taxpayer has given the BOE a waiver, it becomes even more imperative that prompt action be
taken.
February 2016
Audit Manual
Tax Auditing
(Cont. 3) 0401.05
Authorized Signatory
To preclude any question about the validity of a waiver, Form BOE–146, Waiver of Credit Interest,
must be signed by:
• The owner in the case of a sole proprietorship,
• A partner in the case of a partnership,
• A corporate officer in the case of a corporation,
• A member in the case of a limited liability company (LLC), or
• A person holding a written power of attorney from the owner, partner, member, or a
corporate officer.
Taxpayers may use Form BOE-392, Power of Attorney, to document power of attorney status. In
lieu of Form BOE-392, BOE staff may accept any written documentation identified as a power of
attorney containing the essential elements as described in AM section 0403.15, Power of Attorney.
With respect to corporations, if the title of the person signing the waiver is other than chairman
of the board, president, secretary, or chief financial officer, the auditor must verify, by examining
the corporate articles or bylaws regarding corporate officers, that the titled position constitutes
a corporate officer.
With respect to partnerships, if the person signing the waiver is not listed as a partner on the
Integrated Revenue Information System (IRIS) TAR AI screen, the auditor must verify the validity
of the person’s status as a partner by reviewing the partnership agreement. Any changes in
partners must be reported to district compliance as provided in AM section 0219.03.
A copy of the written power of attorney must be obtained and included with the copy of the waiver(s),
Form BOE–146 in the Forms subfolder of the audit case folder, and transmitted to Headquarters
with the audit report if the waiver signatory is other than a corporate officer, partner or owner.
OVERVIEW - AUDIT PROCEDURES
0401.06
To facilitate the completion of audit assignments pursuant to Regulation 1698.5, Audit Procedures,
audit procedures and guidelines in AM sections 0401.07 to 0401.18 provide for the following:
• Appropriate and timely communication between BOE staff and the taxpayer, of requests,
agreements, and expectations related to an audit.
• Auditing environment for timely completion of an audit within two years (neither BOE
staff nor taxpayers should construe this goal to mean the audit must take two years when
the audit can be completed sooner, or that the completion of an audit must occur within
two years when a longer timeframe is warranted).
• Consistent definitions and procedures to allow audit manual users with various levels of
expertise, both within and outside BOE, to navigate through the sometimes complex audit
process.
February 2016
General Audit Procedures
AUDIT PLAN
0401.07
All audits must be guided by an organized plan. A carefully thought-out, but flexible, audit plan
is the first step towards good working papers and a good start. Such an audit plan forces advance
thinking and a proper overview of the assignment as a whole.
The objectives of the audit plan are as follows:
• Establish open lines of communication.
• Promote understanding of commitments made and agreements reached.
• Identify key potential audit issues.
• Assist in the progression and completion of the audit.
An audit plan allows the auditor and the taxpayer to work together to resolve problems as early
as possible in the audit process and establish a common understanding and working relationship.
The audit plan should be sufficiently detailed so that the taxpayer and BOE staff can assess, at
any time, the extent of work that has been completed, the work remaining, and a timeframe for
the completion of the work remaining. In doing so, the audit plan helps ensure an effective and
efficient audit that is less burdensome, less costly, and less intrusive.
The complexity of the audit plan will differ based on the circumstances of each audit. The auditor
should develop an audit plan that strives for the timely completion of an audit within a two-year
timeframe beginning with the opening conference (AM section 0401.09) and ending with the
exit conference (AM section 0401.16). Most audits, however, will be completed in a much shorter
timeframe although some may require a period beyond two years. The auditor should consider
the duration of the audit and anticipated completion date when preparing the audit plan.
Working With Taxpayers
A positive working relationship with the taxpayer is conducive to the effective and timely completion
of the audit. Taxpayer participation in the development of the audit plan is encouraged. The audit
plan should be discussed and expanded upon during the course of the audit as the auditor learns
more about the taxpayer’s business and records.
By reviewing the audit plan with the taxpayer:
• Both parties will be able to more efficiently manage the fact gathering and analysis process.
• The taxpayer will be able to anticipate deadlines better and provide alternative solutions to
resolving issues, such as when specific records are unavailable or missing but alternative
records or documents can be provided which contain the requested information.
• Apprehension by the taxpayer may be minimized, and communication and cooperation is
enhanced.
• The materiality or immateriality of specific audit areas can be discussed early, and if
appropriate, those areas found to be immaterial may be waived from examination.
• The audit plan can be revised as the need for more, less, or different work arises than
originally noted.
February 2016
Audit Manual
Audit Plan
(Cont. 1) 0401.07
Development of an Audit Plan
The audit plan sets forth the road map for the audit and therefore should be completed as a
preliminary step to conducting the audit. Prior to the opening conference, auditors should begin
to prepare an audit plan.
Because the audit process is collaborative, the auditor should obtain input and information from
the taxpayer regarding the business and its records prior to the formulation of an audit plan.
This may be done in a pre-audit conference (AM section 0401.08) or during preliminary contact
to set-up the first audit appointment (AM section 0403.10).
In order for the audit plan to be meaningful and relevant, the auditor should review the taxpayer’s
history and prior audit(s) in determining the scope of the expected audit. This includes analyzing
tax returns, transcripts, the taxpayer’s account (including ownership); reviewing the prior audit
history; researching the business and industry; researching for other BOE tax and fee accounts;
and performing other information gathering techniques that provide the auditor with a better
understanding of the taxpayer’s business and potential audit issues.
The audit supervisor is required to review and sign the audit plan before it is presented to the
taxpayer. The audit supervisor should document his or her approval on the BOE-414-Z (AM
section 0221.00).
The auditor should discuss the audit plan with the taxpayer at the opening conference (AM section
0401.09), and provide a copy at the time of the discussion. When it is necessary for the auditor
to first review the taxpayer’s records or to obtain supervisory approval, a copy of the audit plan
may be provided to the taxpayer after the discussion but no later than 30 days from the opening
conference.
Additional guidelines for preparing an audit plan:
• The audit plan should be clearly marked “Initial” or “Revised” with a revision date at the
top of all audit plans.
• After the opening conference, the auditor, the supervisor, and assigned team members (if
applicable) should complete the final audit plan incorporating changes made as a result
of discussions with the taxpayer.
• If there are significant changes to the audit plan discussed at the opening conference and the
supervisor who previously signed the audit plan was not present at the opening conference,
the auditor should submit the audit plan to the supervisor for review and approval before
providing it to the taxpayer.
• Any changes or revisions to the audit plan should be provided to the taxpayer.
• Audit supervisors should review the progress of all audits at least monthly. The audit plan
should always be a part of the review and the audit supervisor should write a comment on
the BOE-414-Z at the time of review.
February 2016
General Audit Procedures
Audit Plan
(Cont. 2) 0401.07
Audit Plan Details
In addition to any areas, audit procedures, and/or tasks to be addressed in the audit, the following
items should also be included in the audit plan. Additions or deletions from the audit plan should
be done on a case-by-case basis.
1. Audit Scope — The audit scope shows the audit period, district/branch/area office
conducting the audit, areas to be examined, number of divisions or locations, related
accounts, and overview of transactions.
2. List of Key Personnel — Identify all key BOE staff, taxpayer personnel, and any outside
representatives, including their addresses and telephone numbers. The auditor should
confirm that the taxpayer personnel identified in the audit plan are authorized to provide
the BOE with records, receive Information Document Requests (IDRs), and are authorized
to enter into preliminary and final discussions with BOE. See AM section 0403.14, Contacts
with Third Party Representatives.
3. Timeframes — The audit plan should document the estimated timeframe required to
complete the audit. Although not shown in the audit plan, budgeted hours for the entire
audit should be established and taken into consideration when estimating the time required
for each area of the audit. Establishing a timeframe in the audit plan and adhering to it is
critical in completing audits timely. Throughout the audit process, these timeframes serve
as benchmarks against which progress is measured. Timeframes should be established for
the following:
• Estimated start and completion dates
• Scheduled future field appointments
• Status conferences (AM section 0401.10)
4. Claims for Refund — The audit plan should document claims for refund filed and the
testing procedures to be used to verify the claimed amounts.
5. Amended Returns Filed by the Taxpayer — Determine if any amended returns were
filed by the taxpayer and whether copies of returns will need to be requested.
6. Audit Issues — Identify known audit issues and the potential tax application or effect.
The taxpayer should be informed that additional audit issues may arise during the course
of the audit and changes to the audit plan will be made accordingly.
Signing the Audit Plan
The audit supervisor reviews and signs all audit plans before they are presented to the taxpayer.
Then the auditor and taxpayer should sign the final completed audit plan, and provide the taxpayer
a copy. Signing the audit plan shows a commitment by all parties that the audit will be conducted
in the manner discussed and will allow for the timely completion of the audit. If the taxpayer does
not agree with the audit plan and refuses to sign, the auditor should make changes, if warranted,
in order to reach an agreement with the taxpayer. If the auditor feels no adjustment is warranted,
the auditor should consult with the audit supervisor prior to proceeding as provided in the audit
plan. Both the taxpayer’s and the auditor’s position should be documented on both the audit plan
and on the BOE-414-Z.
The auditor and the audit supervisor should initial and date any amendments to the original audit
plan and provide a copy of the amended audit plan to the taxpayer. The auditor should document
on the BOE-414-Z the delivery of the original and any amended audit plans to the taxpayer, or the
reason the taxpayer did not sign the audit plan. Signed copies of the audit plan and copies of all
amended audit plans, should be scanned and saved in the Forms subfolder of the audit case folder.
February 2016
Audit Manual
PRE-AUDIT CONFERENCE
0401.08
A pre-audit conference is a meeting between the taxpayer and BOE staff (including the audit
supervisor and computer audit specialist (CAS), if appropriate) prior to the opening conference
(start of the audit) to discuss the availability and production of records, including electronic
records. While a telephone discussion may suffice for smaller or less complex audits, a pre-audit
conference is required on larger or more complex audits, especially those where electronic records
are involved. After the auditor conducts the preliminary overview work on the audit, he or she
will have the ability to determine whether a pre-audit conference is warranted.
The pre-audit conference may occur several months before the first day the field work begins.
Among other things, such as discussion of staffing and resources that are needed by the taxpayer
and BOE staff, a pre-audit conference provides for a discussion of the records that are required,
the period for which requested records are available, the manner in which they are to be furnished,
and the timeframe in which they are to be made available. Participation in a comprehensive preaudit conference by key taxpayer and BOE staff will minimize the likelihood of misunderstanding
and reduce delays in retrieving records.
Prior to the pre-audit conference, the auditor should send the taxpayer the appropriate Form BOE80 series, Audit Engagement Letter, to confirm arrangements to begin the audit or to establish
contact with the taxpayer. These forms are discussed in AM section 0403.10.
Taxpayers (owners, partners, or corporate officers) should be invited and encouraged to attend
the pre-audit conference, even if they have authorized another person to represent them (AM
section 0403.14.). The audit supervisor should attend the pre-audit conference, when feasible, to
ensure proper direction and control of the audit is in place. In cases involving electronic records,
the CAS should participate in the pre-audit conference to discuss the availability of the electronic
records, as appropriate. The auditor should suggest that the taxpayer include their information
technology staff in the pre-audit conference to discuss the technical aspects of retrieving the
necessary electronic records.
The CAS assigned to a specific audit will serve as a technical consultant to the auditor(s) to assist
with the electronic records and sampling. At the pre-audit conference, the auditor should inform
the taxpayer that technical questions regarding the data may be addressed to the CAS; and all
questions and issues related to the audit and scope of work will be handled by the auditor. The
CAS should be given access to the BOE-414-Z so that the CAS can enter comments as appropriate.
For more information about the role of CAS, see AM section 0403.12.
Items to be discussed in the pre-audit conference should include, but are not limited to the following:
• General audit procedures
• Use of Prior Audit Percentage of Error (AM section 0405.33)
• Use of Managed Audit Program (AM section 0435.00)
• Availability of and access to records
• Computer assisted audit procedures
• Relevant sampling issues
• Data transfer process
• Verification of data
• Security of data
• Timeframes for the furnishing and reviewing of records
• Name of the person(s) designated to receive IDRs
• Potential new or emerging issues
• Potential claims for refund
February 2016
GENERAL AUDIT PROCEDURES
OPENING CONFERENCE 0401.09
The opening conference is considered the start date of the audit since it is generally the first on-site
meeting between the taxpayer and BOE staff to discuss how the audit will be conducted and to
begin the field work. For large or complex audits, the audit supervisor should attend the opening
conference to ensure that proper direction and control of the audit are in place.
The opening conference establishes the groundwork necessary to conduct an effective and efficient
audit and establishes lines of communication that help build a good working relationship between
the auditor and taxpayer. During the opening conference, the auditor and taxpayer will introduce
the participants of the audit, agree on a general audit plan, discuss audit processes and procedures,
and agree upon expected timeframes. The auditor may charge a reasonable number of hours to
the audit for preliminary work such as the overview work, as well as time spent conducting a
pre-audit conference.
Introduction of Personnel
At the start of the opening conference, the auditor and supervisor (if present) should introduce
themselves to the taxpayer. If the team audit approach is being used, see AM Section 0402.06,
Role of Lead Auditor.
The taxpayer should also introduce their staff and identify those persons who will be working with
the auditor and BOE staff on the audit. The auditor should obtain the name, title, and telephone
number of the taxpayer’s staff in the event that the main contact person is not available or leaves
the company during the audit. Taxpayers (owners, partners, or corporate officers) should be invited
and encouraged to attend the opening conference, even if they have authorized another person
to represent them.
General Discussion
The general discussion at the opening conference is an opportunity for the auditor to perform the
following tasks:
• Advise the taxpayer of relevant law sections or regulations pertaining to the taxpayer’s
business and explain where the information relating to the taxpayer’s business is located
on the BOE website.
• Address any questions the taxpayer may have regarding their rights during the audit or
the appeals process.
• Emphasize the BOE’s expectation of completing the audit within two years, or as appropriate
for the size and complexity of the audit.
• Discuss the general history of the taxpayer, including any changes in ownership,
acquisitions, changes in product line, going concern, and unusual activities during the
period under audit, or current changes that may impact the audit.
• Discuss the facts of any pertinent issue or area within the business, such as how a product
is made or where assets and supplies are purchased.
• Determine whether there are known credit issues for which a claim for refund will be filed.
• Obtain a signed copy of Form BOE-82, Authorization for Electronic Transmission of Data,
and discuss the BOE policy for emailing taxpayer information (AM section 0101.67).
• Request copies of the returns filed and their back-up to start the review of the taxpayer’s
filings.
February 2016
Audit Manual
Opening Conference (Cont.1) 0401.09
Potential Audit Issues
Auditors should inform the taxpayer of potential audit issues, including potential areas of refund,
identified during the cursory review process or established in a prior audit. Possible items to
discuss include, but are not limited to:
• Recurring Audit Issues. If a prior audit determination is being protested or was changed
during the appeals process, the auditor should determine the status of the recurring issues.
When applicable, the auditor should discuss any changes to the law or regulations related
to these items since the last audit.
• Potential Areas of Refund. The auditor should inform the taxpayer of the benefit (i.e.,
interest offset) of providing a claim for refund early in the audit. The taxpayer should
also be notified that if a claim for refund is presented at the end of the audit, the claim for
refund may be addressed separately so as not to delay the completion of the current audit.
• Potential Time Saving Areas. The auditor should consider and discuss any areas where
audit time may be reduced and where efficiencies of reviewing the information can be
accomplished.
• Prior Audit Percentage of Error. The auditor should discuss the possible use of a prior
audit percentage of error. See AM section 0405.33.
• Managed Audit. The auditor should discuss the taxpayer’s eligibility to participate in
the Managed Audit Program. See AM section 0435.00.
• Deletions or additions to the business such as the sale or addition of an asset or entire
division.
Taxpayer’s Return Preparation
Obtaining information on how the sales and use tax returns for the audit period were prepared
will provide valuable information on how to address issues and identify the person(s) within
the taxpayer’s business who is knowledgeable in given areas. The auditor may want to ask the
taxpayer the following questions:
• Who prepared the returns? If it is not the same contact person(s) the auditor is working
with, is that individual(s) still available for questions or information?
• Where are the workpapers/worksheets for the tax returns located and what lead-time is
needed to obtain them?
• Are the tax return workpapers/worksheets electronic, and if so, in what format?
• Have amended sales and use tax returns been filed during the audit period, and if so, for
which periods?
• How were district tax allocations addressed? Is the taxpayer engaged in business in other
taxing jurisdictions?
• Are instructions or return preparation guidelines issued to those preparing the returns,
and if so, are they available?
• Did the method of reporting change over the course of the audit?
February 2016
GENERAL AUDIT PROCEDURES
Opening Conference (Cont.2) 0401.09
Taxpayer Records
Government Code section 15618 authorizes an auditor to examine records of the taxpayer and
of persons doing business with the taxpayer. Revenue and Taxation Code section 7054 provides
additional authority for the examination of records pertaining to the Sales and Use Tax Law.
Similar provisions are found in other tax and fee programs administered by the BOE. Government
Code section 15613 authorizes the BOE to issue a subpoena for the attendance of witnesses or to
produce books, records, accounts and papers.
Taxpayer records (both original and copies) are confidential and must be safeguarded at all times.
The auditor should inform the taxpayer that any information provided is confidential and protected.
The auditor may not remove records from the taxpayer’s or representative’s premises without
permission from the taxpayer or designee. Records relating to the audit of one taxpayer should
not be brought to and accessed/worked on at another taxpayer’s location. Receipt of taxpayer
original records requires accurate and timely completion of Form BOE-945, Receipt for Books
and Records of Account, by the auditor and must be signed by the taxpayer, with a copy provided
to the taxpayer. A scanned copy of the BOE-945 should be saved in the Forms subfolder of the
audit case folder. For additional information on handling taxpayer’s records and preparation of
Form BOE-945, see AM section 0403.35, Receipt of Taxpayer’s Records.
In addition to explaining the legal authority for requesting records, the auditor should also explain
the reason why specific records are being requested as they relate to the audit. This allows the
taxpayer the opportunity to provide or recommend additional or alternative records the auditor
may not be aware of that will provide the same information/documentation being requested.
Below are some questions the auditor should ask the taxpayer if not already covered in a preaudit conference:
• What are the taxpayer’s record keeping practices and record retention policies?
• Has anything changed in the taxpayer’s record keeping during the audit period or from
that of the prior audit?
• What areas of the taxpayer’s organization have responsibility for the records that need to
be examined? Who is the contact person(s) in each area?
• What electronic records are available and in what format are they stored?
• Has there been a change in accounting software?
• What documents are actually retained?
• What alternative records may be available to assist in auditing a specific area if the
requested records are not available?
• How long will it take to retrieve documents from storage? Where is the document storage
area located?
• Who should the auditor contact if the primary contact is unavailable or has left the company?
For additional procedures and guidelines when starting an audit, see AM section 0403.20,
Preliminary Examination.
February 2016
Audit Manual
Opening Conference (Cont.3) 0401.09
Photocopies and Scanning of Taxpayer Records
Photocopies or scans of taxpayer records may be needed for documentation of transactions and to
support the facts as set forth in the audit report. The taxpayer is required to provide photocopies, or
make records available for photocopying or scanning. However, the auditor should limit the request
to relevant portions of a specific issue. The auditor should not arbitrarily request photocopies of
all records in the audit or a particular area in the audit unless there is a legitimate need for such
records.
Additional guidelines:
• It is helpful to establish what procedures the taxpayer would like for photocopying and
scanning records or documents. The taxpayer may request that their staff do all of the
photocopying and scanning. The auditor should ask who to contact if there are any problems
with photocopying or scanning requests.
• In audits where the auditor is permitted to make the photocopies and scans of documents,
if the taxpayer requests it, the auditor should provide the taxpayer a copy of all documents
photocopied or scanned for the audit file.
• The auditor should not photocopy or scan any documents without first securing the
taxpayer’s permission. In addition, no photos of any records should be taken using personal
cell phones or other personal electronic devices.
• State-issued cell phones may be used for the purpose of taking pictures of taxpayer records.
Any pictures and videos taken with a state-issued cell phone should only be for business
purposes. The pictures or videos should only be transferred via email or a direct download
to the users’ machine and then moved to the LAN. When taking pictures of taxpayer records
is not conducive (i.e. voluminous amount of records), staff must issue a properly completed
BOE-945, Receipt for Books and Records of Account, when a scanner or photocopier is
unavailable. See AM section 0403.35.
• The law may prohibit photocopying or scanning of certain documents. If an auditor
encounters this situation in an audit, the auditor should discuss this with his or her
supervisor.
• Photocopies and scans of all taxpayer records must be included as part of the audit working
papers (AWPs) or properly purged at the completion of the audit.
Discussion of Information Document Requests (IDRs)
The auditor should explain the IDR process and determine who should receive the IDRs. See AM
section 0401.12. The auditor should also request a secondary contact in the event the requested
documents, data, or other information cannot be provided by the primary contact.
Discussion of Audit Findings Presentation Sheets (AFPSs)
The auditor should explain the AFPS process and how it will be used in the audit. See AM section
0401.14.
February 2016
GENERAL AUDIT PROCEDURES
Opening Conference (Cont.4) 0401.09
Waiver of Limitation
Form BOE-122, Waiver of Limitation, is a legal agreement that a taxpayer may voluntarily enter
into with the BOE. The waiver of limitation extends the statute of limitations for specific periods
indicated on the form. The auditor should explain how waivers of limitation will be addressed
throughout the audit. See AM section 0215.00.
Generally, a waiver of limitation should be requested when:
• The audit is about to commence and the taxpayer requests a postponement in starting the
audit.
• The audit is in process and the taxpayer requests a postponement in completing the audit.
• There is a documented understatement or overstatement that cannot be billed/refunded
without additional examination and there is insufficient time to conduct an audit that
could be used as a basis for a determination before the expiration of the periods.
Reasons for requesting a waiver of limitation should be entered on the BOE-414-Z. The auditor
should also document any circumstances that may lead to a delay in the audit process. Supervisory
approval of the circumstances which necessitated the request for a waiver or extension will be
noted on the BOE-414-Z before presenting the waiver to the taxpayer. Regulation 1698.5 adds the
provision that if the extension of the statute of limitations totals two years or more, the District
Principal Auditor must approve the extension before it is presented to the taxpayer for signature.
This must also be documented on the BOE-414-Z.
If the taxpayer declines to sign a waiver of limitation, the BOE may issue a determination for
the expiring period(s).
Scheduling Future Appointments
To complete the audit timely, the auditor should establish future audit appointment dates with
the taxpayer so that both parties understand the expectations and resources that will be needed
to complete the audit. This will establish a commitment to obtaining and reviewing audit work
by the next scheduled appointment. Whenever possible, appointments should be scheduled with
the intent of completing work efficiently; generally this means scheduling appointments for a full
working day.
Use of Taxpayer Facility
Taxpayers may be limited in the space they have available. However, it is appropriate for an auditor
to request adequate working space to work efficiently and protect confidential taxpayer records.
The availability of office space should not dictate the number of audit staff assigned to complete
any given audit. During the pre-audit conference or the opening conference, the auditor should
identify the resources needed to conduct the audit, including workspace and electrical outlets.
The auditor should inform the taxpayer of how many auditors will be assigned to the audit.
Some taxpayers assign permanent work areas to auditors until the audit is complete or for the
duration of a field visit. If an auditor is provided with an office, the auditor should determine who
has access to the office and what hours the auditor will have access to the office. If temporary
space is assigned, the audit staff may make an agreement with the taxpayer so that records will
be made available at the beginning of the first day of each field visit. For security purposes, the
taxpayer may require that an auditor obtain and wear an identification or access badge. Generally,
auditors are not authorized to sign any confidentiality agreements in order to obtain an access
or identification badge. An exception can be made with prior approval from the District Principal
Auditor (DPA).
February 2016
Audit Manual
Opening Conference (Cont.5) 0401.09
Taxpayer Requests to Change Audit Location
Audits generally take place at the location where the taxpayer’s original books, records, and source
documents relevant to the audit are maintained, which is usually the taxpayer’s principal place
of business. A request to conduct the audit at a different location should include the reason(s) for
the request. It is the taxpayer’s responsibility to provide all requested records at that location.
Requests will be granted unless BOE staff determines the move will significantly delay the start
or completion of the audit, or the BOE does not have adequate resources available to conduct
the audit at the requested location. Form BOE-122 should be requested in all cases where the
taxpayer requests a transfer of an audit to another district office.
After an initial request to change the audit location has been granted by BOE staff, any subsequent
requests for location changes in the same audit period shall be made in writing and include the
reason(s) for the request. These subsequent requests will be considered on a case-by-case basis.
Approval of these requests is at the discretion of BOE staff.
If the taxpayer operates out of a private residence, or has a small office or work environment that
will not accommodate the auditor(s), BOE staff may require the records be brought to a BOE office
or taxpayer’s representative’s office. If the audit is conducted at a BOE office, the taxpayer will
be provided a receipt for records. See AM section 0403.35.
Exit Conference
The auditor should discuss the purpose of the exit conference and make the taxpayer aware that
the exit conference will be held at the conclusion of the audit so that the taxpayer knows what to
expect and is aware of the timeframes associated with a response to the audit findings. See AM
section 0401.16, Exit Conference.
February 2016
GENERAL AUDIT PROCEDURES
STATUS CONFERENCES
0401.10
There are two kinds of status conferences: (1) meetings between the taxpayer and BOE staff
held throughout the audit to discuss audit issues and the progress of the audit, and (2) meetings
between the audit supervisor and audit staff to discuss the progress of the audit and any audit
issues. Status conferences are used to keep lines of communication between the taxpayer and
auditor open, as well as keep the supervisor apprised of the audit’s progress toward meeting the
projected completion date.
• Status Conference with Taxpayer – Taxpayers (owners, partners, or corporate officers)
should be invited and encouraged to attend status conferences, whether or not the taxpayer
has authorized another party to represent them. Status conferences with the taxpayer
should be held regularly to measure the actual audit progress with planned benchmarks.
Supervisors are encouraged to attend status conferences when available or when there is a
need for their presence (complex issues, delays, slow progress). The auditor should record
a summary of each status conference on the BOE-414-Z. However, some audits may not
require a status conference, particularly in smaller audits where issues are quickly resolved.
When an actual meeting between the audit staff and the taxpayer or representative is not
possible or practical, a telephone conference with the taxpayer or representative may be
sufficient and this type of meeting should be recorded on the BOE-414-Z.
• Status Conference with Audit Supervisor and Staff – Status conferences should be
held between the auditor (or audit team) and audit supervisor on a regular basis. Status
conferences should also be held between the lead auditor and the audit team on a regular
basis. These conferences provide an opportunity to make needed adjustments to keep
the audit on track with the planned completion date. This includes evaluating the initial
budgeted hours and making adjustments to the budgeted hours or workload assignments,
if necessary. The audit supervisor should record the discussion held with the auditor or
the audit team on the BOE-414-Z.
Discussion of Information Document Request (IDR)
While IDRs (AM section 0401.12) are generally discussed separately, the status conference provides
an opportunity for the auditor to:
• Review outstanding and new IDR requests;
• Review the timeframes for outstanding and new IDRs;
• Discuss IDR requests that cannot be resolved with taxpayer;
• Address taxpayer’s questions regarding the materiality of an issue/area that is the subject
of an IDR; and
• Discuss the consequences of non-compliance with an IDR, such as the issuance of a
subpoena.
Discussion of Audit Findings Presentation Sheet (AFPS)
AFPSs (AM section 0401.14) are generally discussed when they are provided to the taxpayer. The
status conference provides an opportunity for the auditor to:
• Discuss and try to reach agreement on the facts related to the audit issue or describe what
facts are still not agreed to, even if there is disagreement with the application of the law;
• Discuss follow-up requests on outstanding AFPS, with specific expectations for completion;
and
• Provide follow-up written confirmation of any agreements or understandings that resulted
from prior meetings.
February 2016
Audit Manual
Status Conferences
(Cont.) 0401.10
Scheduling Audit Appointments
Status conferences provide the opportunity to review any audit appointments that were previously
made and to cancel, postpone, or make new appointments in order to keep the audit moving
towards completion. The audit plan should be revised to reflect any changes.
Resolving Disputes Related to the Conduct of the Audit
The auditor should immediately discuss any disputes (conflicts/issues) concerning the conduct
of the audit with the taxpayer. This may include, but is not limited to, interpersonal disputes,
disagreement of where the audit takes place, or the type of testing being performed. The auditor
should not wait until the end of the audit to resolve any conflicts; they should be discussed during
an audit appointment or during a status conference. If the dispute is not resolved between the
auditor and the taxpayer, assistance from the audit supervisor should be requested. If the audit
supervisor and the taxpayer are unable to resolve the issue, the taxpayer or audit supervisor may
request DPA assistance to resolve the issue. If the issues/dispute cannot be resolved and discussions
have been previously held with the taxpayer representative, bookkeeper, or tax manager, it may
become necessary for the DPA or District Administrator to advise the owner, partner(s), LLC
Member or Chief Financial Officer of the issue and seek resolution with their assistance. When
necessary, the Deputy Director, Field Operations Department may need to seek resolution of the
issues.
INFORMATION DOCUMENT REQUEST (IDR)
0401.12
The purpose of issuing an IDR (Form BOE-698-A) is to document and provide a written request
for information/documentation when the taxpayer fails to provide the records in response to
verbal requests for the same records. The IDR process includes the issuance of an initial IDR, a
second IDR, and a Formal Notice and Demand letter to furnish the information/documentation.
Before auditors proceed with the IDR process, taxpayers should be allowed to comply with verbal
requests for the same records. However, when BOE staff is unable to make verbal contact with the
taxpayer, the auditor may proceed directly with the IDR process. The auditor has the discretion
to determine reasonable response times for verbal requests. The auditor should discuss the IDR
process and significance of issuing an IDR with the taxpayer at the opening conference.
The IDR should generally contain a request for records for a single area of the audit as opposed
to one IDR for all areas of the audit. A single area IDR assists the taxpayer if questions need
to be distributed to different departments. It provides for better organization in monitoring
and following up on IDRs and for better organization of AWPs. In the event that a taxpayer is
unresponsive or provides incomplete records, the use of the single area format allows the auditor
to send a follow-up request using the same IDR, but modified to update the history of the request.
Separate IDRs make it easier to document the history of a request (date of the original request,
follow-up dates, extensions granted). However, if the taxpayer does not provide any records or
minimal records at the beginning of the audit, rather than issuing an initial IDR for each area of
the audit, a single IDR may be prepared to request all records necessary to conduct the audit. In
such cases, the outlined IDR process should be followed including the issuance of a second IDR
and Formal Notice and Demand letter, if necessary.
Auditors should use Form BOE-698-C, Information Document Request Master Log, to maintain
and track all issued IDRs, and to provide a clear focus for the status of IDRs. Copies of the IDR
Master Log (either printed or electronic) should be shared with the taxpayer so that all parties
have a common understanding of the expectations and status. See Exhibit 16 for an illustration
of a completed master log.
NOTE: All IDRs and the IDR Master Log should be included in the Forms subfolder of the audit
case folder as memo schedules.
February 2016
GENERAL AUDIT PROCEDURES
Information Document Request (IDR)
(Cont.1) 0401.12
Initial IDR
The auditor should issue the initial IDR (Exhibit 14) after verbal requests with due dates for
specific information/documentation were made and the taxpayer did not furnish the information/
documentation, unless doing so results in a period of the audit expiring under the statute of
limitations. If a period of the audit will expire, the BOE may issue a determination for an expiring
period(s) in lieu of following the IDR process. When the auditor is unable to make verbal contact
with the taxpayer, or if the taxpayer has established a pattern of delaying the progress of the audit
by not responding to verbal requests, the auditor may proceed directly with the IDR process. All
verbal and IDR requests must be documented on the BOE-414-Z. The auditor or lead auditor of
a team audit will sign the initial IDR before issuance to the taxpayer. The audit supervisor will
review the initial IDR before submission to the taxpayer to ensure the information being requested
by the auditor is reasonable and relevant to the area being reviewed and that the information
being provided by the taxpayer is as stipulated in the IDRs.
All IDR requests will be on Form BOE-698-A, Information Document Request. The auditor should
use the following guidelines when preparing Form BOE-698-A
• Numbering IDRs — IDRs should be numbered sequentially when they are provided to
the taxpayer. They should retain the same number when they are reissued or followed-up
on (unless the nature of the information request has changed). For example, an auditor
may first prepare an IDR for resale certificates, and thus should be numbered 1. Next, the
auditor may prepare an IDR for paid bills, and thus should be numbered 2, and so on.
• Due Date —30 days for the initial IDR and 15 days for the second IDR, measured from
the date the IDR is delivered or mailed to the taxpayer and the person designated by the
taxpayer at the pre-audit or opening conference to receive IDRs.
• Signature — The auditor or lead auditor of a team audit should sign the initial IDR before
issuance to the taxpayer. The audit supervisor should sign the second IDR before issuance
to the taxpayer.
• Subject — Generally, the area of the audit for which information or records are requested.
• Description of Request — Identify the information or documents requested. Clearly
state the reason for the request and provide any applicable law or regulation references if
appropriate.
• History Section — Enter all requests for information, due dates, and responses by the
taxpayer. These will include verbal requests, prior IDRs, follow-ups by the auditor, and
partial responses by the taxpayer.
The auditor should discuss the content of an IDR with the taxpayer to ensure the taxpayer
understands what information or document is being requested and why. Discussion of the applicable
laws and regulations is also essential. The auditor should also discuss alternative documentation
if the information requested is not available or will not resolve the audit issue.
If the taxpayer maintains information or records electronically, the IDR should specifically state
that electronic records are requested. The taxpayer should not be required to create records in
electronic format for audit purposes.
February 2016
Audit Manual
Information Document Request (IDR)
(Cont.2) 0401.12
Responding to IDRs
The auditor must contact the taxpayer within 30 days of receiving a response to the initial IDR.
However, every effort should be made to contact the taxpayer as soon as a response is received.
When the taxpayer provides the requested records, the auditor should either (1) notify the taxpayer
the records are sufficient, (2) issue additional IDRs, or (3) notify the taxpayer that additional
time is needed to review the records provided and provide the taxpayer with a reasonable date
for future contact. All contacts with the taxpayer regarding follow-ups and deadlines must be
recorded on the BOE-414-Z.
Taxpayers will be allowed 30 days to respond to the initial IDR, measured from the date the IDR
is delivered or mailed to the taxpayer and the person designated by the taxpayer at the pre-audit
or opening conference to receive IDRs. Due dates for responses to IDRs shall be within the statute
of limitations applicable to the audit. The timeframes allotted for responses to IDRs are intended
to provide an orderly audit process, but they cannot be used to limit the taxpayer’s right to provide
information. This means if the taxpayer does provide information while the audit is still open,
even if it is after the due date set in the IDR, the auditor must give consideration to and analyze
the information received.
Any response other than full compliance with an IDR must be reviewed by the DPA who will
determine the course of action to be taken in response to any issues or extensions requested by
the taxpayer. The DPA will document his or her recommendations on the BOE-414-Z and in
any necessary correspondence. All telephone contacts with the taxpayer regarding extensions of
IDR due dates must be documented either by a brief letter summarizing the discussion with the
taxpayer or an email, as well as documented on the BOE-414-Z.
In cases where an extension to an IDR is granted, the auditor should note on the IDR form that
an extension was granted, the due date for the extension, and the reason for the extension. A
notation to this effect should also be made on the IDR Master Log (Exhibit 16).
Second IDR
If the taxpayer does not provide, by the date due, the documentation requested in the initial IDR,
the auditor may proceed directly in preparing a second IDR (Exhibit 15) for the same records.
The audit supervisor should review the second IDR to ensure it is prepared correctly before it is
issued to the taxpayer. The second IDR will be issued under the supervisor’s signature and will
include an explanation of the relevance of the records being requested. Form BOE-698-A should
be used to prepare the second IDR and the appropriate box marked “Second IDR” checked. A copy
of the initial IDR should be attached when providing the second IDR to the taxpayer. The history
section of the IDR should reflect all requests for information, due dates, extensions granted, and
responses by the taxpayer. Taxpayers will be allowed 15 days to provide the records in response to
the second IDR measured from the date the IDR is delivered or mailed to the taxpayer and to the
person designated by the taxpayer at the pre-audit or opening conference to receive IDRs, unless
doing so results in a period of the audit expiring under the statute of limitations. The auditor
and supervisor should document all requests for information, due dates, extensions granted, and
responses by the taxpayer on the BOE-414-Z.
If the taxpayer provides incomplete or missing records, the DPA must review the response and
determine if an extension is warranted. In all cases where an extension to the second IDR is
provided, and the taxpayer fails to provide the requested records by the due date of the extension,
a Form BOE-698-B, Formal Notice and Demand letter, should be prepared.
February 2016
GENERAL AUDIT PROCEDURES
Information Document Request (IDR)
(Cont.3) 0401.12
Formal Notice and Demand to Furnish Information
Form BOE-698-B, Formal Notice and Demand letter, (Exhibit 17) should be issued when a taxpayer
fails to furnish the requested records in response to a second IDR requesting the same records as
the initial IDR. The Formal Notice and Demand letter will be signed by the DPA.
The Formal Notice and Demand letter should state the due date for the requested records and
reference the two previous IDRs (copies of each IDR should be attached). The Formal Notice and
Demand letter should be sent to the taxpayer (owner, partner, corporate officer, LLC Member),
and the person designated by the taxpayer at the pre-audit conference to receive IDRs. The auditor
should consider sending a copy of the Formal Notice and Demand letter to a representative in
addition to the taxpayer’s designee to receive IDRs if the designee is uncooperative in responding
to previous information document requests. Taxpayers will have 15 days from the date the Formal
Notice and Demand letter was delivered or mailed to the taxpayer and the taxpayer’s designee
to receive IDRs, unless doing so results in a period of the audit expiring under the statute of
limitations.
The Formal Notice and Demand letter informs the taxpayer that if the BOE does not receive the
requested information, a subpoena may be issued or an estimated liability may be billed (Form
BOE-698-B provides this statement). Subpoena requests should follow the guidelines set forth
in AM Exhibit 4, and should be prepared on Form BOE-301, Subpoena Request Form. Although
individual IDRs are issued for specific areas, a subpoena request should cover all records requested.
The subpoena should be considered only when the records are known or believed to exist, the
potential liability to be revealed by the records is significant, and all other methods of obtaining
the records have been unsuccessful. Because the time to prepare a subpoena request may delay
the audit, it is recommended that the subpoena request process begin immediately after the 15
day deadline noted in the Formal Notice and Demand letter that was sent to the taxpayer. In the
event the taxpayer responds to the Formal Notice and Demand subsequent to the 15 day deadline,
the subpoena request may be withdrawn.
NOTE: Without a subpoena or the taxpayer’s/representative’s permission, under no circumstances
should the auditor take it upon herself/himself to review, schedule, photocopy, or otherwise access
information from files to which the taxpayer has “forbidden” access.
All Formal Notice and Demand letters should be included in the Memos and Misc. Documents
audit subfolder as memo schedules.
AUDIT FINDINGS PRESENTATION SHEET (AFPS)
0401.14
The purpose of issuing an AFPS (Exhibit 18) is to present the auditor’s findings for each area of
the audit as it is completed. It communicates to the taxpayer specific audit findings regarding an
issue or area within an audit and allows the taxpayer to address those findings while the auditor
continues to work on other areas of the audit. The purpose and use of the AFPS form should be
discussed at the opening conference.
AFPSs should be prepared in all large and complex audits with multiple areas of tax change. It is
not necessary to prepare an AFPS for no-change audits or audits with only one or two areas of tax
change that are clearly defined. Although the use of AFPSs was initially intended for use in larger
or complex audits, its use will be helpful in organizing and presenting tax errors to all taxpayers.
An AFPS should be issued during the course of the audit as soon as each area of the audit is
completed. For example, if an auditor has completed the examination of fixed asset accounts, and
will begin the sales for resale test, an AFPS should be issued for the fixed asset examination. An
audit area is considered complete when the auditor has completed all of the verification and the
taxpayer has been given the opportunity and resources to provide documentation to refute the
audit findings for that area. Issuing an AFPS provides the opportunity to conclude and resolve
issues during the audit rather than addressing all issues/areas at the conclusion of the audit.
February 2016
Audit Manual
Audit Findings Presentation Sheet (AFPS)
(Cont.1) 0401.14
Preparing and Issuing AFPSs
AFPSs should be prepared on Form BOE-699, Audit Findings Presentation Sheet. Space is
provided for the discussion of the specific issue, the facts developed, the relevant law, and the audit
recommendation on the issue. All AWPs associated with the respective issue or area, including the
lead and subsidiary schedules, should be provided. The auditor should include as much detail as
possible on the AFPS to isolate the errors in contention. In a team audit, the lead auditor should
review and approve all AFPSs before presentation to the taxpayer. If an issue is controversial
or complex, an AFPS, along with the related AWPs, may be reviewed by the audit supervisor or
district reviewer, when appropriate, prior to providing the AFPS to the taxpayer. All issuances
of AFPSs, follow-ups, and deadlines must be recorded on the BOE-414-Z.
The following guidelines should be used when preparing Form BOE-699:
• AFPS Number — AFPSs should be numbered sequentially at the time they are issued
starting with the number 1. Auditors may assign numbers differently in order to facilitate
team audits, but it is imperative that the taxpayer understand the numbering system so
that they are not looking for a “missing AFPS” which has not been issued.
• Audit Area/Issue — Provide a short description of the audit area being addressed.
• Due Date to Respond — Follow the guidelines for response times set forth by Regulation
1698.5. This will generally be 30 days from the date the AFPS is delivered to the taxpayer.
• Description of Findings — Provide a short description of the findings, schedule reference
number, and estimated taxable measure.
• Summary of Findings — Provide a summary of the audit findings. Include the methodology
the auditor used to determine audited taxable measure if necessary.
• Law or Regulation — Cite the relevant statutory law and regulations along with the
application of the tax to the facts.
• Auditor’s Position — State the auditor’s findings and conclusions based on the relevant
law and facts.
• Taxpayer’s Position — Ask the taxpayer to indicate their position regarding the audit
findings. If they are in disagreement, they should state the reason they do not agree on
the back of Form BOE-699 and attach any supporting documentation for their position.
• Taxpayer Signature — Obtain the signature of the taxpayer or representative (if
applicable) and the date the AFPS was signed.
• Resolution—If the taxpayer disagrees with the audit findings, the auditor must indicate
what steps were taken to resolve any disagreements.
An AFPS Master Log (Exhibit 19) must be maintained to track all AFPSs and to provide a clear
focus for all adjustments made. Auditors should use Form BOE-699-A, Audit Findings Presentation
Sheet Master Log, to maintain and track AFPSs. The AFPS Master Log should be shared with
audit team members and the audit supervisor. This allows the lead auditor or audit supervisor
the opportunity to review AFPSs and monitor the status of the audit. A copy of the AFPS Master
Log may also be shared with the taxpayer.
All AFPSs and the AFPS Master Log should be included in the Memos and Misc. Documents audit
folder as memo schedules.
February 2016
GENERAL AUDIT PROCEDURES
Audit Findings Presentation Sheet (AFPS)
(Cont.2) 0401.14
Taxpayer Response to AFPS
Upon issuance of an AFPS, the auditor should give the taxpayer an opportunity to clarify the
facts and provide rebuttal arguments to the audit findings. The taxpayer should be encouraged to
respond using the back of form BOE-699 or other correspondence. This process can result in the
resolution of the issue at the lowest level, minimizing time and costs for both the BOE and the
taxpayer. The taxpayer should indicate agreement or disagreement with the audit findings and
provide additional documentation to support their position if they disagree. The taxpayer should
be advised that agreement to an area of the audit through use of an AFPS does not preclude
protest or other administrative rights (Form BOE-699 contains this statement).
Response times may vary, depending upon the difficulty and complexity of the issue or area and
the amount of discussion that has already taken place between the auditor and the taxpayer in
advance of issuing the AFPS. The response time should generally be 30 days from the date AFPS
was mailed or delivered to the taxpayer. However, due dates for responses to any AFPS shall be
within the statute of limitations applicable to the audit. Auditors will consider late responses to an
AFPS, provided a period of the audit will not expire due to the statute of limitations. Depending
on the area or issue in the audit, some AFPSs can be responded to in less than 30 days. Others
will require additional time. The auditor has the discretion to adjust this timeframe as warranted.
All responses and follow-ups must be documented on the BOE-414-Z.
If the taxpayer does not respond to the AFPS, or returns an AFPS without any indication of whether
they agree or disagree, the auditor should make every effort to obtain verbal indication of whether
the taxpayer agrees or disagrees. If the taxpayer does not provide any verbal indication, or if the
taxpayer wishes to withhold any agreement, it will be assumed the taxpayer does not agree with
the audit result for that area. The auditor should enter a “Discussion with Taxpayer” comment
in the “General Audit Comments” of Form BOE–414–A, Field Audit Report (AM section 0207.10).
Revising AFPSs
While every effort is made to ensure the audit findings are correct before the issuance of an AFPS,
there are times when an AFPS will need to be revised. For example, once the taxpayer has a
clear understanding of the proposed adjustment, the taxpayer provides additional documentation
to support their position, or the auditor may find a computational error. Both may necessitate
issuing a revised AFPS and providing a copy to the taxpayer for response. A revised AFPS should
be issued when:
• Errors are noted in the computation of taxable measure.
• Additional material facts are provided.
• A different section of the law is applicable rather than the one(s) stated in the original
AFPS.
• Any other adjustment to the audit findings is deemed warranted.
The auditor should use the same numbering for the revised AFPS as the original AFPS, with some
indication that it is a revised version. For example, AFPS 1 is for sales for resale. When a revised
AFPS is issued, it should be numbered 1-A. The second revised AFPS should be numbered 1-B,
and so on. The auditor should note in the Master AFPS Log that a revised AFPS was issued. The
auditor should retain copies of all AFPSs that have been provided to the taxpayer.
February 2016
Audit Manual
Audit Findings Presentation Sheet (AFPS)
(Cont.3) 0401.14
If the auditor determines that a revised AFPS is not warranted based on the taxpayer’s response,
the auditor should make a comment in the resolution section of the AFPS and provide a copy to
the taxpayer. The taxpayer’s responses to AFPSs should not be included in the audit package
without a comment being made in the resolution section as to how the taxpayer’s response was
addressed and why.
Withdrawing an AFPS
In some cases, the taxpayer might provide additional information/documentation resulting in a
no-change in a particular area of the audit. The AFPS should then be formally withdrawn. This
can be accomplished by using the original AFPS, adding a comment in the resolution section that
provides a brief explanation of the reason for the withdrawal and providing a copy to the taxpayer.
The Master AFPS Log should be updated to reflect the AFPS withdrawal
EXIT CONFERENCE 0401.16
The purpose of an exit conference is for the auditor and taxpayer to discuss and review the final
audit findings. The exit conference is generally held after the field work has been completed;
however, an exit conference may also be held on the last day of the field work. The auditor
assigned to a particular area of the audit should methodically lead the taxpayer through the
AWPs, discussing the results of each area of the audit. The auditor may want to recap any findings
previously discussed in status conferences or through an AFPS.
The auditor should provide the taxpayer a digital copy of the final AWPs (unless the taxpayer
specifically requests a paper copy), prior to the exit conference so the taxpayer has the opportunity
to review them. When providing a copy of the digital AWPs, the auditor must redact or remove files
containing confidential information such as Federal Tax Information or BOE-1164s. If the auditor
has not completed the AWPs prior to the exit conference, he or she may provide the taxpayer a
copy during the exit conference.
If at the time of any discussion the AWPs are not complete, the auditor may provide digital copies
of all schedules that were used in the discussion with the taxpayer. Once the AWPs are completed,
the auditor should ensure the taxpayer receives a copy of the final set of AWPs either by mail,
encrypted email, or hand-delivery. Delivery of the AWPs should be documented on the BOE-414-Z.
Who Should Attend the Exit Conference?
Generally the auditor will facilitate the exit conference. Taxpayers (owners, partners, LLC
Members, or corporate officers) should be invited and encouraged to attend the exit conference,
even if they have authorized another party to represent them. At a minimum, the auditor should
request the person who primarily handled the audit for the taxpayer, be present at the exit
conference. The audit supervisor should attend the exit conference when the audit tax liability
is above $25,000, when it is likely the taxpayer will disagree with the audit findings, or when
there is an evasion penalty.
February 2016
GENERAL AUDIT PROCEDURES
Exit Conference (Cont.) 0401.16
Agenda for the Exit Conference
In addition to an explanation of the audit findings, the following are suggested topics for the exit
conference:
• Review Process — The auditor should explain the BOE’s review process (by the audit
supervisor and reviewer) and provide an estimated date the audit will be submitted for
review. The taxpayer should be made aware that the audit is not final until after the review
and billing process. Any AWPs adjusted as a result of the review process will be provided
to the taxpayer as soon as possible.
• Timeframe to Provide Additional Documentation — Generally, taxpayers will be
allowed 30 days from the date of the exit conference to indicate whether they agree or
disagree with the audit findings, unless doing so results in a period of the audit expiring
under the statute of limitations. If the taxpayer disagrees with the audit findings, they
may provide additional information within these 30 days for the auditor to consider. The
auditor may adjust the audit findings if warranted based on the information provided.
• Correspondence from the BOE — The auditor should explain the letters or notices
the taxpayer can expect to receive from BOE, such as the formal audit report, the 10-day
hearing process, BOE-836-A, Report of Discussion of Audit Findings, and the Notice of
Determination.
• Prepaying an Audit Liability — The auditor should provide the taxpayer an estimate of
when a Notice of Determination may be issued. The auditor should also inform the taxpayer
how to download a copy of Form BOE-1, Audit Prepayment Information, and explain how
to prepay an audit liability to stop the accrual of additional interest.
• Petition for Redetermination, Administrative Protest, Claim for Refund and
Settlement — The auditor should inform the taxpayer how to download a copy of
Publication 17, Appeals Procedures: Sales and Use Taxes and Special Taxes, and explain
to the taxpayer their protest and appeals rights.
Exit conferences are also addressed in AM section 0207.00.
CONCURRENT AUDITS
0401.18
Generally, the BOE will not hold in abeyance the start of an audit pending the conclusion of an
audit of prior periods or pending completion of an appeal of a prior audit currently in the BOE’s
appeals process. In cases where a prior audit is under appeal and the audit for the subsequent
periods is not held in abeyance, the BOE will begin the current audit by examining areas that are
not affected by the outcome of the appeal. However, each audit engagement should be considered
on a case-by-case basis and the decision whether to postpone the subsequent audit or begin the
subsequent audit will be at the discretion of the District Administrator.
February 2016
Audit Manual
TEAM AUDITS
0402.00
OVERVIEW0402.01
To accelerate the completion of audits, the BOE has implemented a team audit approach. However,
not all audits may be conducive to or require the audit team approach and use of a team audit
will be at the discretion of the audit supervisors or District Principal Auditor (DPA).
The implementation of the team audit approach is beneficial to both the BOE and the taxpayer as it
provides for a more efficient and effective audit program. Team auditing will increase productivity
by reducing the time necessary to complete an audit which ultimately decreases the disruption
to the taxpayer’s operations.
In the team audit approach, the team consists of one lead auditor and one or more audit team
members who will work on the audit through its completion. This approach allows the lead
auditor to manage the audit workload and timeframes within the time constraints of each audit.
It provides less experienced audit staff an opportunity to participate in auditing large and complex
businesses that they would not otherwise experience early in their career. Thus, team auditing
is an effective and efficient training tool that will prepare and train audit staff to conduct these
types of audits in the future.
District Audit Workload
Once accounts are selected for audit and prioritized, each district office should review their
available audit cases for application of the team audit approach. A list of viable audit cases should
be developed at the beginning of each fiscal year and assigned according to priority. Regular
meetings between the DPA and the audit supervisors should be held to ensure priority audits are
addressed. Neighboring districts should work cooperatively and seek assistance from one another
to ensure that priority work is planned for, managed, and conducted in a timely manner.
Selecting Audit Teams
An audit team may be comprised of auditors from any classification. Audit supervisors should
meet regularly to discuss the availability of audit staff in relation to the scheduled audits. The
audit supervisors, in conjunction with the DPA, will select the lead auditor and the team members
required for a specific audit. The number of audit teams should be distributed equally between
supervisors when possible. If an audit team consists of auditors from various audit crews, the
supervisor of the lead auditor is the designated supervisor for that audit team.
Additional guidelines when selecting audit teams are as follows:
• Lead auditors and their respective team members should encourage each other to be focused
and productive.
• Less experienced auditors should initially be assigned to work on the smaller, less complex
segments of large or medium size audits. As these auditors progress, they should be assigned
to work on more complex segments of the audit.
• Each audit team member should be assigned a specific area(s) or segment(s) of the audit.
• Not all audit team members must be present at a taxpayer’s location at the same time for a
specific appointment. However, the audit team members should be aware of their workload
in any given audit and the timeframe within which to complete a designated topic, area,
or segment.
• For continuity between audits, a previous audit team member may be assigned as the
lead auditor on a subsequent audit of the same taxpayer. However, the lead auditor of the
prior audit may not be assigned as the lead auditor in the subsequent audit of that same
taxpayer.
February 2016
GENERAL AUDIT PROCEDURES
Overview
(Cont.) 0402.01
• Smaller audits may also be conducive to the team auditing approach; however, smaller
audits may require fewer audit team members than larger audits. Smaller audits should
also be considered as training audits for new audit staff.
• Auditors may work on more than one team audit concurrently.
• Auditors who are assigned as audit team members on large assignments may also be
assigned to work on their own smaller, individual audits as time permits.
ROLE OF THE AUDIT SUPERVISOR
0402.04
The role of the audit supervisor in team auditing cannot be over-emphasized, especially when
an office has multiple audit crews with audit team members crossing supervisory lines. Audit
supervisors should work closely together to establish the best audit team for each audit.
Planning/Reviewing
To assist the audit team in effective planning, the audit supervisor should:
• Communicate the goals of the audit to the lead auditor and the audit team members to
keep them focused on completing the audit timely;
• Provide adequate resources to assist in the timely completion of the audit;
• Ensure the appropriate delegation of tasks, not only to complete the audit, but to further
develop audit team members’ audit skills; and
• Work with the lead auditor to review the prior audit and other completed audit assignments
that will help identify successful audit techniques and avoid those that are less productive.
The following documents are subject to the audit supervisor’s review and approval during the
course of the audit:
• Audit Plan (AM section 0401.07) — The audit supervisor is required to review and sign all
audit plans prior to submission to the taxpayer. The audit supervisor should also make a
comment on the BOE-414-Z, documenting his or her approval.
• Information Document Request (IDR) — The audit supervisor is required to review each
initial IDR to ensure it is correct and the information being requested is reasonable and
relevant to the area being reviewed. In addition, the audit supervisor should ensure that the
information requested is provided by the taxpayer as stipulated in the IDRs. If necessary,
a second IDR requesting the same records as the initial IDR, may be issued. The second
IDR must be reviewed and signed by the audit supervisor. The second IDR should provide
an explanation of the relevance of the records being requested. The audit supervisor should
document their review of each IDR on the BOE-414-Z. For more information on IDRs, see
AM section 0401.12.
• Audit Findings Presentation Sheet (AFPS) — In a team audit, the lead auditor should review
and approve all AFPSs before presentation to the taxpayer. If an issue is controversial or
complex, an AFPS, along with the related AWPs should be reviewed by the audit supervisor
prior to providing the AFPS to the taxpayer. Early review of any AFPSs by the supervisor
will reduce the time spent by the supervisor in reviewing the entire audit package at the
end of the audit. For more information on AFPSs, see AM section 0401.14.
• Waiver of Limitations (Form BOE-122) — The audit supervisor should ensure that no
periods within the audit expire under the statute of limitations and the taxpayer does not
request any unreasonable delays in completing the audit.
February 2016
Audit Manual
Role of the Audit Supervisor
(Cont.1) 0402.04
• BOE-414-Z (AM section 0221.00) — The audit supervisor should provide all team members,
including the CAS, access to the team audit’s BOE-414-Z in the 414-Z Program. The audit
supervisor should review the BOE-414-Z on a regular basis to stay current on the audit’s
progress and provide guidance to complete the audit timely.
• Formal Notice and Demand Letter — The audit supervisor will review the formal demand
for the production of books and records prior to submission to the DPA for approval and
signature.
• Subpoena Requests — The audit supervisor and DPA will review all subpoena requests
prior to submission to the District Administrator for approval and signature.
Budgeted Hours/Time Management
The audit supervisor assigns the initial budgeted hours for all new audit assignments. When
setting budgeted hours for team audits, the audit supervisor should:
• Establish initial budgeted hours for audit assignments of accounts with no prior audit
history by using historical hours per audit by industry, auditor experience, and other
relevant factors.
• Establish budgeted hours based on hours spent on the prior audit in combination with the
factors noted above if an audit assignment has a prior audit of the taxpayer’s business.
• Have the flexibility to assign initial budgeted hours that differ from the average in-state
and out-of-state hours.
• After the completion of the audit, review the variance, if any, between budgeted and actual
hours, and discuss with the audit team the lessons learned, both positive and negative,
so that future audits can duplicate successful techniques and procedures, and avoid those
that were less productive or less efficient.
Communication
To assist the lead auditor and audit team members in maintaining effective communication in
the audit, the audit supervisor should:
• Arrange for one-on-one meetings with the lead auditor or audit team members when
necessary;
• Keep their Outlook calendar up to date in the event a meeting needs to be scheduled;
• Attend the pre-audit conference, opening conference, any status conferences, as well as
the exit conference with the taxpayer when available;
• Oversee the development and mailing of correspondence to taxpayers (owners, corporate
officers) where the taxpayer’s representative(s) delays the audit by not providing the
necessary books and records or when requested information is not furnished on a timely
basis; and
• Hold regular status meetings each month with staff to ensure the audit team stays on
track for the timely completion of the audit. The meetings should include discussions on
current audit findings, foreseeable audit and scheduling issues, and the overall progress of
the audit. Status meetings are also an appropriate time for the audit supervisor to review
required forms such as the audit plan, IDRs, AFPSs, waivers, and the BOE-414-Z. Audit
team members should be prepared to provide a copy of their Form BOE-609-A, Auditor’s
Time Report, for review by the audit supervisor and lead auditor. Budgeted hours and any
necessary amendments should also be discussed. These regular status meetings will help
ensure the audit team stays on track for timely completion of the audit.
February 2016
GENERAL AUDIT PROCEDURES
Role of the Audit Supervisor
(Cont.2) 0402.04
With respect to field visits, the audit supervisor should:
• Make his or her presence known to the taxpayer as early on in the audit as possible. The
presence of the audit supervisor at the taxpayer’s location during an audit imparts a sense
of urgency to expedite the audit process and lends credence to the work being performed
by the lead auditor and the audit team members.
• Visit the business location on a regular basis, where feasible, to review the progress being
made and to answer any questions that may arise.
• Allow the lead auditor to be in control of the pre-audit conference, opening conference,
status conferences, and the exit conference with the taxpayer. However, the audit supervisor
should be present to offer assistance and answer questions.
• Introduce the next audit team. If a subsequent audit is scheduled during the last field visit
or at the exit conference, the audit supervisor should bring in the next team of auditors
and introduce them to the taxpayer or taxpayer’s representative to establish the next
audit cycle. The supervisor should attempt to retain one or more of the prior audit team
members as part of the new audit team.
ROLE OF THE LEAD AUDITOR
0402.06
The lead auditor sets and communicates the goals of the audit, organizes the work, and ensures
adherence to timelines. The lead auditor listens objectively and communicates expectations
and instructions to both taxpayers and audit team members. The lead auditor also encourages
a cooperative, productive, and positive atmosphere while promoting adherence to BOE policies
and procedures.
The lead auditor is responsible for the overall management of the audit and is involved in the
decision making in all aspects of the audit. The lead auditor:
• Acts as the main contact person and liaison between taxpayer and BOE during the audit;
• Interacts with various levels of professional and managerial staff;
• Distributes, prioritizes, and reviews the work of audit team members; and
• Communicates and negotiates with taxpayers on sensitive issues and problems.
The lead auditor is a role model and should:
• Be professional in all interactions with taxpayers, representatives, supervisors, and other
audit team members;
• Provide guidance to audit team members on complex tax and audit issues; and
• Promote and develop the strengths in each audit team member, thereby improving their
skills.
Planning/Reviewing
Overview
The lead auditor is responsible for reviewing the taxpayer’s history and prior audit(s) and
determining the scope of the expected audit. This generally takes place in the period prior to
the opening conference when the auditor performs most of the preliminary overview work.
This includes analyzing tax returns, transcripts, the taxpayer’s account (including ownership);
reviewing the prior audit history; researching the business and industry; and performing other
information gathering techniques that provide the auditor with a better understanding of the
taxpayer’s business and potential audit issues.
February 2016
Audit Manual
Role of the Lead Auditor
(Cont.1) 0402.06
Audit Plan (AM section 0401.07)
An audit plan is required on all audits. The lead auditor is responsible for the development of a
detailed audit plan for each assignment. The lead auditor should develop an audit plan that strives
for completion of an audit within a two-year timeframe, where applicable, commencing with the
date of the opening conference and ending with the date of the exit conference. While most audits
will be completed in a much shorter timeframe, others may require a period beyond two years.
The audit plan should include all areas under audit: the audit procedures to be used, timeframes,
deadlines and estimated completion dates. The lead auditor should:
• Discuss the audit plan with the audit supervisor and audit team members;
• Assign the tasks within the audit plan to the audit team members;
• Make audit team members aware of all audit appointments and whether or not they are
expected to be present;
• Work with the audit supervisor to develop budgeted hours for the audit and/or for each
member of the team, or for each area of the audit for which they are assigned;
• Present the audit plan to the audit supervisor for review and signature prior to it being
submitted to the taxpayer; and
• Discuss and provide a copy of the draft audit plan to the taxpayer at the opening conference,
or when necessary for the auditor to first review the taxpayer’s records, within 30 days
from the opening conference.
Contact with the Computer Audit Specialist (CAS)
The lead auditor should consult with the CAS during the planning stages and throughout the
audit as deemed necessary to determine the electronic records that are needed and to prepare
appropriate sampling plans. While considered a member of the audit team, the CAS will serve
in a consulting capacity while the lead auditor is responsible for making decisions regarding the
audit approach. Additional guidelines with respect to working with the CAS are as follows:
• The lead auditor should introduce the CAS to the taxpayer at the pre-audit conference.
• The taxpayer may address specific technical questions regarding the data to the CAS;
however, the taxpayer should be made aware that all questions and issues related to the
audit approach and scope of work should be discussed with the lead auditor.
• The lead auditor should routinely follow-up with the CAS on the status of the taxpayer’s
electronic data analysis.
Budgeted Hours/Time Management
Budgeted Hours
The lead auditor should work with the audit supervisor to determine the budgeted hours for
each assignment. The budgeted hours should be based on factors such as the size and complexity
of the business, number of audit team members, and the hours used in prior audits. While the
audit supervisor will ultimately set the initial budgeted hours during the planning stage, it is the
responsibility of the lead auditor to approach the audit supervisor to discuss any changes in the
audit plan that will affect the actual number of hours on the audit. Through discussion with the
audit supervisor, the estimated number of hours may be revised based on changing circumstances
in the audit.
February 2016
GENERAL AUDIT PROCEDURES
Role of the Lead Auditor
(Cont.2) 0402.06
Overall Time Management
The lead auditor is responsible for the overall time management of the audit. Some general time
management techniques include continuous monitoring of the audit, establishing reasonable
timeframes for the taxpayer and audit team members, setting deadlines, confirming deadlines in
writing, and following-up on those deadlines. Additional time management procedures the lead
auditor should use include, but are not limited to:
• Scheduling a pre-audit conference (where applicable);
• Adhering to the timelines set forth in the audit plan (or amended audit plan), and ensuring
adequate resources to do so;
• Ensuring audit team members are aware of audit appointments and whether or not they
are expected to be present;
• Ensuring audit team members have adequate work and are actively working towards
completing their assigned area of the audit timely;
• Holding regular status conferences with the taxpayer;
• Holding regular status meetings with audit team members and holding all audit team
members accountable for their assigned audit areas and timeframes;
• Comparing Form BOE-609-A, Auditor’s Time Report, of each audit team member with
the audit plan and discussing this with the audit supervisor to make sure the hours are
reasonable for the work performed; and
• Preparing timely status reports on all audits for supervisor/management review.
Preparation of Information Document Request (IDR) (AM section 0401.12)
When a taxpayer or their representative fails or refuses to provide records or supporting
information/documents in response to verbal requests for the same records, (or when otherwise
appropriate), the lead auditor is responsible for preparing and tracking IDRs. However, before
proceeding with the IDR process, taxpayers should be allowed to comply with verbal requests for
information/documents. The lead auditor has the discretion to determine reasonable response
times for verbal requests.
As part of the IDR process, the lead auditor should:
• Prepare, maintain, and track all IDRs issued during the course of the audit;
• Sign the initial IDR before issuance to the taxpayer;
• Ensure all IDRs are presented to the audit supervisor for review;
• Timely follow-up with the taxpayer within 30 days on all IDR responses received from the
taxpayer;
• Notify the audit supervisor if any IDRs are not responded to in full;
• Assist in the preparation of the appropriate Formal Notice and Demand letter if the
taxpayer fails or refuses to provide the information stipulated in the initial IDR and the
second IDR; and
• Prepare the request for a subpoena for the production of books and records for the audit
supervisor’s and DPA’s review and district administrator’s approval, when appropriate.
• Document all verbal and IDR requests on the BOE-414-Z.
February 2016
Audit Manual
Role of the Lead Auditor
(Cont.3) 0402.06
Preparation of Audit Findings Presentation Sheet (AFPS) (AM section 0401.14)
During the course of an audit, one or more areas may be completed prior to the completion of the
audit as a whole. An AFPS should be prepared for each area upon completion and provided to the
taxpayer. The following guidelines should be followed when preparing AFPSs in a team audit:
• The lead auditor must ensure that the audit team members complete the appropriate
AFPS for the respective segment or area for which they are responsible.
• The lead auditor must review all AFPSs with audit team members before presentation to
the taxpayer. If an issue is controversial or complex, an AFPS along with the related AWPs
should be reviewed by the audit supervisor prior to providing the AFPS to the taxpayer.
• The audit team member responsible for the respective audit segment or area should
participate with the lead auditor in the discussion of the AFPS with the taxpayer. The
lead auditor should be present to answer any questions and to assist in the resolution of
non-concurred issues.
• In general, within 30 days of the taxpayer providing additional information in response
to an AFPS, the lead auditor must notify the taxpayer if an adjustment to the audit is
warranted based upon the information provided. It is the duty of the lead auditor to notify
the audit supervisor and taxpayer if this timeframe cannot be met.
Communication
The lead auditor’s communication skills are key to an effective team audit. The lead auditor is
the central communication point between the taxpayer, the audit supervisor, and audit team
members. To ensure effective communication in the audit, the lead auditor must:
• Keep their Outlook calendar up-to-date;
• Periodically discuss the status of the audit with the audit supervisor (at least monthly);
• Provide prompt responses to the audit supervisor’s questions and requests;
• Continually communicate with team members;
• Ensure all audit team members are aware of all audit appointments and whether or not
they are expected to be present;
• Make regular, appropriate, and timely comments on the BOE-414-Z (at least weekly, or
when appropriate) and ensure audit team members do the same;
• Keep the taxpayer continually informed of the status of the audit and prepare appropriate
written correspondence when necessary;
• Prepare timely IDRs;
• Coordinate the preparation and presentation of AFPSs;
• Ensure audit team members provide prompt responses to the reviewer’s questions or “gobacks” on a timely basis; and
• Regularly communicate with other lead auditors in the office or other districts to discuss
experiences and difficulties encountered, and share ideas for successful team audits.
February 2016
GENERAL AUDIT PROCEDURES
Role of the Lead Auditor
(Cont.4) 0402.06
Working With Audit Team Members
The lead auditor should delegate tasks and assignments in a way that enables work to be completed
efficiently and that challenges and develops audit team members. Audit team member duties and
responsibilities should be appropriate for each classification, knowledge and experience level. This
does not preclude experienced audit team members or the lead auditor from performing basic
verification work, should the need arises. Lead auditors are expected to work with the audit team
members for the timely completion of an audit and not simply delegate work.
Additional guidelines when working with audit team members are as follows:
• The audit team members should participate in developing the audit plan.
• Audit team members should be made aware of all audit appointments, and be asked to
attend all conferences with the taxpayer regarding the area in which they worked whenever
possible.
• Audit team members should back up their work on the J:\Drive as necessary, but at least
once a week. However, the audit team members should provide the lead auditor with an
electronic copy of the work they completed at the end of the field visit, or when any changes
to the schedules or AWPs are made throughout the course of the audit. The lead auditor
should always maintain a complete set of the most current electronic AWPs.
• When an audit team member has finished their specific audit area, they should be
redirected to assist on another area of the audit, or should be released to conduct other
audit assignments at other taxpayer’s locations.
The lead auditor should address and appropriately resolve minor issues regarding audit team
members. The lead auditor should also provide the audit supervisor feedback, both positive and
negative, regarding audit team members’ performance and productivity.
Conducting the Audit
The tone for the audit should be set early and an open line of communication with the taxpayer
should be encouraged throughout the audit process. The lead auditor should promote a collaborative
relationship with the taxpayer from the inception of the audit and encourage the taxpayer’s
cooperative participation in the audit process.
The lead auditor is responsible for setting appointments and conducting meetings with the
taxpayer. These meetings include the pre-audit, opening, status, and exit conferences. The audit
team members should be present to assist the lead auditor with the meetings and whenever
possible, the audit supervisor should be present. At the opening conference, the lead auditor
should introduce him or herself, the audit team members, and provide, in writing, the name and
phone number of the audit supervisor and all audit team members.
The lead auditor should explain the audit team’s reporting lines to the taxpayer and each team
member’s role in the audit, including the area or segment in the audit that each team member
will be responsible for completing. Changes in personnel during the course of the audit should be
timely communicated to the taxpayer.
The lead auditor is responsible for securing, monitoring, and maintaining the waiver of limitations
status and obtaining necessary extensions. The lead auditor should inform the supervisor of
the circumstances that necessitate a request for a waiver, and ensure supervisory approval is
documented on the BOE-414-Z before the waiver is presented to the taxpayer for signature. If
the extension of the statute of limitations totals two years or more, approval by the DPA will be
documented on the BOE-414-Z.
February 2016
Audit Manual
Role of the Lead Auditor
(Cont.5) 0402.06
At the conclusion of an audit, the lead auditor is responsible for compiling the AWPs into a final
product for presentation to the taxpayer. Audit team members should complete the final working
papers in their assigned area and be prepared to present them to the taxpayer along with the
lead auditor. This includes completing the necessary schedules, forms, and general and subsidiary
comments.
At the exit conference (AM section 0401.16), the lead auditor may want to recap any findings
previously discussed in status conferences or through an AFPS. The audit team member assigned
to a particular area of the audit should lead the discussion of that area. However, the lead auditor
should be present to assist with any questions or concerns the taxpayer may have.
ROLE OF AUDIT TEAM MEMBER
0402.08
The role of the audit team member is to work with the audit supervisor and lead auditor to timely
complete the audit. The audit team member is not strictly limited to their tasks or assigned area(s)
in the audit. A good audit team member contributes to the success of the team. They share helpful
ideas and information and may go beyond what is required of them.
Budgeted Hours/Time Management
To assist the lead auditor in managing the time it takes to complete the audit, the audit team
member should:
• Complete their assigned tasks timely and inform the lead auditor of any potential delays.
• Keep track of their hours on Form BOE-609-A and be prepared to provide the lead auditor
and the audit supervisor a copy of the completed form and other pertinent documents
during regular status conferences.
• Compare their actual hours to the budgeted hours on the audit plan and notify the lead
auditor of any possible differences.
In team audits, each area of the audit may be completed in parts rather than simultaneously. The
entire team does not need to visit the taxpayer’s location all at once, unless all records are available
and the taxpayer has the facilities to accommodate all BOE staff assigned to the audit team. Thus,
audit team members may be scheduled to perform fieldwork at different times, depending on
the availability of records or taxpayer’s facilities. For example, the taxpayer may have all of the
records for a sales test, but not the paid bills test. The audit team member assigned to the sales
test will go to the taxpayer’s location, but the audit team member assigned to the paid bills test
may be working at another taxpayer’s location during this time. Once the paid bills are available,
the audit team member assigned to paid bills will go to the taxpayer’s location to complete their
area. It is not necessary for the lead auditor or other audit team members to be in the field at the
same time, thus saving the BOE and the taxpayer time and resources.
Audit team members who have completed their assigned area(s) of the audit should ask for
instructions from the lead auditor on the next area of the audit to be completed. Audit team
members may not return to the work location of the team audit to work on audits of other taxpayers.
February 2016
GENERAL AUDIT PROCEDURES
Role of Audit Team Member
(Cont.1) 0402.08
Communication
During a team audit, the audit team member must effectively convey information and encourage
an exchange of ideas. To achieve this, the audit team member should:
• Share helpful ideas and information with the team;
• Proactively inform the lead auditor or audit supervisor of any obstacles that may arise;
• Independently prepare complex oral and written communications;
• Possess the ability to express alternative views in a constructive manner and seek mutually
beneficial solutions; and
• Work well with others, even when differences in communication style, viewpoints, or culture
exist.
The audit team member should be present at all meetings and discussions for areas in which they
worked whenever possible. This includes, but is not limited to, audit plan preparation, the opening,
status, and exit conferences with the taxpayer, and any status conferences with the supervisor.
During the opening conference, the lead auditor and audit team members should discuss with the
taxpayer which team members to contact if any questions arise in the audit. Furthermore, the
lead auditor and audit team member should discuss with the taxpayer which BOE staff member
the taxpayer should contact if he or she has any questions regarding the audit. Because situations
are different, and taxpayers have different preferences of whom they wish to communicate with,
these contacts should be established and understood by both the taxpayer and all audit team
members at the beginning of the audit. These contacts should also be noted on the audit plan.
See AM section 0401.09, Opening Conference, for more detailed information.
On a regular basis, each audit team member is expected to enter comments related to the audit
in process on the BOE-414-Z.
When an audit team member has completed their area(s) of the audit, they must immediately
inform the lead auditor so that an AFPS can be prepared. The audit team member who completed
the particular area should complete the AFPS. The audit team member may conduct the actual
discussion of AFPSs with the taxpayer, if necessary; the lead auditor should be present to answer
any questions and to assist in the resolution of non-concurred issues.
February 2016
Audit Manual
Role of Audit Team Member
(Cont.2) 0402.08
Conducting the Audit
Audit team members are assigned different areas in the audit based on their expertise and the
complexity of the audit area. Such areas may include tests of sales for resale, paid bills, test of
assets, etc. The audit team member is responsible for performing those tasks, as well as completing
the write-up for that particular area. This includes:
• Working paper completion — The entire schedule should be completed including calculations
and all referencing.
• Projection of error — The audit team member should complete any projection of errors
associated with their assigned area.
• Schedule comments — comments related to individual transactions in the schedule, such
as disallowed sales for resale or purchases subject to use tax, should be completed by the
audit team member.
• General comments — The general comments (Schedule 12 comments) should be completed
by the audit team member who is responsible for that area.
• Go-Backs — The audit team member assigned to a particular area is responsible for
answering an audit reviewer’s question(s) on a go-back regarding that area in a timely
manner. The audit team member is also responsible for making any required comments
or corrections required by the reviewer.
• IDRs — The audit team member should assist in the preparation of document requests
including IDRs and follow-up IDRs, and Formal Notice and Demand letters.
• AFPSs — The audit team member responsible for their respective audit segment or area
will complete the appropriate AFPS; however, the lead auditor must review all AFPSs prior
to presentation to the taxpayer. The audit team member should also participate in the
discussion of the AFPS with the taxpayer. Any documentation provided by the taxpayer
in response to an AFPS should be reviewed by the audit team member and discussed with
the lead auditor as appropriate.
It is the responsibility of the audit team member to be aware of all areas of the audit in case they
are asked to fill in for another audit team member. One purpose of the team audit approach is to
respond to setbacks with minimal disruption to productivity. If an audit team member is unable
to attend a conference or perform fieldwork, it is up to the other audit team members to willingly
accept new assignments and change focus as demands may modify the course of the audit. At the
exit conference, the audit team member assigned to a particular area of the audit should lead the
discussion of that area.
ROLE OF THE COMPUTER AUDIT SPECIALIST IN A TEAM AUDIT
0402.12
The lead auditor is responsible for the audit as a whole. However, the CAS assigned to a specific
audit is considered part of the audit team with respect to that audit and will serve as a technical
consultant to the auditor(s) to assist with the electronic records and sampling.
The CAS’s responsibility is primarily that of: obtaining the necessary data, data processing,
recommending strata breaks and sample sizes and sample selection as defined in the auditor’s
Form BOE-472 Audit Sampling Plan. Specific technical questions regarding the data and testing
may be addressed to the CAS, however, all questions and issues related to the audit and scope of
work should be discussed with the lead auditor.
For detailed information on the role and responsibilities of a CAS in an audit, see AM section
0403.12.
February 2016
General Audit Procedures
PROGRAMMING — AUDIT SURVEY
STARTING AN ASSIGNMENT — GENERAL
0403.00
0403.05
Generally, an assignment should be started only after proper arrangements have been
made in advance. In rare instances, it may be desirable to start an assignment without
notifying the taxpayer, as in the case of a surprise investigation of a person suspected of
fraudulent reporting practices.
If the necessary records are located in an area handled by another district or branch office,
the audit assignment normally should be transferred to that district or branch office along
with Form BOE–579, Audit Assignment Transfer. This form should be accompanied by
a fact sheet setting forth as much pertinent information as is available, including any
audit memoranda that will assist the receiving office in completing the case. The auditor’s
supervisor may, in unusual circumstances, arrange for the auditor to conduct the audit
at the other location.
TRANSFERRING AN AUDIT TO ANOTHER DISTRICT
0403.07
When transferring an audit to another district, the auditor should prepare a new audit case using
the Excel Audit Program. Although, it is not required to start a new case, it is recommended since
forms such as the BOE-122, Waiver of Limitation, must be prepared in Start21, Form BOE-579
must be completed, and an electronic copy of the transcripts downloaded and saved. The auditor
may prepare an audit transfer folder (transfer folder) without creating a new audit case folder,
however, all forms and supporting documentation must be included in the transfer folder.
Rename the audit transfer folder as follows:
Audit Transfer Folder
Naming Format
District Code_Case Number_Taxpayer Name_BOE 579 to District
Example
EA_54321_ABCO_BOE 579 to AA
When sending a transfer folder to another district, the office designator used to name all electronic
forms and folders should reference the district of account. Save Form BOE-579 in the transfer
folder. It can be created in Start21, but a separate copy must be saved in the Forms subfolder.
The following forms, if available, must be completed, signed, scanned, or saved in the Forms
subfolder using the appropriate naming convention as described in Audit Manual section 0302.00:
•
•
•
•
•
•
•
•
•
BOE-122, Waiver of Limitation
BOE-392, Power of Attorney
BOE-80RU, Record Update
BOE-101, Claim for Refund or Credit
BOE-82, Authorization for Electronic Transmission of Data
BOE-414Z, Assignment Activity History
BOE-414M, Electronic Transcript of Returns
Transfer Letter
Any additional documents
Once the transfer folder has been prepared including all required documents, the auditor will cut
and paste the transfer folder to the audit control inbox and notify their audit supervisor of the
pending audit transfer. The audit supervisor will then review the transfer folder for completeness
and notify Audit Control of the pending audit transfer.
June 2014
Audit Manual
Transferring an Audit to Another District
(Cont.) 0403.07
Generally, Audit Control updates IRIS for comments, hours, and transfers; enters “Y” for digital
audits on the AUD MC screen; transfers the electronic 414Z to the receiving district; and completes
any other IRIS or audit transfer functions. Once all tasks are complete, district staff (generally
Audit Control) cuts and pastes the transfer folder from the Audit Control Inbox into the Transfer
Documents to Other Districts folder for the receiving district (generally located on the district J:\
drive above the Audit Control Inbox).
District staff will send an email to the receiving district notifying them of the pending audit
transfer. After the audit has been transferred, the office making the audit uses its own designator
for the audit case folder and files.
PRELIMINARY ARRANGEMENTS
The following procedures must be performed before starting an audit assignment:
0403.10
(a) Review the district master file (if available) to obtain information about the taxpayer’s type
of business, starting date, closeout date, ownership, reorganizations, and general record
of reporting; and to review refund notices, delinquencies, audit memos, etc. The following
taxpayer information may also be obtained through the Integrated Revenue Information
System (IRIS) or the Internet:
• The IRIS TPS TP screen for prior audit information and petition and claim for
refund status. If a “Y” is noted under the appeal category, check the APL PR
screen for more information.
• The IRIS COM BA screen for comments input from all IRIS subsystems. If
payment problems are noted, the auditor may request that compliance staff
review the account on Automated Compliance Management System (ACMS) for
additional information.
• The CTS AL screen to find related businesses, accounts or permits with the BOE.
• The DIF DA screen to identify any outstanding balance and to determine if any
collection action is being taken against the taxpayer.
• The Internet to find information on company history, product lines, store locations,
recent mergers and acquisitions, bankruptcies, etc.
(b) Contact the taxpayer to arrange for the following information:
• Exact date and time for starting the audit assignment or a pre-audit conference
(AM section 0401.08).
• Records to be available at the start date of the audit.
• Name and position of person to be contacted. (The auditor must leave his or her
name and telephone number with the taxpayer at this time.)
• Desk space/work area.
(c) Verify registration information, including:
• The current ownership is the same as the permit. Sole proprietors may not know
that becoming a partnership or incorporating is a change in ownership.
• The accuracy of the assigned area code(s).
• The accuracy and currency of all subpermits.
• The correctness of the taxpayer’s local and transit tax allocation procedures.
• Any other area(s) which could impact the accuracy of the reported local tax.
February 2016
General Audit Procedures
Preliminary Arrangements
(Cont. 1) 0403.10
If any errors are discovered, the auditor is to take immediate corrective action such as:
• Obtaining the date when the change or error first occurred.
• Notifying District Compliance as described in AM section 0219.03 (or preparing other
forms as required by District Compliance) if an area code change is required.
• Notifying District Compliance of new or closed-out subpermits.
The appropriate BOE–80 series “Audit Engagement Letter” should be used to confirm arrangements
to begin audits or to establish contact with the taxpayer.
BOE–80–A Audit Engagement Letter – Confirm Start Date
BOE–80–B
Audit Engagement Letter – Agreement to Delay Start Date
BOE–80–C Audit Engagement Letter – Initiate Contact
BOE–80–D
Audit Engagement Letter – 10–Day Follow Up
BOE–80–DOH Audit Engagement Letter – 10–Day Follow Up (Out-of-State)
BOE–80–EOH Audit Engagement Letter – In Area (Out-of-State)
BOE–80–FOH Audit Engagement Letter – Apology (Out-of-State)
Forms BOE–80–A, BOE–80–B, BOE–80–C, and BOE–80–EOH include the following enclosures:
•
•
•
•
Form BOE–80–RU, Record Update
Publication 70, Understanding Your Rights as a California Taxpayer
Publication 76, Audits
Publication 17, Appeals Procedures, Sales and Use Taxes and Special Taxes
Form BOE–80–RU is intended to help obtain taxpayer’s current registration information at
the start of an audit. The auditor should verify the accuracy of the information provided by the
taxpayer on Form BOE–80–RU and include a comment to that effect on Form BOE–414–Z, Audit
Assignment History. A copy of Form BOE–80–RU should be included in the Forms subfolder of
the audit case folder. To update the taxpayer’s registration information on IRIS, a copy of Form
BOE–80–RU should be sent to the District Compliance Supervisor.
Normally the initial contact with the taxpayer will be by telephone. When the audit appointment
results from a telephone contact, the appointment must be immediately confirmed by mail using
Form BOE–80–A, Audit Engagement Letter — Confirm Start Date, with the enclosures listed above.
If the audit will commence within a week of making the appointment, the engagement letter and
enclosures may be given to the taxpayer at the start of the audit. If the audit appointment is
with the taxpayer’s representative, the engagement letter and enclosures should be sent to the
taxpayer, with a copy to the representative.
The auditor should grant reasonable requests by taxpayers to delay the start of an audit, but
should be alert to detect attempts to forestall it. If excessive delay in the start date is agreed to,
and a reporting period is about to expire, Form BOE–80–B, Audit Engagement Letter – Agreement
to Delay Start Date should be used. Form BOE–122, Waiver of Limitation, covering a minimum
of two quarterly reporting periods should be included with the enclosures. (AM section 0215.15
provides guidance when a waiver of limitation should be requested.) If the audit is a result of a
claim for refund filed by the taxpayer, Form BOE–146, Waiver of Credit Interest, should be obtained.
February 2016
Audit Manual
Preliminary Arrangements
(Cont. 2) 0403.10
If the auditor is unable to contact the taxpayer by telephone, Form BOE–80–C, Audit Engagement
Letter – Initiate Contact should be used. If the taxpayer does not respond by the date specified
on Form BOE–80–C, Form BOE–80–D, Audit Engagement Letter – 10–Day Follow Up should
be sent to the taxpayer. As Form BOE–80–D explains, if the books and records are not provided
by a specific date, the BOE will either issue a subpoena requiring the taxpayer to provide the
books and records or prepare a billing for estimated additional taxes due. The books and records
must be subpoenaed when an estimated billing has been prepared and the taxpayer, at any time,
disagrees with the proposed assessment or determination.
During the course of an audit, if the taxpayer or the taxpayer’s representative refuses to provide
or claims not to have some or all of the records which the auditor has requested orally, procedures
outlined in AM section 0401.12, Information Document Request, should be followed. These
procedures also apply when the taxpayer refuses to provide access to computerized records that can
be used for testing purposes. However, if most of the records are available, or the auditor believes
that the requested records do not exist and the estimated deficiency is either small or would not
be significantly altered if the records were available, then no further effort should be expended
to obtain the records. A letter should be written to the taxpayer confirming that a request for the
records had been made, acknowledging that the taxpayer or representatives failed to provide the
records requested, and advising that a billing based on the available records is being prepared.
Comments regarding contacts and attempts to contact taxpayers, both oral and written, must be
documented on Form BOE–414–Z. Copies of correspondence referenced on the BOE–414–Z should
be included in the audit Correspondence subfolder of the audit case folder. It should be noted in
the “books and records” comment of the Field Audit Report or Field Billing Order if any records
were withheld or were not available. The auditor’s comments must clearly state the effect the lack
of records had on the amount billed.
VIDEO AND AUDIO TAPING
0403.11
If the taxpayer insists on video or audio taping the auditor as a condition of making the records
available, the BOE may consider issuing a subpoena for the records.
An auditor should not consent to videotaping without discussing the request with his or her
supervisor. Although there may be limited circumstances where videotaping is approved, generally
if a taxpayer insists on videotaping the auditor as a precondition to the availability of the necessary
books and records, the taxpayer has in effect refused to cooperate with the auditor and has not
made the necessary records available as required by law. Under these circumstances, the subpoena
process may be used to obtain the books and records. (See AM Exhibit 4).
Although the taxpayer may not make audio taping a precondition for disclosure of the necessary
records, the BOE will allow a taxpayer to audiotape audit discussions with the auditor provided
the BOE makes its own audio recording. Depending on the experience of the auditor and/or the
nature of the audit issues, the district may want to consider having a supervisor present during
the audio taping of the audit discussions.
February 2016
GENERAL AUDIT PROCEDURES
ROLE AND RESPONSIBILITIES OF COMPUTER AUDIT SPECIALIST
0403.12
The goal of the Computer Audit Specialist (CAS) program is to provide specialized technical
support and assistance to field audit staff in dealing with electronic records and in the design,
implementation and analysis of statistical samples. By leveraging the advanced electronic data
analysis techniques and tools used by the CAS, field audits can be performed more accurately
and efficiently. The CAS enables audit staff and taxpayers to make more informed decisions
regarding the population to be tested, sample size, stratification levels, sample representativeness,
statistically proper handling of unusual sample units, sample evaluations, etc.
The CAS serves in a consulting capacity and is required to be consulted on all audits where:
• A previous audit exceeded 400 hours and large volumes of electronic data will be utilized;
• There are large volumes of electronic data;
• A prior audit was performed with a CAS;
• Assistance is needed by the auditor to obtain usable data.
The CAS may also be consulted on other complex audits at the discretion of the audit supervisor.
In addition, the CAS supplies expert advice on electronic data downloads, statistical sampling
procedures, and sample evaluations, as needed by the audit staff and district audit management.
CAS Coordination with District Principal Auditors or Area Administrators
To enhance communication between the CAS and District Principal Auditor (DPA) or Area
Administrator, the CAS staff is required to do the following:
• Schedule and attend monthly meetings with the DPA or Area Administrator to review
audits with CAS involvement and discuss their progress.
• Provide access to their Outlook calendars to the DPA or Area Administrator of the districts
they reside in and support. CAS staff must keep their Outlook calendars up to date
(including approved time off).
• Attend district office staff meetings provided they are notified in advance and are available.
• Establish designated office hours (days and hours they will be in the office). Typically instate CAS have one regularly scheduled office day per week and out-of-state CAS have
one office day on non-travel weeks. When exceptions have to be made, the CAS will give
the DPA advanced notice.
• The CAS must timely document their work on the BOE-414-Z for each account they are
working.
• The CAS will report any delays related to their role in the audit directly to the DPA or
Area Administrator, Supervising Tax Auditor, and the auditor.
• The CAS will secure the taxpayer’s electronic data consistent with the established security
policies for taxpayer’s electronic data.
General Audit Roles & Responsibilities of the CAS and Audit Staff
The CAS is a member of the audit team and serves as a technical consultant to the auditor(s). The
CAS should be available for consultations and to attend meetings and status conferences upon
the request of the Audit Supervisor, the DPA or the Area Administrator.
February 2016
Audit Manual
Role and Responsibilities of Computer Audit Specialist
(Cont. 1) 0403.12
The auditor is responsible for making decisions regarding the audit approach; however, the CAS
may offer suggestions pertaining to electronic records and statistical sampling. As such, the
development of an audit plan for an audit utilizing a CAS requires a coordinated effort between
the CAS and the auditor with the following principles in mind:
• Request records and data that are relevant to the audit.
• Ensure the transaction data is material to the audit.
• Consider the nature of transactions and the ease with which data can be accessed and
analyzed.
• Ensure timely communication between the CAS and the auditor throughout the development
of the audit plan and the audit process.
If there is any concern or disagreement between the CAS and the auditor regarding the audit
plan or methodology, the CAS should bring these concerns to the attention of the DPA or Area
Administrator, Audit Supervisor and the CAS Supervisor. There should be no discussion of
concerns in front of the taxpayer.
The CAS’s analysis, evaluation and understanding of the taxpayer’s electronic records, and
processing of the data will be documented by the CAS for inclusion in the audit verification
comments. The CAS’s documentation should include a detailed log and reconciliation of how the
target population(s) was achieved from the original population provided and the taxpayer’s data
layout.
Pre-Audit Conference
On accounts where a CAS consultation is required, the lead auditor should contact and meet with
the CAS before scheduling the pre-audit conference with the taxpayer. See AM section 0401.08 for
more information on the Pre-Audit Conference. At or prior to the pre-audit conference, the auditor
will provide the taxpayer a copy of Publication 147, What to Expect in a Computer Assisted Audit.
The CAS will attend the pre-audit conference(s) with other BOE representatives, the taxpayer
and their representative along with the taxpayer’s appropriate Information Technology (IT) staff.
The pre-audit conference must include an explanation and a discussion of the following issues
and documents relating to the CAS involvement in the audit.
• Publication 147, What to Expect in a Computer Assisted Audit
• Availability and access to records
• What data fields/elements are maintained in the taxpayer’s database
• How data is stored in the taxpayer’s computer system
• Checklist for electronic data
• Electronic data transfer process
• Security of taxpayer data
• Validation and reconciliation of data
• Relevant sampling issues
• Timeframes for furnishing and reviewing records
• Work to be performed by the CAS, including work to be performed at the taxpayer’s location.
February 2016
GENERAL AUDIT PROCEDURES
Role and Responsibilities of Computer Audit Specialist
(Cont. 2) 0403.12
The CAS, auditor and taxpayer should work together to establish reasonable timeframes for the
taxpayer to furnish the data requested and the CAS to process the data. The auditor is responsible
for following up with the taxpayer to ensure all requested data is provided. The Checklist for
Electronic Data will be provided to the taxpayer by the CAS to ensure that all requested data is
provided.
The CAS should work with the taxpayer’s IT staff to achieve a thorough understanding of the
taxpayer’s electronic books and records. Whenever possible, the CAS should review the extraction
query written by the taxpayer for the requested data to ensure the data provided will be complete,
correct and unfiltered.
At the pre-audit conference, the taxpayer should be encouraged to perform their own data
validation(s) and reconciliation(s) due to their knowledge and expertise with their accounting
system. This will minimize the auditor and CAS time required to complete this task.
Initial Data Analysis
After data is provided by the taxpayer, two key steps must be completed before the data can be
used for audit purposes:
1. Validation – This refers to reconciling control totals and record counts related to data files
provided for use in the audit. Validation is the responsibility of the CAS.
Depending on the volume of data and number of data files, this may take up to several
days by the CAS. The auditor will be contacted immediately via email when the initial
validation work is complete. If the data is successfully validated, the CAS will provide the
auditor with the necessary data files to complete the reconciliation. If the data cannot be
validated, the CAS will inform the auditor and audit supervisor so appropriate action may
be taken to secure the necessary electronic records.
In the event the CAS cannot complete the validation process timely, notification will be
made immediately to the auditor and auditor supervisor.
2. Reconciliation – This refers to the audit procedure of tracing amounts to the books and
records to verify the data provided by the taxpayer accurately represents the amounts
recorded in the books and records. The taxpayer and the auditor should come to a
consensus that the electronic data received is an accurate and complete representation of
the transactions requested.
While the CAS will provide guidance and assistance as needed to the auditor and the
taxpayer regarding the reconciliation of data, it is the auditor’s responsibility to ensure
the data is verified for accuracy and completeness.
February 2016
Audit Manual
Role and Responsibilities of Computer Audit Specialist
(Cont. 3) 0403.12
Sampling and Testing
After the electronic data is validated and reconciled, the auditor and CAS will work in a concerted
effort with the taxpayer regarding sampling characteristics, such as:
• Population
• Sample size
• Accounts of interest
• Sample units
• Cost centers
• Locations
• Divisions of interest
• Eliminated transactions
• Handling of credits and offsets (which method will be used)
• Handling of missing invoices
Should agreement not be possible, the auditor will make the final decision on and be responsible
for the sampling characteristics and the sampling methodology. Should agreement be reached and
based on the sampling plan, the CAS will complete and provide the necessary documents and/or
schedules to the auditor for inclusion in the audit working papers.
Form BOE-472, Use of Sampling in Auditing, will be used by the auditor (the CAS will assist
when necessary) to document the sample selection methodology.
After the electronic data is verified and reconciled, at the request of the auditor, the CAS will:
• Filter the electronic data for selecting the sample or accounts of interest.
• Design statistical sampling plans for appropriate areas of the audit.
• Perform other computer assisted audit procedures as needed.
See AM Chapter 13, section 1305.00, for more information on sample selection and evaluation of
sample results.
Exit Conference
As a general rule, the CAS’s work will be completed long before the exit conference. Presence
of a CAS at the exit conference is not mandatory; however, the DPA or Area Administrator, or
Supervising Tax Auditor may request the CAS attend when beneficial.
February 2016
General Audit Procedures
CONTACTS WITH THIRD PARTY REPRESENTATIVES
0403.14
In order to protect the taxpayer, it is always a good practice to secure written authorization from
the taxpayer to discuss their case with a third-party representative, preferably prior to initiating
any discussion or correspondence with the person claiming to be a representative of the taxpayer. It
is, however, not generally necessary to obtain written authorization when the taxpayer introduces
or refers the auditor to the representative. It is also not necessary to obtain written authorization
when the representative is a professional governed by a code of ethics, e.g., a Certified Public
Accountant (CPA) or attorney. However, as stated above, it is a good practice – particularly when
contacted unilaterally by a professional – to obtain a written authorization or acknowledge the
contact in writing with a copy to the taxpayer. Taxpayers should receive copies of all correspondence
between the BOE and taxpayer’s representative concerning the taxpayer’s case(s).
POWER OF ATTORNEY
0403.15
A taxpayer may be represented by legal counsel, CPA, or other representative as evidenced by
a power of attorney document signed by the taxpayer, appointing a representative, which is
provided to the BOE. Taxpayers may use Form BOE-392, Power of Attorney, to document power
of attorney status conveyed to a representative. In lieu of a BOE-392, BOE staff will accept any
written document identified as a “power of attorney” containing substantially all of the following
information:
1. Taxpayer’s name, telephone number, taxpayer identification number(s), account or permit
number(s) and mailing address;
2. The name, address (including e-mail, if any), and telephone and FAX number of the
appointed representative(s);
3. The tax matters in which the representative is authorized to represent the taxpayer; the
scope of the representative’s authority; and the tax period(s) for which the authorization
is granted;
4. A statement that the power of attorney revokes all prior powers-of-attorney, with any
exceptions to the revocation noted;
5. The time period during which the power of attorney shall be in effect; and
6. The signature(s) and title of all affected taxpayers and the date of signature.
In the event a taxpayer has submitted a power of attorney document appointing a representative,
BOE staff must deal with the representative regarding all tax matters identified in the power of
attorney document (unless directed otherwise by the taxpayer). However, staff should continue
to be responsive to any direct communication from the taxpayer, and copy the taxpayer on all
written correspondence sent to the representative, where appropriate.
If the representative has demonstrated a repeated failure to respond to inquiries or requests from
staff, especially regarding issues that are time sensitive and require immediate action, staff may,
after consulting with a supervisor, contact the taxpayer directly. All actions or correspondence
must be fully documented on the BOE-414-Z.
The decision to contact the taxpayer directly should be based on the representative’s degree
of cooperation with BOE staff and the taxpayer’s compliance with the BOE action(s) that are
requested through the representative. All subsequent contacts with the taxpayer and the taxpayer’s
representative must be fully documented on the BOE-414-Z to protect against potential claims or
allegations of harassment. In situations requiring personal contact with the taxpayer, a supervisor
or lead person may accompany the employee in difficult negotiations.
February 2016
Audit Manual
Power of Attorney
(Cont.) 0403.15
If the taxpayer or his or her representative has obtained a restraining order forbidding contact by
the BOE, staff must comply with the order. In such cases, the Deputy Director, Field Operations
Department, Internal Affairs Division, and the Chief Counsel should be notified of the restraining
order for appropriate action.
A copy of the written power of attorney must be scanned and placed in the Forms subfolder of
the audit case folder. In addition, a paper copy of the power of attorney should be submitted and
saved in the district file when the auditor transfers the completed audit case folder to the Audit
Control In-Box on the J:\Drive and initiates the email approval chain in Outlook. See AM section
0213.03. Send the original paper copy of the written power of attorney documents to the Taxpayer
Records Unit (MIC 36) to be scanned into Documentum.
WRITTEN CORRESPONDENCE
0403.18
The auditor should confirm in writing any significant verbal contact or agreements with the
taxpayer or taxpayer’s representative which involve:`
• Delays in appointments
• Records that are not available
• Requests for supporting documentation
• Requests for books and records
• Requests for delay of audit work
• Confirmation of meetings to discuss audit findings
• Other contacts significant to the audit
By use of this procedure, the taxpayer will be kept aware of the progress of the audit. When
corresponding directly with the taxpayer’s representative, a copy should always be sent to the
taxpayer.
February 2016
General Audit Procedures
PRELIMINARY EXAMINATION
0403.20
This is the point at which the auditor takes “inventory” of all potential information sources.
Unless the method used in reporting is entirely erroneous, audit time will ordinarily be saved by
adapting the audit procedures to the taxpayer’s reporting methods. The auditor should ask the
taxpayer to produce the desired records. These may be:
•
•
•
•
•
•
General Ledger
General Journal
Sales Journal or Revenue Journal
Purchase Journal
Duplicate returns and working papers supporting them
One or more months original documents, e.g., sales invoices, and purchase invoices
In addition to the above listed records, the auditor should question the taxpayer relating to such
specifics as:
• Internal controls
• Systems in use
• Summary records, etc. (Including income tax returns)
If such preliminary examination of records indicates that substantial portions of the necessary
documentation are not available (such as resale certificates), the auditor should advise the
taxpayer what further data is needed and postpone starting the audit until this information
has been obtained. See AM section 0401.12, Information Document Requests, for procedures on
requesting records, in writing, when the taxpayer fails to respond to verbal request for the same
records. Consideration should be given to securing a Waiver of Limitation, Form BOE–122. See
AM section 0215.15.
When conducting larger audits, other information will be helpful, such as:
• The names of employees with whom the auditor will have contact.
• A list of all books and records in use and the name and location of the person in charge of
the particular records.
• A list of sources of taxable transactions and how they are accounted for in the records.
• An explanatory chart of accounts.
• An explanation of the physical layout of the plant or the type of operations.
• Outside accountants’ reports, if available.
• Minute book, if a corporation.
• Copies of Federal and/or State income tax returns.
Where the taxpayer has not prepared detailed schedules in substantiation of reported amounts,
such as, purchases subject to use tax and deductions, the auditor should request they prepare such
schedules for the periods to be test-checked. Ordinarily, a listing of the detail in chronological
sequence showing invoice numbers and amounts of each transaction will be sufficient. Additional
information may be required in some cases and the auditor should advise the taxpayer as to the
extent of the required information and the form in which it is to be submitted.
On completion of the above, potential areas of under or overstated tax should now begin to form
in the auditor’s mind.
February 2016
Audit Manual
SPECIAL CONSIDERATION — FIRE OR NATURAL DISASTER
0403.23
Occasionally, a taxpayer will have losses of records and merchandise as the result of a fire or
natural disaster (e.g., earthquake, flood). If records have been destroyed, the auditor may have
to use specialized audit techniques as described in AM section 0407.00 to verify the taxpayer’s
reported amounts. The auditor should also note changes in business operations as a result of
restoration, such as a different product mix or increased/decreased shelf space.
Whenever a fire or natural disaster is relevant to reporting during the audit period, the auditor
should document the claimed event and loss. Examples of documentation supporting the claim
include:
• A report to the police department giving the date of the event and approximate loss
• A fire department report
• A claim for loss filed with an insurance company
The taxpayer should be made aware that losses of money cannot be offset against taxable sales
since the sale has already taken place and thus the tax is owed to the state.
PRELIMINARY TESTING
0403.25
The auditor has reached the point where a decision must be made to proceed with the audit or
whether the audit should be waived as non-productive.
Informal spot or random tests of records and returns should be made to evaluate each of the
components of the reported amounts to determine which areas are likely to contain a material
amount of understatement or overstatement of tax measure. To be meaningful, the tests should
be short and as widely spread over the audit period as possible, emphasizing periods where there
were significant changes in:
• Personnel
• Accounting methods, and
• Types of transactions
Such a test may consist of an examination of one return selected at random, verification of the
figures entered thereon, and tracing the figures to the books of original entry. It should also
consist of an examination of a representative number of sales or revenue tickets and the tracing
of the amounts shown on the ticket to the appropriate journal. Tests should be made of purchase
invoices covering supplies and expense items. A more detailed examination of equipment purchases
should be conducted. Tax accrual accounts in the General Ledger should be examined for possible
irregularities. Revenue accounts should be tested for disclosure of possible unreported sales.
Similar short tests should be made to verify the accuracy of the amounts claimed as deductions.
If the results of these tests indicate the taxpayer has been properly reporting the tax the audit
report should be completed using Form BOE–414–C or Form BOE–596 (see AM Chapter 2).
The tests may result in a no change audit report or a waiver of an audit assignment or the
verification of certain phases of the assignment (e.g., sales for resale, etc.). The testing techniques
examine all facets of the taxpayer’s business activity relating to the records maintained and
the taxpayer’s knowledge and understanding of the particular tax act or acts under which they
operate. If this preliminary testing does develop an area of under or overstated tax, then a more
formal and expanded test should be developed as discussed in subsequent sections of this manual.
February 2016
General Audit Procedures
SURVEY OF PLANT
0403.30
In auditing a small concern, the auditor can usually look over the place of business without making
a tour of the premises. In an audit of a large firm, auditors should ask to be shown through the
plant and office. This need not be done immediately. In fact, it is preferable to wait until the
audit is started and the auditor has become familiar with the accounting system. This survey
will help the auditor to understand many features of the operation such as the method of securing
and billing orders, the method of making nontaxable sales, the processes in which material is
consumed, and the use of equipment and machinery possibly purchased from an out-of-state
source. All of this will enable the auditor to design the audit program more intelligently. In case
of widespread complex operations, the extent of the tour may be limited.
RECEIPT FOR TAXPAYER’S RECORDS
0403.35
Whenever a taxpayer leaves his or her records at a BOE office or whenever records are picked up
in the field and removed from the taxpayer’s premises,* a Receipt for Books and Records, Form
BOE–945, must be completed. Receipts will be made in duplicate, the original being given to the
taxpayer or representative and the duplicate retained in the working paper file. In preparing the
form, care should be taken to adequately describe the books and records.
*California retailers of cigarette and tobacco products are required by Law to keep complete
and legible cigarette and tobacco product purchase invoices at each licensed location for at
least one year after the date of purchase. Accordingly, auditors may not remove from the
taxpayer’s facilities the invoices for cigarette and tobacco products purchased during the
previous 12 months. The taxpayer may provide copies of such invoices.
Form BOE-945 has a mailing address box to be checked by the taxpayer when signing the form.
This box requests the taxpayer to indicate if the mailing address listed on the form represents
a change to the mailing address of record. The auditor must verify that the taxpayer completed
the mailing address box. If the taxpayer did not complete the box, the auditor should request
the taxpayer to provide the information prior to the auditor signing the form. If the taxpayer
indicates there is a change of address of record, the auditor should confirm the correct address,
make a copy of the Form BOE–945 and provide it to the appropriate account maintenance staff.
If the taxpayer indicates there is no change to the official address of record, no further action is
required by the auditor.
When taxpayer data is in the possession of the BOE it will be stored in secure, lockable areas.
Thus, taxpayer books and records must be stored in a locked area when the records are not
actually being used.
When the books and records are returned to the taxpayer or representative, the original receipt
should be obtained with proper signature of taxpayer or representative affixed thereto indicating
their return. If the original receipt is not available, the duplicate copy retained by the staff should
be used to obtain receipt for return of the material listed thereon.
If the taxpayer wishes to have the records returned by mail, this should be done in such a way
that the BOE has the taxpayer’s written instructions and a record of the shipment. The taxpayer
should be asked to pay the shipping charges if they are excessive.
February 2016
Audit Manual
Receipt for Taxpayer’s Records
(Cont.) 0403.35
If the taxpayer does not respond to normal attempts to return the records, a letter should be sent
to the taxpayer by certified mail at the address given on Form BOE–945. The letter should notify
the taxpayer that the records are no longer needed and unless he or she responds or advises the
Board within 15 days where to ship the records, the records will be destroyed as authorized by
the taxpayer on Form BOE–945. To allow an ample margin of time there should be no actual
destruction of the records until at least 30 days after mailing the certified letter.
After 30 days, if the taxpayer’s records can serve no useful purpose in connection with the tax
obligation, they should be removed from the files and disposed of in the same manner as other
records the destruction of which has been authorized. A record of such destruction, together with
copies of Form BOE–945 and the certified letter, should be retained.
October 2008
General Audit Procedures
AUDIT PROGRAM — PROCEDURE TO FOLLOW
PLANNING THE AUDIT
0404.00
0404.05
This section presumes that as a result of the preliminary probing and testing as described in
AM sections 0403.20 and 0403.25 the auditor has become aware of a potential area of under or
overstated tax. It is now the function of the auditor to:
(a) Determine whether the correct amount of tax has been reported; and
(b) If not, what is the amount of under or overstated tax.
Any good auditing procedure that will expeditiously achieve this end result is the preferred
procedure. The auditor must set up and design an adequate test program.
There are two basic approaches to this problem which may be named and defined as:
(a) Direct Audit Approach — auditing the formal accounts and records of the taxpayer.
(b) Indirect Audit Approach — where reliance cannot be placed upon the formal accounts.
Illustrative of the indirect audit approach is any method used to impeach the records, e.g.,
mark-up of purchases, bank deposits, independent sources, etc., whether formal records
are kept or not.
Depending upon the audit approach found necessary, the auditor should:
(a) Establish a test base,
(b) Establish test periods, and
(c) Come to an understanding with the taxpayer to the extent possible as to:
• Reasonableness of test approach
• Assistance to be furnished by taxpayer in assembling or preparing test data, e.g.,
sales invoices, vendor’s invoices, resale certificates, or EDP runs as necessary
EXPLORATORY TESTING
0404.15
All testing is exploratory in nature and even though preliminary testing did indicate that further
testing was necessary, continuing errors are not always supported by additional testing.
The auditor is to be continuously alert to discontinue testing at the earliest possible moment they
are able to determine that further testing is unwarranted. This is a cut-off technique which is
discussed fully under section 0405.35. In cases of this nature, the working papers will contain
appropriate comments regarding the test procedure used and the findings.
This expanded testing differs from the “spot” or “random” tests discussed in section 0403.25
in that controls are established so that projections can be made to estimate the amount of the
misplaced tax. The word “estimate” as used here means the results of the test when applied to
the audit period.
The “controls” mentioned here involve test periods, etc., and will be more fully discussed in section
0405.20.
Note should be made of the fact that tests sufficient to support a no change recommendation may
well be short of the testing degree and completeness necessary to sustain a change recommendation.
February 2016
Audit Manual
MAKING THE AUDIT — PROCEDURES AND TECHNIQUES
0405.00
GENERAL0405.05
After having determined an account should be audited, it is necessary to devise an audit program.
To do this, the auditor should be familiar with tax auditing techniques. The auditor should be
alert to the possibility of revising the use and application of such techniques as the need arises.
Some of the special techniques and procedures are:
•
•
•
•
•
Short tests
Use of test basis
Bank deposits
Cut-off techniques
Whole dollar auditing
These procedures and techniques are described in the following sections.
AUDITS ON A TAXABLE MEASURE BASIS
0405.10
An audit made on a taxable measure basis generally places emphasis on the verification or
accumulation of taxable differences as compared to an audit performed on a total sales and claimed
deduction basis using individual lead schedules.
The use of the taxable measure basis should in no way be construed as relieving the auditor of
his responsibility to verify that all sources of revenue and deductions have been examined or of
writing verification comments thereon. Comments should cover fully the nature of the transactions
verified, the audit procedure used in making the verification and the result.
There are certain cases where the taxable measure basis may be preferable:
• Where records are available, but verification of the total gross reported and deductions
is not significant. The taxable transactions are few in number and the taxpayer has
reported taxable measure only based on a listing of these transactions, capitalizing tax
reimbursement, or by mark-up of taxable purchases.
• Where the total gross reported is not an important factor in determining taxable measure.
This may apply, for example, for sales tax purposes, to service enterprises, contractors,
public utilities, manufacturers and wholesalers.
• Where the records are such that an indirect audit approach is necessary and the taxable
measure must be reconstructed. (See section 0404.05)
• Where the taxpayer has prepared returns on a taxable sales basis and audit time can be
conserved by conforming to this method.
As an example, where a grocer has used a method other than the “grocers method” to arrive at
the taxable measure or the overall mark-up, as reflected by recorded gross sales, is unfavorable,
our audit might be conducted in a more efficient manner through a verification of taxable sales.
Although total gross reported loses much of its significance in audits prepared on a taxable measure
basis, a comparison between recorded and reported total gross is important, for it may disclose
that sales, gross receipts, or fuel used, for one month or one department or branch of a business
was not included in the reported totals. This comparison also may disclose classes of transactions
or use erroneously considered nontaxable by the taxpayer. If the comparison between recorded
total gross and reported gross discloses unreported taxable transactions, these items should be
listed on a schedule.
January 2000
General Audit Procedures
Audits on a Taxable Measure Basis
(Cont.) 0405.10
If the taxpayer has reported on the basis of lists or tapes of taxable items, the auditor should
verify the correctness of these lists by:
• Verifying that the lists include all items regarded as taxable by the taxpayer, and
• Determining if there were any items subject to tax not so regarded by the taxpayer.
If the taxpayer has reported on a basis of tax actually charged to the customer and has credited
the amount charged to a tax accrual account, the clerical accuracy of the posting to that account,
as well as the computations made in converting the tax accrued to taxable measure should be
verified. This will involve tests of:
• The computations of tax charged on customer’s invoices.
• The posting of tax charges to the sales journal or other record where such charges are
summarized.
• The clerical accuracy of the footings and the posting of the tax charges to the tax accrual
account.
• The mathematics of the conversion of tax charged to taxable measure reported.
Debits to the accrual account should be scrutinized to determine that these charges represent
proper deductions from the amount of tax accrued. Debits may include but are not limited to
items such as:
• Payments to the Board
• Tax on cash discounts, returned sales or rescinded sales
• Tax refunded due to an overcharge or erroneous charging of tax on an exempt transaction
In addition, the auditor should determine the effect on the accrual account of allowable bad debts,
tax-paid purchases resold and other adjustments which legitimately reduce the taxpayer’s accrued
tax liability. Many accounting systems fail to adjust the tax accrual accounts for transactions of
this type.
A reconciliation of the tax accrual account and the tax reported should be made, and a summary
of the tax accrual account should be prepared and included in the audit working papers when
material to the audit findings. Consideration should also be given to sales and use taxes collected
for and paid to other states, for tax credit allowable under section 6406 of the Sales and Use
Tax Law, and for taxable self-consumed merchandise reported on Line 2 but not credited to the
accrual account.
It is important that deductions claimed or netted be tested to the extent that the auditor is satisfied
that they are allowable. Test procedures should be similar to those used when auditing on a
total sales basis. Tests made should be as short or extensive as warranted under the particular
circumstances involved. Schedules for deductions should be indexed in accordance with the system
outlined in sections 0302.50 to 0302.65.
Self-consumed merchandise and purchases subject to use tax should be audited in accordance
with instructions included in sections 0408.05 to 0408.40.
General or over-all verification comments should be written on summary schedules. Specific
verification comments should be written on subsidiary schedules.
The auditor should recognize that not all audits should be made on a taxable measure basis.
When it is necessary to verify total gross less allowable deductions, or in those audits where it
is necessary to prepare lead schedules in order to reconcile recorded and reported amounts, the
audit should be made on a total sales basis.
January 2000
Audit Manual
SHORT TESTS
0405.15
Short tests are discussed in prior and succeeding sections, under Preliminary Testing (0403.25)
and under Specialized Techniques (0407.00) for the various tax acts. It is the purpose here to
discuss short tests as a technique.
The end result of a short test is a decision as to whether to proceed or to accept as correct that
item being tested. If we decide to proceed, the short test may be expanded to anything from a
short period controlled test to, on occasion, a complete examination.
A short test may be defined as the examination of any record, supplemental data, original detail, etc.
for any purpose. A short test audit may be a combination of several short tests. A short test might
be, for example, the review of an income tax return to see if the mark-up over cost is acceptable
for the type of business, a spot check of sales invoices for proper tax accrual, etc. If the foregoing
mentioned mark-up test indicates an acceptable margin and total sales per the income tax return
agree with total sales reported per the sales tax returns, total reported sales might be accepted.
Deductions might be accepted as claimed if, as a result of spot checking various transactions in
detail (e.g., a resale sales invoice may be traced to its segregation in the sales journal as a resale,
then to claimed resales, and finally to the individual resale certificate), no exceptions are noted.
A short test may be used to substantiate the auditor’s recommendation for a no-change phase of
an audit such as acceptance of recorded and claimed sales for resale in a sales tax audit which
might be a change audit for other reasons.
The nature of the short test places a great deal of emphasis on the individual auditor’s judgment.
The auditor must be able to intelligently evaluate the results of a short test and come to a decision
as to what to do. It is recognized that there is a “calculated risk factor” involved in arriving at
a decision not to proceed. In a few cases, the decision may be in error. If the auditor arrived at
the decision as a result of good logic, properly presented, they need not be unduly concerned if it
is later found that some misplaced tax did exist.
To prevent misunderstanding, one other type of short test should be discussed. In certain
businesses where the number of transactions are large (e.g., department stores), it may be necessary
to design a controlled test for a short period. An example might be the operations of one day or
less. This test, even though formal in nature vs. spot checking, would be construed as a short test
because this forms the basis of a decision to stop testing or to proceed. If it is decided to proceed,
this original test might be the nucleus of an expanded audit program.
USE OF TEST BASIS
0405.20
There are two broad categories of testing used in sales and use tax auditing. The preferred
category is statistical sampling, which is covered in detail in Chapter 13. The second category
of testing used when statistical sampling cannot be used is block sampling and related methods.
This section focuses on block sampling and related methods.
An audit made on a test basis is one in which the transactions of only a part of the audit period
are examined in detail. The balance of the period is adjusted on the basis of the findings in the
test periods. Such findings are usually expressed in terms of percentages of error calculated from
the errors and differences disclosed in the test period. This basis assumes that the differences
disclosed in the test period, which are audited in detail, will occur in the same proportion in the
balance of the audit period.
January 2000
General Audit Procedures
Use of Test Basis
(Cont. 1) 0405.20
(a)When to use a test period. There are certain conditions necessary before a test can be
used. These are:
• Units of sale or the amounts of the items of claimed deductions are uniform as to
size and distribution throughout the audit period.
• Basic characteristics of the business and the methods of reporting remain the same
throughout the audit period. Should the basic characteristics of the business change
during the audit period, separate tests should be made for each specific period with
attendant percentages of error for each.
• The sample audited in detail contains sufficient items to make possible an
accurate percentage calculation. In other words, if the sample tested has only a
few transactions, errors may not lend themselves to a percentage calculation of
reasonable accuracy.
(b)The test base. It is important to establish a clearly defined test base. The test base
should be representative of the total population of the item being tested. There are two
main points to consider in establishing the test base:
• Establish what is being tested.
• Establish the period or sample to be tested.
In order to establish the most representative test base possible, using available
information, audit staff should compare the selected test base characteristics to
the population characteristics. For example, if the taxpayer’s accounting system
can produce reports to show summary amounts for taxable versus nontaxable
transactions, the ratio of the taxable versus nontaxable in the test base period should
be similar to the ratio of taxable versus nontaxable transactions in the population.
It is important that a firm sample be established so that a percentage of error can
be computed and applied. This is, in effect the denominator, the differences found
in the denominator being the numerator. For example, if sales for resale are to be
tested for one month, all recorded and claimed resales must be examined for that
month with exceptions or differences to allowable resales being noted. It follows
that what is being tested is equally important. If the item being tested is sales
for resale, only resales should be considered in this particular test. If the auditor
finds a sale in interstate commerce erroneously recorded and claimed as a sale for
resale, this should be eliminated from the test base and all factors influencing the
calculation of a percentage of error.
It may be that what is being tested is a hodgepodge of various deductions. In
this case, the base would be all the deductions recorded and claimed. The most
expeditious approach may then be to revert to taxable sales as the base. The auditor
should ascertain that all invoices for the test periods are available for examination.
Verification should then be made in accordance with the taxpayer’s method of
computing the claimed deduction.
January 2000
Audit Manual
Use of Test Basis
(Cont. 2) 0405.20
If the taxpayer’s method has been to capitalize the tax collected, the auditor should examine
invoices representing sales to verify that:
• The tax has been properly computed and added to taxable invoices.
• The tax so computed has been properly accrued in the sales tax accrual account.
• The tax so accrued had been remitted to the State.
• All exceptions noted will be scheduled and summarized and the disallowed deduction
for the entire audit period will be computed.
If the method used by the taxpayer is to deduct the sum of the taxable sales from total
sales and claim the residual amount as a deduction, the auditor should verify the
taxable sales only. Any exceptions should be scheduled and a percentage of taxable
sales understated should be computed based on the relationship the additional
taxable sales bear to total taxable sales reported. The percentage thus computed
will be applied to reported taxable sales in all periods other than those listed. Use
actual additional taxable sales determined for the test periods. This method is
not practical when the taxable sales are very small or when they fluctuate greatly
from month to month. In such case, it may be necessary to base the percentage on
deductions claimed rather than on taxable sales.
The procedure under both of these methods is, in effect, auditing on a taxable sales
basis (0405.10).
(c)Size of test period. Auditors must use their experience and exercise judgment in
determining the size of test periods. The following principles should be considered in
selecting a test period:
• The size should be adequate to insure reasonable accuracy.
• The auditing time required should not be excessive in relation to the problem.
January 2000
In general, when auditing a business with good internal control, and a good
accounting system, the test period may be a relatively small portion of the total
audit period. However, in an audit of a business with little or no internal control,
the test period should cover a larger proportion of the audit period. If records are
available, the periods selected for test should be spread over the entire audit period
so that samples can be taken of all years and all seasons of the year. The size of
each test period, in addition to the above considerations, will depend on the number
of documents required to be examined. Usually the test periods should consist of
complete months or quarters, but periods of less than a month may be selected if
daily or weekly controls can be established.
Statisticians have established that several short tests over the audit period are
superior to one equivalent long period. For example, a test of three scattered months
throughout the audit period will give better results than a one-quarter test.
General Audit Procedures
Use of Test Basis
(Cont. 3) 0405.20
(d)Application of the test results. If a percentage of error (whether a net underpayment
or overpayment) is determined from a sample, then that percentage of error will be applied
to the population tested for all reporting periods in the audit period. The percentage of
error obtained in the test period may be calculated and applied to the entire audit period
in the following manner:
Claimed resales (July 19XX)
Disallowed resales per test (July 19XX)
Percentage of error $750/$5,000
Claimed Resales (Audit Period)
Disallowed claimed resales($150,000 X 15%)
$5,000
$750
15%
$150,000
$22,500
The percentage of error would then be applied to the claimed resales for each quarter in
the audit period.
(e)Elimination of nonrecurring items. In making a test of the taxpayer’s records to
determine their accuracy, differences are sometimes found which do not appear to be a
type, either in size of the transaction, kind of product sold, omission due to an unusual
situation, or other reasons to include with the other differences found which are to be used
in computing a percentage of error. These are normally items of considerable size, and the
opposition to including them in the percentage of error is quite strong. Before handling
these items as nonrecurring errors, they should be carefully scrutinized to determine
whether or not they are nonrecurring errors. It is suggested that an error of this nature
be similar, but not limited, to one or more of the following examples:
• The size of the item is much in excess of the normal item and occurs only at rare
intervals.
• The item was omitted or included due to some unusual circumstance.
• The product sold is a type not ordinarily handled.
If taxable sales of a nonrecurring nature are disclosed when auditing on a test
basis, those sales should be excluded from the calculations of a percentage
of error. For example, if a claimed resale ascertained to be taxable is of a
nonrecurring nature, all sales of a similar nature should be examined for the
entire audit period and the total of such sales deducted from claimed resales
in the appropriate reporting periods and shown as a separate amount in the
measure of additional tax. The percentage of error developed in the test periods
should then be applied to the adjusted resales claimed for all periods in the audit
not covered by the test. For example:
Total claimed resales in test periods
$10,000
Nonrecurring taxable sales excluded
$4,000
Adjusted resales
$6,000
Other claimed resales disallowed
$1,200
% of disallowance of adjusted resales ($1,200/$6,000)
20%*
* To be applied to adjusted resales.
In any instance where an item is found in a test which would result in a distorted
answer and has an element which is out-of-the-ordinary, it can be considered, for
classification, as nonrecurring. The fact that no other sales were made to that
particular customer should not be considered a reason. Sufficient tests should be
made in other periods to establish that items of a similar nature have not occurred.
March 2001
Audit Manual
Use of Test Basis
(Cont. 4) 0405.20
(f) Alphabetical vs. chronological filing of detail to be tested. It will be found that
some firms file their sales invoices on an annual alphabetical basis, the sales being posted
to the books of original entry chronologically.
The auditor in this situation can trace the sales for resale (if again this is the item being
tested) back from the sales journal to the invoice then to the resale certificate. This is a
time consuming process and may be short cut by:
• Spot testing the accuracy of posting as a sale for resale.
• Determine a test base by relating to dollar volume (i.e., a one-month test may be
estimated in terms of dollars by dividing total claimed resales by the number of
months).
• Selecting every third, fourth, or fifth, etc. letter of the alphabet as appropriate to
approximate the desired number of dollars.
• Schedule exceptions noted and in terms of dollars, schedule every invoice examined;
this will give a firm base for the calculation and application of a percentage of error.
• If the auditor makes the audit soon after the start of the taxpayer’s accounting year,
the alphabetical invoice file may provide a reasonable size test period.
(g)Statistical sampling techniques. The use of statistical sampling as a means of testing
has some very real advantages. The Board encourages testing with statistical sampling
techniques if it is feasible. Statistical sampling is fully discussed in Chapter 13.
(h)Discussion with the taxpayer. The auditor should, whenever possible, discuss the use
of test periods with the taxpayer, include the taxpayer in the development or selection of
a sampling plan, and endeavor to obtain a concurrence. Often such a discussion will be of
material assistance in selecting representative test periods and the test base. Please note,
a Form BOE–472 is required to be used for audits with a cell designation 1D through 4D
(section 0405.23) or any time sampling is performed. (See section 0404.05)
(i) Use of a test basis with no supporting detail. An audit made on a test basis where
there is no supporting detail (i.e. — no detailed journals) is conducted similarly to a detailed
audit where there is no support for the claimed amount. However, the taxpayer should be
requested to prepare supporting schedules for the test periods only. Invoices submitted by
the taxpayer should be examined in detail and all transactions verified in the usual manner.
The difference between the amount verified and the amount claimed will be disallowed
in the same manner and to the same extent as in a detailed audit, and a percentage of
overstatement of the deduction will be computed. This will be true regardless of whether
complete details of the claimed deduction have been furnished.
For example:
Resales claimed for test periods
$2,500
Total of sales for resale invoices presented for examination
$2,300
Difference
$200
Total resales verified from invoices presented
$2,000
Amount disallowed ($2,500 – $2,000)
$500
Percent of disallowance ($500 / $2,500)
20%*
* This percentage of disallowance is to be applied to all periods of the audit other than the test
periods. (Actual amount disallowed will be used for the test periods.)
January 2000
General Audit Procedures
Use of Test Basis
(Cont. 5) 0405.20
(j) Accepting sample elements as a result of a reply to an XYZ Inquiry. In a verification
test of resales where a sample of the vendor’s sales for resale is questioned, situations may
develop as a result of the nature of replies from purchasers in which consideration must
be given to accepting an element from the test sample.
When an XYZ response states that use tax has been or is to be paid to the Board and it
is apparent the action was taken after the receipt of the XYZ, the item being questioned
should remain part of the sample to develop the percentage of error. This audit approach
recognizes that similar transactions have occurred in the untested periods and that those
purchasers will not receive such notification and not be prompted to report and pay the
use tax to the Board. However, an adjustment for the actual amount of the tax reportedly
paid by the purchaser should be made in the vendor’s audit.
In those cases where the purchaser replies that the tax has been paid to the Board and
it is apparent that payment was made prior to receipt of notification that the sale was
being questioned, the reply should not be counted as an error. However, the questioned
transaction should remain in the sample base on which the percentage of error is computed.
There may also be cases where the purchaser’s statement is questioned after checking
the permit information in the system (TAR AI, REV FZ, AUD MC, etc). The auditor may
find that the item has been in inventory for an extended period of time, or the purchaser
is in a line of business not normally selling such items, or the purchaser has reported no
or very low sales. In such situations, the auditor should not reject the response without
performing further verification. If the auditor does not accept the reply to the XYZ letter
as support for the claimed sale for resale, the questioned transaction should remain part
of the sample.
In all of these situations, a BOE–1164 should be prepared advising the district office in
which the purchaser’s account is located that the purchaser either has indicated that the
use tax was or is to be paid on the questioned sale(s) item(s) or that the item(s) is still held
in resale inventory.
See section 0409.51 for a discussion regarding XYZ non-responses.
(k)Analyzing sample results for reasonableness. The proposed measure resulting from
the projection of the sample results must be compared and analyzed for reasonableness by
looking at the taxpayer’s business as a whole. This type of analysis does not necessarily
involve preparing a schedule to evaluate the impact, but the auditor must be alert to
indications that the projection of the sample results is possibly unreasonable. If the
results appear unreasonable, the auditor must discuss the situation with the taxpayer.
The auditor and the taxpayer should come to some agreement as to whether or not the
results are representative of the business for the time period in question.
(l) Missing Documents — If, during the course of a sample, a document cannot be located,
normal auditing procedure requires the auditor to ascertain the reason for the missing
or incomplete documents. When the investigation fails to reveal any specific reason,
the auditor may first determine whether there is any acceptable alternative evidence.
Fortunately, as more and more companies are converting to true paperless systems, it is
generally not difficult to obtain a considerable amount of data about a missing invoice.
The only statistical requirement is that an audited value be established for each sampling
unit.
January 2000
Audit Manual
Use of Test Basis
(Cont. 6) 0405.20
If missing invoices would create a material error and the taxpayer objects to the sample,
the auditor may want to discuss possible alternatives with their supervisor.
Based upon the facts of the situation and guidelines presented in this manual, the auditor
and the taxpayer together shall discuss whether to consider missing or incomplete
documents as incorrect (in error), correct (no error), whether to substitute another sample
unit, or whether they should be removed from the sample base and projection.
Alternative procedures that can be considered, if appropriate, when missing documents
are encountered include:
• The taxpayer and/or auditor can contact the vendor or customer for a copy of the missing or unreadable documentation.
• Allow the taxpayer to produce additional documentation on similar transactions for the same customer or vendor. The auditor can decide whether or not the taxability of the transaction(s) with missing documentation is similar to the transactions for which documentation is provided.
• Remove the missing item from the sample base and population.
(m) Timing — The auditor must take care to be aware of timing differences between
the date of a transaction and the date it is recorded by the taxpayer. For example,
paid bills are frequently recorded when paid rather than on the date of the invoice.
See section 1305.25(d) for a discussion of installment payments.
January 2000
General Audit Procedures
USE OF FORM BOE–472, AUDIT SAMPLING PLAN
0405.23
In an effort to document the sampling method used in an audit, the Board has developed Form
BOE–472 - Audit Sampling Plan. Its purpose is to establish the most efficient means of developing
a sampling plan and document: (1) the sampling method that will be used to determine a percentage
of error in the population being tested and (2) the projection of the sample results.
The purpose of the BOE–472 is to establish the most effective and efficient means of developing
a sampling plan. This form must be used in all large audits (defined here as any audit with a cell
designation of 1D through 4D) or any time sampling is performed. This plan will provide much
of the information that will later be needed to complete the working paper documentation and
audit comments.
Prior to determining the type of testing to be used in a given audit situation, the auditor must
make a thorough examination of the business operation for the period under audit. This
examination should include a review of source documents, changes in business activity, and
changes in accounting procedures and key personnel. Once this information has been evaluated,
a determination of the best method of testing can be made. Form BOE–472 will assist the auditor
and taxpayer in identifying crucial elements of the audit sampling plan. This form is to be used
as a tool to gather information in conducting samples, as well as to educate taxpayers about the
sampling process and make the taxpayer aware of important considerations that might impact the
audit. This form also identifies special situations that might arise during a test and allows both
the taxpayer and auditor to agree on how to handle them. It should be completed with assistance
and input from the taxpayer, prior to the actual selection of the sample, and used in conjunction
with information and guidelines provided in the appropriate sections of the Audit Manual.
The information and methods documented in this form are not binding on either the taxpayer or
Board staff. The sampling plan can and should be continually evaluated (and changed, if necessary)
based upon information obtained during the audit process. However, if any deviation from this
sampling plan is required, the deviations will be fully explained and discussed with the taxpayer.
While BOE–472 includes many situations that might arise in sampling, it cannot include them
all. As such, the form should be modified (in Section 11, “Other”) to address any situations not
included in previous sections of the form. Once the information has been evaluated, the auditor
is in a position to determine the best method of testing.
This form is to be included in the audit working papers as a subsidiary schedule. A separate plan
should be completed for each area tested. For example, if the audit includes a sample test of both
paid bills and resales, two BOE–472s should be completed.
August 2005
Audit Manual
BANK DEPOSITS
0405.25
In cases where the taxpayer has maintained a bank account, the bank deposits may be a more
accurate source of determining gross receipts than recorded figures. There are two methods of
estimating gross receipts on the basis of bank deposits:
(a) Where records of deposits are available for the entire period, they should be scheduled for
that period.
(b) Where records of deposits are available only for a portion of the audit period, a percentage of
error should be computed and then applied to recorded or reported sales for the remainder
of the period.
In either method, the bank deposits should be scheduled by months from the bank statements,
from the bank deposit books if verified as reflecting all deposits, or from data furnished by the
bank. The record of cash deposits must be adjusted for certain types of transactions which will
affect total receipts, namely:
Increases:
Cash expenditures and withdrawals from cash receipts before bank deposits are
made.
Decreases:
Deposits representing receipts from sources other than sales, i.e., loans, redeposits
of NSF checks, rental income from real property, charges relating to cashing
customers’ checks, etc.
Other:
The auditor should be alert to such items as possible trade-ins, returns of
merchandise sales, changes in accounts receivable, etc.
If the taxpayer has a record of cash pay-outs, the totals by months should be scheduled. If no
such record exists, pay-outs for merchandise sometimes can be estimated by examining the check
record or canceled checks to determine which types of merchandise are paid by bank checks. For
instance, a restaurant may pay by check for meats, groceries, produce and dairy products, but
pay cash for its daily needs of bakery goods, soft drinks, candy, etc. The latter purchases, as well
as cash withdrawals, may be estimated after a conference with the taxpayer.
Credits for loans and increases in capital must be supported by documentary evidence in the
form of canceled notes, letters from banks, savings bank books showing withdrawals, etc. The
non-taxable receipts must be traced to bank statements to verify the amount and date of those
deposits. Where vending machines are on the premises, copies of statements of settlement from
the operators can be used to verify income from these sources.
In most cases, when this method of estimating receipts is used, either no record of accounts
receivable is available or accounts receivable balances are so small they are not taken into account.
When there is a record of accounts receivable and there is an increase in receivables between
the beginning and end of the audit period, the increase should be added to the last quarter. In
unusual cases, where the increase is a large factor in the audit, it should be prorated to quarters.
The auditor should at all times be alert for evidence of bank accounts for which the taxpayer has
not produced statements or deposit books.
Bank deposits are useful in determining gross receipts for sales tax audits. Bank deposits may
also be used as a short test to see if there is a reasonable relationship between cash receipts and
recorded gross receipts; their use otherwise would be as an indirect audit approach.
August 2005
General Audit Procedures
OBTAINING FINANCIAL INFORMATION
0405.27
Board staff must first try to obtain from the taxpayer any data or documents which should have
been retained in accordance with Revenue and Taxation Code section 7053. However, if all other
available avenues of information have been exhausted and approval of the district administrator
has been obtained, Board staff may request the information directly from the taxpayer’s financial
institution either by obtaining the taxpayer’s authorization or by issuing a subpoena duces tecum.
Procedures for requesting records directly from a financial institution, including procedures
to comply with the California Right to Financial Privacy Act, are explained in detail in CPPM
sections 135.070 through 135.073.
MARK-UP METHODS
0405.30
Use of mark-up methods as an audit procedure is widespread in sales tax auditing and are discussed
under specialized techniques (section 0407.10).
The auditor is cautioned not to rely too heavily on mark-up percentages (gross profit divided by
cost of goods sold) for all types of businesses. It may be time consuming to obtain and have little
meaning. For example, in a wholesale or manufacturing operation having little in the way of
taxable sales, a mark-up percentage calculation would have little meaning.
USING THIRD-PARTY PROPRIETARY DATA IN AUDITS
0405.32
GENERAL
The BOE obtains information about taxpayers from various sources including, but not limited
to, other state agencies, businesses, wholesalers, and data houses. Some of this information may
include third-party proprietary data that cannot be shared with the taxpayer.
In many industries, a third party compiles data about individuals and companies based on their
financial transactions for the purpose of selling the data. “Proprietary data” is the data not
owned by the BOE and marked by a third-party contractor or provider with restrictive language
asserting intellectual property rights. The data, including certain data provided to the BOE in a
subscription based service, may be copyrighted and distribution is prohibited without the thirdparty’s prior consent.
PROCEDURE
When audit staff relies upon third-party proprietary data in an audit, they must inform the
taxpayer they are doing so at the time the audit is being conducted. Audit staff must also provide
the taxpayer information (i.e., the third-party source) on where the taxpayer can obtain the data,
when available. Staff should document the source of data and the date of the discussion with the
taxpayer in the BOE-414-Z Program (see AM section 0221.00) and in the audit working papers.
July 2016
Audit Manual
USE OF PRIOR AUDIT PERCENTAGES OF ERROR
IN SUBSEQUENT AUDITS
0405.33
The prior audit percentages of error (PAPE) program involves, under certain circumstances, the
use of a percentage of error developed in a prior audit for the sales or accounts payable portion in
two subsequent audits. Staff must obtain approval from the Deputy Director, Field Operations
Department (FOD) to apply a PAPE to the second subsequent audit. The PAPE can be a valuable
tool in streamlining the audit process. It is designed to reduce the time it takes to complete an
audit and minimize the burden on taxpayers.
When planning the audit, supervisors and auditors should evaluate whether the taxpayer is
eligible for the use of a PAPE. This evaluation should be conducted whether or not the taxpayer
has already requested the use of a PAPE. If the taxpayer is eligible for the use of a PAPE, the
auditor should discuss the PAPE with the taxpayer as soon as possible rather than wait for the
taxpayer to request using a PAPE. The date of the discussion and the taxpayer’s response should
be documented on Form BOE-414-Z, Assignment Activity History. A decision that the taxpayer is
not eligible should also be explained and documented on Form BOE-414-Z.
To qualify for the PAPE, the taxpayer must have at least one prior audit and must meet the
conditions discussed in this section. The most recent prior audit and the subsequent two audits
must indicate consistent operations, volume, and potential type of errors. Limited testing of the
taxpayer’s records and internal controls will be necessary in order to determine whether there have
been any changes to the taxpayer’s operations since the last audit. Such testing should include
an examination of source documents, such as invoices and paid bills, for changes in processing
procedures since the last audit. Other changes to look for include:
(a)
Nature of their business
(b)
Accounting procedures
(c)
Key personnel or turnover of staff
(d)
New or revised laws or regulations affecting their business
(e)
Significant increases in the population being sampled
If limited testing discloses some change(s) to the taxpayer’s operations, the auditor should take
into consideration the materiality of the change(s) and whether or not a PAPE can still be used for
a portion of the audit period or the area being tested. If the change(s) in the taxpayer’s operation
is minor, the risk of underestimating the audit results by applying a PAPE may be small. It is
important to remember, as noted above, that the use of a PAPE is limited to two subsequent audits
and therefore will not create a basis for RTC section 6596 relief in a third subsequent audit.
The techniques used in the prior audit to calculate the PAPE will not preclude its use in the
subsequent two audits; however, other factors, as noted above, must be taken into consideration
before approving the use of the PAPE in the subsequent two audits.
To be representative, if stratified dollar limitations were used in the last audit, generally the same
dollar stratification should be used in the subsequent two audits. If there is an indication during
the limited testing that a different stratification level may be appropriate in the subsequent two
audits, the percentage of error to apply in the subsequent two audits will be calculated by combining
multiple strata from the prior audit. To compute the single percentage of error or a specific area
tested in the prior audit, divide the total measure of errors by the population.
April 2015
GENERAL AUDIT PROCEDURES
Use of Prior Audit Percentages of Error in Current Audits
(Cont.1) 0405.33
For example, if claimed exempt sales were sampled using stratified dollar limitations in the
prior audit, the single percentage of error (recomputed PAPE) is the ratio of the total measure of
disallowed exempt sales to the total claimed exempt sales, in the prior audit. The total measure
of errors (numerator) can be obtained from the audit work papers’ lead schedule, the front of
Form BOE-414-A, Report of Field Audit, or IRIS. The total population of claimed exempt sales
(denominator) can be obtained from Form BOE-414, Transcript of Return Filed-Sales and Use
Tax or in the prior audit work papers. The recomputed PAPE in this example is then applied
to the quarterly claimed exempt sales in the subsequent two audit periods, which are generally
available on Form BOE-414-M.
After discussing the use of a PAPE with an eligible taxpayer(s), a detailed outline memo from the Audit
Supervisor to the District Principal Auditor (DPA) or in the case of a second subsequent audit, from
the Audit Supervisor to the DPA and Deputy Director, FOD should be prepared for each interested
taxpayer indicating why they would make a good candidate for inclusion in this program (Exhibit 5).
Each outline should include:
(a) Name, account number, case ID and NAICS code of the eligible taxpayer
(b) Nature of taxpayer’s business
(c) Current audit period
(d) Portion(s) of audit where a prior percentage of error is to be used
(e) Prior audit periods and corresponding percentages of error for those portion(s)
(f) Population(s) to which the prior percentage(s) of error was applied
(g) Proposed percentage of error to be used for the portion(s) in the current audit
(h)Population(s) to which the proposed percentage(s) of error will be applied in the current
audit
(i) Any other pertinent information
The memo outline should be approved by the DPA and in the case of a second subsequent audit
the DPA and Deputy Director, FOD, and maintained in the Memos & Misc. Documents subfolder
of the audit case folder as a memo schedule.
Upon the DPA’s and if needed Deputy Director, FOD approval of a PAPE, the DPA (or designee)
will enter basic information on the account into the District Reports Data Base (DRD). Basic
information includes:
•
•
•
•
•
•
•
•
Account Number
Case ID
Taxpayer Name
Auditor Name
Industry Type (NAICS)
Audit Period
“Area” that PAPE will be applied to
Approval date by District Principal Auditor
April 2015
Audit Manual
Use of Prior Audit Percentages of Error in Current Audits
(Cont.2) 0405.33
In addition, immediately after the audit has been transmitted to headquarters, the DPA (or
designee) will enter the remaining detailed information regarding the outcome of using the PAPE
into the District Reports Data Base (DRD). This information will include:
•
•
•
•
Tax for “Proposed” PAPE assessment
Estimated Hours Saved
Total Audit Hours
Transmittal date
USE OF SUCCESSOR OR PREDECCESSOR
INFORMATION IN AN AUDIT
0405.34
BOE employees may access confidential taxpayer information to perform their duties. However,
Revenue and Taxation Code (RTC) section 7056, prohibits BOE employees from divulging in any
manner, whether directly or by inference, to a third party business affairs, operations, or any
other information pertaining to any taxpayer.
When a closed-out business retains no books and records for audit, BOE auditors may have to use
other reliable sources of information to verify the taxpayer’s reporting. In some cases, the only
reliable source of information available is from the business of the predecessor or successor. BOE
auditors may use successor information in the audit of the predecessor’s business, or vice versa,
under either of the following two conditions:
1. The auditor obtains written permission from all parties involved; or
2. The auditor uses the information without divulging the source, whether directly or by
inference.
When obtaining permission from both the predecessor and the successor, the auditor must first get
written permission from the taxpayer of the business being audited. Once permission is received,
the auditor may request written permission from the taxpayer of the other business. This procedure
applies even if the predecessor and successor are related, as in a closely-held family business.
For example: if the auditor would like to use a site test of the successor’s business in
the audit of the predecessor’s business, the auditor must first obtain written permission
from the predecessor to use this procedure. This is necessary because while engaging the
successor for permission, the auditor will disclose, either directly or by inference, to the
successor that the predecessor is being audited. Once written permission is received from
the predecessor, the auditor must then obtain written permission from the successor to
use a site test of its business in the audit of the predecessor.
If obtaining written permission from both the predecessor and the successor is unlikely, staff may
not use information from one taxpayer’s business in an audit of another business while disclosing
the source of the information. Staff should not complete an audit without clear explanation of
the basis for the audit result. In situations where taxpayers maintain no books and records, staff
must consider other alternative methods, such as the use of industry averages or the prevailing
regional averages of similar businesses. July 2016
General Audit Procedures
CUT-OFF TECHNIQUES
0405.35
“Cut-Off” is that point in the audit program where the auditor has accumulated sufficient data
to support a reasonable conclusion or opinion based on acceptable audit standards. It might be
defined as when to stop testing or examining data. This may refer to the audit as a whole or to
a specific task or test. This is a judgment area for the auditor. For example, when a short test
indicates an error, but an expanded test does not seem to sustain this error, the auditor must
stop and analyze why this condition exists, whether to continue testing and on what basis, etc.
When a prospective cut-off point is reached, a decision should be made whether to accept the test
results, alter the audit approach, or discontinue the audit. In terms of testing, the audit approach
or testing program may be altered by:
(a) Expanding the test base by inclusion of additional test periods.
(b) Narrowing the test base because the results do not disclose significant error. For example:
• Cut-off detail examination of certain invoices to examine only those over a given
amount.
• Cut-off detail examination of certain invoices to examine only those for certain
customers or vendors as the case might be.
Important points to consider in deciding whether to cut-off, alter the audit approach, or discontinue
completely are:
(a) Materiality of error encountered.
(b) Frequency of error.
(c) Blind alleys:
• Source detail missing.
• Change in filing system.
(d) Discovery of a more efficient approach, e.g., change from invoice testing to an accounts
payable examination selection of certain vendors. This will be found to be equally applicable
to sales invoices and accounts receivable.
(e) Arrival at an opinion prior to completion of the test as originally planned.
August 2008
Audit Manual
WHOLE DOLLAR AUDITING
0405.40
The principle of dollar auditing (i.e., dropping cents) is a time-saving technique. In whole-dollar
auditing, cents are eliminated at the earliest practical stage in an accounting sequence and only
whole-dollar amounts are recorded thereafter.
(a) Rules that apply when rounding to whole dollars:
• Eliminate cents between $.01 and $.49 (e.g. $7.18 becomes $7)
• Increase to next dollar, cents between $.51 to $.99 (e.g. $5.72 becomes $6)
• Round $.50 amounts to the nearest even dollar ($17.50 becomes $18; $18.50 also
becomes $18).
Do not show a decimal point or place figures or symbols in cents columns when amounts
are rounded to whole dollars.
(b)Treatment of variances:
• The sum of whole-dollar amounts will often differ by a few dollars from the sum
of the exact amounts. For tax auditing purposes, this is not important since the
variance in terms of tax is negligible.
• These small variances (usually less than $5) will be dropped at the first convenient
place they can be identified in the working papers. Variance differences standing
alone are easily discernible. Variance differences commingled with clerical errors
or errors on returns are not easily discernible and need not be dropped.
• An example of a column to eliminate rounding variances in lead schedules is
shown in Exhibit 6. In some cases, it is possible to drop readily identifiable
variance differences in subsidiary schedules.
(c)Common situations where whole-dollar auditing should not be used are:
• When a taxpayer objects. A brief explanation to the taxpayer may overcome
this objection.
• When computing markup from shelf tests.
• When basic data must be compiled with accuracy to avoid distortions when the
findings are expanded, e.g., computing a percentage of error.
• When items to be scheduled do not reflect normal distribution of fractional dollar
amounts, such as when repetitive purchases at one given price are made, or when
sales are made under a policy of pricing at only slightly less than whole dollars.
WORKING PAPERS
0405.45
Chapter 3, Audit Working Papers, contains the basic information relating to audit working papers.
Usually each portion of an audit, namely, total sales, self consumed merchandise, sales for resale,
etc., should be considered as a separate unit with separate working papers for each unit.
January 2000
General Audit Procedures
MAKING THE AUDIT —
APPLYING PROCEDURES AND TECHNIQUES
0406.00
GENERAL0406.05
While the basic tools given to the auditor in this chapter are guides, there is nothing which will
replace initiative, ingenuity and judgment in applying, adapting and improvising as necessity
warrants.
The following sections briefly describe the books, records and detail that the auditor will normally
encounter in making audits. All or part of these described records may be used in performing any
given audit and they may be used in either a direct or indirect audit approach.
EXAMINATION OF GENERAL LEDGER ACCOUNTS
0406.10
The general ledger accounts must be examined for debits and credits which may represent
unreported taxable transactions. As examples, sales of merchandise at cost may have been credited
to the purchase or inventory accounts; sales of by-products may have been credited directly to
profit and loss, surplus or expense accounts; sales of furniture, equipment and other capital assets
may have been credited to equipment, depreciation or other accounts. Debits to general ledger
equipment and supply accounts may represent unreported purchases subject to use tax.
EXAMINATION OF GENERAL JOURNAL
0406.15
Transactions not disclosed by examination of other records may sometimes be disclosed by
examination of the general journal. The auditor should examine general journal entries noting
those which may indicate unreported taxable transactions.
All data pertaining to these entries should be examined; such as, correspondence, contracts,
invoices and other documents to determine whether the entry represents an unreported taxable
transaction.
EXAMINATION OF CASH RECEIPTS AND DISBURSEMENTS RECORDS
0406.20
The cash receipts record should be examined to determine that receipts from cash transactions
have been credited to the proper sales or revenue accounts. Care should be exercised not to
duplicate taxable transactions disclosed in the examination of other records.
EXAMINATION OF ACCOUNTS RECEIVABLE LEDGER
0406.25
The accounts receivable with the owners, partners, officers, or employees of the company should
be examined for evidence of taxable transactions not otherwise recorded in the sales or revenue
accounts. Partners’ drawing accounts and employees’ advance accounts should be examined.
EXAMINATION OF PURCHASE JOURNAL
0406.30
Entries may be made in the purchase journal for sales at cost or returned merchandise. Inventory
withdrawals which should have been reflected in the inventory accounts may appear as credits in
the purchase journal. These postings should be scrutinized for taxable transactions.
January 2000
Audit Manual
SCHEDULE OF TOTAL SALES OR REVENUE
0406.35
Unnecessary scheduling should be avoided. However, good auditing procedures should always
be kept in mind. Time can usually be saved by reconciling the sales or revenue reported to the
general ledger accounts. Taxable differences, where encountered, can be transferred to the
Schedule 414–A2, Summary of Differences, when conducting a total sales or Line One audit.
In some cases, it is more practical to trace the reported figures to the sales or revenue journal or
general ledger by periods. If there are frequent differences appearing, it would be advisable to
schedule total sales or revenue. If there are only a few isolated differences, the periods where
the differences occur should be scheduled. When the recorded figures can be used in tying-in
several items such as total sales and several deductions, a detailed schedule of total sales may be
advisable. This may be scheduled from the sales journal if the segregation between taxable and
nontaxable sales are not shown in the general ledger.
Where the sales are scheduled from the sales journal or other detailed sources, the scheduled
figures should be reconciled with the general ledger.
In all cases, proper planning is necessary to determine the correct method to be used for the
assignment. Verification comments should always indicate the general method of reconciliation
used.
GROSS PROFIT AND NET WORTH ANALYSIS
0406.40
The auditor will encounter some cases where the taxpayer has no records of any kind, or perhaps
only fragmentary records. Where this condition exists, sales must be estimated as accurately as
possible based on whatever information is available. In order to estimate sales, it must be assumed
that gross profit equals increases in capital assets, operating expenses, and net withdrawals of
the proprietor. Algebraically, this is expressed as follows:
(a) Gross Profit = Sales minus Cost of Goods Sold
(b) Cost of Goods Sold = Gross Profit ÷ by Mark-Up %
(c) Mark-Up Percentage = Gross Profit ÷ Cost of Sales
(d) Gross Profit = Capital Asset increases + Expenses + Withdrawals
(e) Sales = Cost of Goods Sold + Capital Asset increases + Expenses + Withdrawals
The items to be determined are:
• Percentage of mark-up
• Capital asset increases, operating expenses and withdrawals.
The percentage of mark-up may have to be estimated based on auditor’s knowledge of mark-ups
of similar type and size of business located in the same general area. If at all possible to do so, a
mark-up should be computed based on current purchase invoices which may be available. This
mark-up could then be compared to the known mark-up of similar businesses as a test of its
accuracy.
Increases in capital assets, operating expenses and the proprietor’s net withdrawals must be
compiled from data and estimates based on information derived from questioning the taxpayer
and other persons who have knowledge of the business. Information regarding increases in
capital assets may be obtained by noting new equipment, machinery, etc., and determining the
equity held by the taxpayer, etc. Average operating expenses may be estimated from canceled
checks of records of expenditures; wages may be taken from social security records; rent from
rental agreements. Withdrawals by the proprietor may be estimated from canceled checks, bank
deposit books, investments, etc.
January 2000
General Audit Procedures
MARK-UP BASED ON INCOME TAX RETURNS
0406.45
In many instances, income tax returns are no more accurate than the records from which they
are compiled. The income tax returns, however, may be of aid to the auditor in supporting
sales estimated by using one of the methods outlined above. For example, where the taxpayer’s
records have actually been lost or destroyed, the income tax returns may be compared with the
sales estimated by using procedures set forth in section 0406.40. This procedure is, of course,
based on the premise that at the time the income tax return was compiled the taxpayer was in
possession of their records. Where there is a discrepancy between the purchases and sales per the
records and the purchases and sales per the income tax return, the taxpayer should be requested
to account for such differences. Consideration must be given to purchases and receipts which do
not represent sales of tangible personal property.
INCOME TAX RETURNS AS BASIS OF AUDIT
0406.50
Where a taxpayer has acceptable records, but gross receipts recorded in the books and reported
on business tax returns are not in agreement with gross receipts on the income tax returns, these
differences should be reconciled if possible. In making this reconciliation, differences due to
netting of, for example, sales tax from gross receipts per the sales tax return should be recognized.
Another example of this would be reporting for income tax purposes on a cash basis vs. an accrual
basis for sales tax purposes.
EXAMINATION OF SALES OR REVENUE INVOICES
0406.55
Sales or revenue invoices usually represent the original record of a transaction after an order of
execution, such as a purchase order has been given. In the process of most of our audits under
the various tax acts, it is a necessary part of the audit procedure to examine a representative
number of these invoices to determine how the transaction is recorded thereon and in the case of
reimbursable taxes, on what the tax was accrued.
Following is an itemization of the various functions involved in the examination of this original
detail:
(a)Postings. This is the first step in the verification of the accuracy of the books of original
entry. The invoice, sales or revenue, is vouched directly to the sales or revenue journal
for accuracy of posting relative to amount and classification in the journal.
(b)Tax accrual. On those taxes subject to reimbursement (i.e., sales and use tax), the tax
as accrued on the invoice is important for reasons such as:
• Accrual of the tax based on the measure, i.e., sales tax rate times the selling price.
This would relate to audits verifying the taxpayer’s reporting on an accrual of tax
basis, and
• The provisions of Regulation 1700 of the Sales and Use Tax Law concerning excess
tax reimbursement.
(c)Deductions. At the time the invoice is being reviewed for posting accuracy, etc., it also,
will be reviewed for evidence of exemption or non-taxability. For example, if a sale is being
claimed as an exempt sale for resale, the resale certificate itself could be examined at that
time.
January 2000
Audit Manual
Examination of Sales or Revenue Invoices
(Cont.) 0406.55
(d)What is the form of the invoice, i.e., are the charges segregated; are they lump sum
charges, etc.? The importance of this will relate to the particular tax act. For example, sales
tax vendors are, under certain conditions, allowed to bill lump sum where they consider
themselves to be consumers rather than retailers of the property used in repairing tangible
personal property.
In summary, it cannot be overemphasized that the sales or revenue invoice is of
prime importance in the audit process and any information found thereon is worthy of
consideration; the importance then extends from the document itself to what is done with
it in the process of recording.
CONCESSIONAIRES0406.60
For sales and use tax purposes, concessionaires are independent retailers who are authorized,
through contract with, or permission of, another retail business enterprise (the prime retailer), to
operate within the perimeter of the prime retailer’s own retail business premises. Concessionaires
appear to be wholly under the control of the prime retailer, and to make retail sales that to the
general public might reasonably be believed to be the transactions of the prime retailer. The
usual bases for payment of store occupancy to the prime retailer are:
(a) Percentage of net or gross sales with possible provision for minimum rental payment
(b) A fixed rental
(c) A profit-sharing arrangement
The prime retailer’s general ledger should contain a clearing account for concessionaire operations.
The prime retailer may be held jointly and severally liable for sales and use taxes imposed on
unreported retail sales by the concessionaire while operating as a concessionaire. The prime
retailer will be relieved of this liability for the period in which the concessionaire holds a permit
for the location of the prime retailer, or the prime retailer has a written statement (as provided
in Regulation 1699) taken in good faith in which the concessionaire affirms that he or she holds
a seller’s permit for the prime retailer’s location.
If the prime retailer has concessionaires, the auditor should secure a complete list of all leased
departments operated during the audit period, showing the concessionaire’s name, address,
phone number, and seller’s permit number, if any. Even when the prime retailer does report the
concessionaires’ sales transactions, special attention should be given to the possible liability for
use tax of the concessionaire for operating supplies, giveaways, etc., since these are often shipped
into California from the concessionaires’ out-of-state home office or purchased from out-of-state
retailers.
August 2005
General Audit Procedures
SPECIALIZED TECHNIQUES — SALES AND USE TAX
0407.00
GENERAL0407.05
A tax auditor is concerned primarily in ascertaining whether the reported tax liability is
substantially correct.
When it is determined that a taxpayer’s records are such that sales cannot be verified by a direct
audit approach, the auditor must estimate the sales from whatever information is available. The
following sources of information and procedures have been found useful in determining probable
sales:
•
•
•
•
Bank deposits (section 0405.25)
Gross profit and net worth analysis test (section 0406.40)
Income tax returns (section 0406.50)
Purchases plus mark-up (section 0407.10)
If enough information is available to do so, the auditor should use two or more of these methods
to estimate the sales, comparing the results of one method against the results of another.
Note should be made of an additional factor which might be considered when the propriety of the
recorded sales is questioned. This is the net profit. A continuing low net profit or loss would be
indicative of a possible understatement of total sales. The value of this consideration is substantive
only to other findings.
MARK-UP METHODS
0407.10
Mark-up procedures to determine audited sales (i.e., gross sales, sales of a deduction or taxable
sales) are a vital part of sales tax auditing. The auditor should expand on this use whenever the
opportunity presents itself.
Mark-up, sometimes expressed as mark-on, is the amount added to cost to obtain the sales price,
and generally is referred to in terms of percentages. The percentage of mark-up is computed
by dividing gross profit by cost of goods sold: G.P./C.G.S. = % of M.U. Taxpayer’s often discuss
gross profit in terms of percentages based on sales (i.e., profit margin) but seldom discuss markup based on cost. Care should be exercised by the auditor to make certain they are on common
ground with the taxpayer when discussing gross profit and mark-up percentages.
Mark-up factor is the factor by which cost of sales is multiplied to determine total sales: C.G.S. x
M.U.F. = S. The mark-up factor always will be the percentage of mark-up plus 100%. In computing
sales, the mark-up factor should be used as it saves one step (adding the amount of the mark-up
to cost of sales) in the computation of sales. The mark-up factor is obtained by dividing sales by
cost of goods sold: S./C.G.S. = M.U.F.
Before proceeding, one other point should be made. Mark-up as previously discussed may be
used to determine sales; it may also be used as a short test in examining the mark-up produced
by the taxpayer’s records. Is this mark-up satisfactory for the type of business involved? If it is,
this may satisfy as verification of total sales, etc. This same technique may be used to verify a
deduction. For example, sales of food products in a liquor store.
A mark-up test and/or procedure to determine sales is only as reliable as the base from which the
auditor is working or in other words, purchases or if available, cost of goods sold. Verification of
purchases is discussed in a subsequent paragraph.
January 2000
Audit Manual
Mark-Up Methods
(Cont. 1) 0407.10
In many types of businesses, particularly where the unit of sales is small, the volume of transactions
relatively large and the mark-up does not fluctuate greatly, the sales may be estimated with a
fair degree of accuracy by establishing the mark-up from a shelf test and applying the computed
mark-up to the cost of sales. This procedure applies to audits of such concerns as restaurants,
small retail stores of all kinds, and under certain conditions, to audits made on the basis of taxable
sales. The following items must be considered in this type of audit:
(a) The determination of total purchases
(b)The segregation of purchases between departments or types of merchandise having the
same general level of mark-up
(c) Self consumed merchandise
(d) Shrinkage of inventory
(e) Inventory adjustments
(f) The computation of mark-up for each department or class of merchandise
Verifying total purchases (Item a). Where a record of purchases is available, the monthly or
quarterly totals should be tied-in for the entire audit period. These should be proved by comparing
purchase invoices to recorded purchases on a test basis to insure that total purchases have been
recorded. In many cases, however, a record of purchases will not be available. Under those
circumstances, the purchase invoices should be scheduled for a test period. The auditor should
make sufficient tests to determine that all purchase invoices are on hand. Recommended tests are:
• Scrutinize accounts payable for names of vendors with no supporting invoices.
• Ascertain names of brands and types of merchandise carried by a personal inspection of
the stock and compare with invoices submitted by the taxpayer.
• Examine canceled checks or check stubs.
• Examine record of cash paid outs.
• Examine vendor’s monthly statements for completeness of invoices.
When the auditor is doubtful that all purchase invoices are available, purchases for a test period
should be obtained from a representative number of vendors. If it is found that the taxpayer’s
records are incomplete, some or all of the purchases should be obtained from all vendors’ records.
This procedure should be used in extreme measures only as it is usually very time consuming.
January 2000
General Audit Procedures
Mark-Up Methods
(Cont. 2) 0407.10
Segregation of purchases (Item b). If there are widely different mark-ups in the various
departments or types of merchandise, the purchases, if possible, should be segregated into classes
to facilitate the application of appropriate mark-ups. Before adopting this procedure, however,
the auditor should make sure that the purchases can be so segregated. If they cannot, an average
weighted mark-up applicable to all purchases should be computed. Following are some of the
frequently used segregations:
(a) Drug Stores
(c) Liquor Stores
• Proprietary drugs (non-prescription)
• Distilled spirits
• Ethical pharmaceuticals
• Beer
• Drug sundries
• Wine
• Tobacco products
• Soda
• Notions, stationery and supplies
• Food
• Liquor
• Tobacco products
• Fountain supplies
• Newspapers and magazines
• Food products
• Other merchandise
• Newspapers and magazines
(b) Service Stations and Garages
(d)Clothing Stores
• Garments
• Tires and tubes
• Accessories
• Oil
• Shoes
• Grease
• Miscellaneous merchandise
• Parts
• Accessories
• Batteries
• Gasoline
Self-consumed merchandise (Item c). The recorded cost of goods sold should be reduced by
the cost of merchandise consumed by the taxpayer, given to employees, or given to customers for
promotional purposes. If self-consumed quantities are not supported by the records, a reasonable
estimate should be made with the assistance of the taxpayer. The estimate should contain an
analysis of the self-consumption by categories to support the allowance. For example, in an audit
of a bar the audit workpapers should include a schedule showing the number of drinks (broken
down by liquor, beer, and wine) in each of the following categories:
• Self-consumed by owner and family
• Consumed by employees
• Gifts/give-aways
Each category should then be costed out to arrive at the total self-consumption allowance. The
dollar value of each category should also be translated into the percentage of total taxable
purchases. If an allowance greater than 3% is being recommended, complete justification must
be included.
August 2005
Audit Manual
Mark-Up Methods
(Cont. 3) 0407.10
Shrinkage of inventory (Item d). An allowance should be made for pilferage, spoilage, theft,
natural disasters and fire losses where applicable. When shrinkage is present, an amount of up
to 1% of the cost of these items may be allowed. When the taxpayer claims shrinkage of more
than 1% they must substantiate the amount. This substantiation may consist of police reports,
reports from regularly employed security guards, private detective agencies or similar service
firms, insurance claims, as well as losses computed through sales and inventory reconciliations.
Detailed comments supporting the pilferage allowance should be included in the audit work papers.
The pilferage allowance should also be translated from a percentage to dollars and a breakdown
of the volume and type merchandise the dollars represent, included in the audit work papers.
In the absence of detailed data, a reasonable estimate of pilferage, spoilage, theft, or fire losses
may be made based on available data from:
•
•
•
•
Police reports
Insurance claims and settlements
Inventory (for fire loss and large theft claims)
Type, size and location of store, and availability of inventory for pilferage
When a merchandise shrinkage allowance is given, it should be set out as a separate item; not
buried in the mark-up used. (See the illustration under item “f” — Calculation Mark-up)
Inventory adjustments (Item e). In many cases, the taxpayer will not have inventories which
can be checked for accuracy. In this event, the purchases may be considered the cost of sales if
there is evidence that inventories were substantially constant.
Inventory adjustments are especially critical in making audits on new businesses and close-out
businesses. If adjustments are not made it may result in assessing tax on goods not yet sold.
Calculation of mark-up (Item f). The accuracy of an audit based on purchases marked up to
selling prices depends principally upon two factors; the correctness of cost of sales and the accuracy
of the calculation of mark-up. The cost and selling price must be known to compute the mark-up.
This procedure contemplates the auditor will make an actual examination of price tags, price
stickers, signs or any other device used to inform the customer of the unit sales price.
In those instances where the audit is not made at the taxpayer’s place of business or when it is
either impractical or impossible to determine the taxpayer’s posted unit sales prices, the auditor
should use standard catalogs or price lists. For example, when auditing liquor stores under these
circumstances, the auditor may use the retail prices listed in Patterson’s Guide or the Beverage
Industry News.
January 2000
General Audit Procedures
Mark-Up Methods
(Cont. 4) 0407.10
If all items sold are marked up by approximately the same percentage, a straight average may
be used. However, if the mark-up on the several classes of purchasers varies materially, a markup should be computed for each of the classes or a weighted mark-up should be computed. The
weighted mark-up is usually based on dollar volume of purchases although the units purchased
and units sold method may be used to an advantage in certain instances. The most commonly
used methods of computing mark-up are in order of preference:
(1) Weighted average; purchases of one or more purchasing cycles
(2) Segregation of classes of merchandise
(3) Average of selected items
Effect should be given to mark-downs where they can be established.
Mark-up for periods outside of the audit period may be used when current records are so incomplete
as to prohibit establishment of a current mark-up.
The calculation of mark-up, based on cost, is illustrated by the following example:
Sales (Ex-tax)
$25,000
Cost of Sales:
Inventory 1–1–XX
$2,000
Purchases
20,606
Inventory 12–31–XX
Cost of Sales per Books & Records
$22,606
7,000
$15,606
Adjustments:
Self Consumed
*Shrinkage (pilferage)
$400
152 –552
Adjusted Cost of Sales
15,054
Gross Profit
$ 9,946
Mark-up = 9,946/15,046 = 66.10%
*pilferage based on COS after adjustments allowed for self consumption.
Mark-up based on weighted average (Item 1). Total purchases for at least one purchasing
cycle should be used to determine the weighted mark-up. Depending on the type, size and
purchasing habits of the business, a purchasing cycle could cover a period from one week to six
months. When the purchase invoices have been pulled for the test period, the taxpayer should be
requested to price all invoices at retail. Those prices should then be test checked with shelf or list
prices. The total purchase price and total sales prices of each invoice can then be recapped and
from the total costs and selling prices, a percentage of mark-up can be computed. This percentage
can be applied to quarterly cost of sales if such figures are available, to estimate quarterly sales.
If quarterly totals are not available, the percentage of mark-up can be applied to cost of sales on
an annual basis and any understatement of taxable sales developed can then be allocated to the
quarters in each year on a sales ratio basis.
January 2000
Audit Manual
Mark-Up Methods
(Cont. 5) 0407.10
Mark-up based on purchase segregation (Item 2) This method of computing a mark-up is
best suited to retail stores whose merchandise categories are few in number, sharply defined and
with a wide variance in mark-up and sales volume. Purchases must be recorded in a manner
which will allow verification of segregation in a minimum amount of time, not only for the test
period but the entire period being audited. The auditor will determine the cost price and sales
price of each category of merchandise for a representative test period.
Individual mark-ups will be computed for each class of merchandise. The percentages of markup thus computed will be applied to their respective purchase category over the entire period of
the audit. Before using this method, the auditor must determine that an accurate segregation
of purchases can be made over the entire audit period. If such segregation is not possible, this
method should not be used. Wherever inventories are available, the mark-up is to be applied to
cost of sales. Otherwise, purchases may be considered to be cost of sales.
Mark-up based on average of selected items (Item 3). This method of computing the overall
mark-up may be used in certain types of businesses where the units of sale are generally small
and the mark-up and sales volume of the various kinds of merchandise handled do not vary
materially. The use of a straight average mark-up computed from shelf prices of representative
items will usually be sufficiently accurate for this kind of audit. Such items should be included
in the computation approximately in proportion to the volume of each class of merchandise
handled. Slow moving merchandise and unusual merchandise not regularly sold should not be
used in computing the mark-up. The percentage of mark-up computed should be applied to cost
of sales for the audit period. Any substantial error in reporting revealed by a comparison of sales
computed by this method and reported can be allocated against all quarters of the audit period
on a percentage basis. If adequate records are not available to reflect cost of sales for the audit
period, representative periods may be selected to compute estimated sales. The results of these
periods can be projected to all periods on a percentage of error basis.
When sales computed by a mark-up method indicate only a small understatement, sound judgment
must be exercised in concluding whether the difference actually represents an understatement
rather than inaccuracies in the mark-up procedure. In reaching such a conclusion, consideration
should be given to all available facts.
In addition to the foregoing, the auditor is referred to other chapters of this manual for specific
application of mark-up methods and techniques; such as, Chapter 8, Bars and Restaurants and
Chapter 9, Grocers.
March 2001
General Audit Procedures
SHORT TESTS
0407.15
The tax returns of some types of small concerns may be proved approximately correct or incorrect
on a short test basis (0405.15) by verifying certain essential information. Listed below are examples
of the types of information which may be considered in short tests:
(a)
Small markets or grocery stores:
• Records show an adequate mark-up on cost
• Purchases subject to use tax were properly reported
• Computation of the food product deduction on an over-all basis for the period of
audit show it to be reported substantially correct
• The ratio of taxable sales to total sales is approximately correct after giving
consideration to the size, type, and location of the store
(b)
Small service stations and garages:
• Taxable sales reported appear to be correct based on observation of size, type,
location and size of inventory of taxable merchandise
• Purchases subject to use tax, such as grease, tools and supplies have been reported
• Taxable and over-all mark-up is satisfactory
(c)
Small retail stores:
• Bank deposits, after adjusting for nontaxable income, and cash paid-outs are in
agreement with reported sales
• Sales tickets show proper application of tax
• Over-all mark-up is satisfactory
(d)
Small restaurants and lunch stands:
• Purchases include all types of food ordinarily sold in the business
• The mark-up is satisfactory
• The deduction for food products for consumption off premises is reasonable and
properly supported
(e)
Bars:
• Sales computed based upon mark-ups determined from short tests, applied to
merchandise purchases on an over-all basis are in reasonable agreement with
those reported
• Self-consumed taxable merchandise as reported is adequate for this operation
VERIFICATION OF RECORDED TOTAL SALES
0407.20
If recorded sales have been scheduled or reconciled with reported sales, sufficient verification
should be made to prove their accuracy and to disclose any taxable sales not entered in the regular
sales account. Additional taxable sales developed in this examination should be scheduled on a
subsidiary schedule if few in number. However, if numerous unreported sales in different sales
categories are disclosed, a separate subsidiary schedule should be used for each class of unreported
transactions.
January 2000
Audit Manual
CASH REGISTER SHORTAGES
0407.25
Questions are frequently raised about amounts classified as “cash register shortages”. Factors
which may cause differences between sales recorded on the cash register and cash and valid sales
checks received are as follows:
1.
Sales are rung on the cash register incorrectly, are then re-rung correctly, but the
sales clerk fails to cancel (void) the first ring.
Erroneous duplicate over-rings are allowable as a reduction of sales.
2.
Sales are recorded on the register for more than the actual sales amount; for
example, a $1.00 item rung on the register as $10.00. The reverse (under-rings) also
occur.
Over-rings and under-rings are to be treated as a reduction or addition to sales
recorded on the cash register.
3.
Charge sales checks have illegible or missing credit card imprints or handwritten
customer names. (These are billed as an unidentifiable receivable and subsequently
written off to cash register shortage.)
Illegible charge sales checks are considered as worthless or uncollectible accounts.
Accordingly, such uncollectible sales qualify as a bad debt deduction. However, any
amounts which are subsequently collected should be reported.
4.
Charge sales checks are lost prior to billing.
Charge sales checks lost prior to billing are considered as uncollectible accounts
qualifying as a bad debt deduction.
5.
Employee or other theft from register.
These amounts are not allowable as a reduction of sales. When money is stolen,
there is not a question as to whether or not consideration was received.
6.
Charge sales checks indicated by sales person as cash and therefore never billed to
the customer.
These are considered to be worthless accounts similar to items 3 and 4.
7.
Counterfeit money received.
Sales paid for by counterfeit money, fraudulent checks or unauthorized charge plates
are allowable reduction of sales. However, the reduction is limited to the original
sales amount. Losses attributable to counterfeit money or fraudulent checks in
excess of the original sale are not allowable.
8.
Cash register change errors.
Change errors are not to be treated as an adjustment to recorded cash register
sales. Such errors are similar to lost or stolen money. The change error occurs
after consideration for the merchandise has been received. Any recourse against
a customer who has received excessive change would be based on the fact that
they have money which belongs to the store. It would not be based on lack of
consideration received for the merchandise purchased.
Differences which are claimed as a reduction of cash register sales must be supported by the facts
on hand. The analysis of a representative test period should, in fact, substantiate that any one,
or a combination of the factors enumerated, does support a reduction in cash register sales in the
amounts and to the extent claimed.
January 2000
General Audit Procedures
PURCHASES SUBJECT TO SALES OR USE TAX
0408.00
GENERAL0408.05
The auditor must be alert to distinguish between sales tax and use tax in order to assert the tax
liability properly. 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, is liable for the use tax on the cost of the property
purchased. In the latter case, the purchaser’s liability is not extinguished unless they have paid
the tax to the State, or to a vendor who is authorized or required to collect the use tax and has
issued a receipt to the purchaser.
If a purchaser certifies in writing to a seller that the property purchased will be used in a manner
or for a purpose entitling the seller to regard the gross receipts from the sale as exempt from the
sales tax and uses the property in some other manner or for some other purpose, the purchaser
shall be liable for payment of sales tax as if the purchaser were a retailer making a retail sale of
the property at the time of such use and the sales price of the property to the purchaser shall be
deemed the gross receipts from such retail sale.
Many consumers neglect to report taxable purchases because a satisfactory method of accumulating
these purchases is not used. The auditor should be particularly vigilant in examining purchase
orders, purchase invoices, requisitions and journal entries as well as general ledger accounts labeled
“Research and Development” and “Promotional” for evidence of use tax. See section 0409.75 for
a discussion of the audit procedures to be used for drop shipment transactions.
METHODS OF VERIFICATION
0408.10
Based on the type of business and the condition of the records, there are three general procedures
used 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.
AUDITS OF SALES SUBJECT TO USE TAX
0408.12
In determining the party liable for the assessment of use tax, the auditor should not presume the
use tax will be assessed in the future audit of a purchaser due to the size of the entity or audit
history, and may assess use tax against the seller. To avoid a duplicate assessment of use tax on
the same transaction, the auditor should complete Form BOE-1164, Memorandum of Possible
Tax Liability, and make a notation whether use tax was assessed on the seller/purchaser. The
auditor sends a copy of the form to both taxpayer files. In addition, the auditor may preclude the
duplicate assessment of use tax by using Form BOE 503-C (paper version) or Form BOE-503-C1
(electronic version), Statement of Property Purchased Without Payment of California Use Tax.
Generally, in a simultaneous audit of the seller and purchaser, the use tax is assessed in the audit
of the purchaser. However, the auditor should verify tax is not being assessed in the audit of the
seller to avoid double taxation of the transaction. The auditor should adhere to the guidelines
outlined in AM section 1302.25 when the transaction relates to a statistical sample.
January 2014
Audit Manual
EXAMINATION OF PURCHASE INVOICES
0408.15
Invoices for a representative period, depending on the volume, should be examined and compared
with the purchase record to determine that all invoices are on hand. Either all purchases that
are considered taxable should be scheduled, or if details of reported amounts are available, the
purchases should be traced to the taxpayer’s working papers and only the omitted items need
be scheduled. A copy of the schedule should then be submitted to the taxpayer for verification.
The taxpayer may be able to prove that the questioned items were not subject to the tax or were
reported in another quarter. If the results of the test prove the taxpayer is reporting all items
correctly, this phase of the examination should be discontinued. If, however, the test indicates
improper reporting the test may be expanded, possibly to cover the entire audit period.
After having examined several months’ invoices, the auditor should be familiar with the
names of vendors who supply the taxpayer with resale merchandise only or those vendors who
consistently charge tax on consumable items as well as those vendors who do not charge tax
on consumable items. Thereafter, the examination of invoices can be limited to those issued
by vendors in the latter category. Frequently the “miscellaneous” file for each letter of an
alphabetic file is a source of purchases subject to use tax.
An examination of purchases for capital expenditures should be made in detail only as the
transactions are generally few in number with a relatively high unit value. Furthermore, such
purchases usually are not made at regular intervals or in consistent amounts.
Wherever possible, estimate purchases of supplies, expendable tools, etc. based on a test period.
This is particularly true in types of businesses where the consumable supplies bear a direct
relationship to units produced or sold, e.g., coke used in the cupola process for producing steel,
advertising material used in sales promotion, grease used in lube jobs, etc.
The monthly amounts of merchandise so consumed can be determined by an examination of
several months’ purchase invoices. When this method is used, the taxpayer should be consulted
and approval secured, if possible. (See Chapters 8 and 9 for discussions regarding purchases
subject to use tax in restaurants and grocery stores, respectively.)
In instances where a voucher number system is used for accounts payable and filed in numerical
order by years, it will be necessary to control any test, beyond either spot checking or a complete
year’s examination of invoices, working from the voucher register to the invoices. A dollar volume
test as described under section 0405.20 might be used here if it is not practical to make a test from
the voucher register. Invoices filed alphabetically by years may be examined (short of spot tests
or complete review) by working from the distribution thereof in the purchase journal or check
register. That is, specific expense account distributions may be reviewed or tested back from the
book of original entry to the invoices. Here, again, as suggested in the foregoing a dollar volume
test might be developed.
January 2000
General Audit Procedures
USE OF FORM BOE–503, “ABC” LETTER PROCEDURE
0408.16
The taxpayer may be able to prove that the questioned items were not subject to tax; or were
reported in another reporting period; or the tax was paid by the vendor on their tax return or
audit determination. To assist the taxpayer in satisfying their use tax obligation, the Board has
developed the Form BOE–503 – ABC Letter Procedure (hereafter called “ABC” Letter). (See
Exhibit 7)
The “ABC” Letter procedure utilizes the following form set:
(1) BOE–503–A, explains the “ABC” Letter procedure
(2) BOE–503–B, Sample “ABC” Cover Letter
(3) BOE–503–C, Concerning Property Purchased Without Payment of California Use
Tax
When it is appropriate to use the “ABC” Letter process, the auditor will provide the taxpayer with
a copy of the BOE–503–A, B, and C. The auditor should discuss the “ABC” Letter process with
the taxpayer and explain that a satisfactory response to an “ABC” Letter inquiry alone is not
necessarily enough to relieve the taxpayer from payment of the use tax, and that other evidence
may be considered in reaching a conclusion. The auditor should also explain that since the
“ABC” Letter is not a substitute for a receipt for payment of use tax, additional documentation
or information may be required.
A period of four weeks will be allowed for the taxpayer to prepare and send the “ABC” statements
and for their vendors to reply. It is recommended that the “ABC” statements be returned directly
to the Board. If this is the case, the auditor should provide the taxpayer with return envelopes
with the address of his or her district or branch office. Please note, business reply envelopes
(no postage necessary) should not be used. If the taxpayer elects to have the “ABC” statements
returned to them, the auditor should explain to the taxpayer that the likelihood of having staff
contact the vendor or sending an additional mailing is greater.
The taxpayer may customize the “ABC” cover letter (BOE–503–B) by using the text contained
therein on their own letterhead, however, the text in the sample letter should be used without
additions, deletions, or changes. Any modification to the cover letter must be approved by the
auditor’s supervisor.
The “ABC” statement (BOE–503–C) must be used as provided by the auditor. The use of a
standardized “ABC” statement will reduce any possible controversy over whether the substantiation
provided is satisfactory. The auditor should put his or her office designation in the space marked
“DMA” and their initials in the space marked “Auditor’s Initials,” both located at the top right of
the “ABC” statement.
The taxpayer’s vendor is requested to return the completed “ABC” statement within 10 days. The
10–day requirement is intended to encourage a prompt response from the vendor. If the taxpayer
chooses the recommended procedure of having the completed “ABC” statements returned directly
to the Board, the taxpayer may add a statement in the letter (BOE–503–B) asking their vendor
to send a copy of the completed “ABC” statement to them by fax or mail.
The original “ABC” statement should be sent or faxed to the Board by the taxpayer’s vendor. If
the completed “ABC” statements are to be sent directly to the taxpayer, the signed original should
be examined. If a second “ABC” Letter is necessary, the auditor should establish a reasonable
period of time based on the circumstances involved.
January 2000
Audit Manual
Use of Form BOE–503, “ABC” Letter Procedure
(Cont.) 0408.16
Upon receipt of the “ABC” statement, the auditor should verify the information contained therein.
For instance, the auditor should verify the permit number, audit periods, determination date, etc.
for accuracy. Any inconsistencies should be brought to the taxpayer’s attention. Additionally, if
the response on the “ABC” statement is Item C, and all other information is correct, the in-state
auditor should assess use tax on the California consumer and prepare and send a Form BOE–1164,
“Audit Memorandum of Possible Tax Liability” to the Out-of-State District Office along with a
copy of the “ABC” statement notifying them that the transaction was assessed against the buyer.
ASSERTION OF USE TAX ON LEASES
0408.17
In general, 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 is necessary to determine if any tax liability exists. In addition,
such a procedure insures that lessors have a proper permit and are reporting the tax. 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 BOE–1164) should be prepared
and sent to the lessor’s district. The auditor should 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 BOE–1164 should be sent to the lessor’s district showing the amount of
tax assessed and the applicable periods.
As a note, the California Sales and Use Tax Law does not provide an exemption from sales or use
tax for sales made to California governmental agencies(RTC section 6005). This provision also
applies to out-of-state sellers and lessors who make sales or leases to California governmental
agencies. In such case, the registered out-of-state retailer should collect and report the California
use tax.
USE OF FORM BOE–1164,
AUDIT MEMORANDUM OF POSSIBLE TAX LIABILITY
0408.18
In the examination of purchase invoices, the auditor frequently notices that the California vendor
did not charge sales tax on some or all of the invoices issued, and the purchaser did not issue
a purchase order marked “for resale” or a resale certificate to the vendor. The nature of the
merchandise will sometimes be sufficient evidence to indicate that a resale certificate, if timely
given, was not taken in good faith; e.g., where a retail jewelry store purchased janitorial supplies
or a service station purchases a commercial type hydraulic jack. If in doubt, and the amount
involved is substantial, 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
should not be determined against the purchaser unless the sale occurred outside of California or
is otherwise a transaction subject to use tax. Rather, Form BOE–1164 should be prepared setting
forth the pertinent facts about the transaction. This form, along with any supporting documents,
will be used as basis for investigation.
The auditor should also prepare Form BOE–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 mark the block “Seller
has valid (resale) (exemption) certificate from buyer on file.” The auditor must also include a copy
of that certificate with the Form BOE–1164.
June 2014
General Audit Procedures
Use of Form BOE–1164, Audit Memorandum of Possible Tax Liability
(Cont.) 0408.18
The auditor should also prepare Form BOE–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 merchants which are discovered during audits of California
sellers should be disallowed against the seller (see Publication 32, Tax Tips for Sales to Purchasers
from Mexico, for an explanation of the Mexican merchant program). However, the auditor should
prepare Form BOE–1164 for such sales. The form should identify the purchaser and describe the
merchandise purchased. The completed form should be sent to the San Diego District Office for its
information in monitoring and administering the Mexican merchant program and taking possible
action against any merchants who abuse the program (AM section 0409.50).
See AM section 0401.20 for information on confidentiality of Form BOE–1164.
INFORMATION ON OUT-OF-STATE RETAILERS 0408.19
Out-of-state retailers “engaged in business in this state” are required to register and collect use
tax on taxable sales made to consumers in this state. RTC section 6203 provides that “retailer
engaged in business in this state” specifically includes, but is not limited to, any of the following:
• Any retailer maintaining, occupying, or using, permanently or temporarily, directly or
indirectly, or through a subsidiary, or agent, by whatever name called, an office, place of
distribution, sales or sample room or place, warehouse or storage place, or other place of
business.
• Any retailer having any representative, agent, salesperson, canvasser, independent
contractor, or solicitor operating in this state under the authority of the retailer or its
subsidiary for the purpose of selling, delivering, installing, assembling, or the taking of
orders for any tangible personal property.
• As respects a lease, any retailer deriving rentals from a lease of tangible personal property
situated in this state.
• Any retailer that is a member of a commonly controlled group, as defined in section 25105,
and is a member of a combined reporting group, as defined in paragraph (3) of subdivision
(b) of section 25106.5 of Title 18 of the California Code of Regulations, that includes another
member of the retailer’s commonly controlled group that, pursuant to an agreement with
or in cooperation with the retailer, performs services in this state in connection with
tangible personal property to be sold by the retailer, including, but not limited to, design
and development of tangible personal property sold by the retailer, or the solicitation of
sales of tangible personal property on behalf of the retailer.
• Any retailer entering into an agreement or agreements under which a person or persons
in this state, for a commission or other consideration, directly or indirectly refer potential
purchasers of tangible personal property to the retailer, whether by an Internet-based link
or an Internet Web site, or otherwise, provided that certain conditions are met.
Auditors should be alert to recognizing and reporting interstate retail sales by persons who are not
collecting the tax. When an auditor discovers that a taxpayer is making taxable purchases from
an unregistered out-of-state vendor without tax, the auditor should advise Out-of-State District
Compliance, using Form BOE–1164 (Exhibit 2).
June 2014
Audit Manual
Information on Out-of-State Retailers
(Cont). 0408.19
Form BOE–1164 is helpful in the proper registration of out-of-state vendors who are engaged
in business in California. A separate Form BOE–1164 must be prepared for each vendor. It is
incorrect to attach a schedule for all vendors to one Form BOE–1164. The buyer’s and out-of-state
retailer’s information must be completed on all Form BOE–1164s along with all other information.
However, copies of invoices and a schedule listing all invoices can be attached to Form BOE–1164
for each vendor instead of preparing multiple Form BOE–1164s for each of the vendor’s invoices.
It is emphasized that a copy of the invoice and schedule of purchases may not serve as a substitute
for completing the actual Form BOE–1164 (except for invoice date, number, and item description,
and amount of use tax reported or included in audit). Additionally, it is stressed that a copy
of the invoice and copy of the paid bill schedule is the best information to attach to the Form
BOE–1164. Auditors must make sure the complete address, including the zip code, is noted on
Form BOE–1164. Without a complete mailing address, it is extremely time consuming and often
impossible for Out-of-State District Compliance to properly identify the vendor for correspondence
regarding possible registration.
Analysis of purchases from out-of-state retailers may develop information that will lead not only
to the registration of out-of-state businesses, but to the possibility of additional tax liability on the
part of those who are registered. Attention should be given to volume purchases of small items
as well as to purchases of large items. (Sales made by sellers in contiguous states deserve more
attention since their volume of business in California is generally extensive.) Reports on sales
made to businesses in the food processing, entertainment, and service industries merit special
attention since these types of business may not be required to hold a seller’s permit and use tax
due from such businesses may not come to the Board’s attention.
Information required on Form BOE–1164 for out-of-state retailers includes:
a. Name and address of out-of-state retailer.
b. Name and address of sales representative.
c. Name and address of customer.
d. Invoice number.
e. Date of invoice.
f. Amount of invoice.
g. Description of property sold.
h. How sale was solicited.
i. Any other relevant information concerning seller, sales representative, scope of sales, etc.
In completing Form BOE–1164 for out-of-state retailers, the importance of items (a), (b), (h) and
(i) cannot be over emphasized. This information should be obtained, if at all possible, in order to
enable Out-of-State District Compliance to determine whether an out-of-state retailer should,
in fact, be registered despite a contention made that it is not “engaged in business” in the state.
BOE-1164 FILE AND FOLDER NAMES
Use the following naming convention for BOE-1164s:
0408.20
To District Code_Vendor/Purchaser or Account Number_Audit Case #_BOE-1164
(If no account number type in the Vendor/Purchaser Name)
The audit case number refers to the case from which the lead was generated. This is needed in
the folder name since there may be cases where a district may send two separate BOE-1164s for
the same vendor/purchaser. Without a unique designator in the filename such as an audit case
ID, Windows will over-write the previous folder.
June 2014
General Audit Procedures
BOE- 1164 File and Folder Names
(Cont.) 0408.20
A folder and file need to be created for each vendor/purchaser under the subfolder of BOE-1164.
Copies of the invoices and supporting documentation should also be included and saved as a file.
Supporting documents can be scanned in one file instead of separate files. See examples below.
BOE 1164 – If the vendor/seller has a seller’s permit with BOE
Filename
AS_013987654_54321_BOE 1164.pdf
(This is the actual 1164)
AS_013987654_54321_SupportDoc1.(xls or
pdf) (supporting document)
AS_013987654_54321_SupportDoc2.(xls or
pdf) (supporting document)
Description
Only one sheet is required for each vendor.
A filtered listing of the transactions by vendor
from the audit work papers is acceptable.
Scanned resale cards, invoices etc. if needed.
BOE 1164 – If the vendor/seller does not have a seller’s permit with BOE
Filename
Description
AS_ZYXW_54321_BOE 1164.pdf
Only one sheet is required for each vendor.
(This is the actual 1164)
AS_ZYXW_54321_SupportDoc1.(xls or pdf)
A filtered listing of the transactions by vendor
(supporting document)
from the audit work papers is acceptable.
AS_ZYXW_54321_SupportDoc2.(xls or pdf)
Scanned resale cards, invoices etc. if needed
(supporting document)
BOE-1164s For Unregistered Out-of-State Retailers
BOE-1164s prepared for unregistered out-of-state vendors will be placed in a separate folder with
the following name:
OH_Unregistered_Audit Case #_BOE 1164
June 2014
Audit Manual
BOE-1164 File and Folder Names
(Cont.) 0408.20
A copy of each completed form BOE-1164 and supporting documentation will be placed in the
OH_Unregistered_Audit Case #_BOE 1164 folder using the following name:
Vendor Name_BOE 1164
Vendor Name_Support
The Excel Audit Program has a feature that allows auditors to print all BOE-1164s into an Access
database which in turn can be converted into one PDF file. While this feature is beneficial in
creating a batch of BOE-1164s all at once, a separate PDF is required for each BOE-1164 form.
This allows the Out-of-State compliance staff to import each BOE-1164 into a database for ease
of reference. Auditors may use the Excel Audit Program to generate all BOE-1164s, however
they must use the Print-to-PDF feature to isolate each BOE-1164 form into a separate PDF. This
requirement also applies to supporting documentation such as purchase invoices.
***Please Note: All BOE-1164s for unregistered out-of-state retailers must be in PDF format.
Because the database used to maintain these files cannot upload Excel files, no Excel files should
be provided to OH.
PROCESSING THE BOE-1164
0408.21
When the audit is complete, either the district reviewer or audit control will forward all BOE1164s to the appropriate _Transfer Documents to Other Districts folder located on the J:\ drive.
All BOE-1164s for unregistered out-of-state retailers go to the OH_Unregistered_1164 folder only.
If the out-of-state retailer is registered and has a permit number, a regular BOE-1164 should be
prepared and forwarded to the appropriate out-of-state office.
Copies of the BOE-1164s are not to be retained in the audit case folder. These files should be
deleted when sent to the appropriate office. It will be the district office’s responsibility to process
and distribute incoming BOE-1164s. The files may be left in the _Transfer Documents to Other
Districts folder, however it is recommended that a separate folder be created on the district drive
to store incoming BOE-1164s that have not been processed or distributed.
June 2014
General Audit Procedures
CALIFORNIA USE TAX COLLECTIONS BY
UNREGISTERED OUT-OF-STATE RETAILERS
0408.23
During audits of California taxpayers, it has occasionally been noted that California use tax is
being remitted to out of state vendors who are not billing the purchasers for the use tax.
Auditors should be alert to these types of transactions and, by utilizing IRIS, determine whether
such out-of-state retailers are registered. When an auditor discovers that a taxpayer is erroneously
paying use tax to an unregistered out-of-state vendor, the auditor should immediately advise Outof-State District Compliance. Additionally, the purchaser should be informed of the responsibility
for the payment of tax to the proper authority per Regulation 1685, Payment of Tax by Purchasers.
Retailers who are required to collect use tax from purchasers must give a receipt to each purchaser
(or lessee) for the amount of tax collected. Regulation 1686, Receipts for Tax Paid to Retailers,
lists information required on the receipt.
EXAMINATION OF SELECTED GENERAL LEDGER ACCOUNTS
0408.25
The verification procedure should include an examination of debits in certain general ledger
accounts. This is necessary as invoices covering capital expenditures frequently are not filed
with the other purchase invoices. From the documentary reference, it is possible to trace the
originating documents. Taxable purchases not previously scheduled on which tax was not added
by the vendor, should be scheduled and verification made that the taxpayer is responsible for tax.
These items are generally located in the following accounts:
Asset Accounts­
Expense Accounts­
Delivery Equipment­
Advertising­
Furniture and Fixtures­
Donations­
Inter-Company Accounts­
Expendable Tools­
Leasehold Improvements­
Experimental and Exploration­
Machinery and Equipment­
Manufacturing Expense­
Nonexpendable Tools­
Repairs­
Work in Progress­
Research and Development­
Supplies
Samples­
Promotional­
This phase of the examination can be done at the same time these accounts are being examined
for additional taxable sales.
The auditor should examine invoices representing purchases of significant taxable additions to
fixed asset accounts.
Unsupported debits to the fixed asset accounts should be questioned by the auditor and listed on
a subsidiary schedule. The taxpayer should be provided with a copy of this schedule and given
a reasonable period of time to obtain support for the items in question before closing the audit.
If no support is provided, use tax should be asserted against the taxpayer. When necessary, a
Waiver of Limitation, Form BOE–122, should be obtained.
August 2005
Audit Manual
Examination of Selected General Ledger Accounts
(Cont.) 0408.25
The examination of asset accounts may reveal that the proper amount of use tax has not been paid
to the Department of Motor Vehicles on the purchase price of a vehicle. Generally, this occurs
in those instances in which (1) the change in ownership was not recorded with the Department
of Motor Vehicles; (2) the selling price was substantially different than the measure on which
tax was collected by the Department of Motor Vehicles; or (3) the vehicle has special equipment
attached which was not included in the measure on which tax was collected by the Department
of Motor Vehicles.
In such instances, the use tax is to be asserted against the purchaser. (See the tables in CPPM
830.005 for specific examples of how penalty and interest may apply to use tax due on purchases
of vehicles.)
The measure of additional tax is not to be included in Form BOE–414–A, Report of Field Audit,
on the seller, even when disclosed by audit of the seller.
In recommending the additional measure against the purchaser, either Form BOE–414–A, Report
of Field Audit, or Form BOE–414–B, Field Billing Order, will be used, depending on the extent
of the examination of the purchaser’s records.
Form BOE–111, Certificate of Vehicle, Mobilehome or Commercial Coach Use Tax Clearance, will
be issued by the district office for those vehicles on which tax is recommended by audit or F.B.O.
and the change in ownership was not recorded with the Department of Motor Vehicles.
OTHER RECORDS
0408.27
Other records may be useful in establishing purchases subject to use tax including property tax
records such as the Business Property Statement that taxpayers are required to file with their
county assessor’s office on an annual basis. The statement lists all equipment the taxpayer uses
in his or her business along with the purchase price and acquisition date.
CAPITALIZATION OF RESALE INVENTORY
0408.28
Note: This section does not apply to the capitalization and depreciation of a vehicle. The application
of tax to the demonstration and display of vehicles is covered in Regulation 1669.5.
There is a strong presumption that resale merchandise withdrawn from an inventory account,
including property used for demonstration and display, capitalized in a fixed asset account and
depreciated for income tax purposes is not held for sale in the regular course of business. To
overcome this presumption, the taxpayer must provide documentation suitable to the Department
that the property has been used solely for exempt demonstration and display purposes while holding
it for sale in the regular course of business. In the absence of such evidence, resale merchandise
withdrawn from an inventory account, capitalized in a fixed asset account and depreciated for
income tax purposes shall be included in the schedule of unreported property subject to tax.
EXAMINATIONS OF JOURNAL ENTRIES AND REQUISITIONS
0408.30
A retailer may carry a stock of supplies most of which is resold, the balance being self-consumed.
All or part of this material may have been purchased for resale. As the supplies are withdrawn
from inventory, requisitions may be made by which cost of sales or another expense account is
debited and the inventory account is credited.
The auditor should examine these requisitions in the same manner as purchase invoices are
examined. If the material was withdrawn from resale (ex-tax) stock and charged to a capital
or an expense account, all unreported items not previously scheduled should be listed. If the
material was withdrawn from mixed stock, that is tax paid and ex-tax stock, the percentage of
ex-tax purchases to total purchases should be computed from a test analysis of purchase invoices.
This percentage would then be applied to material charged to taxable accounts.
August 2005
General Audit Procedures
Examinations of Journal Entries and Requisitions
0408.30
Commingled fungible goods must be treated differently. In such cases, self-consumed merchandise
will be presumed to have been taken from that portion of the stock which was not purchased for
resale to the extent such stock is available (See 0408.35).
It may be found, after a test analysis, that all charges to certain accounts are taxable. In that
case, the totals of these accounts can be listed from the general ledger. In other cases, it may be
determined that all charges, via requisitions, to certain accounts are taxable but the remaining
charges are direct from the purchase journal. Taxable withdrawals from inventory, via requisitions,
can generally be located in the general journal.
Taxable withdrawals from inventory may also be made without a record being kept. For example,
few bar owners list all drinks consumed or given to customers. Where it is discovered unrecorded
withdrawals have been made, the auditor should estimate the amount which will have a bearing
on tax.
FUNGIBLE GOODS
0408.35
Sales of fungible goods will be considered to have been made from goods purchased for resale
until the amount sold equals the amount so purchased. Conversely, merchandise withdrawn
from inventory for self-use will be considered to be taken from stocks of goods not purchased for
resale to the extent that such stock is available.
The following examples illustrate the application of this principle where commingled fungible
goods both purchased for resale and not so purchased are both sold and self-consumed.
Total Goods
Acquired
Example 1
Purchases
Additional
Measure of Tax
$8,000
$2,000
Resold
7,000
7,000
0
Subtotal
$3,000
$1,000
$2,000
1,000
0
$2,000
$1,000
$1,000
0
$10,000
$8,000
$2,000
Resold
3,000
3,000
0
Subtotal
$7,000
$5,000
$2,000
Own Use
4,000
2,000
2,000
Ending Inventory
Purchases
Ending Inventory
Example 3
Goods Not So
Purchased
$10,000
Own Use
Example 2
Goods Purchased
For Resale
1,000
$3,000
$3,000
-0-
$10,000
$8,000
$2,000
Resold
5,000
5,000
0
Subtotal
$5,000
$3,000
$2,000
Own Use
3,000
1,000
2,000
$2,000
$2,000
-0-
Purchases
Ending Inventory
0
$2,000
$1,000
January 2000
Audit Manual
USE OR LOAN OF PROPERTY PURCHASED FOR RESALE
0408.40
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. However, 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.
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.
Property loaned to customers or used by the taxpayer may not be recorded or merely recorded
as memorandum entries. The above types of transactions may be disclosed through a discussion
with the taxpayer, their employees, or by examining sale invoices or rental agreements.
January 2000
General Audit Procedures
AUDIT OF SALES FOR RESALE
0409.00
GENERAL0409.05
Sales for resale is the most common deduction claimed and the auditor should be familiar with
all of the methods used by taxpayers in compiling the amounts reported and the various auditing
procedures used to verify those amounts. Whenever feasible, the audit procedure should be adapted
to the method used by the taxpayer in reporting, as this makes it easier to reconcile audit findings
with reported figures, and usually reduces auditing time. Examination of taxpayer’s working
papers and a conference with the taxpayer will disclose the method used.
METHODS OF REPORTING RESALES
0409.10
The most common methods used by retailers in compiling data for the claimed sales for resale
deduction are:
• To prepare an actual list of deductible items
• To calculate the deduction as described in section 0409.20
• To estimate the deduction
DEDUCTION SUPPORTED BY ACTUAL LISTS
0409.15
The deduction is supported by lists of nontaxable items which may be prepared in one of the
following methods:
• By scheduling each nontaxed invoice
• By recording sales for resale in a separate column in the sales journal
• By preparing adding machine tapes of sales for resale invoices
• By recording sales for resale in the general ledger, and supporting the amounts by journal
entries
DEDUCTION CALCULATED
0409.20
One method frequently used by taxpayers in computing a sales for resale deduction is to determine
the residual amount after deducting the sum of taxable sales and other deductions from total
sales. In determining this residual amount, the taxpayer may:
• List the total taxable sales and exempt sales other than sales for resale if they are few in
number.
• Convert to measure of tax the amount of sales tax reimbursement as recorded in the sales
tax accrual account. If no reserve account is maintained, the sales tax collected is usually
compiled by running adding machine tapes of the sales tax charged on all sales invoices.
• The formula used in this conversion of tax is tax collected divided by rate of
tax (Tax / Rate = Taxable Sales).
DEDUCTION ESTIMATED
0409.28
Where the taxpayer estimates the deduction, there will be no support for the amounts claimed,
nor will the basis for the estimate lend itself to ready verification. In these instances, the auditor
should use one of the verification procedures outlined below which seems best suited to compile
the deduction with a minimum expenditure of audit time.
January 2000
Audit Manual
SELECTION OF THE BASIS FOR THE AUDIT
0409.30
The extent of audit of sales for resale will depend on the conditions encountered. If the claimed
deduction consists of relatively few items so that all transactions can be examined in a reasonable
amount of time, the audit should be made in detail. This is particularly true where the unit sale
is in a large amount or where the amount of the average unit sale is small with an occasional
large sale. If, however, sales for resale are numerous and of a reasonably similar unit value,
the verification can and should be made on a test basis. The size of the test will depend on the
number of documents necessary to examine.
The periods or number of transactions selected should be representative of the business as a
whole. Whenever possible, the test should be selected using a statistical sample. Whether a
statistical sample or block sample is selected, a control of sales for the transactions being tested
must be established.
In audits of unusually large concerns with relatively few retail sales or audits of concerns using
computerized accounting, special procedures may have to be adopted. Because each of these
cases presents its own special problems, possible audit methods for such cases are not discussed
in this chapter.
The audit procedures used to verify sales for resale may be roughly classified as follows:
• Detailed audit — lists of claimed sales for resale available.
• Detailed audit — lists of claimed sales for resale not available.
• Audit on test basis — (section 0405.20).
DETAILED AUDIT — LIST OF CLAIMED RESALES AVAILABLE
0409.35
Claimed resales should be summarized by months or by quarters in accordance with the taxpayer’s
listings. The taxpayer’s detailed schedules will be used as a basis for the verification. The steps
necessary to making the verification are:
(a) The sales invoices should be examined to determine that the claimed amounts are included
in total sales and that the correct amounts have been scheduled. It should be verified that
the amounts claimed do not include nontaxable items (delivery charges, labor, etc.) claimed
under some other classification, and that no part of the invoice represents a taxable sale.
(b) Documentary evidence of the nontaxability of the sales, such as resale certificates,
purchase orders, correspondence, or contracts should be examined. Purchase order,
correspondence or contracts may, also, support a finding that a claimed sale for resale is
taxable notwithstanding the fact that a resale certificate is on file (section 0409.50).
(c) The nature of transactions and the type and number of items purchased should be
scrutinized to determine whether resale certificates (section 0409.55) appear to have been
taken in good faith.
All sales which are questioned for any reason should be listed on a subsidiary schedule. A copy of
this schedule should be given to the taxpayer as an aid in attempting to support the exempt status
of the questioned items. A reasonable period of time should be given the taxpayer to obtain this
information before closing the audit. When necessary a Waiver of Limitation, Form BOE–122,
should be obtained.
January 2000
General Audit Procedures
DETAILED AUDIT — LIST OF CLAIMED RESALES NOT AVAILABLE
0409.40
The taxpayer should be requested to prepare a detailed listing of all claimed sales for resale and
allowed a reasonable amount of time to do so. When his/her work has been completed, the audit
procedure will be the same as set forth in section 0409.35.
EFFECT OF “CONTRA” ITEMS ON DEDUCTIONS FOR SALES FOR RESALE 0409.45
Contra items as they relate to the deduction for sales for resale are:
• Sales for resale omitted from total sales and from the claimed sales for resale
• Sales for resale claimed under the heading of some other deduction, such as labor, etc
• Sales of labor, sales in interstate commerce, etc., claimed under the heading of sales for
resale
When the audit of all deductions is made on a complete basis or when the audit is made on a
taxable sales basis, the final result will not be affected if the deduction is allowed to remain in the
classification under which it was claimed. If the audit is made on a test basis with all deductions
being audited, it will sometimes be necessary to reclassify deductions under their proper heading
to establish a proper base for computation and application of a factor of error.
ACCEPTABLE DOCUMENTARY EVIDENCE
TO SUPPORT SALES FOR RESALE
0409.50
A claimed sale for resale should be allowed 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 this State, an appropriate notation to that effect should be entered in lieu of a seller’s permit
number on the resale certificate. See Regulation 1667 for 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.
Sales to Mexican Merchants for resale are allowable if certain requirements are met. The auditor
should insure that the purchaser was the person named on the Mexican Merchant identification
card, the card was valid at the time of the sale (cards have expiration dates), and the merchandise
purchased for resale related to the special business classification codes on the card. Assistance
in verifying Mexican merchants registered under the program and the type of property they are
authorized to purchase for resale can be obtained by calling the San Diego District. Additional
information about the program is contained in Publication 32.
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.
November 2010
Audit Manual
Acceptable Documentary Evidence to Support Sales for Resale
(Cont.) 0409.50
Documents that qualify as a valid resale certificate include:
1. A purchase order that contains all the elements of a valid resale certificate. Unless a valid
qualified resale certificate is on file, the purchase order must contain the phrase “for resale”
and all other elements of a valid resale certificate.
2. 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”
A purchase order where the tax amount is zero ($0) or is left blank does not indicate that
the property is purchased for resale, unless the purchase order includes the phrase “for
resale” or any of the terminology described previously to specify that the property purchased
is for resale. If each purchase order does not so specify, or is not issued timely within
the meaning of Regulation 1668(a), it will be presumed that the property covered by that
purchase order was not purchased for resale and that sale is subject to tax.
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. For example, a purchase order issued for raw materials for resale and also for tooling
used to process the raw materials should specify that the raw materials are purchased for
resale and that the sale of the tooling is subject to tax.
A seller shall retain copies of the purchase orders along with the qualified resale certificates
in order to support sales for resale.
3. 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 therein.
4. Contracts of sale where all the essential elements of a resale certificate are included. (The
auditor should be especially careful to scrutinize transactions where the purchaser claims
to be reselling to the U.S. Government by determining the merchandise is actually resold
in the form of personal property, title passed to the Government prior to any use by the
purchaser, and it is not used in making improvements to real property.)
Other evidence of the validity of a claimed sale for resale may be accepted, such as:
• Personal knowledge of the auditor gained from audits of the vendees or other sources that
the purchase was actually made for resale purposes.
• A satisfactory response to a Form BOE–504 (XYZ letter) inquiry (See AM sections 0405.20(j)
and 0409.51, and AM Chapter 4 Exhibit 8 for more details).
November 2010
General Audit Procedures
USE OF BOE–504 — XYZ LETTER PROCEDURE
0409.51
The auditor must ensure that the taxpayer understands that any of the above other evidence 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, the auditor may determine that it is appropriate
for a seller to use the Form BOE–504 series of forms (hereafter called “XYZ” Letters) procedure
to help satisfy their 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 their customer paid the tax directly
to the state. Copies of the forms are available on eBOE.
The “XYZ” Letter procedure utilizes the following forms:
• BOE–504–A, explains the “XYZ” Letter procedure
• BOE–504–B, Sample “XYZ” Cover Letter
• BOE–504–C, Statement Concerning Property Purchased Without Payment of California
Sales Tax, for use when auditing in-state sellers
• BOE–504–COS, for use when auditing out-of-state sellers
• BOE–504–CLS, for use when questioning sales made to leasing companies
• BOE–504–BPA and BOE–504–CPA, for use when questioning ex-tax sales of special
printing aids (also see AM section 1103.30)
• BOE–504–CFS, for use when questioning ex-tax sales of feed, fertilizer, seed or annual
plants
• BOE–504–CUS, for use when questioning ex-tax sales made to U.S. Government supply
contractors
When it is appropriate to use the “XYZ” Letter process, the auditor will provide the taxpayer with
a copy of forms BOE–504–A, B, and C (or –COS, –CLS, –CPA, –CFS or –CUS as appropriate). The
auditor should discuss the “XYZ” Letter process with the taxpayer and explain that a response to
an “XYZ” Letter inquiry alone is not necessarily enough to support a sale for resale. The auditor
should also explain that since the “XYZ” Letter is not a substitute for a timely resale certificate,
additional documentation or information may be required. Where the use of “XYZ” Letters is
not advisable or appropriate, and the taxpayer insists on using the procedure, the taxpayer must
be advised in writing that their customer’s response may not be accepted as verification of an
exempt transaction.
A period of four weeks will be allowed 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 Board. If this is the case, the auditor should provide the taxpayer with return envelopes
with the address of his or her district branch office. If the taxpayer elects to have the “XYZ”
statements returned to them, the auditor should explain to the taxpayer that the likelihood of
having staff contact the customer or sending an additional mailing is greater.
The taxpayer may customize the “XYZ” cover letter (BOE–504–B or BOE–504–BPA for special
printing aids) by using the text contained therein on their own letterhead; however, the text in the
sample letter should be used without additions, deletions, or changes. 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 Board. All modifications to the cover letter must be approved by the auditor’s supervisor.
August 2005
Audit Manual
Use of BOE–504 — XYZ Letter Procedure
(Cont.) 0409.51
The “XYZ” statement (BOE–504–C, COS, CLS, CPA, CFS, or CUS) must be used as provided by
the auditor. The use of a standardized “XYZ” statement will reduce any possible controversy over
whether the proof provided is satisfactory. When verifying unique types of sales (e.g. printing
aids, animal feed, fertilizer, etc.), auditor should provide the specialized forms to the taxpayer.
The auditor should put his or her office designation in the space marked “DMA” and their initials
in the space marked “Auditor’s Initials,” both located at the top right of the “XYZ” statements.
The taxpayer’s customer is requested to return the completed “XYZ” statement within 10 days.
The 10–day requirement is intended to encourage a prompt response from the customer. If the
taxpayer chooses the recommended procedure of having the completed “XYZ” statements sent
directly to the Board, the taxpayer may add a statement in the letter (BOE–504–B) asking their
customer to send a copy of the completed “XYZ” statement to them by fax or mail. The original
“XYZ” statement, however, must either be sent or faxed to the Board by the taxpayer’s customer.
If the completed “XYZ” statements are to be sent directly to the taxpayer, only a signed original
will be accepted.
If a second “XYZ” Letter is necessary, the auditor should establish a reasonable period of time
based on the circumstances involved.
As explained in section 0302.80, XYZ responses are part of the audit working papers and should
be included as a subsidiary schedule to the resale examination schedule.
XYZ non-responses should not automatically be considered errors or non-errors. When XYZ
responses are not returned, audit staff should make every effort, if not already done, to determine
the taxability of the questioned sale by alternative methods. Such methods could include, but
are not limited to:
• Examine the customer’s seller’s permit registration to determine whether or not the
purchaser had a permit at the time of purchase, the type of business, reported sales, etc.
• Review the quantity and type of items sold – for resale or consumption.
• Review a subsequent resale certificate (prior to the start of the audit) but for similar
purchases.
• Examine other types of items sold to the customer.
• Contact the customer by telephone to determine the true nature of the sale. If the customer
indicates that the sale was for resale, a copy of the XYZ request letter should be faxed
to the customer for immediate response. This XYZ response will be subject to the same
verification as any other XYZ response.
• Accept or deny based on personal knowledge of 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 other reason. In this situation only (not
where there is just a change in ownership, such as a change in partners or from a sole proprietorship
to partnership/corporation in which the previous owner continues the business under the new
ownership), 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. The auditor must verify file information
regarding the close-out or bankruptcy of the business, as well as the type of business operations
of the customer to ensure that the situation meets these specific requirements.
In all other situations, 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 should be considered an error.
August 2005
General Audit Procedures
WHEN GOOD FAITH OF SELLER IS QUESTIONED
0409.55
A resale certificate relieves the seller from liability for sales tax and the duty of collecting the
use tax if the seller timely takes a certificate 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.
A seller will be presumed to have taken a resale certificate in good faith in the absence of evidence
to the contrary. If the purchaser insists that property of a kind not normally resold in their business
is being purchased for resale, the seller should require a resale certificate containing a statement
that the specific property is being purchased for resale in the regular course of business. If the
good faith of the seller is in question, the burden of proof will rest with the Board.
The auditor has the responsibility of examining the resale certificates. The auditor must be
reasonable and fair-minded and must use good judgment in determining whether the certificate
is sufficient in content and whether the seller acted in good faith in accepting the certificate.
Examining the resale certificates, which give general descriptions of the purchaser’s business,
and invoices of sales for resale, which disclose the type of property sold, requires the auditor
to judge whether items shown on the invoices are properly included within the general
description.
In making a decision, the auditor should be guided by the test of reasonableness. The auditor should
question sales for resale that do not meet such a test or if the seller knows beyond a reasonable
doubt that the property was bought for the purchaser’s own use. Examples of transactions which
should be questioned include:
• Sale of furniture or fixtures to a grocery store
• Sale of janitorial supplies to a restaurant
• Sale of building materials to a contractor where the terms of sale specify delivery to the
job site
• Sale of cleaning solvent to a repairman
• Tools sold by a parts house to a repair shop
When the seller insists a particular item, not reasonably included in the description, was actually
sold for resale, the seller should be required to secure a statement from the purchaser covering
the specific item in question.
PURCHASE ORDERS AND RESALE CERTIFICATES
0409.60
A resale certificate may be qualified by specific instructions on the purchase order. A purchaser who
issued a blanket resale certificate to a supplier may specify on a purchase order that the property
to be purchased is taxable. Purchase order files should be examined when doubtful situations
arise. However, under such circumstances, the purchaser will bear the burden of establishing
either that the purchase order was received by the seller or that tax was paid to the seller.
The seller should obtain a resale certificate qualified by special instructions, i.e., one that states
“see purchase order,” when a purchaser wishes to designate on each purchase order that the
property is for resale. Each purchase order must specify whether the property covered by the order
is purchased for resale or whether tax applies to the order. Refer to AM section 0409.50, item #2.
November 2010
Audit Manual
MISUSE OF RESALE CERTIFICATE
0409.62
When resales are examined during the course of an audit, particular attention should be paid to
transactions that may involve a misuse of a resale certificate. A misuse occurs when the purchaser
is not actively engaged in business as a seller or the purchaser knows at the time of purchase that
the property is not going to be resold in the regular course of business. Specific situations that
indicate the purchaser has made a misuse are when:
• The purchaser, who does not hold a sellers permit, issues a resale certificate with an
erroneous seller’s permit number or gives the valid number of a permit held by another
person, or
• The purchaser’s permit was closed out prior to the date of purchase, or
• The purchase, regardless of amount, is one of a series of purchases which were not intended
to be resold by the purchaser in the regular course of business.
When a misuse occurs, the purchaser will be pursued for the tax and appropriate penalty
(Chapter 5).
A resale certificate which was taken timely and appears to be valid on its face will relieve the
seller of the tax liability if the certificate is taken in good faith. For audit purposes, “valid on its
face” means that the resale certificate contains the five essential elements described in Regulation
1668, even if one or more of the elements are false. If, however, it is found that the seller makes
a practice of accepting defective resale certificates, the sellers good faith is in doubt. In this case,
tax should be asserted against the seller. Questioned sales for resale which represent defective
certificates accepted in good faith should be excluded from the sample and the computation of
the percentage of error.
TAX ASSESSED ON PURCHASER
0409.63
Whenever a purchase from a California seller is assessed tax because the purchaser issued a
resale certificate to the seller, which the seller accepted in good faith, a copy of this certificate
should be obtained from the seller at the time of audit and included in the audit working papers
of the purchaser’s audit. When contacting the seller, the auditor may not inform the seller that
the auditor is reviewing the purchaser’s records. Instead, the auditor is only allowed to inform
the seller that he or she is only verifying whether the seller has a copy of the purchaser’s resale
certificate on file, and if so, to request a copy of the certificate.
Because the issuance of a resale certificate shifts the tax from the seller to the purchaser, it is
imperative that a copy of the resale certificate be obtained while the auditor is reviewing the
purchaser’s records. A verbal comment by the purchaser that a resale certificate was given to
the seller is insufficient. Often customers will indicate concurrence when the audit is completed
but change their mind when the Notice of Determination is received and contend that no such
certificate was issued and the incidence of tax should be on the California seller. Without written
evidence to refute this claim, the Board’s position cannot be sustained.
TAX BILLED BY VENDOR BUT DELETED BY PURCHASER
0409.65
If the seller does not timely obtain a resale certificate, the fact that the purchaser deletes the
tax or tax reimbursement from the seller’s billing, provides his/her seller’s permit number to the
seller, or informs the seller that the transaction is “not taxable” does not relieve the seller from
liability for the tax nor from the burden of proving the sale was for resale.
August 2005
General Audit Procedures
VERIFICATION OF PAYMENT OF USE TAX BY PURCHASER
0409.70
At the time of an audit of a vendor, the vendor may contend that a purchaser-consumer has paid
tax on a transaction on which the vendor failed to collect use tax. In these cases, the vendor
should be given an opportunity to establish that tax was paid by obtaining a statement from the
purchaser that:
• Use tax was declared on a specific return filed by the purchaser, or
• Use tax was paid as a result of a determination made after audit by the Board. In making
this statement, the purchaser must establish that the specific item was included in the
audit or that the item was of the kind and monetary size included in a percentage of error
applied throughout the audit period.
See sections 0405.20 (j) and 0409.51 when XYZ letter inquiries are involved in audit test sample(s).
DROP SHIPMENTS
0409.75
The following audit procedures should be used when examining drop shipment transactions.
Sales and Use Tax Transactions:
The auditor should determine if the drop shipper’s customer (the “true retailer”) holds a California
seller’s permit or a Certificate of Registration – Use Tax. If the true retailer holds such a permit,
the transaction should be allowed as a sale for resale in the audit of the drop shipper.
If the true retailer is not registered with the Board, but the auditor determines that the true
retailer is, in fact, engaged in business in this state, the transaction should be allowed as a sale
for resale in the audit of the drop shipper. The auditor should then notify the appropriate district
office of the facts showing that the true retailer is engaged in business in California.
Use Tax Transactions:
Drop shipments made from inventories located outside California by drop shippers engaged in
business in this state, pursuant to retail sales made by retailers not engaged in business in this
state, are subject to use tax. The auditor should determine whether the consumer in California
to whom the property was drop shipped holds a valid seller’s permit, consumer use tax permit,
Certificate of Registration – Use Tax, or use tax direct payment permit. If the consumer is
registered with the Board, and the transaction is subject to use tax, the sale should be eliminated
from the audit of the drop shipper. The auditor should then immediately notify the appropriate
district office of the potential liability against the California consumer.
June 2000
Audit Manual
MULTISTATE TAX COMMISSION MULTIJURISDICTION
RESALE CERTIFICATE
0409.80
The Multistate Tax Commission (MTC) issued the multijurisdiction resale certificate (MTC
certificate) in July 2000 to provide a standard document for businesses to utilize that will be
uniformly accepted by sellers. Along with many other states, California adopted the MTC certificate.
The certificate contains all of the required elements stated in Regulation 1668, Resale Certificates,
and can be furnished as either a “blanket” or a “qualified” certificate. In reviewing the certificate,
an auditor should determine if the MTC certificate is written as a blanket or a qualified resale
certificate.
Under a blanket MTC certificate, all tangible personal property described on the certificate is
deemed to be sold for resale unless the resale certificate is superseded by a purchase order. To be
accepted as a blanket resale certificate, the purchaser must complete the form in its entirety and
add a general description of tangible personal property or taxable services to be purchased from
the seller. All sales of property stated to be for resale on the certificate can then be sold to the
purchaser without tax. If the purchaser subsequently issues a purchase order indicating that the
purchase is taxable, the resale certificate does not apply to that purchase. However, the burden
is on the purchaser to establish that the purchase order was sent to and received by the seller in
a timely manner or that the tax was paid to the seller.
When a purchaser issues a qualified MTC certificate, the burden is upon the seller to examine
each purchase order issued by its customer to determine if the purchase is subject to tax or is
for resale. To be accepted as a qualified resale certificate, the certificate must be completed in
its entirety and the “general description” line should contain the statement “see purchase order”
or be left blank. Each purchase order must specify whether the property covered by the order is
for resale or taxable. A purchase order containing any of the terminology included in Item 2 of
AM section 0409.50, indicating that tax or tax reimbursement should not be added to the sales
invoice, will be regarded as designating that the property described is purchased for resale. If the
purchase order does not specify the merchandise is for resale, the purchase is presumed to be the
purchaser’s own use and the sale is subject to tax. Item 2. of AM section 0409.50 also addresses
purchase orders where the applicable amount of tax is shown as $0 or is left blank.
An example of the multijurisdiction MTC Uniform Sales & Use Tax Certificate can be found on
the Multistate Taxation Commission website.
June 2014
General Audit Procedures
AUDIT OF SALES TO THE U. S. GOVERNMENT
0410.00
GENERAL0410.05
The details covering sales to the United States Government are contained in Regulations 1521,
1614, 1616 and 1618. These regulations may be summarized as follows:
(a) Sales tax does not apply to sales to:
• The United States or its unincorporated agencies and instrumentalities.
• Any incorporated agency or instrumentality of the United States wholly owned by
either the United States, or by a corporation wholly owned by the United States.
• The American National Red Cross, its chapters and branches.
• Incorporated federal instrumentalities not wholly owned by the United States,
unless federal law permits taxing the instrumentality. Examples of incorporated
federal instrumentalities exempt from tax are federal reserve banks, federal credit
unions, federal land banks, and federal home loan banks.
(b)Use tax does not apply to the storage, use, or other consumption of tangible personal
property by agencies or instrumentalities of the United States unless federal law permits
taxing the agency or instrumentality.
(c) Neither sales nor use tax applies to sales of machinery and equipment to United States
construction contractors or subcontractors, provided title to the property passes to the
United States before the contractor makes any use of it. Such sales are sales for resale,
and the purchasing contractor may issue a resale certificate. A contractor who uses the
machinery or equipment before title passes to the United States is the consumer of property,
and either sales tax or use tax applies with respect to the sale to or the use by the contractor.
The application of tax to consumable supplies and overhead materials on United States
Government Supply Contracts (Regulation 1618) is covered in section 0411.00.
(d) Generally, either the sales tax or the use tax applies with respect to sales of tangible personal
property (including materials, fixtures, supplies, and equipment used to perform the
construction contract) to United States construction contractors for use in the performance
of such contracts for the construction of improvements on or to real property in this state
(Regulation 1521).
(e)Tax does not apply to the sale of items to a person insured pursuant to Part A of the
Medicare Act as such sales are considered exempt sales to the United States (Regulation
1614).
January 2000
Audit Manual
AUDITING PROCEDURE
0410.10
An audit of this deduction should be made in the same manner as an audit of a deduction for
sales for resale. Ordinarily the number of such sales is limited and the audit should be made on
a complete basis. If, however, the number of items claimed is exceptionally large and the average
unit of sale is comparatively small, a test basis may be used. Documentary evidence required
to support the deduction, where the sale is made directly to the United States Government, a
subdivision or agent, should consist of one or more of the following documents:
•
•
•
•
Purchase orders
Copy of U.S. Government credit card or credit card number
Other documents demonstrating direct payment by the United States
Shipping and other documents if there is a question whether the merchandise was sold
directly to an individual who is in the armed services
In the absence of documentation to support claimed sales to the U.S. Government, the auditor may
determine that it is appropriate for a seller to use the Form BOE–504 series of forms (BOE–504–
CUS) procedure to help satisfy their burden of proving that a sale was not at retail even though
exempt documentation was not obtained (see AM section 0409.51 for procedures).
Sales to contractors who are engaged in work on projects owned by the United States Government
are not sales to the Government. If the contractor is actually selling tangible personal property
to the U.S. Government, such sales are sales for resale and should be verified as such. Mention
is made of this in this AM section only because many retailers classify such sales as sales to the
United States Government and erroneously claim the deduction under that heading rather than
sales for resale. If the auditor has reason to believe the material purchased was not actually sold
by the contractor-customer to the U.S. Government, Form BOE–1164 (see AM section 0401.20),
should be prepared setting forth all pertinent phases of the transaction.
SALES TO FEDERAL EMPLOYEES
USING U.S. GOVERNMENT BANKCARDS
0410.15
The federal government issues credit cards to its employees for purchases of goods and services
under the current program called “GSA SmartPay.” Credit Cards under this program are issued
by Citibank, JPMorgan Chase, Mellon Bank, Bank of America, and U.S. Bank. The current
contract with these banks is set to expire on November 29, 2008 and will be replaced by a new
program called “GSA SmartPay2” which will run from November 30, 2008 to November 29, 2018.
Citibank, JP Morgan Chase, and U.S. Bank will continue to issue credit cards and debit cards
under the GSA SmartPay2 program.
The credit and debit cards bear 16–digit account numbers with unique prefixes and government
designed artwork, and are imprinted with “United States of America” at the top. In the right-hand
corner, cards contain a logo which says “SmartPay.” The cards also bear wording that denotes
the card is for “Official Government Use Only.” The General Services Administration (GSA)
administers the program for all departments and agencies of the U.S. Government.
Purchases made with most cards are directly billed to the government and will represent nontaxable
sales to the U.S. Government. Those purchases directly billed to the employee are subject to sales
tax. To determine which government credit cards are government-billed and which are employeebilled, retailers will have to consider the type of card, the type of transaction, and the card account
numbers. Generally, through use of the Bankcard System and coding authorization, purchases
are automatically denied if a particular type of card is used to make a type of purchase for which
that card was not issued.
August 2008
General Audit Procedures
Sales to Federal Employees Using U.S. Government Bankcards
(Cont.) 0410.15
For FLEET CARDS, there are two types of U.S. Government “fleet” cards which may be issued
to federal employees to make fleet type purchases (e.g., gasoline, oil, etc.). One is a Voyager card
and the other is a MasterCard. The Voyager cards contain 16–digit account number that starts
with the prefix 8699. The MasterCard cards contain 16–digit account numbers that start with
the prefixes 5565 and 5568. All fleet type purchases made with these cards are billed directly to
the U.S. Government and are not taxable.
For PURCHASE CARDS, there are two types of U.S. Government “purchase” cards which may
be issued to federal employees to make purchases of goods (e.g., office supplies, parts, etc.). One is
a credit or debit Visa card and the other is a credit or debit MasterCard. The Visa cards contain
16–digit account numbers that start with the prefixes 4486, 4614, or 4716. The MasterCard cards
contain 16–digit account numbers that start with the prefixes 5564, 5565 or 5568. All purchases
of goods made with these cards are billed directly to the U.S. Government and are not taxable.
For TRAVEL CARDS, there are two types of U.S. Government “travel” credit cards which may
be used by federal employees to make travel type purchases (e.g., hotels, car rentals, restaurants,
etc.). One is a Visa card and the other is a MasterCard. The Visa cards contain 16–digit account
numbers that start with the prefixes 4486 or 4614. The MasterCard cards contain 16–digit account
numbers that start with the prefixes 5565 or 5568. Federal government travel cards may either
be billed to the U.S. Government or to the federal employee depending upon the account number.
If purchases made with travel cards are billed to the employee, the sales are subject to tax. To
determine whether purchases made with federal government travel cards are government-billed
or employee-billed, retailers must look at the 6th digit of the account number of the card. If the
6th digit is 1, 2, 3, or 4, purchases are billed to the employee and are taxable. If the 6th digit is
0, 6, 7, 8, or 9, purchases are billed to the U.S. Government and are not taxable. This procedure
applies to both Visa and MasterCard travel cards.
In some instances, some federal agencies will issue INTEGRATED CARDS for the purpose of
“fleet,” “property,” and “travel” purchases. These cards are provided by MasterCard and contain a
16–digit account numbers with prefixes that start with 5564, 5565 or 5568. All fleet and property
purchases made with these cards are billed directly to the U.S. Government and are not taxable.
However, travel purchases may be either government-billed or employee-billed depending upon
the account number. To determine whether travel purchases are government-billed or employeebilled, retailers must again look at the 6th digit of the account number of the card. If the 6th digit
is 1, 2, 3, or 4, purchases are billed to the employee and are taxable. If the 6th digit is 0, 6, 7, 8,
or 9, purchases are billed to the U.S. Government and are not taxable.
Exception: All purchases made with integrated MasterCard credit cards provided by the Bureau
of Reclamation employees, including travel purchases, are billed directly to the U.S. Government
and are thus exempt from tax. Bureau of Reclamation employees will have to identify themselves
to the retailer and show proof of Bureau employment to obtain the exemption.
Retailers who make U.S. Government credit card sales should retain the credit card receipt
containing the imprint of the credit card and the sales invoice to support exempt transactions to
the U.S. Government. If the purchase is by telephone, the retailer should note the credit card
account number and purchaser’s name on the credit card receipt.
November 2010
Audit Manual
UNITED STATES GOVERNMENT SUPPLY CONTRACTS
GENERAL 0411.00
0411.05
The contract between the United States Government and the government supply contractor
determines when title passes for property used in the performance of the contract. If title passes
prior to use, the supply contractor may purchase the property for resale to the United States
Government and the subsequent sale to the United States Government is exempt under section
6381 of the Revenue and Taxation Code. Exhibit 9E provides a decision table that may be used
to assist the auditor in deciding if title to the property passes prior to use.
The United States Government established the Federal Acquisition Regulation (FAR) to set
uniform policies and procedures for the acquisition of goods and services. Individual agencies may
issue supplements to FAR that may supersede the current FAR if there is a conflict. Because of
potential revisions to FAR and the agency supplements, contracts should be reviewed to determine
what clauses are included. (See sections 0411.15 and 0411.25 for classified contracts exception.)
Several of the standard definitions and clauses are included as Exhibit 9A. The FAR is accessible
at https://www.acquisition.gov/. The auditor should check the website for current versions of
applicable clauses.
Tangible personal property sold to or used by contractors in the performance of a contract with
the United States Government to improve real property is not addressed in this section. The
provisions of Regulation 1521, Construction Contractors, continue to govern the application of tax
to such sales or use of tangible personal property.
TITLE CLAUSES 0411.10
Generally, title will transfer to the government under one of the following three FAR title clauses:
FAR 52.245-1, Government Property (Exhibit 9D)
The clause has different title passage provisions for fixed price contracts, cost reimbursement or
time and material contracts, or cost reimbursement line items under fixed price contracts. In cost
reimbursement or time and material contracts, or cost reimbursement line items in fixed price
contracts, title passes prior to use for reimbursable items. In fixed price contracts, this clause will
not pass title to items to the government unless the item is a deliverable or a cost-reimbursable
contract line item. However, title to property may still pass to the government prior to use under
one of the payments clauses. Also note that there is an alternate title clause for basic or applied
research at nonprofit institutions of higher education or at nonprofit organizations whose primary
purpose is the conduct of scientific research.
FAR 52.232-16, Progress Payments (Exhibit 9B)
Title passes at the date of the contract for property purchased prior to that date. Otherwise, title
passes at the time the property is allocable or should have been allocable to the contract.
FAR 52.232-32, Performance-Based Payments (Exhibit 9C)
Title passes at the time of the first performance-based payment for property purchased prior to
that date. Otherwise, title passes at the time property is allocable or should have been allocable
to the contract. If title passes under this clause, there is the potential for use of the property prior
to title passing to the United States Government for items purchased prior to the first payment.
If there is a use prior to the first performance-based payment, the use by the contractor will
generally be taxable.
In addition to the clauses described above, a contract could contain a title clause specific to that
contract.
August 2005
General Audit Procedures
TYPES OF CONTRACTS
0411.15
The contract types are grouped into two broad categories: fixed-price contracts and cost-type
contracts. The specific contract types range from firm-fixed-price, in which the contractor has
full responsibility for the performance costs and resulting profit (or loss), to cost-plus-fixed-fee,
in which the contractor has minimal responsibility for the performance costs and the negotiated
fee (profit) is fixed. In between there are the various incentive contracts, such as flexibly-priced
contracts, in which the contractor’s responsibility for the performance costs and the profit or fee
incentives offered are tailored to the uncertainties involved in contract performance.
Cost Reimbursement Contracts
FAR 45.107 states cost-type contracts, including time and material contracts, shall contain FAR
52.245-1, the government property clause. The only exception is for purchase orders for property
repair that do not meet the simplified acquisition threshold, generally set at $150,000 based on
FAR 2.101. Therefore, the auditor may presume that a cost-type contract, including a fixed price
contract with cost-reimbursable contract line items, contains the government property clause.
The auditor should consider materiality when deciding to review the contracts potentially falling
under the property repair exemption.
Fixed Price Contracts
In fixed price contracts, the government property clause, FAR 52.245-1, passes title to contract
deliverables and cost-reimbursable contract line items. In order to pass title to overhead supplies
or consumables not directly provided for in the contract, the contract must contain either the
progress payments clause or the performance-based payments clause described in section 0411.10.
Fixed price contracts greater than $2.5 million and contracts with qualifying small business
concerns are eligible for contract financing and may contain either the progress payments clause
or the performance-based payments clause. According to the Defense Contract Management
Agency (DCMA), if progress payments are provided, the contract must contain the progress
payment clause and if performance-based payments are provided, the contract must contain the
performance-based payment clause. If the contract contains either clause, title would pass based
on the provisions of the payment clause.
Flexibly Priced Contracts
A flexibly priced contract can be either a Fixed, Cost Reimbursement, or Time and Material
contract. Passage of title is based on the type of contract and the FAR clauses noted in section
0411.10 that are included in the contract.
May 2012
Audit Manual
TYPES OF COSTS Direct Consumables
0411.20
“Direct consumable supplies,” as defined by Regulation 1618, are those supplies which are
consumed in the performance of a contract and are specifically identified to the contract and
charged as a direct item of cost to the contract. In cost-type contracts, title transfers prior to use
for reimbursable costs. However, in fixed price contracts, title passage under the government
property clause is dependent on whether the cost is reimbursable and whether the contract has
a provision directing the contractor to purchase the property as a direct item of cost.
Special tooling and special test equipment are generally treated in the same manner as other
direct consumable supplies. The Progress Payments clause and the Performance-Based Payments
clause pass title to that special tooling or special test equipment to which the Government will
acquire title. According to DCMA, the Government will only finance the special tooling or special
test equipment if it has acquired title to the special tooling or special test equipment. Therefore,
once the Government finances the special tooling or special test equipment, the auditor may
assume that the Government has acquired title to the property. If the contract contains either
the Progress Payment clause or the Performance-Based Payment clause, title will pass according
to the provisions of that clause.
Indirect Consumables
“Indirect consumable supplies” (overhead materials) are supplies consumed in the performance of a
contract, the cost of which is charged to an overhead expense account and then allocated to various
contracts based on generally accepted accounting principles. Title to indirect consumables will pass
prior to use in cost reimbursement contracts, time and material contracts and cost-reimbursable
line items in fixed price contracts. Otherwise, in order for title to pass prior to use, the contract
must contain a financing payments clause and title will pass as provided for under that clause.
For title to pass at the time provided under a contract’s payment clause, the contractor must
allocate the overhead materials among the various commercial and qualifying and non-qualifying
government contracts by means of a reasonable system of allocation which conforms to governing
federal regulations and generally accepted accounting principles. One acceptable method is an
allocation based on direct labor hours.
“Overhead materials” includes amounts recorded in cost accumulation pools that are allocated
to qualifying and non-qualifying contracts including United States Government and commercial
contract(s). Contractors may have Independent Research and Development (IRAD) and Bid and
Proposal (B&P) accounts that accumulate costs for these two tasks. These costs are not taxable
if (1) the purchased item is non-taxable (i.e. labor only, electronically delivered software, etc); or
(2) a qualifying United States Government contract was in existence at the time of use and such
costs were allocated to such contracts. For example, bid and proposal expenses will be subject to
tax if they include purchases of tangible personal property and are incurred at a time when no
qualifying government contract was in existence. Some contractors may accumulate the IRAD
and B&P costs in projects as if they were contracts. However, they are not contracts but costs.
Leases
In general, a lease of tangible personal property to a United States contractor is subject to tax
whether or not such contractor is properly authorized to act as a purchasing agent of the United
States. However, leases are exempt when they are (1) to contractors that occupy the legal status
of agents of the United States and (2) to non-agent cost-plus federal contractors, other than
Department of Defense contractors, that act as agents when procuring from General Services
Administration (“GSA”) Supply Sources (“FSS” or “ADPS”) pursuant to a letter of authorization
issued by a federal contracting officer which has language creating an agency relationship.
May 2012
General Audit Procedures
Types of Costs
(Cont.) 0411.20
It has been the policy of the Department of Defense not to designate government contractors as
legal agents of the United States. Therefore, a lease between a Department of Defense contractor
and a vendor would not include the United States as a party to such lease, notwithstanding any
FAR provision which attempts to characterize the buyer-lessee as an agent for the Department of
Defense. Consequently, lease payments made by a Department of Defense contractor, which are
charged as direct consumable supplies to a fixed price contract or cost reimbursement contract
are subject to the sales or use tax.
Should a Department of Defense contractor nevertheless claim agency relationship with respect to a
lease, the contractor is required to provide documentation to support such claim. The documentation
should be submitted to the Chief, Tax Policy Division, with a copy to the Deputy Director, Field
Operations Department. The Chief, Tax Policy Division will communicate with the Secretary of
Defense to ascertain the Department’s position with respect to the specific contract.
AUDITING PROCEDURES
Classified or Proprietary Contracts
0411.25
Based on federal regulations, the auditor may not view classified or proprietary contracts because
they do not have sufficient security clearance. Generally, these types of contracts are cost-type
contracts, including time and material contracts, and therefore are required to contain the
government property clause. If the auditor can verify through other documentation that the
contract is a cost reimbursement contract, a time and material contract or a fixed price contract
with cost-reimbursable contract line items, the auditor may accept that the contract contains the
government property clause without reviewing the actual contract.
The supply contractor is required to submit their costs to the government on a form, often called
the Incurred Cost Schedule, listing the contract number, type of contract (cost, fixed, etc), and a
summary of the costs. The auditor may be able to identify the type of contract by this form which
is subject to disclosure and available for the auditor’s review. This form may have different names,
but relates to the Indirect Cost document that is provided by the Contractor to Defense Contract
Audit Agency (DCAA) / Defense Contract Management Agency (DCMA) on an annual basis. The
guidelines for the document and a sample are available at http://www.dcaa.mil/chap6.pdf.
If the contract is a fixed price contract, the auditor cannot assume that title passes prior to use.
The auditor should verify that the contract contains a clause that passes title prior to use, as
described in section 0411.10, before accepting that the sales qualify as exempt sales to the United
States Government. However, the auditor may explore alternative audit methods that determine,
with the least possible expenditure of time, the correct amount of tax due.
Regardless of the type of contract, staff must develop a comprehensive understanding of the
internal accounting practices of the United States Government contractor under audit, including
the accounting system, cost flows, and internal controls. Review of the Government Contractor’s
Disclosure Statement, which is reviewed by DCAA on an annual basis to verify adherence
to accounting practices identified in the Disclosure Statement may help the auditor gain an
understanding of the contractor’s records. The auditor must be able to verify that the supplies
and goods purchased for resale to the United States Government are in fact resold or that tax
has been paid on the purchase price. On a test basis, the auditor should trace the posting of the
purchases to an overhead account, verify the allocation method, and confirm the submission of
the cost to the United States Government. For example, the auditor could identify the accounting
pool associated with the overhead account to which the purchase was charged and review the
Incurred Cost Schedule (submitted to DCAA on an annual basis) to verify the pool’s allocation
to the Government contracts.
May 2012
Audit Manual
AUDIT OF CASH DISCOUNTS
0412.00
GENERAL0412.05
There are several methods of compiling a deduction for cash discounts depending primarily upon
the accounting methods in use and the sales policy of the taxpayer. As the deduction is limited
to cash discounts actually taken on taxable sales, the problem is to separate the discounts taken
on taxable sales from those taken on nontaxable sales. The verification should be made only
after total sales and other deductions have been verified, as any change made by the auditor in
the taxpayer’s classification of taxable and nontaxable sales will affect the deduction for cash
discounts. Methods of reporting may be summarized as follows:
•
•
•
•
Actual discounts taken on taxable sales
Percentage of total discounts taken based on ratio of taxable sales to total sales
Composite percentage of taxable sales
Cost of trading stamps issued on taxable sales
ACTUAL CASH DISCOUNTS TAKEN ON TAXABLE SALES
0412.10
The taxpayer’s working papers should be examined to determine how the deduction was compiled.
If an actual listing of the sales invoices on which the discounts were allowed is available, the
auditor can verify the deduction in detail by reference to the sales invoices and the cash receipts
record. Usually the sales are too numerous for listing and the cash discounts are summarized
by months from the “cash discounts” column in the cash receipts records. In those cases, the
audit should be based on a test period. If other deductions were verified on a test basis, the same
periods should be used in whole or in part to test this deduction. This will prevent further work
in verifying the exempt status of additional transactions outside the test periods used in verifying
the other deductions. Each cash discount shown by the cash receipts records should be compared
with the sales invoice to which it pertains. Auditors should satisfy themselves that each discount
allowed passes the following tests:
•
•
•
•
That the discount was actually taken by the purchaser
That the difference between the invoice price and cash received is actually a cash discount
That the discount applies to a taxable sale
That the cost of trading stamps has been reduced by any “dividends” or rebates received
from the stamp company based on purchases of stamps
• That the discount was computed so as to reduce the amount of sales tax reimbursement
initially charged the customer on the gross taxable sales
When there is no indication that the discount was computed on the selling price exclusive of sales
tax reimbursement, it will be considered that the discount was allowed on the total sales price
including sales tax reimbursement. This is usually the case with unit or lump-sum discounts.
When there is evidence that the discount was computed by applying a percentage to the selling
price exclusive of sales tax reimbursement, the discount will not be allowed as a deduction since
excess tax reimbursement has been retained by the retailer.
If a taxpayer has not claimed a deduction for cash discounts, credit or refund should be recommended
in an audit only if the taxpayer refunds to the customer any excess tax reimbursement which results
from the method of computing the cash discount.
January 2000
General Audit Procedures
COMPOSITE PERCENTAGE OF DEDUCTIONS TAKEN
0412.15
Some companies allow cash discounts on different bases to various classes of customers. For
instance, the discount rate may be based on sales volume or on different types of merchandise
sold. Under these conditions, a composite percentage can be computed and used. A representative
test period should be selected and the taxpayer be requested to analyze all cash discounts taken
on taxable sales by scheduling the discounts allowed and the related taxable sales for the period.
The percentage will then be computed in accordance with the following example:
Total discounts allowed on taxable sales.......................................$1,560
Total taxable sales on which discounts apply...........................$100,000
Average discount rate ($1,560/$100,000) or..................................1.56 %
This rate can then be applied to quarterly taxable sales (excluding purchases subject to use tax)
for the entire audit period.
PERCENTAGE OF TOTAL DISCOUNTS TAKEN
0412.20
Theoretically, if all customers took the cash discount allowed and if the same rate of discount
were applicable to all sales, the cash discount deduction could be computed by determining the
ratio that taxable sales bore to total sales (excluding purchases subject to use tax) applied to total
discounts allowed. This may be expressed as follows:
Allowable Discounts =
Taxable Sales
Total Sales + Tax
X Discounts Taken
However, in many instances, it will be found that a large proportion of the discounts are taken
by large purchasers who buy for resale. Thus, the use of the above formula would produce an
inaccurate result. In these cases, the auditor should determine the ratio that discounts taken
on taxable sales bear to total discounts taken for one or two test periods. This percentage would
then be applied to total discounts taken each quarter of the audit period:
Allowable Discounts =
Discounts Taken on Taxable Sales – Tax
X Discounts Taken
Total Discounts Taken
The total discounts taken can be transcribed from the general ledger account after the auditor
has satisfied himself/herself the account represents discounts allowed only and does not include
any bad debts on nondeductible items.
TRADING STAMPS
0412.25
The cost of trading stamps may be taken as a deduction in the same manner as cash discounts if
the taxpayer complies with either of the procedures which follow:
• Adjust the price on which tax reimbursement is computed so it will correspond to the price
upon which the retailer computes the tax paid by him to the State.
For example, a retailer makes a sale for $100 plus $7.25 tax reimbursement, gives trading
stamps which cost $3 on the ex-tax selling price of $100 and takes a deduction of $3 as a
cash discount. He reports sales of $97 and pays $7.03 (7.25% of $97). Collection of excessive
sales tax reimbursement of 22 cents resulted from the transaction. The taxpayer should
have reported sales of $100 since tax reimbursement was collected on that amount.
• Consider the price which determines the number of stamps to be given a customer as the
total amount (including sales tax) paid by the customer.
For example, if one stamp is given for each 10 cents of purchase price and the total purchase
price is $10.73 ($10.00 plus $.73 sales tax), give 107 stamps to the customer rather than
100.
January 2000
Audit Manual
SALES PROMOTION PLANS
0412.30
From time to time retailers introduce various promotional plans, some of which may qualify as
allowable cash discounts. Such plans must be individually analyzed to determine their status
for sales tax purposes.
SALES TAX INCLUDED IN CASH DISCOUNTS
0412.35
If the cash discount taken by the purchaser is allowed on both taxable and nontaxable items (sales
tax, installation/repair labor, cartage, etc.), the latter items must be eliminated before computing
the deduction. In most instances, this nontaxable element will be limited to sales tax and may be
excluded after the gross discount has been computed. This can be accomplished by multiplying
the discount by a factor which will reduce the gross discount to the allowable discount. The factor
is derived using the following formula:
Factor = 1.00 –
Tax Rate
1 + Tax Rate
For example, if tax has been included in the discounts at the rate of 7.25%, then the factor will
be .9324, computed as follows:
Factor = 1.00 –
January 2000
.0825
1.00 + .0825
= .9237876
General Audit Procedures
AUDIT OF RETURNED MERCHANDISE
0413.00
GENERAL0413.05
A deduction for returned merchandise must meet the requirements of Regulation 1655, Returns,
Defects and Replacements. Actual returns of taxable sales are deductible if the following conditions
are met:
• The original sale is included in reported taxable sales.
• The full sales price, including sales tax, is refunded either in cash or credit. For purposes
of the returned merchandise deduction, “full sales price” is construed to include only
amounts required to be included in the measure of tax under RTC sections 6011 and
6012, plus any sales tax added. Charges not required to be included in the measure of tax,
such as nontaxable shipping charges, need not be refunded in order to claim the returned
merchandise deduction (even if sales tax was erroneously collected on such charges).
• The customer is not required to purchase other property at a price greater than the amount
charged for the property returned in order to obtain the refund or credit.
Refund or credit of the entire amount is deemed to be given when the purchase price and sales
tax, less rehandling and restocking costs, if any, are refunded or credited to the customer. The
refund or credit should be computed in the following manner:
Example 1
Price of merchandise returned
Sales tax @ 7.5%
Total
$100.00
$7.50
$107.50
Restocking and rehandling charge
$10.00
Amount refunded or credited
$97.50
If the retailer sets up a credit in its books rather than refunding cash, the retailer must provide
proof that the customer was notified of the available credit. Generally, a deduction for returned
merchandise should not be allowed if the retailer did not give written notice to the customer that
the credit is available.
METHODS OF CLAIMING THE DEDUCTION
0413.10
Merchandise returns are generally entered in the taxpayer’s books in one of the following ways:
• As debits to an account in the general ledger, and claimed as a deduction on the sales tax
return. The deduction, when handled in this manner, should be audited in the same way
as any other deduction.
• As debit entries in the sales journal (therefore, a reduction in sales) with no deduction being
shown on the sales tax returns. When this procedure is followed the verification of the
deduction should be made in conjunction with the audit of total sales (AM section 0413.20).
AUDITING PROCEDURE — DEDUCTION CLAIMED
0413.15
The original documents covering returned merchandise usually consist of credit memoranda
which, together with the original sales invoices, are the basis of the credit. Occasionally, an
auditor will encounter a situation where no credit memoranda are issued, the taxpayer merely
marking on the original invoices or in the sales journal the words “canceled” or “returned.” Such
returns or cancellations should not be allowed unless the taxpayer can furnish documentary
evidence of returns actually made and meeting the conditions listed in AM section 0413.05. The
claimed deduction can be audited on a complete basis or a test basis, depending on the frequency
of returns and the amounts involved.
March 2016
Audit Manual
AUDITING PROCEDURE — DEDUCTION NETTED FROM SALES
0413.20
When returned merchandise is “netted” from total sales (AM section 0413.10), a separate
verification of the returns cannot be made as there is no control of the recorded or netted amounts.
The verification must therefore be combined with the examination of total sales, all credit
memoranda being examined at the time the sales tickets are examined. All netted items not
meeting the requirements listed in AM section 0413.05 are to be treated as additional taxable sales
not reported and may be combined with unreported or unrecorded sales as a basis for computing
an understatement of taxable sales.
SHIPPING AND HANDLING CHARGES
0413.23
Under RTC sections 6011 and 6012, as explained in Regulation 1628, Transportation Charges,
separately stated charges for transportation from the retailer’s place of business or other point
from which shipment is made directly to the purchaser are not subject to tax. The amount of
transportation charges excluded from the measure of tax shall not exceed the actual cost of the
transportation. If a separately stated charge is made designating “postage and handling” or
“shipping and handling,” only that portion of the charge which represents actual postage or actual
shipping may be excluded from the measure of tax. The amount excluded from the measure of
tax need not be refunded in order for a retailer to claim a returned merchandise deduction. If
tax is erroneously collected on nontaxable shipping charges, this amount also does not need to
be refunded because it constitutes excess tax reimbursement which has already been properly
remitted to the State (AM section 0417.00).
Handling charges are included in the definitions of “sales price” and “gross receipts” and are
included in the measure of tax. Therefore, handling charges, including the portion of the sales tax
related to the handling charges, must be refunded to the customer in order to claim the returned
merchandise deduction.
In cases where a deduction is claimed for the returned merchandise but the taxpayer does not
refund the amount attributed to handling, this will be deemed to be a restocking charge. The
retailer will be permitted a returned merchandise deduction as long as the handling amount
does not exceed the actual cost of restocking. The auditor should accept the deduction without
further examination in cases where the handling charge is less than 10 percent of the sales price
attributed to the actual merchandise in the original transaction.
If the handling charge is in excess of 10 percent of the sales price of the merchandise, the auditor
should examine a sample of transactions to ensure the handling charge does not exceed the actual
cost of restocking the merchandise. When “postage and handling” or “shipping and handling”
charges are billed as lump sum, the handling charge would be considered the lump sum charge
minus the actual cost of postage or shipping.
March 2016
GENERAL AUDIT PROCEDURES
Shipping and Handling Charges
(Cont.) 0413.20
Example 2
A retailer makes a sale and charges the customer:
Sale
Shipping and Handling
Subtotal
Sales Tax (7.5% X $115)
Total
$100.00
$15.00
$115.00
$8.63
$123.63
The retailer remits the full amount of the tax to the State. When the merchandise is
returned, the retailer refunds:
Returned Merchandise
Sales Tax (7.5% X $100)
Total
$100.00
$7.50
$107.50
The actual cost of shipping is $8 and the handling charge is therefore $7 ($15 - $8 = $7).
The auditor should accept the returned merchandise deduction because the $7 handling
charge is less than 10 percent of the selling price of the merchandise ($7/$100); therefore,
the retailer is allowed to retain that amount as a restocking fee.
When determining whether the returned merchandise deduction should be examined further, staff
must first rely upon the use of aggregate data as illustrated in Example 3 as the intent of the 10
percent threshold is to avoid detailed testing. This is especially true when it is highly improbable
that the original handling charge is in excess of the actual cost of restocking merchandise.
Example 3
Assume the same facts and circumstances noted in Example 2 above. Additionally, the
taxpayer’s records for the prior year state:
Total Sales (net of shipping and handling)
$15,000,000
Shipping and Handling Revenue
$1,000,000
Shipping Merchandise Expenses
$700,000
Under this scenario, staff would consider that $300,000 in revenue is derived from handling
charges ($1,000,000 - $700,000). For the specific period in question, the handling charge
is 2 percent of total sales ($300,000/$15,000,000). Since the handling charge is less than
10 percent of the merchandise sales, the claimed returned merchandise deduction should
be accepted without further testing.
In the event that adequate documentation is not available to use aggregate data, staff should
perform a cursory review of transactions to determine if the retailer qualifies under the 10 percent
threshold explained above.
It is important to note that in cases where the handling portion exceeds 10 percent of the sales
price, the returned merchandise deduction is not necessarily disallowed. The deduction must be
further analyzed to verify whether the un-refunded handling portion of the original sale exceeds
the actual cost of restocking the merchandise. Only in such cases should staff deny the claimed
returned merchandise deduction or claim for refund.
March 2016
Audit Manual
REHANDLING AND RESTOCKING CHARGES
0413.25
There are two methods of compiling the cost of rehandling and restocking returned merchandise.
The retailer may use:
(a)The actual cost of rehandling and restocking the returned merchandise. The cost may
include, but is not limited to the retailer’s direct costs of the following:
• Inspection of the merchandise after the request has been made for its return
• Issuance of authorization for return of the merchandise after the request has been
made for its return
• Freight or delivery charge for shipment of the merchandise from the customer to the
retailer
• Returning the merchandise to stock, and
• Direct “paper work” involved in the return of merchandise such as preparation of credit
memos, accounts receivable corrections, inventory record adjustments, etc., to the extent
that it is possible to determine these costs.
(b)A percentage of the sales price based on the average cost of rehandling and restocking
returned merchandise.
The percentage must be based on the average of the actual costs of rehandling and restocking
the returned merchandise for the entire previously completed accounting cycle (normally
one year). The percentage is computed by dividing the total allowable rehandling and
restocking costs incurred in the previous accounting cycle by the total sales price (excluding
sales tax) of the merchandise returned during that period. Retailers choosing the percentage
of sales method may not:
• Use industry-wide averages
• Use actual cost during any accounting cycle in which an election was made to use the
percentage method.
Regardless of which of the two methods is used, only the actual cost or average actual cost of
rehandling and restocking returned merchandise is allowable. The taxpayer must maintain
adequate records to support how the charge for restocking and rehandling was determined. If
the taxpayer incorrectly computes the percentage and charges a greater restocking charge for the
entire subsequent year, only those transactions where the actual restocking costs on any specific
transaction are equal to or greater than the erroneous percentage claimed may be allowed.
March 2016
General Audit Procedures
RETURN OF TAX REIMBURSEMENT
0413.26
If the retailer separately computes the sales tax refund or credit at an amount less than the sales
tax on the original transaction, the difference between the sales tax collected and the sales tax
refunded is regarded as excess tax reimbursement and should be handled in accordance with AM
section 0417.00.
EXAMINATION OF ACCOUNTS RECEIVABLE
0413.30
The auditor should examine a sufficient number of individual customers’ accounts to satisfy
themselves that the credit memoranda on file actually represent bona fide credits of the original
sales price plus tax. Some retailers issue a credit memo in full but make a service charge or
some charge other than a restocking or rehandling charge to the customer. If this condition is
discovered, the auditor should disallow the deduction.
It will be noted that Regulation 1655 states in part, “...the full sales price,...is refunded in cash
or credit.…”
Where the retailer has issued a credit memo and notified the customer in writing at the last
known address that a bona fide credit for the full sales price including sales tax is available and
the customer’s account is so credited, the deduction is allowable. This will be true even though
the customer does not utilize the credit and after a reasonable period of time the retailer transfers
the unused credit to miscellaneous income or some other income account.
DEFECTIVE MERCHANDISE
0413.35
When defective merchandise is returned to the seller, under conditions not meeting the requirements
of Regulation 1655 (AM section 0413.05), a deduction may be taken only for the amount credited
or refunded because of the defective condition of the merchandise. No deduction can be allowed for
the amount refunded or credited because of the return of the merchandise. Accordingly, where the
returned defective merchandise has some value, the amount refunded or credited to the customer
must be reduced by the value of the merchandise in its defective condition.
PRICE ADJUSTMENTS
0413.40
Occasionally, the auditor will encounter situations where amounts claimed as returned merchandise
represent price adjustments on merchandise actually retained by the customer. For example, a
customer is not entirely satisfied with the merchandise, and wishes to return it. The seller, not
wanting to restock the merchandise, will prevail upon the customer to keep the merchandise at
a reduced price. The price adjustment is then refunded or credited to the customer. Such price
adjustments will be deductible if the customer is actually given a refund in cash or a credit in an
amount equal to the agreed upon adjustment, plus sales tax on that amount.
March 2016
Audit Manual
AUDITS OF SALES IN INTERSTATE OR FOREIGN COMMERCE
0414.00
GENERAL0414.05
Regulation 1620 describes the transactions which are exempt from sales tax when shipment is
made in interstate or foreign commerce. It also sets forth the conditions which determine whether
merchandise shipped into this state is subject to sales tax or use tax.
AUDITING PROCEDURE — SHIPMENTS OUT-OF-STATE
0414.10
The general auditing procedure for sales for resale applies to this deduction. The audit may be
made on either a complete basis or a test basis depending on the number and dollar value of the
transactions. Examples of documentary evidence to support a deduction as a sale in interstate
or foreign commerce are:
(a) Delivery by facilities operated by the retailer
• Correspondence
• Delivery receipts
• Expense vouchers supporting delivery expense
(b) Shipment by carrier
• Freight
Bills of lading
Freight invoices
• Express
Express receipts
Express company invoices
• Parcel post
Parcel post receipts
Record of parcel post shipments
In many instances the sales invoice will show parcel post charges and shipping
instructions
(c) Delivery by the retailer to a customs broker, forwarding agent, export packer or any other
person engaged in business of preparing property for export, who is not the purchaser,
who ships or delivers the property to a foreign destination as provided in 1620(a)(3)(C)2.
• Bills of lading
The bill of lading shall include the identification of the invoice, contract number or
other identification of the transaction involved and the identification of the export
packer to which delivery is was made.
• Copies of import documents of foreign country
• Notation on invoice
• Invoices for services of customs broker or forwarding agent
• Delivery receipts
(d) Delivery to a steamship or other conveyance furnished by a foreign purchaser for shipment
to a foreign destination.
• Bills of lading
• Import documents of a foreign country or other documentary evidence of export
must be obtained and retained by retailers to support deductions taken.
January 2000
General Audit Procedures
Auditing Procedure — Shipments Out-of-State
(Cont.) 0414.10
In addition to the above, it often is possible to support the exempt status of the shipment by
examining purchase orders or other contractual documentation received from the purchaser
specifying that the destination of the goods is a specific point outside the United States. The
purchase order or contractual documentation received from the purchaser shall include the
following minimum elements: 1) a provision requiring or statement indicating that the property
is to be delivered by a retailer to an export packer for subsequent shipment to a foreign country;
and 2) the specific point outside the United States where the property is shipped. There should
be some specificity as to the destination point. The minimum specificity for this element is
identification of to whom it is being shipped and in what city and country.
The auditor should note that the following transactions are taxable:
• If delivery is made in California to the purchaser or the purchaser’s agent, except as
permitted in (c) and (d) above.
• If the sale is made to the purchasing carrier which transports the property to an out of state
point in the capacity of a purchaser rather than as a common carrier, i.e., the property is
not shipped under a commercial bill of lading.
CERTIFICATE OF VERIFICATION — OUT-OF-STATE DELIVERY
0414.12
Generally, a claimed sale in interstate commerce should not be questioned if sufficient evidence
of out-of-state shipment is provided as explained in section 0414.10. However, in certain audit
situations, additional verification of claimed interstate commerce shipments may disclose that
merchandise was not actually shipped to the purchaser, or that the out-of-state shipment consisted
of an empty box with the actual merchandise delivered to the purchaser in California. The auditor
should be alert to the following situations to determine if additional verification of interstate
shipments is warranted:
• The shipping charges for certain interstate shipments are substantially lower than
shipments of the same or similar items using the same mode of transportation, for example
UPS Ground or Federal Express. (When comparing invoices and shipping charges, the
auditor should make sure all the items were included in the shipment and not backordered.)
• The value of the item(s) listed for insurance purposes is substantially lower than the cost
of the item(s) to be shipped or there is no insurance at all.
• A large number of high value items are shipped to post office boxes.
Use of Form BOE–52 by Seller
In situations where it appears the taxpayer has met its responsibility in accounting for interstate
commerce transactions, but lacks adequate documentation to support certain questioned items, the
use of Form BOE–52 (Exhibit 13) and cover letter BOE–52–L (Exhibit 13A) should be discussed
as an option. It should be explained to the taxpayer that this certificate may be used to request
the purchaser’s statement to help substantiate the claimed interstate commerce deduction. It
should be emphasized that the return of the certificate may or may not be accepted as support
for the claimed exemption.
A period of four weeks will normally be sufficient for the taxpayer to prepare and send the certificate
and for a reply to be received. The taxpayer should prepare the certificate to be completed in
triplicate. It is recommended that the certificate be returned directly to the Board. If this is the
case, the auditor should provide the taxpayer with return envelopes with the address of his or
her district or branch office. Please note, business reply envelopes (no postage necessary) should
not be used.
February 2002
Audit Manual
Certificate of Verification — Out-of-State Delivery
(Cont.) 0414.12
The taxpayer may customize the cover letter, Form BOE–52–L, by using the text contained
therein on their own letterhead; however, the text in the sample letter should be used without
additions, deletions or changes. Any modifications to the cover letter must be approved by the
auditor’s supervisor.
The taxpayer’s customer is asked to return the completed certificate within 10 days. The 10–day
requirement is intended to encourage a prompt response from the customer. If the taxpayer
chooses the recommended procedure of having the completed certificate returned directly to the
Board, the taxpayer may add a request to the cover letter asking its customer to also send a copy
of the completed certificate to the taxpayer. The taxpayer’s customer should send the originally
signed and completed certificate to the Board (may be sent by facsimile). However, if the taxpayer’s
customer sends the certificate directly to the taxpayer and then the taxpayer sends the certificate
to the Board, the Board will accept only the originally signed and completed certificate and will
not accept a facsimile copy. If a second certificate is necessary for verification, the auditor should
establish a reasonable period of time for completion based on the circumstances involved.
Use of Form BOE–52 by Audit Staff
When the auditor has good reason to believe that merchandise was not shipped as specified by
the shipping documents, or that empty boxes may have been shipped to purchasers as a means
to support the interstate commerce exemption, it may be appropriate to use Form BOE–52 as
a verification method for receipt of out-of-state shipments. In addition to the certificate, Form
BOE–52–L1 (Exhibit 13B) provides a suggested cover letter for use by the districts in explaining
the purpose of the certificate and requesting the purchaser’s statement regarding receipt of the
item and place of delivery. The decision to use this verification method should be based on the
materiality of the questioned transaction(s) and on the surrounding circumstances. The auditor
should prepare the certificate to be completed in triplicate. Postage-paid return envelopes may
be included in the mailing to increase the likelihood of response for this case in which the Board
is seeking verification of shipment without seller involvement.
Returned Form BOE–52s
As explained above, the seller, or the auditor when the seller is not involved, should prepare the
certificate to be completed in triplicate. The original certificate should be scanned and saved in
the Supporting Audit Documents subfolder of the audit case folder. If out-of-state delivery is
indicated to Arizona, New Mexico, Oklahoma, Texas, Utah, or country of Mexico, a copy should
be sent to the Audit Support Unit (MIC: 44). For all other areas, a copy should be sent to the
taxing authority in the state of the purchaser, for example the Department of Revenue of that
state. The final copy should be given to the seller for their records.
August 2005
General Audit Procedures
AUDIT PROCEDURE — SHIPMENTS INTO THE STATE
0414.15
Property purchased out of state for consumption in California is ordinarily subject to the use tax.
In some cases, it is important that the auditor determine whether sales or use tax is applicable
to property shipped from a point outside this State to a point inside the State. Examples of
documents used to make this determination are:
•
•
•
•
•
•
Purchase orders
Sales contracts
Sales invoices
Bills of lading
Freight bills
Correspondence
In examining the above documents to determine the applicable tax, the auditor should bear in
mind that if title to the property (or possession under a conditional sales contract) passes to the
purchaser outside this State, the use tax is applicable.
Property purchased by insurance companies for their own consumption is exempt from use tax.
January 2000
Audit Manual
AUDIT OF DEDUCTION FOR LABOR
0415.00
GENERAL0415.05
Labor charges to customers may be classified in two categories:
(a) Exempt
• Installation
• Repair or reconditioning
(b)Taxable
• Fabrication
• Assembly
The principal problem involved in auditing the deduction is that of segregating installation and
repair labor from fabrication labor and the fair retail price of the merchandise used in repairing or
reconditioning property. This problem has been overcome to some extent by authorizing certain
classes of businesses, who make lump-sum charges for repairing, to claim as a labor deduction a
fixed percentage of the total charges to the customer. Examples of this type of repair are motor
rewinding, restringing tennis rackets, etc. In auditing this type of deduction, the auditor should
verify total repair sales and apply the authorized percentage.
AUDITING PROCEDURE
0415.10
Unusual labor charges claimed as deductions should, of course, be examined in detail. However,
the deduction for labor usually consists of a great many items so that the audit generally will be
made on a test basis such as described under Audit of Sales for Resale, section 0409.00. Sales
invoices, together with repair orders, cost sheet and other original documents should be secured
for the test period. The total labor claimed during the period tested should be reconciled with
the amounts shown by detailed invoices. Differences should be scheduled and a percentage of
error computed.
The general rule is that installation and repair labor charges are exempt if segregated in the
taxpayer’s records. Generally, the segregation is shown on sales invoices, but the deduction should
be allowed even though it is not shown on the invoice if either:
• Sales tax has been charged on a portion of the total sales from which the selling price of
the material can be computed, or
• The charge for labor is segregated in the sales journal, cost sheets, estimate sheets or
repair orders
The segregation should be questioned if material is billed at cost or less with all profit on the
transaction allocated to labor. If the retailer does not make a segregation, the retail selling price
of the parts and materials will be determined based on information available. In general, the
material should be priced at the fair retail value, but if the retail price is not known, the mark-up
realized on an entire job should be prorated according to material and labor costs.
January 2000
General Audit Procedures
Auditing Procedure
(Cont.) 0415.10
Among the problems which may arise in verification of labor deductions are:
(a)Some repair jobs actually involve both repair and fabrication labor. For example a
repairman may, of necessity, fabricate certain parts used in the repair.
(b)Some remodeling jobs may be either repair or fabrication labor depending upon the end
product. For example, labor charges for rebinding a rug are classified as repair. However,
labor charges for cutting a rug into two or more pieces and rebinding the pieces so that the
customer receives two or more rugs is classified as fabrication labor.
(c) Audit of labor deductions claimed by construction contractors frequently involves complex
problems. Many of these require differentiation between fabrication and installation labor.
Others necessitate determining whether the contractor is the consumer or the retailer of
the property furnished.
• A contractor may fabricate and install a fixture. The fabrication labor must be
segregated from the installation labor to properly determine the tax liability.
• A construction contractor, when billing a time-and-material contract, may add tax
reimbursement on a marked up price of materials. The amount billed and not the
cost should be considered the selling price of the materials.
As many labor operations are borderline, the auditor should make a clear, concise statement of
the reason for disallowing each item or category of items; i.e., a machine shop may make a labor
charge described as “repairing customer’s pipe”. An examination of the job record indicates the
pipe was “cut into designated lengths and threaded.” This brief description indicates fabrication
labor, not repair labor, as claimed.
January 2000
Audit Manual
AUDIT OF SALES TAX INCLUDED IN SALES
0416.00
GENERAL0416.05
Some retailers, when accounting for total sales, record only the sales price of the merchandise
in the sales account and credit sales tax reimbursement to a reserve account. This procedure
contemplates a separation of the sales price from the sales tax on either sales tickets or cash
register readings. In any event, sales tax collected is not included in reported gross sales.
Other retail establishments such as markets, taverns, and restaurants often find that separation
of the sales price from tax reimbursement is not practical, and the entire amount charged the
customer is credited to sales. In the latter cases, the taxpayer is entitled to a deduction for sales
tax included in total sales provided it can be proved to the satisfaction of the board that they have
not absorbed the tax but have actually taken it into consideration in determining the total sales
price of the merchandise.
AUDITING PROCEDURE
0416.10
In cases where a sales tax accrual account is maintained, the clerical accuracy and propriety of the
amounts posted to that account should be verified. A sales tax accrual account showing credits
only slightly in excess of taxes paid, or payments in excess of collections, does not necessarily
indicate errors in reporting.
In reconciling the accrual account, the auditor should adjust for tax on the measure of cash
discounts, bad debts claimed, refunds of tax to customers who were charged in error and for
any other instances where the taxpayer did not debit the accrual account where such a charge
was in order. In addition, the auditor should adjust for such items as reported self-consumed
merchandise and any other sales reported on which the taxpayer did not accrue tax. If any excess
debit or credit of tax still exists, after making the above adjustments, it should be the taxpayer’s
responsibility to explain such excesses.
In cases where a deduction is claimed for sales tax included in reported gross sales, the auditor
should determine:
(a) That total amounts of sales tickets are entered in the sales journal.
(b) If sales tickets are not prepared, that sales tax is rung up on the cash register if it is added
to selling prices.
(c) That where sales tax is not added to sales prices, effect was given to the tax by the retailer
in determining the total sales prices.
Regulation 1700 establishes the presumption that the selling price includes tax
reimbursement if the taxpayer posts or provides the notices contained in Regulation
1700(a)(2)(C) 1 and 2. Failure by the taxpayer to satisfy these presumptions does
not preclude acceptance of other evidence to support the tax included deduction.
Claimed “tax included” deductions should be allowed unless there is sufficient
evidence to rebut the taxpayer’s claim. The mere failure to comply with the
presumptions of Regulation 1700 is in itself insufficient proof that the retailer has
not included the tax in the selling price.
This deduction is computed after the balance of the audit is completed and is based on audited
sales (purchases subject to use tax not included) minus deductions. In order to avoid the allowance
of sales tax included on disallowed deductions on which sales tax was not charged, the audited
taxable sales (tax included) should be decreased by the amounts of such disallowed sales. Sales
tax included in taxable sales may then be computed by multiplying taxable sales (tax included)
by a factor.
January 2000
General Audit Procedures
Auditing Procedure
(Cont.) 0416.10
The factor to be used can be computed as follows:
Factor =
Tax Rate
1 + Tax Rate
=
.0725
1.00 + .0725
= .067599
Factors for other current tax rates are:
Tax Rate
6.50%
7.00%
7.125%
7.25%
7.375%
7.50%
7.625%
7.75%
7.85%
7.875%
7.925%
8.00%
8.25%
8.50%
8.75%
Factor
.061033
.065421
.066511
.067599
.068685
.069767
.070848
.071926
.072786
.073001
.073431
.074074
.076212
.078341
.080460
Sales tax included should be allowed in all audits where sales have been estimated if the basic
factors in the estimate include sales tax. For example, where prices which include sales tax are
used to develop a mark-up of purchases, the sales estimated by the mark-up method will have
the tax included.
March 2001
Audit Manual
TREATMENT OF EXCESS TAX REIMBURSEMENT
0417.00
GENERAL0417.05
Retailers sometimes charge their customers tax on exempt sales or, in the case of taxable sales,
tax in excess of the amount due. Retailers who have collected excess tax reimbursement should
be encouraged to refund the excess tax to their customers. Regulation 1700 explains the sales
tax reimbursement rules.
Tax reimbursement greater than the amount of tax imposed upon a transaction is excess tax
reimbursement to the extent that it exceeds the taxpayer’s own tax liability on the same transaction.
If the taxpayer has no tax liability on the transaction, the entire amount of reimbursement collected
in excess of the tax imposed on the transaction is excess tax reimbursement and must be returned
to the customer. If the taxpayer fails or refuses to return such excess tax reimbursement to the
customer, it must be paid to the State whether it was mistakenly computed, or knowingly computed.
REFUNDS OF EXCESS TAX REIMBURSEMENT
0417.07
Regulation 1700, Reimbursement for Sales Tax, provides that refunds of excess tax reimbursement
paid to the BOE as sales tax may be refunded to the retailer upon submission of “evidence sufficient
to establish that excess amounts have been or will be returned to the customer.”
This has been construed to mean that the retailer must actually refund amounts collected as
excess tax reimbursement to their customers rather than give a credit unless they can show one
of the following:
• The customer agrees to a credit.
• The customer’s debt to the retailer is acknowledged by the customer or made certain by
a court proceeding.
• The amounts to be credited are small and apply to numerous customers.
The retailer should maintain records as provided in Regulation 1700(b)(3) as evidence that
the excess amounts have been or will be returned to the customer. As explained below, staff
should encourage retailers to use Form BOE-52-L2, Notice of Pending Refund of Excess Sales
Tax Reimbursement, (Exhibit 13C) to notify and obtain acknowledgement from customers of the
pending refund.
All audits involving refunds of excess tax reimbursement must have copies of signed
acknowledgement forms included in the audit working papers. Form BOE–52–L2 is
available to assist retailers in obtaining sufficient evidence from customers that excess tax
reimbursement has been or will be returned to the customer and to assist retailers in notifying
and obtaining acknowledgement from customers of the pending refund. Form BOE-52-L2 also
allows retailers to assign a limited Power of Attorney to their customers for purposes of obtaining
the status of a claim for refund of excess tax reimbursement. The limited power of attorney is
optional and only applies to refunds of excess tax reimbursement of $300,000 or more.
Auditors should encourage retailers to complete the BOE–52–L2 letter for each customer affected
and retain the customers’ signed responses. When a claim for refund of excess tax reimbursement
is $300,000 or more, auditors should also encourage retailers to grant the limited power of attorney
to their customer. Without the limited power of attorney, the BOE cannot divulge information
on the status of a refund to the retailer’s customer.
Form BOE-52-L2 informs the customer of the amount of indebtedness in writing and provides
a check box for the customer to indicate their preference of a refund or credit to their account
for the amount of excess sales tax paid. The retailer must obtain and maintain the signed
acknowledgement in their records as proof of the refund or credit being given.
February 2016
General Audit Procedures
Refunds of Excess Tax Reimbursement
(Cont.) 0417.07
Retailers are not required to use this form, however any other type of documentation used by the
retailer must satisfy all of the requirements under Regulation 1700 (b)(3) that show excess tax
amounts have been or will be returned to the customer. Auditors are required to include a signed
copy of Form BOE-52-L2 or other documentation in the Supporting Audit Documents subfolder
of the digital audit case folder for all audits involving refunds of excess tax reimbursement,
regardless of the amount of refund,
When BOE staff receives a request from a customer regarding the status of a claim for refund of
excess tax reimbursement, staff may provide the status of the claim to the customer after obtaining
verification that the customer has been granted limited power of attorney by the retailer to disclose
this information to the customer. Staff may obtain verification of the customer’s limited power of
attorney either from the customer or through the digital audit archive file of the retailer/taxpayer
who made the claim.
Form BOE–52–L2 is available on eBOE.
AUDITING PROCEDURE
0417.10
The auditor must audit not only on the basis of gross receipts, but must inquire into tax
reimbursement on an individual transaction basis. An examination of the sales tax accrual
account may indicate an over-collection of tax; however, the overage is seldom the amount of
excess reimbursement. In some cases, an overage will result from the breakage factor in following
the prescribed reimbursement charts, which is not excess reimbursement. Tests of individual
transactions by examining sales invoices, dinner tags, register tapes, contracts, etc., are necessary.
When testing discloses a pattern of excess reimbursement to the extent necessary to support an
informed opinion (section 0404.15) the auditor should so inform the taxpayer. If the taxpayer
does not elect to refund the excess tax to their customers, or cannot, then the auditor should
project, or expand the test to estimate the excess tax for the audit period. The measure of excess
tax reimbursement disclosed by audit should be separately set forth in the audit report captioned
“Measure of Excess Tax Reimbursement.”
OFFSETS0417.15
Offsets allow a taxpayer to satisfy their tax liability on a transaction by paying to the State an
equivalent amount of tax reimbursement collected from a customer on the same transaction. Such
offsets can be made only on a transaction-by-transaction basis. Tax reimbursement collected on
a specific transaction can be used only to satisfy a tax liability arising from the same transaction.
The “same transaction” means all activities involved in the acquisition and disposition of the same
property. The “same transaction” may involve several persons, such as a vendor, a subcontractor,
a prime contractor, and the final customer; or a vendor, a lessor, and a series of sublessors.
If tax reimbursement equal to or in excess of the tax liability on a transaction is collected and paid
to the State, the taxpayer has no further tax liability. Any refund will be limited to the amount
paid to the State in excess of the tax liability. If an audit discloses that tax reimbursement was
collected in excess of the tax liability on the transaction, and that no tax has been paid to the
State on the transaction, the tax liability will be assessed and the tax reimbursement in excess
of that amount must be returned to the customer or paid to the State.
A taxpayer may offset tax reimbursement collected on a transaction against their tax liability on
the transaction whether the liability was satisfied by paying sales tax reimbursement to a vendor,
paying use tax to a vendor, or paying use tax to the State. Tax reimbursement collected from a
customer on a transaction is excessive only to the extent that it exceeds the taxpayer’s own tax
liability on the same transaction.
February 2016
Audit Manual
Offsets
(Cont.) 0417.15
An offset of a taxpayer’s own tax liability against tax reimbursement collected from a customer can
be made only with respect to transactions in which possession of the property upon which
the taxpayer’s liability is based is transferred, either permanently or temporarily, to the
customer, as in the case of construction contracts or leases. A taxpayer, such as a repairman,
who uses shop supplies in performing a job for a customer cannot offset their tax liability arising
from the use of the supplies against tax reimbursement collected from the customer.
SPECIFIC APPLICATIONS
0417.20
The following examples illustrate the application of tax to certain transactions engaged in by
taxpayers.
Lessors of Mobile Transportation Equipment. A lessor of mobile transportation equipment
purchases such equipment extax under a resale certificate and collects tax reimbursement on
the rental receipts, but pays no tax to the State. The lessor must pay tax on the purchase price
of the equipment since a timely election to measure the tax by fair rental value was not made.
However, the tax reimbursement collected on rental receipts is excess tax reimbursement only
to the extent that it exceeds the tax liability measured by the purchase price. Such excess tax
reimbursement must be returned to the lessee or paid to the State.
Other Lessors of Tangible Personal Property. A lessor purchases property and pays sales
tax reimbursement on the purchase to the vendor. The property is leased in the same form as
acquired and tax reimbursement is collected on the rental receipts. To the extent that the tax
reimbursement collected on rental receipts exceeds the tax reimbursement paid on the purchase
price, it must be returned to the customer or paid to the State. The law applies in this manner
whether the property is leased to a single lessee or a series of lessees.
Construction Contractors. Please refer to section 1207.05 regarding Construction Contractors
and possible offsets.
January 2000
General Audit Procedures
AUDIT OF PRESCRIPTION MEDICINES
0418.00
GENERAL0418.05
Medicines sold under a prescription issued by a physician, dentist, surgeon, or podiatrist for
the treatment of a human being, and filled by a registered pharmacist, are exempt from the
sales tax. In addition, effective January 1, 1995, tax does not apply to medicine furnished by
a pharmaceutical manufacturer or distributor without charge to a licensed physician, surgeon,
dentist, podiatrist, or health facility for the treatment of a human being, or to an institution of
higher education for instruction or research. For definitions of terminology, and other conditions
under which medicines are exempt, see the applicable sections of the law, rules and regulations.
From an audit standpoint, exempt sales to and by doctors, dentists, hospitals and certain political
entities present no particular problem. The following section is limited to auditing prescription
pharmacies.
AUDITING PROCEDURE
0418.10
Section 4331 of the Business and Professions Code requires that all prescriptions filled shall
be kept on file and open for inspection by duly constituted authorities. Also, Regulation 1591
requires that “any deduction on account of sales of medicines shall be supported by appropriate
records.” The only records specifically required by regulation are the prescriptions themselves,
which must be numbered and filed in numerical sequence. Refills are required to be noted on the
reverse side of the prescription, or on a separate attachment thereto, with the date of refilling
and initialed by the pharmacist.
Many pharmacies keep a “prescription register” to record the prescription number, prescriber’s
name, patient’s name, date sold, and the sales price of the prescription. When pharmacies use
this “register” as a basis for their deduction the auditor need only apply normal verification
techniques to determine the accuracy of the claimed deduction. Where such a “register” is not
kept, the auditor should first determine taxpayer’s method of compiling the deduction and apply
appropriate testing techniques to verify the accuracy of the detail supporting the compilation of
the deduction. The auditor should be mindful of the requirement in Regulation 1591 that the
taxpayer must support the claimed deduction by appropriate records.
January 2000
Audit Manual
AUDIT OF OTHER DEDUCTIONS
0419.00
AUDIT OF BAD DEBT DEDUCTIONS — GENERAL
0419.03
A deduction may be claimed for the measure of tax represented by accounts on which the retailer
paid the sales or use tax and which were found to be worthless and charged off for income tax
purposes, or if the retailer is not required to file income tax returns, charged off in accordance
with generally accepted principles. The fact that the account was written off is sufficient to allow
the deduction if all other prescribed conditions are met. The auditor need not be concerned with
whether the account is actually worthless. Bad debts may originate from sales on open accounts,
unsecured installment sales, or from repossessions of merchandise sold on a conditional sales
contract.
Amounts charged off usually will be greater than amounts allowable as a deduction under the
Sales and Use Tax Law. This is because amounts charged off may include charges for sales tax
reimbursement, labor, transportation, etc., or the whole amount may represent a sale for resale
or a sale in interstate or foreign commerce. The auditor must therefore analyze the sales which
are the basis for claimed bad debt deductions, either on an actual or test basis.
Generally a retailer has a bad debt deduction if the selling price upon which tax was reported
and paid is more than the payments, trade-in allowances, and other credits applicable to the sale.
The wholesale value of merchandise repossessed is an example of “other credits.”
The allowable loss for sales and use tax purposes is the pro-rata portion of the book loss which
the taxable sales price of the tangible bears to the total sales price which may include exempt
tangible items composing the sale.
An example of a computation of the allowable loss follows:
Original Sales Price Tangible Personal Property
Installation Labor and Insurance
Sales Tax
Gross Sales Price
Total Consideration Received:
Cash Down
$50
Cash paid on Account
25 Book Loss per Records
Loss Allowable for Sales Tax Purposes:
$ 200
$ 222
X $ 147
$200
10
14
$224
75
$149
= 132
Many retailers fail to claim a bad debt deduction. If at the time of audit the taxpayer has not
worked up the data to support an allowable deduction, they should be furnished the format as
outlined in Regulation 1642 and asked to compile the information.
Verification of bad debts may be made on a test basis. Representative periods should be selected
with concurrence of the taxpayer. The percentage of overstatement or understatement computed
during the test periods will be applied to all other periods of the audit. Audited differences will
be used for the test periods.
Certain larger retailers such as department stores are authorized to compute deductions on
a formula basis. Formulas approved by the Board take into account the retailer’s bad debt
experience, both as to losses and recoveries, over substantial periods of time. Such a formula
appears in section 0419.15.
January 2000
General Audit Procedures
AUDITING PROCEDURE
0419.10
The auditor should review the accounting records and income tax returns to determine that bad
debts have been properly written off. Auditors should satisfy themselves that the method used
by the taxpayer to arrive at the allowable deduction is substantially correct. Special attention
should be directed to the following:
• Was Sale Prior to a Change in the Tax Rate?
An adjustment must be made to compensate for the tax rate differential between sales
made at one rate and claimed as bad debts after the rate has changed or a district tax has
been added or discontinued. The audit report should be completed in such a manner than
tax credit will be given for state, local, county and district tax.
• Effect of Charging an Account Other Than Bad Debt Expense for the Repossession Loss
Many accounting systems require charging repossession losses directly against the cost of
goods sold or other cost account rather than Bad Debt Expense. This method has the same
general effect on the financial condition and therefore is an acceptable write-off method.
• Effect of Reporting on a Cash Basis
If retailers have been reporting their sales tax liability on a cash basis, ordinarily no bad
debt deduction will be allowed. This is because sales tax has not previously been paid on the
accounts deemed to be worthless. If accounts receivable have been picked up in a previous
audit, a bad debt deduction may be allowed for any such receivables which subsequently
go bad even though the taxpayer continued to report on a cash basis.
As provided in Regulation 1642, Bad Debts, a bad debt deduction will not be disallowed
solely for the reason that a retailer is on a cash reporting basis for income tax purposes.
• Consolidation of Debts
The auditor should determine that the remaining contract balance (net payoff) is a measure
of the taxable sale only. Some retailers consolidate other debts of the customer into the
contract which do not pertain to the allowable loss.
• Worthless Accounts Subsequently Collected
General accounting records should be reviewed to determine that collections of previously
written off accounts have been properly reported for sales tax purposes. These should
be reported on the same pro-rate basis used for claiming the bad debt deductions, i.e.,
ratably allocated to the taxable and nontaxable elements of the original sale. If, however,
delinquency charges have accrued, collections may be applied to such charges first and
remainder then pro-rated to determine the taxable portion to be reported.
• Collection Expense
Collection agencies charge a fee for their services, normally 50% of the amount collected
by them. Any amount paid directly to or retained by a collection agency in attempting to
enforce collection of amounts owing is not allowable as part of the bad debt loss.
Review should be made of receipts from the collection agency to assure that amounts shown
as collected are gross, including the collection charge.
February 2002
Audit Manual
Auditing Procedure
(Cont.) 0419.10
• Insurance Indemnification
Review of accounting records should include a search for insurance recoveries on accounts
receivables, property damage, and similar type insurance policies applicable to sustained
bad debt losses. Any such indemnification should be used to reduce the allowable bad
debt loss.
The verification of repossession losses should include, as standard procedure, sufficient
testing to insure that all repossessed merchandise is brought back into inventory or has
been resold. A comparison of the value used for computing the bad debt loss with the
subsequent selling price should show a reasonable relationship.
SPECIAL SITUATIONS
0419.15
Bad Debts Incurred by Lessors
• A bad debt deduction is allowable on reported taxable rental receipts which are found to
be worthless and charged off for income tax purposes.
• On leases or renewals of leases, the lessor is required to collect use tax from the lessee at the
time rentals are paid by the lessee and to pay the tax during the corresponding reporting
period. If the lessor has computed and paid tax to the state on lease payments that were
due but not paid by the lessee, then the lessor has made a tax overpayment subject to
refund or credit. Therefore, the taxpayer may claim a refund without having to write off
the account as a bad debt for income tax purposes. If however, the account was properly
written off and claimed as a bad debt deduction, it should be allowed.
• When leases of tangible personal property situated in this State are not subject to use tax
because of the exempt status of the lessee (e.g. insurance companies), the lessor nevertheless
is subject to sales tax measured by the rental receipts. Therefore, taxes are due from the
lessor on the basis of rentals payable and not rentals paid, and a valid bad debt deduction
may result for sales tax purposes.
Bad Debt Deductions to Persons Other Than the Retailer
• A successor who pays full consideration for receivables acquired from their predecessor is
entitled to a bad debt deduction to the same extent that the predecessor would have been
had they continued the business.
• A retailer who sells receivables at a discount cannot obtain a bad debt deduction for the
amount of the discount.
• See section 0419.17 for audit procedures on bad debt deductions claimed by lenders on
purchased receivables.
Bad Debts of Construction Contractors
• When under a time and material contract a contractor bills their customer for tax
reimbursement computed upon a marked-up price for materials, pays the tax accordingly
and the receivable is thereafter found to be worthless and charged off for income tax
purposes, or if the contractor is not required to file income tax returns, charged off in
accordance with generally accepted accounting principles, a bad debt deduction may be
taken by the contractor for the total amount. The contractor is a retailer in this situation.
• Since a contractor is the retailer of fixtures (other than those used in performance of
contracts with the United States) bad debt losses incurred in connection with the furnishing
and installing of fixtures are to be treated in the same manner as those resulting from
other types of retail sales.
August 2005
General Audit Procedures
Special Situations
(Cont. 1) 0419.15
Bad Debts for Department Stores Using Formula under Regulation 1642 in
Determining Sales Tax Credit for Bad Debts – CONTRACT METHOD
• The provisions of Regulation 1641, Credit Sales and Repossessions, and Regulation 1642,
Bad Debts, apply when considering bad debts as an allowable deduction.
• Certain retailers, such as department stores, are authorized to compute deductions on a
contract basis. This formula has been authorized for the computation of allowable bad
debt deductions. The formula follows:
1. Determine the relationship between taxable sales per the tax returns and gross
charges per the books for the last available calendar year. In almost every retail
store this calculation can be made from the normal quarterly reconciliations of
book totals representing total net register sales with taxable sales per the return.
Only sales from California outlets should be included in the formula.
EXAMPLE:
Gross registered sales per sales audit including retail sales tax........................$0.00
Less gross returns and credits per sales audit......................................................0.00
(A)
Net Register Sales..............................................................................$0.00
Add unallowable credits:
Trade-ins ............................................................................................................$0.00
Market value of repossession.................................................................................0.00
Expense allowances included in credits.................................................................0.00
Partial credit returns..............................................................................................0.00
Miscellaneous unallowable credits.........................................................................0.00 ........ $0.00
SUB TOTAL...................................................................................................................... $0.00
Less exempt transactions included in (A) above:
Sales for resale......................................................................................................$0.00
Sales of food products.............................................................................................0.00
Sales to U.S. Government.......................................................................................0.00
Out-of-state sales..................................................................................................$0.00
Less shipping charges included............................................................................(0.00)
Fed. Excise Tax included......................................................................................(0.00) ........ $0.00
Federal Excise Tax..................................................................................................0.00
Retail Sales Tax......................................................................................................0.00
Other exemptions:
Sales of merchandise certificates on register.................................................0.00
Hunting and fishing licenses run on register.................................................0.00
Exempt shipping charges.................................................................................0.00
Non-taxable sales in cost and leased workroom departments.......................0.00
Non-taxable sales of concessions
included in sales per our return.............................................................................0.00
Sales of concessions who report their own sales tax.............................................0.00
Miscellaneous exemptions....................................................................................................... $0.00
(B) Taxable Merchandise Sales per return before taking bad debt deduction.................... $0.00
Annual percentage of taxable sales per return to net register =
(B)
(A)
Merchandise Sales per Return
Net Register Sales
February 2002
Audit Manual
Special Situations
(Cont. 2) 0419.15
2. Determine the relationship of the carrying charge balance to the charge sale balance
under the financing contract at the time of write off. A test will be performed
to determine the relationship between carrying charges and sales balance. A
representative sample of transactions should be chosen and must be of a size or
number of periods that will result in an accurate factor. This test should be repeated
at least every three year and updated whenever there is material change in the age
of bad debts, the method of contracting charge sales, or other changes which may
affect the factor.
CARRYING CHARGES
AT WRITE OFF
$0.00
TOTAL WRITE OFF
$0.00
CARRYING CHARGES
AS % OF TOTAL WRITE
OFFS
0.0%
Revolving
0.00
0.00
0.0
Service
0.00
0.00
0.0
Lease
0.00
0.00
0.0
Total
$0.00
$0.00
0.0
30 Day
3. Determine the ratio of recoveries to charge off for the two preceding fiscal years:
CARRYING CHARGES
AT WRITE OFF
TOTAL WRITE OFF
30 Day
$0.00
$0.00
Revolving
0.00
0.00
0.0
Service
0.00
0.00
0.0
Lease
0.00
0.00
0.0
Total
$0.00
$0.00
0.0
Average Net Loss Percent =
CARRYING CHARGES
AS % OF TOTAL
WRITE OFFS
0.0%
Total Column III
Total Column I
Result: Having made the calculations involved in (l) to (3), proceed to make the calculations
for the Quarterly return as follows:
(a) Apply the percentage obtained in (3) to the total accounts being written off. Thus,
anticipated future recoveries are taken into consideration at time of charge off and
only expected eventual net loss is used as the basis for deduction on the sales tax
return.
(b) Reduce the amount obtained in (a) by the amount of carrying charge included as
determined by average percentage obtained in (2). Thus, carrying charge element
included in net charge off is eliminated.
(c) Reduce the result obtained in (b) by the percentage determined in (1). Thus, the
gross write-offs for the quarter have been adjusted for nontaxable elements and now
reflect the allowable bad debt deduction on taxable sales.
January 2000
General Audit Procedures
Special Situations
(Cont. 3) 0419.15
• It is important to note that the effect of these calculations and application of the formulas
results in a completely equitable deduction for bad debts for purposes of the return even
though a customer’s account being written off contains charges arising from sales made by
concessions reporting their own sales and some non-taxable sales by concessions included
in company return, some exempt workroom sales, carrying charges, etc. If each charge
off and recovery had to be analyzed and scheduled, the retailer could not afford to make
the calculations involved, nor could the State afford to audit them. Under this method,
the State always has the use of the money representing the tax effect of anticipated future
recoveries, which in view of saving in clerical cost is well worth the sacrifice to the retailer.
BAD DEBTS INCURRED BY LENDERS ON
PURCHASED ACCOUNTS RECEIVABLE
General
0419.17
A retailer may sell an account receivable (“account”) with or without recourse. “With recourse”
means the retailer must reimburse the purchaser of the account (“lender”) for any losses the lender
suffers. “Without recourse” means the retailer has no obligation to reimburse the lender even if
the lender cannot recover the full amount of the debt.
Accounts sold with recourse: A lender who purchases an account with recourse may not take
a bad debt deduction under the Sales and Use Tax Law with respect to any loss it suffers on
that account (i.e., uncollectible debt for which it fails to obtain reimbursement from the retailer).
However, a retailer who sells an account with recourse may take a bad debt deduction for the
amount of uncollectible debt for which the retailer actually reimburses the lender pursuant to
their contract, to the extent that such loss represents amounts on which the retailer reported and
paid tax. These rules remain the law, and have not been affected by the provisions of Regulation
1642(h)(3) and (i).
Accounts sold without recourse: Regulation 1642(h)(3) and (i) apply to bad debt losses incurred
on accounts created as a result of retail sales of tangible personal property for which the retailer
remitted California sales or use tax on or after January 1, 2000. Transactions prior to January
1, 2000, may qualify for treatment under the Board’s memorandum opinion in WFS Financial,
Inc. (WFS) as discussed below.
Regulation 1642 subdivisions (h)(3) and (i)
Auditors reviewing lenders’ claims for deduction or refund for which the retailer remitted California
sales or use tax on or after January 1, 2000 should review Regulation 1642(h)(3) and (i). The
subdivisions describe the conditions that must be met to claim a deduction or refund, the election
agreement between the retailer and the lender, and election agreements between lenders and
affiliated entities.
WFS Memorandum Opinion
On December 14, 2000, the Board issued a memorandum opinion on a claim by a financial
institution, WFS, for a refund for bad debts incurred from accounts purchased without recourse.
The WFS opinion sets forth the requirements of when such transactions can qualify for bad debt
deductions. The opinion can be found in the memorandum opinion section of the Business Taxes
Law Guide.
August 2008
Audit Manual
Bad Debts Incurred by Lenders on Purchased Accounts Receivable
(Cont. 1) 0419.17
The Legislature’s adoption of AB 599 (Stats. 2000, Ch. 600) superseded and replaced the WFS
memorandum opinion. RTC sections 6055 and 6203.5, as amended by AB 599, are incorporated
into and explained in Regulation 1642, Bad Debts. The WFS decision applies through December
31, 1999, but not thereafter. The provisions of Regulation 1642(h)(3) and (i) became operative
on January 1, 2000. Regulation 1642 (h)(3) and (i) generally apply to bad debts incurred in
connection with transactions occurring during the 4th quarter 1999 since the taxes on those
transactions were generally paid after January 1, 2000. However, the WFS decision itself applied
to a claim for refund that included the 4th quarter 1999. Accordingly, to ensure fair and uniform
treatment of all lenders and for administrative ease, a lender may rely on the provisions of either
WFS or Regulation 1642(h)(3) and (i) for bad debts incurred in connection with transactions that
occurred during the 4th quarter 1999. The provisions of WFS and Regulation 1642(h)(3) and (i)
are otherwise mutually exclusive.
It is imperative to note that the determination of whether WFS or Regulation 1642(h)(3) and (i)
applies is based on the date the taxes were remitted (usually ascertained based on the date at
which the sale occurred), not the date the bad debts were incurred. For bad debts incurred in
connection with sales of tangible personal property during the 3rd quarter 1999 and earlier, only
the provisions of WFS apply and not the provisions of Regulation 1642(h)(3) and (i). Generally for
bad debts incurred in connection with sales of tangible personal property during the 1st quarter
2000 and later, only the provisions of Regulation 1642(h)(3) and (i) apply and not the provisions
of WFS.
Since the determination of whether WFS or Regulation 1642(h)(3) and (i) applies is based on the
date tax was paid, but the timing of the bad debt deduction is based on the date the loss is written
off, there will be claims submitted which include losses covered by both WFS and Regulation
1642(h)(3) and (i) which were written off in the same reporting period. For example, in the 2nd
quarter 2002, a lender writes off two accounts as worthless, one for a sale that occurred in the
1st quarter 1999 and the other for a sale that occurred in the 1st quarter 2000. Tax had been
paid for the first transaction prior to January 1, 2000, and the provisions of WFS apply to the loss
from that account. Tax had been paid for the second transaction after January 1, 2000; therefore,
provisions of Regulation 1642(h)(3) and (i) apply to that loss. Since the lender’s right to claim the
losses from these two accounts was established during the 2nd quarter of 2002, the deduction for
both accounts should be taken on the lender’s return for that reporting period. This means the
statute of limitations for filing the lender’s claim related to the losses on both accounts starts to
run on July 31, 2002 (the due date of the return for the 2nd quarter 2002).
Indirect Loans
If a consumer wishes to make a purchase on credit without using an existing credit account, the
consumer may apply for a loan for that particular purchase. This is the method used for most
purchases of automobiles, aircraft, and vessels, as well as many other large purchases, such as
jewelry. The retailer may coordinate the loan application process, with the consumer signing a
credit contract with the retailer who thereafter assigns the account to a lender. This type of loan
is commonly called an “indirect loan” because the consumer does not contract directly with the
lender who will service the loan, but rather contracts with the retailer. Since the retailer will
then assign the account to the lender, bad debts from these accounts may qualify for deduction
under Regulation 1642(h)(3) and (i).
August 2008
General Audit Procedures
Bad Debts Incurred by Lenders on Purchased Accounts Receivable
(Cont. 2) 0419.17
Direct Loans
Alternately, a consumer may arrange his or her own financing by contracting for a loan directly
with a lender. This type of loan is commonly called a “direct loan” because the consumer contracts
directly with the lender who will service the loan. In a direct loan situation, the consumer pays for
his or her purchase with the proceeds from the loan (plus any down payment or other amounts paid
out of the consumer’s own funds). Methods of remitting the loan proceeds to the retailer include:
• a check issued by the lender in the retailer’s name, which may be sent directly to the
retailer or physically delivered by the consumer;
• a check issued in the names of both the retailer and the consumer which must be executed
by both parties (and which may also be sent directly to the retailer or be physically delivered
by the consumer, although the latter is more common because the consumer must also
execute the check);
• and a direct electronic funds transfer from the lender to the account of the retailer.
The Board held in a separate case that bad debts incurred on certain direct loans are also eligible
for deduction under WFS guidelines. In that case, although the purchaser contracted for financing
directly with the lender, the lender worked closely with the dealer and remitted payment directly
to the dealer. If instead the loan proceeds were to come into the full possession of the consumer
(e.g., the consumer deposits the funds into the consumer’s own account and then draws from
that account to pay the purchase price), the loan would not qualify under WFS. Furthermore,
for a direct loan to qualify under WFS, the dealer must receive payment in a manner that is
essentially the same as for indirect loans that qualify under WFS. While no specific time frame
is required, this usually occurs within ten days of the date of sale. For example, when the loan
is for the purchase of a vehicle, a qualifying direct loan would result in the lender’s name being
placed as lien holder on the ownership certificate as part of the initial registration of the vehicle
in the consumer’s name. Of course, the other conditions specified in WFS must also be satisfied.
The Board’s decision that a lender making a direct loan might qualify for a bad debt deduction under
WFS is also applicable to claims for bad debt deductions or refunds under Regulation 1642(h)(3)
and (i). However, no deduction or refund is allowable unless and until the lender and the retailer
who paid the tax file the election as explained in Regulation 1642(h)(3) and (i). Furthermore,
Regulation 1642(h)(3) and (i) applies only when the lender has purchased the account directly
from the retailer, or when the lender holds the account pursuant to the lender’s contract directly
with the retailer. Thus, even if a lender providing a direct loan can convince the retailer to sign
an election agreement with the retailer, that does not automatically mean that the losses on the
account will qualify for deduction or refund under Regulation 1642(h)(3) and (i). For Regulation
1642(h)(3) and (i) requirements with respect to a direct loan, a lender claiming a bad debt deduction
or refund will be regarded as satisfying these conditions if the transaction would have qualified
for deduction under WFS (as modified by the Board’s ruling on direct loans).
August 2008
Audit Manual
Bad Debts Incurred by Lenders on Purchased Accounts Receivable
(Cont. 3) 0419.17
For example, a consumer obtains a line of credit with a lender, perhaps secured by a second deed
of trust on the consumer’s home. The consumer then uses a check to access the line of credit
to purchase a big-ticket item. The retailer receiving the check has no contact whatsoever with
the lender except to deposit the check and obtain the funds. The lender and retailer thereafter
enter into an election agreement. The loss on this account cannot qualify for deduction or refund
under Regulation 1642(h)(3) and (i) since the lender cannot be regarded as having purchased the
account from the retailer or holding the account pursuant to a contract with the retailer. On the
other hand, a consumer applies for a loan from his or her credit union to purchase a vehicle. The
consumer then purchases a vehicle under the normal vehicle sales contract giving him or her a
stated number of days to pay the purchase price to the dealer. If the consumer does not make
payment timely, the sales contract provides for the dealer to carry the loan (which the dealer
could promptly assign to a lender, perhaps even the consumer’s own credit union). During the
completion of the paperwork and during the sale transaction process, the consumer provides
information to the dealer regarding the credit union loan. The dealer contacts the credit union
directly and after the necessary paperwork is completed, the credit union deposits the funds directly
into the dealer’s account. This direct loan will be regarded as satisfying the requirements that
the lender purchased the account from the dealer, and if the other requirements of Regulation
1642(h)(3) and (i) are satisfied, the lender is eligible to claim a bad debt deduction or refund under
Regulation 1642(h)(3) and (i).
Refinanced Loans
When a loan is refinanced with the original lender, there are two situations where a deduction for
bad debts incurred on the refinanced loan will be allowed provided all other requirements for a
deduction are satisfied. One is when the refinancing is for the purpose of lowering the amount of
the payment (through a reduced rate or extension of the term). The other is when the purpose of
the refinancing is to obtain additional funds to pay for necessary repairs to the property purchased
with the funds from the original loan, but only when the lender makes payment directly to the
repair facility. When calculating the amount of the bad debt loss on qualified refinanced loans
whose principal amount is increased to pay for repairs, the percentage of taxable loss must be
reduced by the nontaxable portion of the repairs (in addition to the other adjustments for the
nontaxable portion `of the original loan). Losses incurred from refinanced loans through a different
lender do not qualify for bad debt deductions, nor do losses from refinanced loans where the
borrower withdrew any funds other than amounts paid by the lender directly to a repair facility
for necessary repairs to the property originally financed.
Claims for Refund on SL Accounts
Generally, returns filed by SL accounts (Certificate of Registration – Lender) qualify as a claim
for refund since bad debt losses usually exceed recoveries of previously claimed bad debt losses.
The Audit Determination and Refund Section (ADRS) processes a claim for refund with or without
detailed verification.
When the account has a prior field examination and the refund being claimed is consistent with
the prior examination, ADRS processes the refund without detailed verification. RTC section
6961(b) authorizes the Board to later audit such refund and issue a determination if adjustments
are warranted. ADRS notifies the taxpayer accordingly. If inconsistency exists between the
claim for refund and the prior examination, ADRS will either contact the lender for additional
information or refer the case to the district office for verification.
Audits of SL Accounts are selected on a standard three-year audit cycle. When an account has
been selected for audit, ADRS will refer subsequent credit returns (claims for refund) to the
appropriate district office in a timely manner. Credit returns outside the audit period will no
longer be held by ADRS.
August 2008
General Audit Procedures
Bad Debts Incurred by Lenders on Purchased Accounts Receivable
(Cont. 4) 0419.17
Audit Procedures
When reviewing claims for deduction or refund based on lender bad debts, the auditor should
perform the following procedures:
• Carefully review software applications used by claimants to gather information for SL
credit return (claim for refund) preparation and consider the impact of such applications
on audit results.
The software applications have inherent limitations related to human error, retroactive
changes, user specific issues and other factors. In particular, the costs associated with
repossessions have been found to be a troublesome area for these applications. The auditor
may wish to consult a Computer Audit Specialist for assistance;
• Verify the accuracy of the claim for deduction or refund;
• Confirm the records provided adequately support the claim for deduction or refund;
• Ensure the records provided by the claimant are complete, as required by Regulation
1642(e);
• Confirm that the lender holds a Seller’s Permit or a Certificate of Registration – Lender (SL);
• Confirm that there is a valid election agreement on file specifying the claimant is the person
entitled to claim the deduction or refund for that account; and
• Verify local and district tax deallocation from the jurisdiction that received the original
local or district tax allocation.
For a lender to claim a bad debt deduction or refund, Regulation 1642(i)(2)(B) requires that “the
account must have been found worthless and charged off by the lender for income tax purposes.”
The standard practice of the lending/financial industry requires bad debts to be written off after
a prescribed number of days regardless of any collection activity or payment arrangements
made with the debtor, and without regard to whether the account is actually worthless. Thus,
although accounts may be written off in accordance with industry standard practice, this does
not necessarily mean they are worthless. For example, an account may be written off after the
prescribed amount of time has passed, but the lender may have a payment plan in effect with a
debtor. Although the account may be written off as a bad debt for other purposes, such an account
would not generally be considered “worthless” for purposes of Regulation 1642 while the payment
plan remains in effect.
Auditors must include in the general comment section of the audit report a comment as to whether
the claim for refund qualifies under WFS or Regulation 1642(h)(3) and (i). Both the lender’s and
retailer’s accounts must be cross referenced, indicating the claim for refund, the basis of the claim
(WFS or Regulation 1642(h)(3) and (i)), and the periods covered for each. The audit must include
a review of the election agreement(s) to ensure each agreement is valid under Regulation 1642(h)
(3)(A), (i)(3), or (i)(4)(A), as applicable, and pertains to the transactions under audit.
In addition to the verification of write-offs and recoveries, field examination must include a review
of possible use tax liabilities. This review is critical to educate taxpayers regarding use tax and
ensure taxpayers have reported all tax liabilities before claim for refunds are approved. The audit
report must include a “use tax” comment.
August 2008
Audit Manual
Bad Debts Incurred by Lenders on Purchased Accounts Receivable
(Cont. 5) 0419.17
Computing the Amount of the Bad Debt Loss: A lender must provide a listing of all transactions
(electronic or hard copy) for which it claims a bad debt deduction or refund, and must also be
able to provide source documents for all such transactions. Transactions should be selected for
review based on the auditor’s discretion and not that of the lender. The amount of the bad debt
for which the claim for deduction or refund is filed frequently includes some nontaxable elements
(e.g., tax, license, earned or unearned interest, late fees, etc.). It would thus be highly unusual for
a lender to be entitled to a bad debt deduction for the entire amount of its losses on an account.
Rather, the lender must adjust the amount of losses so that claimed deduction includes only the
allowable taxable amounts. There are three basic methods of verifying the lender’s claim for a
bad debt deduction or refund: Actual Basis, Statistical Sampling and Mean Allowable.
Regardless of the method used, prior to beginning verification of the claim, all claimants should be
informed that it might later be necessary to expand the size of the sample to ensure a representative
sample is taken so the accuracy of the claim is assured. A claimant must be able and willing to
provide documentation to support all transactions included in the claim, regardless of accessibility.
Transactions for which the claimant is not capable and willing to provide supporting documentation
must be disallowed, even in cases where the claimant purports to have documentation but cannot
provide copies because they are not readily accessible.
1. Actual Basis: The lender provides a listing of accounts on an actual basis and computes
the amount of the allowable bad debt loss on each account on a transaction-by-transaction
basis. The information included in the listing must include the items in Appendix 2 of
Regulation 1642, Bad Debts. Under this method, the lender computes the claimed bad debt
loss for sales and use tax purposes on an actual basis and the auditor verifies the accuracy
of the lender’s listing using statistical sampling techniques. The auditor must follow the
guidelines for performing a statistical sample set forth in AM Chapter 13, Statistical
Sampling, except for the sample size noted below.
When statistical sampling is used the auditor must select a sample size of at least 10
percent of the population. The auditor may discover no material discrepancies after
testing a sufficient portion of the sample that the auditor is comfortable in concluding the
amount of bad debt loss claimed by the taxpayer is correct. If so, the auditor, in his or
her discretion, may terminate the test and accept the amount of bad debt loss claimed by
the taxpayer. In reaching this conclusion prior to completing the test, the auditor must
consider all factors relevant to the sample, the most important of which is the size and
uniformity of the population. When the sample discloses material discrepancies among
the lender’s listing, the sample differences must be evaluated before projecting to the
population. The Board’s Statistical Sampling Evaluation program will be used to evaluate
the differences. If the sample evaluates well, a percentage of error should be computed
and applied to the population of transactions included on the lender’s listing to determine
the allowable refund amount. If the sample discloses discrepancies and does not evaluate
well, the auditor should consider expanding the sample.
August 2008
General Audit Procedures
Bad Debts Incurred by Lenders on Purchased Accounts Receivable
(Cont. 6) 0419.17
2. Statistical Sampling: The lender has provided a listing of the bad debt accounts written
off per their books but they have not computed the allowable bad debt loss as described
in Regulation 1642(d). The amount listed may include non-taxable elements such as tax,
license, interest, late fees, repossession fees, etc. The auditor must perform a statistical
sample of the transactions to compute the allowable portion of the bad debt loss, in
accordance with the guidelines set forth in AM Chapter 13, Statistical Sampling. However,
the auditor must select a sample size of at least 10 percent of the population. The lender
must provide a listing for the sample that computes the allowable portion of the bad debt
on a transaction-by-transaction basis in accordance with Regulation 1642(d). The auditor
must verify the accuracy of the sample data.
Under this method, the lender provided the total write off amount for the population. It
includes items not allowable under Regulation 1642. The sample is used to compute an
audited allowable amount on a transaction-by-transaction basis. Thus every transaction
examined in the sample will show a difference between the audited and claimed bad debt.
These differences must be evaluated using the Board’s Statistical Sampling Evaluation
program. When the sample evaluates well, it will be used to compute an audited allowable
bad debt percentage. The allowable bad debt percentage is the audited allowable amount
per the sample (computed in accordance with Regulation 1642) divided by the total bad
debt claimed in the sample. The allowable bad debt percentage will be applied to the total
claimed bad debt to arrive at the total audited allowable bad debt amount. If the sample
differences do not evaluate well, staff should consider expanding the sample. On the other
hand, the auditor may discover no material discrepancies after testing a sufficient portion
of the sample that the auditor is comfortable in concluding the amount of bad debt loss
claimed by the taxpayer is correct. If so, the auditor, in his or her discretion, may terminate
the test and accept the amount of bad debt loss claimed by the taxpayer. In reaching this
conclusion prior to completing the test, the auditor must consider all factors relevant to
the sample, the most important of which is the size and uniformity of the population.
3. Mean Allowable: The third method is similar to the second method described above.
Under this method a mean allowable bad debt per account is computed in lieu of an
allowable percentage. The verification procedures the auditor must perform are identical
to those described in method two above. When the sample evaluates well, it will be used
to compute an audited allowable mean bad debt per account.
The mean allowable amount per account is computed by taking the allowable write off
amount per the sample (computed in accordance with Regulation 1642) divided by the total
number of accounts examined in the sample. The mean allowable amount per account
will be applied to the total number of accounts contained in the population to arrive at
the total allowable bad debt. If the sample differences do not evaluate well, the auditor
must expand the sample or provide adequate comments to support the application of the
results of the sample.
August 2008
Audit Manual
Bad Debts Incurred by Lenders on Purchased Accounts Receivable
(Cont. 7) 0419.17
Required Documentation – Vehicles: The following is a list of information the auditor must
review when verifying a claimed bad debt deduction or refund incurred in connection with the
financing of a vehicle. However, to the extent this information is not relevant to the actual
computation of the allowable bad debt deduction or deallocation of tax, it need not be scheduled.
For example, if a statistical sample uses the loan origination number as the basis for selection,
this number must be available for all transactions within the population and must be scheduled.
If there is a valid reason for not scheduling that information, adequate supporting comments must
be included explaining how the information was made available and why it was impractical to
include such information in the supporting schedules.
Total Population of Claim on Electronic Media (disc or CD-ROM)
• Must exclude or readily identify loans that do not qualify
• Must identify loan origination date (date contract entered into)
• Must include seller’s/dealer’s name and address (city and state)
• Must include consumer’s name and address (city and state)
• Must include the following additional information:
• Reference number – number assigned to each loan
• Type of vehicle/property – e.g., vehicle, RV, mobile home, etc.
• Date of repossession charge off – the date charged off for income tax purposes
• Loan number – actual loan account number
• Charge off or loss per records – amount charged off for income tax purposes
• Summarized number of transactions in each local tax and district tax area
Sample Selection
• Minimum sample size of 10 percent of loan contracts (population) selected using statistical
sampling procedures (i.e., random, systematic with random start, etc.).
• For each loan in the sample — evidence that the uncollectible portion has been charged off
for income tax purposes or in accordance with GAAP. Printouts from taxpayer accounting
system will suffice.
• For losses claimed under Regulation 1642(h)(3) and (i), an election agreement for each
loan as required by Regulation 1642 (i)(3)(A) and, if applicable, the election agreement
required by either Regulation 1642 (h)(3)(A) or (i)(4)(A).
August 2008
General Audit Procedures
Bad Debts Incurred by Lenders on Purchased Accounts Receivable
(Cont. 8) 0419.17
Documentation and Information for Selected Sample
• Complete contract file, including the “No Recourse” statement. If “No Recourse” statement
is not available, copy of the contract/agreement between dealer and the financial institution
establishing that the lender holds the account without recourse.
• Reference number – number assigned to each loan
• Loan origination date – date contract entered into
• Date of repossession charge off – the date charged off for income tax purposes
• Loan number – actual loan account number
• Sales price of vehicle – total amount subject to tax including document preparation charge
and taxable smog
• Nontaxable charges such as charges for optional service contracts, Smog Check Certificate
fee, etc.
• Sales tax reimbursement collected from the consumer on sale
• Vehicle License Fee
• Insurance – net amount
• Down payment
• Any adjustments to the principal
• Finance charges – net amount
• Payments on principal
• Value of repossession – sales price for subsequent sale
• Charge off or loss per records – amount charged off for income tax purposes
• Repossession expense – auctioneer’s fees, reconditioning, etc.
• Recovery – payments made after the loan is charged off on records
• Reversals – adjustments for non-sufficient funds (NSF) checks, etc.
• Taxpayer must compute the amount of refund per Regulation 1642
Local Tax Verification: When reviewing a claim for refund under WFS or Regulation 1642(h)
(3) and (i), it is imperative the local and district taxes are properly deallocated. For example,
when the claimed bad debt loss relates to sales of vehicles, the name and address of the dealer
and consumer must be included for each transaction scheduled to properly deallocate the local and
district taxes on an actual basis. For loans approved by the lender on a transaction-by-transaction
basis, the lender should allocate the local and district taxes on an actual basis. In cases where
transaction-by-transaction information is not available and the deallocation cannot be done on
an actual basis, the regulation provides that the lender may allocate local and district taxes on
an appropriate basis subject to approval by the Board. When verifying the accuracy of such an
alternative method, the field auditor must fully explain (1) the basis for concluding whether the
alternative method is accurate and (2) specifically how the local tax deallocation was calculated.
August 2008
Audit Manual
CREDIT FOR TAX PAID TO OTHER STATES, SECTION 6406 CREDIT
0419.20
Credit for sales or use tax imposed by other states and paid on purchases of tangible personal
property may be taken as a credit against the amount of tax due. The property must have
been purchased for use, consumption or storage (not resale) in California. The department’s
administrative practice is not to question the validity of the imposition of a tax by another state.
If the purchaser can show that tax was paid to another state on a transaction subject to use tax
in California, the credit is allowable.
The only two exceptions to this general practice are: (1) when the taxpayer obtains a refund of
the tax paid to the other state prior to our review of the transaction, or (2) when it can be shown
that the purchaser or vendor is intentionally reporting tax to the other state in order to take
advantage of the section 6406 credit.
With respect to vehicles, vessels and aircraft, the section 6406 credit shall be denied when tax on
the sale or purchase of the vehicle, vessel or aircraft was first due in California.
Auditing procedure normally includes verifying the purchase invoices to ascertain that the purchase
price was included on Line 2 of the return and to verify the amount of section 6406 credit claimed
on the return. The auditor must also verify that the tax (amount of credit claimed) was paid
either to the retailer located in another state or to that state itself. Section 6406 also provides
that credit is not allowed on out of state tax measured by periodic payments made under a lease
for a period prior to the storage, use or other consumption of the property in this State.
The amount of tax credit claimed may not exceed the lesser of (1) the tax actually paid and owed
to another state, or (2) the tax computed using the combined state and local tax rates in effect at
the time the property was first brought to California. Section 0203.16 describes the method of
handling the difference developed in this portion of the audit.
The section 6406 credit is apportioned to the county tax and transit tax against which it is allowed
in proportion to the amounts of those taxes.
SHIPMENT BY MAIL OR COMMON CARRIER TO INDIAN RESERVATIONS
0419.22
Generally, sales tax applies on sales of tangible personal property by an off-reservation retailer
to an Indian on an Indian reservation when the property is delivered by mail or common carrier
unless the following three conditions are met:
1. The contract of sale (or equivalent document) must include a statement expressly
requiring delivery on the reservation (F.O.B. reservation).
2. Title cannot pass prior to the time the merchandise is delivered to the Indian purchaser
on the reservation.
3. The goods must in fact be delivered directly to the Indian purchaser on the reservation.
When all three conditions are met, the transaction qualifies as a sale on the reservation even
if the transportation documents, such as a bill of lading, do not state that the delivery is at
destination (F.O.B. reservation), provided the transportation documents do not contain any
language contradictory to the language contained in the contract of sale.
For example, if the contract of sale contains a clause passing title on the reservation and an F.O.B.
reservation clause, and the transportation document is silent regarding F.O.B. or otherwise does
not indicate delivery is at destination, the transaction will qualify as a sale on the reservation
provided the three conditions listed above are met. However, if the contract of sale contains a
clause passing title on the reservation and an F.O.B. reservation clause, but the transportation
document contains an F.O.B. origin clause, the documents would contradict each other and the
sale would be deemed to occur at the time the retailer transfers the property to the shipper.
Accordingly, the transaction will be subject to sales tax even when the above conditions are met.
January 2014
General Audit Procedures
PROPERTY USED IN TRIBAL SELF-GOVERNANCE BY TRIBES WITHOUT
RESERVATION FACILITIES
0419.24
Generally, sales tax applies to sales of tangible personal property by an off-reservation retailer
to an Indian when ownership of the merchandise is transferred to an Indian purchaser outside
Indian country. However, Sales and Use Tax Regulation 1616, Federal Areas, subdivision (d)(4)
(G), provides a sales and use tax exemption for sales of property used in tribal self-governance.
To qualify for the exemption, all of the following criteria must be met:
1. The sale must be to a tribal government of an Indian tribe that is officially recognized
by the United States,
2. The tribal government’s Indian tribe does not have a reservation, or the principal place
where the tribal government meets to conduct tribal business is not on the reservation
because the reservation does not have a building or lacks essential utility services
necessary to meet and conduct tribal business,
3. The property is purchased by the tribal government for use in tribal self-governance, and
4. Title to the property transfers and the property is delivered to the tribal government
at the principal place where the tribal government meets to conduct tribal business.
To verify the address where title to the property will transfer is valid, a list that contains eligible
tribal governments along with the address outside Indian country where they meet to conduct
tribal business is available on BOE’s webpage. The list of the tribal meeting locations is available
at http://www.boe.ca.gov/sutax/tribal_gov_meeting_locations.htm.
To support the exempt sale, retailers should obtain an exemption certificate from the tribal
government as supporting documentation. Tribal governments may use Form BOE-146-TSG,
Exemption Certificate – Property Used in Tribal Self-Governance and Statement of Delivery, as
part of the necessary documentation to retailers that the sale meets the criteria for the exemption.
TAX PAID PURCHASES RESOLD
0419.25
Regulation 1701 provides that a retailer who resells tangible personal property before making
any use thereof (other than retention, demonstration or display while holding it for sale in the
regular course of business) may take a deduction of the purchase price of the property if, with
respect to its purchase, the retailer has reimbursed their vendor for the sales tax or has paid the
use tax. The sole criteria is that the retailer must have some taxable measure whether sales tax
or self-accrued use tax, or otherwise, against which a deduction may be taken.
The allowable deduction is the original purchase price of the property upon which tax has been
paid regardless of the subsequent sales price. If this type of property is sold at a loss, the deduction
is still allowable on the basis of the original purchase price. The following examples illustrate
the allowable deduction:
Original purchase price
Tax paid 7.25%
Subsequent sales price
Sales tax 7.25%
Allowable deduction
$500.00
36.25
500.00
36.25
500.00
500.00
36.25
700.00
50.75
500.00
January 2014
Audit Manual
Tax Paid Purchases Resold
(Cont.) 0419.25
Exceptions to this policy are:
• Property acquired on a tax-paid basis and leased in substantially the same form as acquired
cannot be converted into a sale by taking a tax paid purchases resold credit.
• Property acquired on a tax-paid basis and placed in standby service will be considered
used. This will preclude a tax-paid purchase resold deduction if the property is located at
the place of intended use and committed to that use, even though never physically used
there and it is ultimately removed and sold.
If credit is allowed for tax paid purchases resold and there is some question that the supplier
might also refund the tax, the facts should be stated in a memorandum and forwarded to the
district office in which the vendor is located.
AUDIT OF CHARITABLE ORGANIZATIONS
0419.30
Sales made by charitable organizations are exempt provided the conditions included in Regulation
1570 are met. Compliance Policy and Procedures Manual section 255.050 also contains information
relating to charitable organizations.
Included among the conditions that must be met is that each year a “welfare exemption” from
property taxation must be secured. The exemption claim is filed through the County Assessor’s
Office by March 15 of each year. Sales are taxable during a year for which an organization does
not qualify for a “welfare exemption.” The procedure by which an organization qualifies for an
exemption appears in CPPM. The auditor should ascertain that the exemption covers all real
and/or personal property owned by the organization and situated at the location from which the
sales are made. An organization not owning the real property must qualify for an exemption of
the personal property at that location.
Organizations that started after the filing date should make application to the County Assessor to
find out whether or not they qualify for the exemption. The organization should receive a letter,
which informs them that they qualify, from the Assessor or the Assessment Policy and Standards
Division of the Board’s Property and Special Taxes Department. Such a letter exempts them from
the payment of sales tax pending their qualifying at the normal filing time.
Sales or use tax applies to sales to charitable organizations of tools, supplies, and equipment when
the property is used or consumed by the organization. Effective January 1, 1990 sales or use tax
does not apply to purchases by the organization of tangible personal property for the purpose of
donation.
August 2005
GENERAL AUDIT PROCEDURES
AUDITING TRANSPORTATION CHARGES
0419.35
Revenue and Taxation Code section 6012, (see also Regulation 1628, Transportation Charges),
provides that the amount of transportation charges excluded from the measure of tax shall meet
the following requirements:
If transported by a common carrier:
• The transportation charge is separately stated in the invoice, bill, statement,
contract, etc.;
• The transportation is from the retailer’s place of business or other point from
which shipment is made directly to the purchaser;
• The transportation charge does not exceed the cost of the transportation to the
retailer.
If transported by the retailer or property sold for a delivered price:
• The transportation charge is separately stated in the invoice, bill, statement,
contract, etc.;
• The transportation is from the retailer’s place of business or other point from
which shipment is made directly to the purchaser;
• The charges are reasonable; and
• Title to the property has passed to the purchaser prior to such transportation.
The exclusion of transportation charges is determined on a transaction by transaction basis.
Transportation charges are regarded as separately stated only if they are separately set forth in
the contract of sale or other document issued at the same time as the sale. The retailer’s records
supporting their nontaxable transportation charges must be maintained on a transaction by
transaction basis in order to claim an exemption.
When verifying claimed nontaxable transportation charges, auditors should determine whether
the taxpayer accounts for these charges on a transaction by transaction basis. If the taxpayer
accounts for transportation charges on a transaction by transaction basis, then the auditor may
test those charges. The results of the auditor’s test may be projected for all periods within the audit
for which transportation charges are supported by records on a transaction by transaction basis.
If the taxpayer does not account for transportation charges on a transaction by transaction basis,
then the charges should not be tested. The entire claimed nontaxable transportation deduction
is subject to tax. If documentary support on a transaction by transaction basis is provided for
a limited period, e.g., three quarters of the audit period, only that period will be considered; the
deduction for all unsupported quarters will be disallowed.
NOTE: This section does not apply to transportation of landfill material. See Regulation 1628,
subdivision (c) if auditing transportation charges involving landfill material.
February 2016
Audit Manual
NEW OR REMANUFACTURED TRUCKS, TRUCK TRACTORS,
TRAILERS, OR SEMITRAILERS
0419.45
Sections 6388 and 6388.5 provide sales and use tax exemptions on the sale, or storage, use or
other consumption of certain vehicles and trailers delivered inside California. Regulation 1620.1,
Sales of Certain Vehicles and Trailers for Use in Interstate or Out-of-State Commerce, clarifies
these exemptions and describes the records needed to support the exemptions.
Section 6388 Exemption (Regulation 1620.1(b)(2)):
This exemption typically shows up in audits of vehicle manufacturers or remanufacturers who
deliver a vehicle [as defined in subdivision 1620.1(a)(8) “vehicle” includes certain trailers] to a
purchaser who is not a resident of California for use exclusively in out-of-state or foreign commerce,
when the purchaser:
1. Purchases the vehicle from a dealer located outside California,
2. Removes the vehicle from California within 30 days from the date of delivery,
3. Provides an affidavit to the manufacturer or remanufacturer, stating:
a. The name and location of the out-of-state dealer from whom the vehicle as purchased,
b. The name and location of the in-state manufacturer or remanufacturer that delivered
the vehicle to the purchaser and the date of delivery,
c. That the purchaser is not a resident of California,
d. That the vehicle was purchased for use exclusively outside California,
e. That the vehicle was removed from California within 30 days of the delivery date, and
f. The date of removal.
4. Provides evidence of out-of-state vehicle registration [state of registration, license plate
number and Vehicle Identification Number (VIN) or serial number] to the manufacturer
or remanufacturer within 60 days of providing the affidavit to the deliverer.
To file the affidavit, the purchaser should use Form BOE–837, Affidavit for Section 6388 or 6388.5
Exemption from the CA Sales & Use Tax (Exhibit 11). Alternative documentation is permissible
as long as it contains all the information required by Form BOE–837.
Audits of vehicle manufacturers and remanufacturers: Manufacturers and remanufacturers
should have an affidavit and registration documentation on file to support a claimed exempt
transfer of a vehicle. Note: It is rebuttably presumed that a vehicle registered outside California
and apportioned for use within California is not purchased for use exclusively outside California.
Audits of purchasers: The Board may audit purchasers claiming exemption under Regulation
1620.1(b)(2). Under this exemption, purchasers must maintain internal records documenting
that the qualifying vehicle was taken out of California within the time mandated by statute and
was used exclusively outside California. Examples of documentary evidence are bills of lading
showing the first functional use of the vehicle, vehicle logs/reports, fuel receipts, hotel bills, and
copies of license or registration fee receipts showing the date of payment. Purchasers should also
be able to show that they are residents of somewhere other than California.
August 2005
General Audit Procedures
New or Remanufactured Trucks, Truck Tractors, Trailers, or Semitrailers
(Cont. 2) 0419.45
Section 6388.5 Exemption (1620.1(b)(3)):
This exemption typically shows up in audits of trailer manufacturers or remanufacturers,
dealers, or purchasers. To qualify for exemption, the purchaser must use the trailer exclusively
in interstate, out-of-state, or foreign commerce and meet the following criteria:
1. A trailer that is manufactured or remanufactured outside California must be removed from
California within 30 days from the date of delivery; or a trailer that is manufactured or
remanufactured within California must be removed from California within 75 days from
the date of delivery.
2. If the trailer is registered outside the state, the purchaser or purchaser’s agent provides
the delivering manufacturer, remanufacturer, or dealer a copy of the current out-of-state
license and registration for the trailer showing the VIN or serial number; or, if the trailer
is registered in-state under the PTI (Permanent Trailer Identification) program, the
purchaser or purchaser’s agent provides the delivering manufacturer, remanufacturer, or
dealer a copy of the federal document assigning or confirming the purchaser’s or lessee’s
USDOT (United States Department of Transportation) number, FMC (Federal Maritime
Commission) number, or a copy of the current SSRS (Single State Registration System)
filing with the DMV. A purchaser or purchaser’s agent may not use an FMC number if the
purchaser has a current USDOT number. Evidence of registration outside California must
be submitted to the dealer, manufacturer, or remanufacturer no later than 60 days after
the timely providing of an affidavit described in subdivision 1620.1(b)(3)(A)3. Evidence
of a USDOT number, FMC number, or SSRS filing must be submitted with the affidavit.
[Descriptions of the PTI, USDOT, FMC, and SSRS programs are described in Regulation
1620.1(a).]
3. The purchaser or purchaser’s agent must also provide a valid affidavit to the manufacturer,
remanufacturer, or dealer, stating:
a. The name and location of the dealer from whom the trailer was purchased,
b. The name and location of the California dealer, manufacturer or
remanufacturer that delivered the trailer to the purchaser and the date of
delivery,
c. That the vehicle was purchased for use exclusively outside the state, or
exclusively in interstate or foreign commerce, or both,
d. That the vehicle was removed from the state within the appropriate time
periods provided for in subdivision 1620.1(b)(3)(A)(1), and
e. The date of removal.
As noted in the previous section, the purchaser must use Form BOE–837 (Exhibit 11) or its
equivalent as the affidavit.
Audits of purchasers: Purchasers of trailers under this exemption must maintain internal records
documenting that the qualifying trailer was taken out of California within the mandated time and
was used exclusively in out-of-state, foreign or interstate commerce. Examples of documentary
evidence are bills of lading (also indicating the first functional use of the vehicle), vehicle logs/
reports, fuel receipts, hotel bills, and copies of license or registration fee receipts showing the
date of payment.
Note: the exemption under 1620.1(b)(3) only applies to trailers and semitrailers – it does not apply
to trucks or truck tractors.
August 2005
Audit Manual
SALES TAX EXEMPTION FOR
FOREIGN MISSIONS AND CONSULS
0419.50
In general, sales and use tax applies to the sale and use of tangible personal property sold or
leased to foreign governments. However, neither sales tax nor use tax applies to sales to foreign
missions or representative offices, foreign consular officers, employees, and members of their
families if those persons have been granted immunity from tax according to treaties or other
diplomatic agreements with the United States.
Mission and Official Tax Exemption Cards – Diplomatic tax exemption cards labeled “Official
Purchases Only” are issued by the U.S. Department of State, Office of Foreign Missions (OFM)
to foreign missions and by the American Institute in Taiwan (AIT) to representative offices (such
as the Taipei Economic and Cultural Representative Office in the United States and the Taipei
Economic and Cultural Offices) for use when making official purchases. The person whose name
and photo appear on the card is the mission’s or representative office’s point of contact and is
responsible for ensuring the accuracy of the exemption. This individual does not need to be present
when purchases are made in the name of the mission or representative office. Official purchases
must be paid in a form of payment bearing the name of the foreign mission or representative office.
Such forms of payment include official checks, official credit cards, or electronic funds transfers
(automated clearinghouse debits, automated clearinghouse credits, or wire transfers). Cash, credit
cards or personal checks in the name of the bearer of the mission tax exemption card cannot be
used as payment.
Personal Tax Exemption Cards – Diplomatic tax exemption cards labeled “Personal Tax Exemption”
are used by eligible foreign mission and representative office members and their dependents to
obtain exemption from sales or use tax on personal purchases. The card is not transferable and
must be used solely for the benefit of the individual identified and pictured on the card. Acceptable
forms of payment include cash, credit cards or personal checks in the name of the bearer of the
personal tax exemption card.
Each tax exemption card includes the name of the person to whom it is issued, personal
identification information, a photograph, an expiration date, and an identification number (e.g.,
PID#). The tax exemption cards also contain text on the front and back that indicate the level of
exemption authorized for the cardholder. Some cards authorize an unrestricted exemption from
sales taxes, and other cards authorize an exemption with some degree of restriction, such as a
minimum purchase requirement, excluded categories, or both. For example, if the tax exemption
card is granted for a minimum level of exemption of $100, as indicated on the card, the purchaser
must purchase merchandise aggregating over $100 in a single transaction to qualify for the
exemption. The total purchase may be composed of all taxable merchandise or a combination of
taxable and non-taxable merchandise, i.e., a sale of cigarettes for $36 is exempt if sold together
with $64 non-taxable food products. Separate purchases in the same store will not qualify if the
amount of each transaction does not exceed the amount indicated on the card, even though the
combination of all individual purchases in that store may exceed that amount. Examples of tax
exemption cards issued by OFM and AIT are provided in Exhibit 19.
To support the exemption, the retailer must prepare and retain an invoice or other written evidence
of the sale and should enter the name of the purchaser, the identification number, the name of the
foreign mission or representative office, the expiration date of the card, and the minimum level of
exemption specified on the card, if any. For official purchases, the retailer shall retain evidence
that the form of payment was in the name of the foreign mission or representative office. Such
payments may include official checks, official credit cards, or electronic funds transfers (automated
clearinghouse debits, automated clearinghouse credits, or wire transfers).
August 2016
GENERAL AUDIT PROCEDURES
Sales Tax Exemption forForeign Missions and Consuls
(Cont.) 0419.50
Questions regarding tax exemption cards issued by OFM may be made by telephone to the OFM
at (202) 895-3500 x2. Questions regarding tax exemption cards issued by AIT may be made by
telephone to the AIT at (703) 525–8474.
Tax exemption cards alone may not be used for exemption from taxes imposed on sales of vehicles.
For special rules regarding sales of vehicles, see AM Chapter 6, “Vehicle, Vessel and Aircraft
Dealers.”
AUDIT OF ELECTRONIC BENEFIT TRANSFER (EBT) CARD PURCHASES
0419.60
GENERAL
The Electronic Benefit Transfer (EBT) program is the system used for the delivery, redemption,
and reconciliation of two types of public assistance benefits:
• Those issued by the United States Government (USG), specifically, CalFresh (formerly,
the federal food stamps program); and
• The state-authorized cash aid benefits (state welfare benefits programs, such as CalWorks
and General Assistance).
Recipients of public assistance access their issued benefits with an EBT card which is similar
to a “debit card.” Paper food stamps have been replaced by the EBT card. The EBT program is
administered on behalf of the USG and the state by both the California Department of Social
Services and the state’s counties.
EBT PROGRAM
Counties are responsible for administering certain federal and state public assistance benefits
programs. The EBT program allows counties to provide cash benefits to recipients via EBT cards.
CalFresh and state-authorized cash aid benefit recipients can use their EBT card at point-of-sale
terminals at participating retailers that are authorized to process these transactions. At the time
of a purchase with the EBT card, the recipient selects either the federal CalFresh account or the
state-authorized cash aid benefit account from which payment will be made.
PRODUCTS PURCHASED WITH AN EBT CARD – FEDERAL CALFRESH ACCOUNT
Products which are eligible to be purchased with an EBT card federal CalFresh account and are
so purchased are not subject to the sales and use tax. Products which are normally taxable, but
are exempt when purchased with an EBT card federal CalFresh account include among other
things: non-alcoholic carbonated beverages and ice. This deduction will normally be found when
auditing grocery stores; however, it could be claimed by mini-marts, liquor stores, drugstores with
food sections, and other retailers which are eligible to accept an EBT card.
Taxpayers may claim the deduction on an actual basis, as an amount equal to 2% of the EBT card
federal CalFresh account purchases made during the period of the return, or as a percentage
computed by the taxpayer in accordance with Regulation 1602.5(c).
As this deduction will usually be rather small, any large claimed deductions will warrant careful
examination.
August 2016
Audit Manual
Audit of Electronic Benefit Transfer (EBT) Card Purchases
(Cont.1) 0419.60
RESTAURANT MEALS PROGRAM
General
The Restaurant Meals Program (RMP) is an optional county-administered program that allows
eligible CalFresh recipients to use their federal CalFresh benefits via their EBT card to purchase
hot prepared food products at participating restaurants in certain counties within the state.
The RMP does not apply when recipients use state-issued cash aid benefits to pay for hot prepared
food products.
Counties offering the RMP are responsible for certifying the eligibility of recipients of CalFresh
benefits and for informing the RMP recipients of names and addresses of participating restaurants.
The following counties participate in the RMP as of 2015:
• Alameda,
• Los Angeles,
• San Francisco,
• Sacramento,
• San Diego
• Santa Clara, and
• San Luis Obispo.
New counties join each year; the listing of participating counties is available at
http://www.cdss.ca.gov/foodstamps/PG3665.htm.
Pursuant to the terms of the RMP, participating restaurants cannot charge sales tax or any other
fees to individuals using their federal CalFresh benefits to purchase hot prepared food products.
However, the terms of the RMP do not prohibit participating restaurants from charging sales
tax on sales of hot prepared food products normally subject to tax, when the sales are made to
individuals using state-issued cash aid benefits to purchase the hot prepared food products, and
not federal CalFresh benefits.
Ultimately, whether tax applies to the sales of retailers participating under the terms of the RMP
depends in part on whether the payment received is authorized pursuant to the federal CalFresh
benefits program, and thus, a sale to the United States Government (USG); or the payment
received is authorized pursuant to a state-issued cash aid program, which represents a sale to
the State of California.
CalFresh – Sales to the USG
The sale of hot prepared food products to a CalFresh benefits recipient who uses an EBT card to
authorize payment for the hot prepared food products may qualify as a sale to the USG provided
the following conditions are met. To qualify as a sale to the USG:
1. The CalFresh benefits recipient must be an authorized EBT cardholder,
2. Both the CalFresh recipient and the retailer must be eligible to participate in the RMP,
and
3. The CalFresh recipient must select the federal CalFresh account to authorize payment for
the sale of the hot prepared food products.
February 2016
GENERAL AUDIT PROCEDURES
Audit of Electronic Benefit Transfer (EBT) Card Purchases
(Cont.2) 0419.60
Provided all of these conditions are satisfied, the sale of hot prepared food products qualifies as
a sale to the USG, and tax does not apply to the sale. To support a claim that tax does not apply
to the sale, the retailer is required to obtain evidence of direct payment by the USG. Evidence of
direct payment by the USG includes sales receipts which indicate either “Supplemental Nutrition
Assistance Program” or “SNAP” or bank statements listing electronic funds transfers to the
taxpayer as either “Supplemental Nutrition Assistance Program” or “SNAP.”
State-issued Cash Aid Benefits Program (CalWorks, Public Assistance, etc.)
When a qualifying individual selects the state-issued cash aid benefits account to authorize
payment for the sale of hot prepared food products, a sale to the state occurs. There are no general
exemptions from tax to sales of tangible personal property to the state. Tax applies to sales of hot
prepared food products to the state as the sale of tangible personal property generally, regardless
of whether the retailer is eligible to participate in the RMP.
In some cases, qualifying individuals using their public assistance benefits at RMP participating
restaurants may combine their federal CalFresh benefits and state-issued cash aid benefits on
their EBT card to cover the purchase of hot prepared food products. When payment is made partly
with federal CalFresh benefits, and partly with state-issued cash aid, only the portion of the gross
receipts that represents a sale to the USG (federal CalFresh benefits) is subject to an exemption
from tax. The remaining amount represents a sale to the state and as such is subject to tax. The
retailer is required to identify in its records the taxable and nontaxable portions of its sales and
maintain written evidence to support an exemption from tax, such as documents showing direct
payment by the USG.
FEDERAL EXCISE TAX
0419.65
Gross receipts subject to sales tax include the amount of any manufacturer’s or importer’s excise
tax included in the price of the merchandise, whether or not separately stated.
Taxable receipts do not include any federal tax, with respect to a retail sale, imposed upon the
retailer or consumer such as a federal tax on the sale of jewelry, luggage, furs, etc. (Regulation
1617, Federal Taxes.) However, retailers must retain records to show that the amounts deducted
as federal tax have been returned to the United States or will be returned to the United States
in accordance with section 4053 of the Internal Revenue Code.
February 2016
Audit Manual
AUDIT OF LEASES
0420.00
GENERAL0420.05
There are three basic ways that the tax applies to leases, and the variability of this treatment
depends on the type of property being leased, the means by which a lessor obtained the property,
and the contract between the lessor and lessee. Some leases are taxed based on the cost of the
property being leased, some are taxed based on the rental receipts, and some leases are taxed
based on the fair rental value of the property being leased. Regulations 1660 and 1661 explain
the application of tax to leases.
AUDITING PROCEDURE
0420.10
The auditor should determine the taxpayer’s method of reporting tax on leased property. Most
taxpayers choose one reporting method (cost, rental receipts or fair rental value) and use that
method exclusively for all lease transactions. Under this situation, the audit may be made on
either a complete or test basis depending on the number and dollar value of the lease transactions.
When a taxpayer reports leases under more than one method, a more detailed analysis of the
transactions will be required to assure there are no errors in reporting lease transactions.
Auditors should always keep in mind the various criteria that are applied to leases to determine
the application of tax:
•
•
•
•
How was the property obtained by the lessor?
What is the nature of the property being leased?
Was the election of the lessor made timely?
Is the transaction a lease or sale?
The auditor should be alert to the following areas that cause misunderstandings in the application
of tax to leases:
• The sale was an occasional sale.
• Property affixed to realty.
• Tax paid to another state.
TIMELY ELECTION
0420.15
It should be stressed that in order for a lessor to utilize the available options to determine the
measure of tax, an election must be made timely. Generally, a timely election means that the
election must be made on the return for the reporting period in which the leased equipment first
enters lease service. Clerical oversight is not an acceptable excuse for not making a timely election.
Once the election is made, it is irrevocable.
March 2001
General Audit Procedures
ITEMS INCLUDED IN RENTAL RECEIPTS
0420.20
The following items are generally considered to be included in rental receipts (these rules apply
when the rental receipts are subject to tax):
• LICENSE and ROYALTY CHARGES. If a rental or lease agreement calls for a royalty
to be paid based on units produced or for use of the property, such royalties are includable
in rental receipts. For example: a computer company sells pre-written software in a taxable
transaction. Charges for site license fees that permit purchasers to install additional copies
of the program on other computers represent additional gross receipts from the original
sale of the program.
• ADVANCE RENTALS. Advance rental payments received by the lessor at the time the
lease commences are subject to the tax at the time the amounts are paid by the lessee.
It is immaterial that the advance rental payment is designated as applicable to the final
period of the lease. Generally, if the amount collected at the commencement of a lease is
designated as a “security deposit” rather than an advance rental, the amount collected
would not be subject to tax until it is actually applied to a rental payment.
• CHARGES DESIGNATED AS INTEREST. When equipment is actually leased and
not sold on credit, the amounts designated by the lessor as interest which are payable
by the lessee, in addition to amounts designated as rentals, are includable in the rental
payments subject to tax.
• PROPERTY TAX. When a lessee is required by the rental contract to pay for any personal
property taxes assessed on the lease property, such amounts are regarded as part of the
taxable rental receipts whether the personal property tax is assessed directly against the
lessee or the lessor. (Exception: Personal property taxes are not included in rental receipts
when assessed against personal property where a bank or financial corporation is the lessor
and pays in lieu franchise tax on net income to California. The California Franchise Tax
Board maintains a listing of banks and financial corporations that pay in lieu tax.)
• MANDATORY CHARGES. When the lessee is obligated under the lease contract to
use services provided by the lessor such as equipment maintenance, warranty, assembly,
disassembly, etc., such additional charges are includable in rental receipts. However,
if the lease contract merely requires that the lessee maintain the property, the lessee’s
maintenance costs are not includable in rental receipts.
Another example of mandatory charges is the collision damage insurance supplement offered
generally by daily car rental companies. If it is required that the customer purchase the
insurance as part of the rental agreement, such charges are includable in rental receipts.
• DEFICIENCY CHARGES. These charges generally represent the difference between
the actual value of the property returned to the lessor by the lessee at the termination of
the lease and the value of the property prescribed in the lease contract upon which the
periodic rentals were based. Such additional deficiency charges are includable in rental
receipts. On the other hand, credits to lessees represent a reduction in rental receipts if
these adjustments are called for in the lease contract.
• DELIVERY CHARGES. In those circumstances where delivery of tangible personal
property is made by facilities of the lessor (as distinguished from an independent contract
carrier), the delivery charge is included in the measure of tax unless the transportation
occurs after possession of the leased property is transferred to the lessee or after the right
to possession is granted to the lessee and the delivery charges are separately stated.
Charges for delivery made by an independent contract carrier may also be taxable where
the sale is made for a delivered price.
February 2002
Audit Manual
Items Included in Rental Receipts
(Cont.) 0420.20
• RETURN TRANSPORTATION CHARGES. Transportation charges at the termination
of a lease for return of rented property from the lessee to the lessor are subject to tax unless
the lessee has the option to provide his own return transportation. Such charges must
also be separately stated and not be included with delivery charges in order to be exempt.
ITEMS EXCLUDED FROM RENTAL RECEIPTS
0420.25
The following items are generally considered to be excludable from rental receipts subject to tax
(these rules apply when the rental receipts are subject to tax):
• OPTIONAL CHARGES. These are the opposite of mandatory charges discussed
previously. For example, when the lessee is not obligated to use the maintenance or other
service provided by the lessor, or to accept the collision damage insurance supplemental
offered by the daily car rental company, but chooses voluntarily to do so, the additional
charges are not includable in rental receipts subject to tax.
• LATE CHARGES. An additional payment made by a lessee for failing to pay the rental
payment timely is not regarded as part of the taxable rental receipts.
• AUTOMOBILE ANNUAL LICENSE FEES. The annual license fees and taxes on motor
vehicles are not includable in rental receipts whether paid by the lessor or lessee. This
differs from the treatment of property tax. The annual license fees and taxes on vehicles
are specifically exempt by law from the measure of tax.
SALE OF LEASED PROPERTY BY LESSOR
0420.30
Sale of leased property by the lessor is subject to sales or use tax in the same manner as sales
generally. The election chosen by the lessor at the commencement of the lease does not alter the
tax application to sales of leased property by lessors. Where the lease agreement provides the
lessee with an option to purchase the leased property, a sale occurs and tax is due based on that
sale at the time the option is exercised.
January 2000
General Audit Procedures
REPAIR AND MAINTENANCE CONTRACTS
0420.35
Sales tax does not apply to sales of repair parts to a lessor which are used by the lessor in
maintaining the leased equipment pursuant to a mandatory maintenance contract where the
rental receipts are subject to tax. Such repair parts are regarded as being part of the sale of the
leased item and may be purchased for resale.
The lessor is the consumer of repair parts used to repair equipment where an optional maintenance
agreement exists. If the lessor makes a separate charge to the lessee for the parts, the lessor is
a retailer of the parts.
FUEL USED IN RENTAL VEHICLES “WET RENTALS”
0420.40
A “wet rental” is a lease of a vehicle in which the total rental charge includes fuel furnished by the
lessor. Whether the sale of the fuel to the lessor is subject to sales or use tax depends on whether
the lessor is the retailer or the consumer of the fuel furnished.
Lessor is Retailer of Fuel. — When the lease of a vehicle is subject to tax as a continuing
sale, the lessor is the retailer of fuel furnished under wet rentals of the vehicles. Such fuel
may be purchased ex-tax under a resale certificate, and if sales or use tax is reported and
paid on the total rental receipts no additional tax liability accrues.
Lessor is Consumer of Fuel. — When the lease of a vehicle is not a continuing sale
because tax has been paid on the cost of the vehicle, or because the vehicle is mobile
transportation equipment, the lessor is the consumer of fuel furnished under a wet rental,
and tax applies to the sale of fuel to the lessor. However, if the lessor makes a separate
charge to the lessee for the fuel, the lessor is the retailer of such fuel and the retail sale of
the fuel is subject to sales tax. In that case the lessor may purchase the fuel ex-tax under
a resale certificate.
January 2000
Audit Manual
AUDIT OF SALE AND LEASEBACK TRANSACTIONS
0420.45
In analyzing sale and leaseback transactions, the primary consideration is the intent of the parties
at the time they entered into the transaction i.e., did the parties intend to sell the equipment and
enter into a subsequent lease or did the parties intend to enter into a financing agreement. If the
agreement describes the transaction as a sale transaction and as a lease transaction, this is some
evidence that the parties intended that the transaction have those legal effects. Consequently, all
sales and leaseback transactions should be taxed in accordance with their express terms unless
it is clearly established that the transactions are financing agreements.
Taxpayers must establish that all of the following factors are present to establish that a transaction,
which is in the form of a sale and leaseback, is, in substance, a financing transaction only.
1. Ownership of property under the contract reverts to the “lessee” upon completion of all
lease payments. The presence of an option to purchase in a leaseback agreement does not
itself necessarily preclude the transaction from being treated as a loan for sales and use
tax purposes. The fact that title might not pass automatically to the “lessee” at the end of
the lease term, or upon the payment of a mandatory amount (whether nominal or not), but
only upon the payment of an option price, will not in itself result in the transaction being
treated as a sale and leaseback, provided the economic circumstances (option price is fair
market value or less) are such that it is readily apparent that the option will be exercised.
2. Financing agreements, as provided for under the Commercial Code, were filed by the
parties.
3. The treatment of the transaction for state and federal income tax purposes is consistent with
the parties’ contention that the agreement is a financing agreement. On the other hand, if
the parties have treated the transaction as a sale and leaseback for income tax purposes,
this is a clear indication that the parties intended that there be a sale and leaseback of
the property. Therefore, if the transaction is intentionally structured by the parties to
realize income tax benefits from a sale and leaseback, the intention of the parties that the
transaction be given effect in accordance with its form has been clearly established and
the transaction will be treated as a sale and leaseback for sales and use tax purposes.
4. The amount which would be attributable to interest had the transaction been structured
originally as a financing agreement is not usurious (excessive) under California law.
Where a transaction is entered into as a sale and leaseback which would be in violation of
the usury provisions of this state if cast in the form of a loan, then the transaction will be
given validity in accordance with the express terms of the agreement and will be treated
as a sale and leaseback for sales and use tax purposes.
5. In situations where the “lessee” defaulted, the “lessor” resorted to the legal remedies
available to a secured party as opposed to legal remedies available to an owner of leased
property.
If all the factors as enumerated above are present, then the transaction would qualify as a financing
agreement for sales and use tax purposes.
January 2000
General Audit Procedures
AUDIT OF LEASE TRANSACTIONS WITH GOVERNMENTAL BODIES
0420.50
Section 6006.3 provides that governmental bodies shall be treated as bound for a fixed term,
notwithstanding any right to terminate the contract in the event that sufficient funds are not
appropriated, and that these contracts are included in the definition of a “sale under a security
agreement.”
If such a contract with a governmental agency is voluntarily terminated by the agency, the agency
technically is not in default. However, the seller will be allowed to claim a repossession loss under
the guidelines of Regulation 1642, Bad Debts (section 0419.03).
Any transaction regarded under section 6006.3 as a sale under a security agreement with a
governmental body, which has been designated as a lease because of budgetary restrictions and
which was still active as of January 1, 1987, shall be classified as a sale on that date. This applies to
transactions involving both mobile transportation equipment and other tangible personal property.
The sales price that must be reported is the original contract price, net of finance charges, amounts
billed for insurance and other non-taxable items. Amounts which were included in the original
contract and collected by the lessor/seller will not be considered as additional gross receipts when
collected.
Any sales or use tax previously paid on one of these transactions may be credited against any
sales or use tax due on that transaction. This credit may be applied only against tax due on the
same transaction. If the use tax paid on the “lease” exceeds the tax due on the sale, the taxpayer
may file a claim for refund. Audits which include such refunds should follow the instructions
regarding refunds (section 0402.20).
When the property is mobile transportation equipment, the sellers (lessors) have been reporting
their own use tax liability, measured by fair rental value. Consequently, the sellers (lessors) of
mobile transportation equipment are not required to refund to their customers any overpayments
of use tax paid on the “leases.”
When the property involved is not mobile transportation equipment, the sellers (lessors) have
been collecting and remitting the lessees’ use tax. The amount of use tax paid on each “lease”
will be offset against tax due on the sale, on a transaction by transaction basis. In cases where
an overpayment has been made, no refund or credit against the seller’s existing liability will be
made until the requirements of Regulation 1700 have been met (section 0417.07).
January 2000
Audit Manual
AUDIT OF NONTAXABLE ELECTRONIC SALES
AND PURCHASES OF COMPUTER SOFTWARE INTRODUCTION 0421.00
0421.01
This section provides guidance regarding the uniform documentation standards and audit
procedures to be used in the verification of claimed nontaxable sales and purchases of electronically
transferred computer software, including software electronically transferred pursuant to a software
maintenance contract, and software transferred by the “load and leave” process.
Please note: When sales and purchases of electronically transferred software do not include the
transfer of tangible personal property, the Technology Transfer Agreement provisions of the
Revenue and Taxation Code do not apply.
Sales of prewritten software and software maintenance contracts are not taxable transactions if
the seller transfers the software via:
(1) Remote telecommunications to the purchaser’s computer; or
(2) Installation of the software directly into the permanent storage memory of the customer’s
computer, unless the installation is part of the sale of the computer.
In both cases, in order for tax not to apply, no tangible personal property, such as storage media,
may be transferred in the transaction.
Software or periodic software upgrades or updates may be electronically transferred directly to
a purchaser’s computer over the Internet, or by a “load and leave” process.
SOFTWARE TRANSFERRED BY A LOAD-AND-LEAVE PROCESS
0421.02
A sale of software by the load-and-leave process requires the seller, the seller’s employee, or the
seller’s agent to personally install the software directly into the permanent storage memory of
the customer’s computer and requires that the installation is not part of the sale of the computer.
When software is transferred via load-and-leave, the seller or seller’s agent must retain title and
possession of the storage media containing the software during the entire installation process.
Any transfer of title or possession of the storage media containing the software to the purchaser,
however temporary, will render the transaction taxable. During the load-and-leave process, the
period of time the seller’s storage media is connected to the customer’s computer is not considered
a temporary transfer provided that the seller or seller’s agent maintains control of the loading
process and retains title to and possession of the storage media/device at all times.
SALES AND PURCHASES OF SOFTWARE TRANSFERRED
ELECTRONICALLY 0421.03
Sales and purchases of software transferred electronically are not subject to tax if no tangible
personal property is furnished by the seller in the transaction. In cases where tangible personal
property is provided in the transaction, in any format except written documentation or manuals
(including documentation or manuals in machine-readable form) designed to facilitate the use of
the program, tax applies to the original electronic transfer of the software, even when the tangible
personal property is shipped subsequent to the electronic transfer of the software provided that
the transfer of tangible personal property is part of the original sale of the software.
April 2014
General Audit Procedures
Sales and Purchases of Software Transferred
Electronically (Cont.) 0421.03
However, where the software is transferred electronically, if another copy of the software is later
sold to the purchaser on tangible storage media as part of a separate and distinct transaction,
tax will not apply to the prior sale of the electronically supplied copy of the software. Conversely,
where the software is transferred on tangible storage media, if another copy of the software is later
sold to the purchaser and transferred electronically as part of a separate and distinct transaction,
tax will not apply to the subsequent sale of the electronically supplied copy of the software. The
determination as to whether a transaction is separate and distinct will be based on the facts and
circumstances, and evaluated on a case-by-case basis.
In most cases, electronic delivery of the software will be initiated by customers by going to the
seller’s website to “pull” a copy of the software to their computers. In those cases, the seller will
transmit an access code, or “key,” that customers must use to activate the software. An auditor
should be aware that charges for the use of an access code or “key” to “unlock” software programs or
features previously transferred on tangible storage media are subject to tax. Conversely, charges for
the use of an access code or “key” to “unlock” software programs or features previously transferred
electronically are not subject to tax.
Some software providers may offer a cloud computing service model known as “Software as a
Service,” in which: (1) customers can access the software on a remote network or location, (2)
customers do not receive a copy of the software, electronic or otherwise, and (3) the seller retains
possession and control of the software at all times. Under these conditions, tax does not apply
to charges for “Software as a Service,” or similar models, such as “Platform as a Service” or
“Infrastructure as a Service,” in which there is not a transfer of title or possession of any tangible
personal property in the transaction.
Some sellers may give customers the option of receiving the software either electronically or
through the transfer on a tangible storage media. Sellers that provide such an option may maintain
separate and distinct product codes, part numbers or stock keeping units (SKU) for the electronic
delivery and storage media delivery modes. The seller’s billing system should then add or not add
sales tax reimbursement or use tax to the sale, depending on whether the product code is for the
storage media version or the electronic version. The seller may have multiple software products
having different distribution methods associated with each product. For instance, a particular
software product may only be available to customers through electronic delivery, while another
may be obtained either electronically or on storage media.
When the sale of prewritten software is a nontaxable transaction, the seller is the consumer
of tangible personal property used to produce written documentation or manuals (including
documentation or manuals in machine-readable form) designed to facilitate the use of the
program and transferred to the purchaser for no additional charge. If a separate charge is made
for the documentation or manuals, then tax applies to the separate charge. The transfer of such
documentation does not make an otherwise nontaxable electronic transfer of prewritten software
subject to tax.
April 2014
Audit Manual
AUDIT PROCEDURES FOR SALE
0421.04
Auditors should be mindful that the prevailing business practice in the software industry is to
transfer software electronically without providing a copy of such software on tangible storage
media. When reviewing claimed nontaxable sales of electronically transferred software, the
auditor should conduct a review of the taxpayer’s business practices, policies, procedures, and the
company website (if one exists) to gain an understanding of the method(s) used to sell, transfer,
or distribute software to its customers.
Staff should accept the taxpayer’s claim that its sales of electronically transferred software are
nontaxable when staff has conducted preliminary testing (informal spot or random tests) and
found that no exceptions exist and staff is satisfied that:
• The taxpayer’s policy and common practice is not to transfer a tangible copy of the software
to the purchaser,
• There is no documentation to support that such transfers occurred.
Additional “controlled” testing should be conducted when exceptions exists. An auditor should
always keep in mind the general auditing procedures and techniques outlined in this chapter,
including short tests and cut-off techniques. One way to determine if a customer was provided
with a copy of software on tangible storage media is to check for shipping charges. The absence
of a charge to the customer for shipping is indicative that the software was shipped electronically.
As with other types of sales, large dollar transactions may be stratified for review on an actual
basis, as deemed appropriate by the auditor.
Reviewing Individual Transactions
Unless there is affirmative evidence that a copy of the software was furnished on tangible storage
media in the transaction (e.g., an invoice shows shipping charges), the auditor should presume
the transaction is nontaxable.
Where there is ambiguity or contradictory information/documentation regarding whether a transfer
of tangible personal property occurred, the auditor should use appropriate auditing procedures
to resolve the issues. The auditor may request copies of shipping documents, billing statements,
or other documentation, such as invoices or purchase orders to determine whether copies of
software on tangible storage media were transferred to buyers. If the underlying sales related
documentation, such as the contract, purchase order, or other pertinent information supports
the taxpayer’s claim that the software was delivered electronically, the auditor should accept the
taxpayer’s claim that the sale was nontaxable. If, after examining the underlying sales related
documentation, substantial ambiguity remains, as part of the audit process, the seller may use
either BOE–504-CSW (paper version) or Form BOE-504-CSW1 (electronic version) – Statement
Concerning Property Purchased Without Payment Of California Sales Tax - Software, to support
its assertion that a copy of the software or software updates were not transferred to the purchaser
on tangible storage media.
An auditor should not conclude that software was transferred on tangible storage media based
upon the fact that a sales invoice has the “ship to” address field completed. There may be valid
business reasons to include a “ship to” address on the invoice, even though no tangible personal
property was actually shipped. For instance, many common billing systems automatically populate
the “ship to” field with the same information that is in the “bill to” field if there is no “ship to”
address. Additionally, the seller may have its billing system set up to track electronic transfers
to states where downloads are subject to tax. A sales invoice with the “ship to” address field
completed should not be considered affirmative evidence showing the software was delivered via
tangible personal property.
April 2014
General Audit Procedures
Audit Procedures for Sale
(Cont.) 0421.04
Load-and-Leave Transactions
The seller/buyer may provide any substantive evidence establishing that the software was not
transferred on tangible storage media. For instance, consistent with audits of electronically
transferred software, the taxpayer may provide evidence regarding its business practices and
policies of only providing or receiving certain software without the transfer of storage media to
the purchaser. In addition, the absence of a separate charge for storage media is evidence that
no such storage media was sold to the purchaser. Although not required, if the parties executed
a contemporaneous statement memorializing the facts of the “load and leave” transaction, it
should be accepted as “pertinent information” that no tangible storage media was delivered to
the purchaser.
A sample contemporaneous statement memorializing the facts of a load and leave transaction may
be as follows: “The software program, [name of software program], was loaded on the computer of
[purchaser’s name] by [seller’s employee or seller’s agent that installed the program], and [seller’s
employee or seller’s agent] did not transfer any tangible personal property containing the software,
such as tangible media, to [purchaser’s name].” This is sample language and there is no specific
wording that must be included in the statement.
AUDIT PROCEDURES FOR PURCHASES
0421.05
When examining purchases of software, staff should look for evidence indicating a tangible copy of
the software was furnished to the purchaser. Because sellers have a common practice regarding
electronically transferred software, staff may presume purchasers of software likewise have a
common practice of receiving software electronically, despite the fact purchasers utilize multiple
vendors. Unless there is affirmative evidence that a copy of the software was furnished on tangible
storage media in the transaction, the auditor should presume the transaction is nontaxable.
Indications that a tangible copy of the software was shipped to the purchaser may include an
amount billed for transportation charges in connection with electronically transferred software,
or a separately stated charge for storage media.
If the auditor still has questions as to the method of delivery, they may find it helpful to gain
insight as to the seller’s business practice. One way to do so would be to visit the software vendor’s
website to see if the vendor makes copies of its software available on disk. Another way is to
determine whether the seller has been audited and if so, contact the auditor of the seller.
DONGLES0421.06
A dongle, which is considered tangible personal property, is a security device used to prevent
unauthorized reproduction of software and/or to make the software fully functional. Even in cases
where the dongle is “optional,” when the dongle is provided as part of the sale of software the
seller is deemed to be selling a single item, as the true item sold is software subject to a physical
security device without which the software will not function properly.
The inclusion of a dongle in connection with the transfer of software renders the entire transaction
to be a taxable sale of tangible personal property. Whether the charge for the dongle is separately
stated or not, even if sold subsequent to the transfer of the software under a separate invoice,
the charges for the software (unless the software program qualifies as a custom program) and for
the dongle are subject to tax. This is true even in cases where the purchaser is not contractually
required to purchase the dongle, provided the purchaser must acquire the dongle to operate the
software.
April 2014
Audit Manual
ANNUAL SOFTWARE LICENSE RENEWALS
0421.07
Tax generally applies to the gross receipts from the sale of annual software license agreements
when the original agreement provides for the delivery of copies of the software on tangible storage
media to the buyer. This is true regardless of whether or not upgrades or updates provided
through the License Agreement are subsequently transferred electronically. For guidance with
respect to upgrades and updates furnished pursuant to optional software maintenance contracts,
see Section 0421.08.
In cases where the original software sale is subject to tax, tax applies to annual software license
renewals without regard to the length of time which has elapsed or the changes resulting from
the upgrades previously provided. Tax applies in the same manner whether there is a single,
multi-year agreement or multiple single year agreements.
However, tax does not apply to the gross receipts from annual software license renewals when
the software updates or upgrades are electronically transferred, and the original sale of the
software was not taxable because the software was transferred to the licensee electronically and
no copies of the software on tangible storage media were furnished with prior updates. Audit
procedures, when necessary, should be performed in substantially the same manner as other
sales and purchase transactions.
OPTIONAL SOFTWARE MAINTENANCE CONTRACTS
0421.08
A software maintenance contract is an agreement requiring the seller of software to provide
the customer with either technical support services or software upgrades and updates, or both.
A maintenance contract is optional if the purchaser may purchase the software without also
purchasing the maintenance contract. Pursuant to Regulation 1502(f)(1)(C), tax applies to 50
percent of the lump sum charge for the sale of an optional software maintenance contract, when
the updates and upgrades were delivered on tangible storage media. If no tangible personal
property is transferred to the purchaser during the term of the maintenance contract, tax does
not apply to any portion of the charge.
When an optional software maintenance contract is silent with respect to whether software on
tangible storage media is to be transferred, or when the terms of an optional software maintenance
contract explicitly provide that no copies of software on tangible storage media will be transferred
to the purchaser, the seller is not required to report tax on any portion of the gross receipts from
the sale of the optional software maintenance contract (provided that no such copies are in fact
transferred).
When the parties of an optional software maintenance contract contemplate a transfer of tangible
personal property, and tangible personal property is in fact transferred, tax applies to 50 percent
of the lump sum charge for the sale of an optional software maintenance contract. The transaction
must be reported on the sales and use tax return for the period in which the transaction occurs.
If, in fact, no tangible personal property was transferred to the purchaser during the term of the
maintenance contract, the seller may file a claim for refund for the tax remitted on the sale of the
maintenance contract. For procedures with respect to the treatment of excess tax reimbursement
and supporting a claim for refund, refer to section 0417.00.
Substantiating whether software upgrades and updates under an optional software maintenance
contract were delivered electronically or by tangible media is the same as substantiating whether
software was delivered electronically.
April 2014
General Audit Procedures
PARTIAL EXEMPTIONS
FARM EQUIPMENT AND MACHINERY
0422.00
0422.10
Revenue and Taxation Code section 6356.5 (see also Regulation 1533.1, Farm Equipment and
Machinery), provides a partial sales and use tax exemption for the sale or purchase of farm
equipment and machinery purchased for use by a qualified person to be used primarily in producing
and harvesting agricultural products. See the regulation for specific definitions. For example,
the following terms (and others) are found in the regulation: “farm equipment and machinery,”
“qualified person,” “primarily,” and “producing and harvesting agricultural products.”
A qualified person who purchases or leases qualified property from an in-state retailer or an outof-state retailer obligated to collect the use tax, must provide the retailer with a partial exemption
certificate in order for the retailer to claim the partial exemption. If a retailer takes a partial
exemption certificate timely and in good faith from a purchaser, the retailer is relieved from the
liability for the sales tax subject to the partial exemption or the duty of collecting the use tax
subject to the partial exemption under the regulation. A seller is presumed to have taken a partial
exemption certificate in good faith in the absence of evidence to the contrary. If the purchaser
does not qualify for the partial exemption or the property is not used in a qualifying manner, the
purchaser is liable for the tax, with applicable interest, to the same extent as if the purchaser
were a retailer making a retail sale of the property at the time the property was purchased.
In an audit of the seller, if the auditor believes the transaction does not qualify for the partial tax
exemption and the seller has accepted a partial exemption certificate timely and in good faith, a
BOE-1164, Audit Memorandum of Possible Tax Liability, should be issued and sent to the district
of the purchaser.
For example, if the purchaser provides a partial exemption certificate to the retailer and then
uses that property in a manner not qualifying for the partial exemption, or the purchaser is not
a qualified person, as discussed above, the purchaser is liable for payment of the sales tax.
October 2015
Audit Manual
SOLAR POWER FACILITY
0422.15
The purchase of a solar power facility may qualify for the farm equipment and machinery partial
exemption in Revenue and Taxation Code (RTC) section 6356.5. (See also Regulation 1533.1, Farm
Equipment and Machinery). To qualify for the partial exemption, there must be:
(1) A qualified person that
(2) Purchases qualifying farm equipment and machinery and
(3) Uses that equipment and machinery primarily in producing and harvesting agricultural
products.
All three of these requirements must be met in order for the purchase to qualify for the partial
exemption.
Solar Power Facility Directly Attached to Farm Equipment and Machinery
When a solar power facility is directly attached to, and primarily provides power to (i.e., operates),
qualifying farm equipment and machinery, the solar power facility generally qualifies as “farm
equipment and machinery.” As such, the purchase of such a solar power facility generally qualifies
for the partial exemption as long as the other requirements for the partial exemption are met.
Solar Power Facility Not Directly Attached to Farm Equipment and Machinery
A solar power facility may qualify as “farm equipment and machinery” when the solar power
facility is not directly attached to qualifying farm equipment and machinery but is instead tied
to the regional power grid and subject to a net metering agreement between the taxpayer and the
electric cooperative. In such cases, the taxpayer needs to demonstrate that the solar facility is
specifically purchased to provide power to (i.e., operate) qualifying farm equipment and machinery.
Factors to consider when determining if a solar power facility was specifically purchased to provide
power to qualifying farm equipment and machinery include, but are not limited to:
• The basis for the design and size of the solar power facility (e.g., a study or calculation),
• The amount of power the solar power facility produces,
• The electrical power needs of the qualifying farm equipment and machinery, and
• Whether the electric cooperative required that the solar power facility be tied to the regional
power grid.
October 2015
General Audit Procedures
Solar Power Facility
(Cont.) 0422.15
When determining whether the solar power facility is primarily used in producing and harvesting
agricultural products, 50 percent or more of the annual energy generated by the solar power
facility needs to be consumed by the qualifying farm equipment and machinery in producing and
harvesting agricultural products. This may be calculated by using the following formula:
Total annual amount of power consumed by the qualifying farm equipment and
machinery in producing and harvesting agricultural products ÷ the total annual
amount of power generated by the solar power facility.
The taxpayer must provide evidence to demonstrate that the solar power facility is primarily used
in producing and harvesting agricultural products. Evidence includes, but is not limited to, data
from meters on the qualifying farm equipment and machinery as well as documentation of the
number of pieces of qualifying farm equipment and machinery, the number of hours the qualifying
farm equipment and machinery operate, and the amount of power consumed by the qualifying
farm equipment and machinery per hour.
Please see Regulation 1533.1 for more information.
Construction Contracts
A solar facility may be furnished and installed by a construction contractor pursuant to a
construction contract. To the extent the construction contractor is regarded as a retailer under
Regulation 1521, Construction Contractors, the farm equipment and machinery partial exemption
applies to the sale of such items to the qualified person so long as all of the requirements of
RTC 6356.5 are met. On the other hand, to the extent the construction contractor is regarded as
the consumer under Regulation 1521, the partial exemption does not apply to the construction
contractor’s purchases of materials for use in constructing the solar facility.
See AM Chapter 12, Construction Contractors, for additional information.
October 2015
Audit Manual
CONTRACT OPERATORS
DIESEL FUEL PARTIAL EXEMPTION
0422.20
Revenue and Taxation Code section 6357.1 (See also Regulation 1533.2, Diesel Fuel Used in
Farming Activities or Food Processing), provides a partial sales and use tax exemption for the
sale, storage, use, or other consumption of diesel fuel used in farming activities or food processing.
The terms “farming activities” and “food processing” are defined in Regulation 1533.2. The sale of
diesel fuel to persons who conduct farming activities for farmers and ranchers on a contract basis
(contract operators) qualifies for the partial sales and use tax exemption, provided the purchaser
provides a timely and complete partial exemption certificate to the fuel vendor.
A contract operator is considered to be a person hired by a commercial farmer or rancher to perform
farming activities in support of the raising or harvesting of any agricultural or horticultural
commodity that may be legally sold or offered for sale to others. For plant products, “farming
activities” include, but are not limited to, preparation of land for planting, including ripping,
leveling, plowing, disking, harrowing and furrowing; seeding and planting; irrigating; spraying
of herbicide or pesticides; pruning; and harvesting. For animal products, “farming activities”
include, but are not limited to, herding, hauling, raising, shearing, feeding, caring for, training,
and management of animals. “Farming activities” do not include activities peripheral to the actual
raising and harvesting of agricultural products, such as the construction, repair or refurbishing
of farming or ranching facilities or equipment.
October 2015
General Audit Procedures
AUDIT OF FRANCHISORS OR LARGE RETAILERS
THIRD-PARTY DATA REQUESTS TO FRANCHISORS
AND LARGE RETAILERS
0423.00
0423.10
The Data Analysis Section (DAS) coordinates, solicits and maintains a database of third-party
data for use in audit selection, to create leads for audit and compliance programs, and to provide
purchase/sales information to auditors on accounts being audited. Third-party data is solicited
from various resources such as auction houses, big box retailers, and franchisors.
Third-party data resources may be identified during audit selection and while auditing a franchisee,
franchisor or large retailer. To enhance the third-party database and streamline requests, DAS
will coordinate requests for franchisor or large retailer data with the district office in which the
franchisor/large retailer is located or with the office auditing a franchisor/large retailer. District
staff will request the third-party data (i.e., either sales reported to the franchisor by their California
franchisee, or all sales made by the large retailer to their resale customers) using the BOE-116
forms as described below.
The following two forms are available on eBOE to request third-party data from franchisors or
large retailers. District staff should use these forms when requesting third-party data directly
from franchisors or large retailers that are identified by the Business Tax and Fee Department
(BTFD) or the DAS.
• BOE-116-A, Franchisor/Vendor Sales Transaction Data-1st Request, and
• BOE-116-B, Franchisor/Vendor Sales Transaction Data-2nd Request,
PROCEDURE0423.15
When staff begins an audit suited for a third-party data request, the BOE-116-A must be used for
the request. This form allows users to fill in or choose relevant information and may be addressed
to either franchisors or large retailers. The BOE-116-A is signed by the District Principal Auditor
(DPA) and instructs the franchisor/large retailer to send the data directly to DAS. DAS is copied
on the BOE-116-A. Third-party data should be requested for the same period(s) as the franchisor
or large retailer is being audited.
Once the initial request for the third-party data to the franchisor or large retailer is made using
the BOE-116-A, DAS will monitor the request. If necessary, the DPA will send a follow-up second
request using the BOE-116-B. DAS maintains a central list of all data requested through the use
of these forms. If a franchisor/large retailer does not comply with the request to supply records,
the DPA of the district conducting the audit may pursue a subpoena for records as outlined in
Exhibit 4.
Upon receipt of the third-party data from the franchisor or large retailer, DAS will notify the district
office and process, cleanse, data match, and validate the data to BOE IRIS registration for seller’s
permit identification and verification. Any leads (i.e., noncompliance leads and under-reported
leads) that result from processing this third-party data will be sent to the appropriate district.
In order to avoid sending franchisors or large retailers multiple requests for the same data, staff
is instructed to contact DAS for third-party data availability when auditing a franchisee and
certain large retail accounts. For franchisor accounts not already available in DAS, staff should
use their judgment and discuss with their supervisors if they believe a third-party data request
is appropriate. All questions regarding third-party data should be emailed to SUTD-Data Request
Mailbox.
July 2015
Audit Manual
AUDIT OF MOTOR VEHICLE FUEL
0430.00
GENERAL0430.05
Sales or use tax applies to retail sales of fuel taxed under the Motor Vehicle Fuel License Tax Law.
The tax applies to the total selling price of such motor vehicle fuel, inclusive of federal and state
excise taxes. Sales tax does not apply to retail sales of motor vehicle fuel for use in propelling
aircraft, regardless of the fact that it is automotive gasoline. Aircraft jet fuel subject to sales tax
unless used on international flights.
Sales or use tax applies to sales of diesel fuel, liquefied petroleum gas (LPG), liquefied natural gas
(LNG) and compressed natural gas (CNG). CNG may be exempt if it is delivered to the retailer in
gaseous form through pipes or lines from the natural gas supplier and compressed by the retailer.
Tax applies to the selling price of the fuel, inclusive of federal excise taxes, but exclusive of state
excise taxes (e.g.. Diesel Fuel Tax).
AUDITING PROCEDURE
0430.10
An inventory reconciliation should be made to verify that recorded purchases include all receipts
of motor vehicle fuel, and that metered withdrawals from storage are correctly reported in gallon
and dollar amounts. Total gallons sold times unit selling prices should agree with reported sales
of motor vehicle fuel. This accountability procedure should help the auditor determine whether
a detailed audit is warranted.
METHODS OF VERIFICATION
0430.15
Where records are inadequate, it may be necessary to base the verification of sales of motor vehicle
fuel on purchases converted to the selling price. Since most service stations sell fuel obtained from
one distributor, a schedule of purchases should be obtained from that company, identified as to
grade of fuel and gallons involved. If inventories are available, they should be used in computing
the net gallons of each grade available for sale.
Unit selling prices should be obtained from the most reliable source available (usually the
distributor) and applied to total gallons sold. The resultant sales figures can then be compared
with reported sales and a percentage of understatement, if any, computed and applied to sales
of motor vehicle fuel reported.
ACQUISITION OF EX-TAX GASOLINE
0430.20
While making audits of service stations, auditors should be alert to ex-tax acquisitions of imported
gasoline, or stolen gasoline, since the sale of this gasoline is a taxable distribution. Purchase
records should be examined to determine whether all fuel was acquired from recognized California
distributors, and it should be noted whether the volume of gasoline sold appears to be in balance
with the volume of gasoline acquired from recognized California sources. If there are indications
that fuel has been acquired illicitly, all available facts should be reported to the Fuel Taxes
Division, Special Taxes Department.
January 2000
General Audit Procedures
AUDIT OF MOTOR VEHICLE FUEL RETAILERS —
PREPAYMENT OF SALES TAX
0431.00
GENERAL0431.05
Effective January 1, 2002, wholesalers and suppliers subject to the motor vehicle fuel tax are
required to collect prepayments of the retail sales tax from their purchasers on the first removal
of fuel at the terminal rack or upon entry into this state and all subsequent transfers of motor
vehicle fuel except aviation gasoline in this state. This process continues down to the level of the
motor vehicle fuel retailer. Each person making prepayments to suppliers may claim the amount
paid as a credit against their sales and use tax liabilities due for the same period. The initial
point of imposition was previously on the first distribution of fuel in this state.
All routine audits of motor vehicle fuel sellers must include verification of the accuracy of
prepayments made and claimed under the “SG” and sales and use tax programs. Since two
separate tax programs and funds are involved, it is critical that audit differences attributable to
each program be properly identified and uniformly handled.
REPORTING REQUIREMENTS
0431.10
All retailers of motor vehicle fuel subject to the provisions of the “Prepayment of Sales Tax on
Motor Vehicle Fuel Program” should be utilizing a modified sales and use tax return (BOE–401–
GS). This return includes a Schedule G (BOE—531—G) which allows the retailer to:
• claim credit for prepayments made on purchases of MVF and
• claim credit for tax paid to other states.
A net figure is carried forward from Schedule G to Line 20 on the face of the sales and use tax
return.
AUDITING PROCEDURES
0431.15
A subsidiary schedule will accompany all gasoline retailers’ BOE–414– (Transcript of Returns
Filed — Sales and Use Tax). This schedule will reflect amounts reported and claimed on Schedule
G of their returns. Such amounts should be verified along with other return amounts. Schedule
G must be completely and correctly prepared to ensure proper funding and allocation of tax.
Particular attention should be given to:
• Credit for Sales Tax Prepaid to Fuel Suppliers
— All credits claimed must be supported by invoices showing the amount of sales tax
prepaid to licensed suppliers or wholesalers. Invoices must show the precollection as
a separate amount and include the supplier’s or wholesaler’s “SG” account number.
If the “SG” number is not listed on the purchase invoice, it should be verified that
the supplier does hold the required “SG” permit. If a separate statement of the
precollection is not shown on the invoice, no credit will be allowed. While the
proper time to claim the credit is the period in which the purchase has been made
(generally, the period in which the invoice date is included), the credit should not
be disallowed merely because it was claimed in a subsequent period. It is critical,
however, that amounts claimed on the return reconcile to the invoiced amounts.
August 2005
Audit Manual
PROCEDURES WHERE RETAILER IS ALSO A SUPPLIER/WHOLESALER
0431.20
All taxpayers holding an “SG” account will have that account examined in conjunction with their
related sales and use tax account.
On occasion a supplier/wholesaler will sell gasoline at retail, claim the prepayment credit on their
SG return and not pass the credit on to their retail account. Rather than assessing the “SG”
account and crediting the related sales tax account, the auditor should comment on the back of
the audit report/FBO or on the front of the BOE–596 under general comments, that a prepayment
offset has been allowed. These comments will assist the Refund Section in their reconciliation of
the sales tax prepayments on MVF by noting that the problem has been addressed.
Where a supplier/retailer makes their first sale at retail (into the tank of a motor vehicle) and
nets the precollection and credit from both the “SG” and sales and use tax return, the auditor
need not adjust the return amounts.
LOCAL TAX ALLOCATION
0431.25
Routine audit procedures should be utilized with regard to the examination of the retailer’s
reported local tax amounts. Since the “Sales Tax Paid to Fuel Suppliers” credit is taken after the
local tax allocation has been computed, no special field procedures are required.
BAD DEBTS
0431.30
Retailers who are not wholesalers or suppliers should have no bad debt credits related to
prepayments.
ELIGIBILITY FOR REMOVAL FROM PREPAYMENT STATUS
0431.35
Taxpayers who have requested and been removed from prepayment status on their returns (see
sections 6471 and 6471.4), must continue to meet the criteria for removal. It should be verified
that the taxpayer continues to qualify: i.e., taxable sales of motor vehicle fuel exceed 75% of their
gross receipts. The most recent twelve-month period should be examined. Compliance staff should
be advised of those who no longer qualify.
CLOSE-OUTS0431.40
The credit for prepayments made to suppliers by the seller of a business cannot be transferred to
the purchaser of that business. Any prepayment credits remaining at the time of closeout should
be claimed on the final return.
WORKING PAPERS
0431.45
Audit workpapers will follow procedures similar to those currently used in adjusting a section 6406
tax credit. A separate audit schedule should be prepared for each Schedule G line item requiring
correction, indexing each schedule as G, followed by the line number of the item being adjusted
(e.g., Schedule G3 — Total Sales Tax Paid). A detailed schedule of differences should also be
shown and segregated by month, vendor name and “SG” account number. The audit workpapers
showing these differences should accompany the audit report transmitted to headquarters.
Verification comments should include a discussion of what work was done to verify all items
related to Schedule G amounts, i.e., repayment of the one-time credit, credit for sales tax paid
to wholesalers/suppliers, carry-over of the one-time credit and credit for tax paid to other states.
August 2005
General Audit Procedures
SPECIAL MOTOR VEHICLE FUEL TRANSACTIONS
0432.00
RETAILERS WHO PREMIX OR BLEND MOTOR VEHICLE FUEL AND LUBE OIL0432.10
A retailer who purchases motor vehicle fuel and adds lubricating oil thereby making premixed
fuel which they sell as boat fuel to consumers is technically acting as a supplier. Because of the
small quantities of premix blended by such retailers, and the insignificant amounts of gasoline
tax involved, it is not administratively practical to require them to be licensed as suppliers, post
bond, and file monthly returns.
Retailers (usually boat marinas) who purchase motor vehicle fuel and add lubricating oil, thereby
making premixed fuel which they sell to consumers are making taxable sales of premix and the
entire selling price, including state and federal excise taxes, is subject to sales and use tax.
RETAILERS WHO PURCHASE PREMIX FROM A SUPPLIER
0432.15
The auditor should see that the manufacturer-supplier of premixed fuel is licensed as a supplier,
or that wholesaler-supplier of premix fuel is licensed as a wholesaler.
CREDIT CARD SALES
0432.20
The service station operator is responsible for sales tax on the retail selling price of all motor
vehicle fuel and other products sold or delivered by them unless adequate support is maintained
for any deduction claimed. Duplicate credit card invoices generally are acceptable in support of
exempt transactions.
MASTER CONTRACT SALES
0432.25
Some oil companies enter into master sales contracts with consumers to provide motor vehicle
fuel and other products for delivery through company-owned or independent operator service
stations at specified prices. Examples of this are the contracts the State of California had with
some of the major oil companies for motor vehicle fuel and other supplies.
The oil company becomes the retailer of the fuel sold and delivered at the service station level
pursuant to the contract and is responsible for the sales tax on such sales. The independent
service station operator is making sales for resale and should obtain a resale certificate from the
oil company involved to cover such sales.
Generally, contract sales are recorded at the service station level on a credit card invoice at the
pump price which includes sales tax reimbursement. The purchaser is billed by the oil company
at the contract price plus sales tax reimbursement on the contract price. In reporting and paying
tax on these sales, the oil company is not allowed to claim a tax-paid purchases resold credit.
If the independent service station operator receives credit from the oil company for the full
amount of the credit card charge, the operator will be receiving credit for sales tax reimbursement.
Therefore, in addition to maintaining documentation as to the amount of the sale and the fact that
it is a sale for resale, the independent service station operator should have records to show that
sales tax reimbursement was not received and retained on any portion of the sale. In some cases,
this will consist of a computer listing received from the oil company, at the end of each accounting
period reflecting the charge back to the operator of the full amount of sales tax reimbursement on
the credit card invoices for master contract sales, and the amount of sales to which the tax applies.
August 2005
Audit Manual
SALES TO THE U.S. GOVERNMENT
0432.30
Generally these sales are recorded at the service station level on a credit card invoice at the
pump price which includes sales tax reimbursement. Since such sales are entirely exempt from
sales tax, the service station operator must have documentation to support the deduction. Some
oil companies make a charge back to the operator for the amount of the tax. The charge back is
supported by a computer printout notifying them of the amount of sales to the U.S. Government
included in their credit card sales. The charge back and printout are acceptable as proof of sales
to the U.S. Government.
In some instances, the burden of support for these exempt sales may fall entirely upon the
operator, in which case reliance would be placed on copies of credit card invoices reflecting that
the sale was to the U.S. Government and a reduction of the selling price by the amount of sales
tax included. Copies of such credit card invoices are acceptable as support for the deduction. It is
anticipated that, if necessary, the oil company credit card department will be able to furnish the
local operator with further documentation. In any event, the auditor should insist on adequate
support for the deduction.
SALES TO LOCAL GOVERNMENTS
0432.35
Sales to local government entities (cities, counties, and school districts) are made by local service
stations at regular pump prices. With the exception of a few local governments which have
participated in the State’s master contract, these sales generally are not made pursuant to any
negotiated contract, and the service station operator is responsible for reporting and paying the
sales tax. Sales to local governments who have participated in the State’s master contract should
be handled in the same manner as outlined in section 0432.25.
Sales of diesel and special motor vehicle fuels (excludes gasoline) to local governments are exempt
from the federal excise tax. However, it is the general practice to bill the total pump price on
the credit card sales slip. At the time the credit card invoice is turned into the oil company for
credit, the oil company normally credits the operator for the full amount of the invoice, including
sales tax. In turn, the oil company bills the local government the price shown on the credit card
invoice less the federal excise tax and charges sales tax reimbursement on the net amount. The
oil company then claims the credit as a deduction on its federal excise tax return. This results
in a reduction in the sales price of the motor vehicle fuel. If the oil company notifies the local
service station operator of the amount of federal excise tax not billed to local governments and
adjusts its credit to the operator for the amount of sales tax thereon, the operator is entitled to
adjust his reported gross receipts by the amount of the federal excise tax. If the operator receives
credit for the full pump price plus tax thereon, and no adjustment is made, the operator will be
held responsible for sales tax on the total amount of the sale since the operator’s gross receipts
remain unchanged.
Sales of gasoline to local governments are no longer exempt from the federal excise tax.
SALES OF GASOLINE FOR USE IN AIRCRAFT
0432.40
Sales of gasoline for use in propelling aircraft are exempt from sales tax provided the distribution
and sale of the gasoline is subject to the California motor vehicle fuel tax and not subject to refund.
Since January 1, 1990, no refund of any motor vehicle fuel tax has been granted for fuel used in
propelling aircraft. In recent years there has been increasing use of automotive gasoline to propel
small aircraft. The automotive gasoline is normally delivered into the aircraft when sold at an
airport, however automobile service stations may sell gasoline for use in propelling aircraft and
deliver it into the purchaser’s storage containers.
August 2005
General Audit Procedures
Sales of Gasoline for Use in Aircraft
(Cont.) 0432.40
The exemption for gasoline delivered directly into the fuel supply tank of an aircraft may be
supported by a properly completed sales invoice or an aircraft exemption certificate. If a sales
invoice is used, it must show the purchaser’s name and address, the aircraft identification number,
the number of gallons sold, the price per gallon, the amount of the sale, and the name and address
of the seller. If the aircraft fuel is delivered into the purchaser’s storage facilities, the exemption
should be supported by an aircraft fuel exemption certificate as well as a sales invoice. A suggested
form of an aircraft exemption certificate is included in Regulation 1598.
Gasoline used for inflight testing of aircraft is used for propulsion of aircraft and is exempt from
sales or use tax. This exemption applies only to gasoline used for propelling aircraft. Gasoline
used while the aircraft is stationary during construction or during the repair, modification, or
maintenance of aircraft is not exempt from the tax.
In years past, aviation gasoline was sometimes used in boats, motor vehicles, and stationary
equipment. Because of the high price and limited availability of aviation gasoline, these other
taxable uses will rarely be encountered.
SALES TO AIRCRAFT COMMON CARRIERS AND
OPERATORS OF WATERBORNE VESSELS
0432.45
Effective July 15, 1991, sales of fuel and petroleum products delivered to the purchasing carriers
in California are subject to sales tax except as provided by Regulation 1621(b)(3)(B) for air common
carriers. The seller must obtain an exemption certificate (See Regulation 1621) from the common
carrier to support the claimed exemption. Between July 15, 1991 and December 31, 2002, a
similar exemption existed for water common carriers. The water common carrier exemption was
discontinued from January 1, 2003 to March 31, 2004. The exemption was reinstated April 1,
2004 and remains in effect until January 1, 2014.
SALES TO AUTO LEASING FIRMS
0432.50
Sales of gasoline to firms leasing automobiles on a “wet rental” basis are sales for resale when
the lease of the automobile is a “continuing sale”. A “wet rental” is one in which the total rental
charge includes gasoline furnished by the lessor.
If the lessor has paid sales or use tax with respect to their purchase of a leased automobile, or if
the lease is of mobile transportation equipment, the lessor is the consumer of gasoline furnished
under a “wet rental,” unless the sales price of the gasoline is separately stated from the vehicle
rental charge.
Sales of gasoline to lessors for resale should be substantiated in the same manner as other sales
for resale. Independent service station operators should document such resales on credit card
purchases with a resale certificate and a copy of the sales slip or statement showing the amount
of the sale.
When a lessee on a “wet rental basis” purchases gasoline and is reimbursed by the lessor, the
purchase is subject to sales tax since the service station operator is making a retail sale.
August 2005
Audit Manual
SALES TO LESSORS OF MOBILE TRANSPORTATION EQUIPMENT
0432.55
Since leases of mobile transportation equipment are not continuing sales or purchases, the lessor
is the consumer of the equipment, and is also the consumer of gasoline furnished under a “wet
rental” when such lease is not a “sale or purchase” under the law. The lessor is the consumer
whether tax was paid on the cost of the equipment or a proper election was made measure their
use tax by the fair rental value of the equipment. Fair rental value does not include amounts
attributable to furnishing fuel. However, if the lessor holds themselves out as a retailer of the
gasoline by separately stating the selling price of the gasoline, plus the sales tax thereon, from
the equipment rental charge, they may properly purchase such gasoline for resale.
REFUND OF SALES TAX ON STATE MOTOR VEHICLE FUEL TAX REFUNDS 0432.60
State motor vehicle fuel tax refunded by the State Controller directly to the consumer is an
adjustment to the selling price of the gasoline. A consumer receiving such a refund may also
be eligible for a refund under the California Sales and Use Tax Law. The sections of the Sales
and Use Tax Law which previously permitted the Controller to refund or collect sales or use tax
in connection with these refunds was repealed effective January 1, 1990. Consumers must now
claim a refund of the sales and use tax from the retailer and the retailer must claim a refund
from the Board.
REFUND OF SALES TAX ON FEDERAL EXCISE TAX REFUNDS
0432.65
Refunds of the federal excise tax on gasoline, diesel, or jet fuel to consumers may also result in a
refund of the sales or use tax measured by the federal tax refund. The rate of federal excise tax
refund depends upon the type of off-highway use. Regulation 1598 requires the seller to obtain
a certificate from the purchaser if the purchaser is eligible for and receives a refund of or credit
for the federal excise tax. The certificate will relieve the seller of liability for collecting sales or
use tax on the amount of measure which represents the federal excise tax.
August 2005
General Audit Procedures
AUDIT OF FUEL DISTRIBUTORS/BROKERS —
PREPAYMENT OF SALES TAX
0433.00
GENERAL0433.05
Fuels subject to the requirement to precollect sales tax include gasoline and gasohol (motor vehicle
fuel); diesel, including dyed diesel; and aircraft jet fuel. Wholesalers and suppliers of these fuels
are required to collect a prepayment of a portion of the sales tax when they remove fuel at the
terminal rack, enter fuel into California, or sell the fuels at any point after removal from the
terminal rack. Retailers or other sellers of fuel who have prepaid the sales tax to their suppliers
may claim a credit for that prepaid tax when they file their sales and use tax returns.
Each supplier and wholesaler must furnish their customer with a receipt or invoice separately
stating the amount of precollected tax. Suppliers and wholesalers are required to show their “SG”
account number on their receipts and invoices.
All taxpayers holding an “SG” account, must have this account investigated in conjunction with
their related sales and use tax account even though only one or two quarters may be involved.
This procedure will facilitate alignment of the “SG” accounts with their related sales and use tax
account and ensure that amounts are being properly reported.
Amounts reported under the “SG” program will be posted to a BOE—414—SG Transcript of
Returns Filed – SG Fuel Accounts.
PREPAYMENT CREDITS
0433.10
The amount of prepayment paid by a supplier or wholesaler to their supplier on the purchase
of MVF will constitute a credit against the amount required to be collected and remitted to the
Board on their prepayment return. Credits are to be taken for the period in which the purchase
was made. All credits claimed must be supported by purchase documents, invoices and receipts
which separately state the amount of tax prepaid. All purchase documents should be retained in
the same manner as other books and records.
AUDITING PROCEDURE
0433.15
An inventory reconciliation should be made to verify that recorded withdrawals are correctly
reported in gallons. Total gallons sold (excluding exempt sales) times the prepayment rate should
agree with the reported prepayment of sales tax.
On occasion a supplier/wholesaler will sell gasoline at retail, claim the prepayment credit on
their SG return and not pass the credit on to their retail account. Rather than assessing the
“SG” account and crediting the related sales tax account, the auditor should comment on the
back of the audit report/FBO or on the front of the BOE–596 under general comments, that a
prepayment offset has been allowed. These comments will assist the Audit Determination and
Refund Section in their reconciliation of the sales tax prepayments on MVF by noting that the
problem has been addressed.
Where a supplier/wholesaler makes their first sale at retail (into the tank of a motor vehicle) and
nets the precollection and credit from both the “SG” and sales and use tax return, the auditor
need not adjust the return amounts.
August 2005
Audit Manual
REPORTING ERRORS
0433.20
When a notified supplier/wholesaler fails to collect the prepayment on their sale/transfer of MVF
subject to the prepayment requirements, but can prove that the full sales tax has been subsequently
reported, a notation to that effect should be made in the audit and such amounts should not be
determined against the supplier/wholesaler. In such an instance, the supplier or wholesaler
should be notified in writing of the precollection requirements. If the supplier/wholesaler has
not shown the precollection on the invoice and is unable to prove that the sales and use taxes
due have been paid, the amount of unreported precollections should be determined against the
supplier/wholesaler.
AUDIT WORKING PAPERS
0433.25
Schedule numbers should correlate with the line numbers on the “SG” return (e.g., Schedule
2.1 Fuel sold to the United States Government or its agencies and instrumentalities). Audited
differences for each line category will be forwarded to a “Summary of Differences” Schedule,
414–SG–1.
Audited differences for “Tax Prepaid to California Vendors,” should also be forwarded to Schedule
414–SG–1. A detailed breakdown of audited amounts must be provided by month, vendor name
and “SG” account number. This schedule should accompany the audit report sent to the Audit
Determination and Refund Section.
BAD DEBTS
0433.30
A refund of the prepayment may be allowed to any person who is unable to collect the prepayment
from the purchaser, insofar as the sales of the fuel are represented by accounts which have been
found to be worthless and charged off for income tax purposes. If any of those accounts are
thereafter collected by the seller, the gallons of fuel represented by the amounts collected must be
included in the next return and the prepayment on those gallons of fuel must be paid to the state.
LOCAL TAX ALLOCATION
0433.35
No local sales and use tax allocation is involved since no allocation of funds is made until the
prepayments are claimed by the retailer.
NEW CAR DEALERS
0433.40
Many new car dealers importing new vehicles into this state with partially filled fuel tanks are
making the first taxable sale of such fuel when the vehicle is sold at retail. Amounts attributable
to such importation are generally considered too minimal to warrant registration of such dealers
as suppliers under the MVF Tax Law or the “SG” program. However, dealers who purchase
gasoline for subsequent retail sale must be coded “G” (MVF retailer) and may require registration
as a wholesaler, depending upon the type of operation.
August 2005
General Audit Procedures
CREDIT OFFSETS
0434.00
In the following examples, it is irrelevant whether the credit offsets or overpayments were
determined on an actual basis or sample examination. (See section 0402.20 for a discussion of
the approach to auditing credits or refunds).
CLAIM FOR REFUND FILED WHILE AUDIT DETERMINATION IN
PETITION STATUS OR WITHIN SIX MONTHS OF FINALITY DATE
0434.05
When a claim for refund is filed for overpayments that were made during a period for which
an audit determination was issued and the determination is in petition status or the claim is
filed within six months of the date that the determination became final, the entire period of the
determination is open to a credit offset adjustment. All overpayments made within the period of
the determination may be offset against the total liability even if the overpayments are beyond
the statutory period of the claim (i.e. three years from the date that the claim is filed). If the total
liability is offset, any remaining overpayments within the statutory period of the claim may be
refunded to the taxpayer. Only overpayments within the statutory period of the claim may be
refunded to a taxpayer. Overpayments outside the statutory period of the claim but within the
determination period may only be used to offset liabilities.
Overpayments, beginning with the earliest within the period of the determination, will be applied
in the quarter that they occurred without regard to the amount of the quarterly liabilities until the
total amount of the liability is offset (Col. C below). If the total liability is offset, any remaining
overpayments within the statutory period of the claim may be refunded to the taxpayer (Col. E
below). The following example illustrates these procedures.
(A)
Periods
2-94
3-94
4-94
1-95
2-95
3-95
4-95
1-96
2-96
3-96
4-96
1-97
Totals
NOTES:
(B)
Taxable Measure Claim for Refund²
per Audit
(Bad Debts not
Determination¹
Claimed)
$15000
19000
30000
9000
5000
12000
23000
24000
10000
13000
4000
15000
$179000
$81000
0
0
-50000
-33000
-40000
-44000
0
-15000
0
-22000
-10000
$-295000
(C)
Offsets³
$-81000
0
0
-50000
-33000
-15000
$-179000
(D)
(E)
Overpayments
Measure of Tax
Outside Statutes 4 per Reaudit 5
(Disallowed)
(B-C-D)
0
0
0
0
0
0
0
0
-15000
0
-22000
-10000
$-47000
-25000
-44000
$-69000
1. Notice of Determination issued on 10/01/98 for the audit period 04/01/94 to 03/31/97. Determination
will become final on 10/31/98 or is in petition status.
2. Claim for refund filed 03/01/99 for bad debts not claimed and not adjusted in the audit. Claim for
refund timely for statutory period 01/01/96 to 03/31/97. Claim for refund also opens period 04/01/94
through 12/31/95 for offsets to 0.
3. Overpayments starting with the earliest period of the claim applied against the total taxable measure
per audit determination until it is completely offset.
4. Remaining overpayments outside statutory period of the claim disallowed.
5. Remaining overpayments within statutory period of claim that are available for refund.
August 2005
Audit Manual
CLAIM FOR REFUND FILED WHEN AUDIT DETERMINATION NOT IN
PETITION STATUS OR MORE THAN SIX MONTHS
AFTER FINALITY DATE
0434.10
When a claim for refund is filed for overpayments that were made during a period for which an
audit determination was issued and the determination is not in petition status and the claim is
filed more than six months after the determination became final, only the overpayments made
within the statutory period of the claim (i.e. three years from the date that the claim was filed)
are available to apply as credit offset adjustments. The overpayments made within the statutory
period of the claim may be offset against corresponding quarterly liabilities on a quarter by quarter
basis. The overpayments outside of the statutory period of the claim cannot be used to offset
liabilities and are disallowed.
Accordingly, the overpayments within the statutory period of the claim will be applied in the
quarter that they occurred against corresponding quarterly liabilities (Col. C below). No credit
offsets will be made outside of the statutory period of the claim. The following example illustrates
these procedures.
(A)
Periods
(B)
Taxable Measure
per Audit
Determination¹
(C)
(D)
Claim for Refund²
Overpayments
Measure
(Bad Debts not
Overpayments Outside Statutes4
of Tax per
Claimed)
Allowed 3
(Disallowed)
Reaudit (A+C)
2-94
$15000
$-81000
3-94
19000
0
4-94
30000
0
1-95
9000
-50000
2-95
5000
-33000
3-95
12000
-40000
4-95
23000
-44000
1-96
24000
0
2-96
10000
-15000
$-15000
3-96
13000
0
0
4-96
4000
-22000
-22000
1-97
15000
-10000
-10000
$179000
$-295000
$-47000
Totals
NOTES:
(E)
$-81000
0
0
-50000
-33000
-40000
-44000
0
$15000
1900
30000
9000
5000
12000
23000
2400
-5000
1300
-18000
5000
$-248000
$132000
1. Notice of Determination for the original audit issued on 08/01/98 for the audit period of 04/01/94 to 03/31/97.
Determination became final on 08/31/98.
2. Claim for refund filed 03/01/99 for bad debts not claimed and not adjusted in the audit. Claim for refund timely
for refund purposes for statutory period 01/01/96 to 03/31/97. Claim for Refund not timely for offset purposes
for period 04/01/94 to 12/31/95.
3. Overpayments within the statutory period of the claim applied against corresponding quarterly liabilities.
4. Overpayments outside statutory period of claim disallowed.
August 2005
General Audit Procedures
SPLIT BILLINGS
0434.15
When a claim for refund is filed for overpayments that were made during an audit period for which
both a phone-in determination and an audit determination were issued, offset rules will apply to
each determination separately.
If the claim for refund is filed while the phone-in determination is in petition status or within
six months of the date that the phone-in determination became final, the period of the phonein determination is open to adjustment. Overpayments claimed during this period may be
offset against the amount of the phone-in liability even if the overpayments are beyond the
statutory period of the claim. If any overpayments remain after the phone-in liability is offset,
they may be refunded to the taxpayer if they are within the statutory period of the claim. Any
remaining overpayments outside of the statutory period of the claim may not be refunded to
the taxpayer nor offset against the audit determination. Such remaining overpayments should
be disallowed.
Additionally, if the claim for refund is filed while the audit determination is in petition status
or within six months of the date that the audit determination became final, the period of the
audit determination is open to adjustment. Overpayments claimed during this period, beginning
with the earliest, may be offset against the total liability for the audit determination even if the
overpayments are beyond the statutory period of the claim. If the total liability of the audit
determination is offset, any remaining overpayments within the statuary period of the claim may
be refunded to the taxpayer. Any remaining overpayments outside the statutory period of the
claim may not be refunded to the taxpayer. Such remaining overpayments should be disallowed.
Only overpayments that fall within the period of the phone-in determination, can be offset
against that determination. Likewise, only overpayments that fall within the period of the audit
determination can be offset against that determination. The following examples illustrate some
applications of offsets when a claim for refund is filed timely for audit periods covered by an audit
determination but not timely for periods covered by a phone-in determination.
August 2005
Audit Manual
CLAIM FOR REFUND FILED TIMELY FOR AUDIT DETERMINATION
BUT NOT FOR PHONE-IN DETERMINATION
(A)
(B)
(C)
Taxable
Taxable
Measure
Claim for
Measure per
Phone-In
per Audit
Refund (Bad
Periods Determination¹ Determination²
Debts)³
2-94
$15000
(D)
(E)
Offsets4
0434.20
(F)
(G)
Overpayments Taxable
Taxable
Outside
Measure
Measure
Statutes
per Phone- per Reaudit5
(Disallowed)
In (A-D)
(C-D-E)
$-81000
$0
$-81000
$15000
$0
0
0
0
3-94
19000
4-94
30000
0
0
0
1-95
9000
-50000
-50000
0
2-95
5000
-33000
-33000
0
3-95
12000
-40000
-40000
0
4-95
23000
-44000
-41000
1-96
24000
0
0
2-96
10000
-15000
-15000
3-96
13000
0
0
4-96
4000
-22000
-22000
1-97
15000
-10000
-10000
Totals
$15000
$164000
$-295000 $-164000
-3000
$-84000
0
$15000
$-47000
Notes:
1. 2–Q–94 liability phoned-in on 07/20/97, determination issued on 07/25/97, and became final on
08/25/97.
2. Waiver was obtained through 10/31/98 and the audit determination was issued on 09/15/98 for the
period 07/01/94 to 03/31/97. The determination became final on 10/15/98.
3. Claim for refund filed on 03/01/99. Neither phone-in nor audit determination in petition status.
Claim for refund not timely for refunds or offsets for 2–Q–94 liability per phone-in determination
(beyond six months of finality date). However, claim for refund is timely for audit determination
for purposes of offsets for period 07/01/94 to 12/31/95 and refunds for statutory periods of 01/01/96
to 03/31/97 (within six months of finality date).
4. Overpayments, beginning with the earliest made during the period of the audit determination,
applied against the total taxable measure per audit determination until it is completely offset.
5. Balance of overpayments within statutory period of claim that are available for refund.
August 2005
General Audit Procedures
APPLICATION OF OVERPAYMENTS TO EXPIRED
LIABILITIES BUT WITHIN THE CLAIM FOR REFUND PERIOD10434.30
A timely filed Claim for Refund opens up the entire claim period to the assessment of underpaid
tax as well as overpaid tax. This is true even if the statute of limitations for part or all of the
claim period has otherwise expired. As such, even though the Board of Equalization is barred
from issuing a deficiency determination for the expired periods, auditors should apply any
underpayments discovered to the verified overpayments up to the point the claim is reduced to
zero. Underpayments may be offset against any overpayment period within the claim, not just the
period in which the underpayment occurred. However, if an underpayment occurred in an expired
period that is not included in the Claim for Refund, it cannot be used to offset any overpayments.
In the following examples, a timely Claim for Refund was received for the period 1Q02-2Q04.
Subsequently, based upon the volume of records required to validate the claim, it was decided to
audit the taxpayer’s records and a waiver for the period 3Q04 & 4Q04 was obtained to protect the
statute of limitations. Column C represents the allowable refund measure for each period and
Column F represents the additional debit measure disclosed in the audit. Column G is the net
debit or credit measure. Column H displays the periods with net credits that may be offset by debit
measure from other periods. Credit measure should be offset in the earliest periods first. For
example, the credit disclosed in 2Q02 (-$10,000) should be applied to the 1Q02 liability ($30,000)
and not subsequent liabilities. Doing so minimizes the impact of fluctuations in quarterly debit
and credit interest.
In Example 1, total debit measure of $790,000 is disclosed for the claim period. After the claimed
credit amounts are offset by the additional debit measure disclosed, a net credit measure of $10,000
is remaining for the claim period. This amount is included in Column K, “Measure per Audit”
and will be refunded to the taxpayer.
In Example 2, total debit measure of $830,000 is disclosed for the claim period. Of that amount,
$800,000 is offset by available credits. The balance of $30,000 cannot be assessed or offset and
is excluded from Col K, “Measure per Audit.”
1
California Court of Appeals decision Sprint Communications Company v. State Board of Equalization (1995) 40
Cal.App.4th 1254
August 2005
Audit Manual
Application of Overpayments to Expired
Liabilities But Within the Claim for Refund Period
(Cont. 1) 0434.30
In Example 1, total debit measure of $790,000 is disclosed for the claim period. After the
claimed credit amounts are offset by the additional debit measure disclosed, a net credit
measure of $10,000 is remaining for the claim period. This amount is included in Column K,
“Measure per Audit” and will be refunded to the taxpayer.
SCHEDULE: 12 A
012-345678
Auditor: J. Smith
01/10/09
EXAMPLE #1: Period of Timely Claim for Refund is 1/1/02 to 6/30/04.
A
B
D
E
CREDIT MEAS. DEBIT MEAS. DEBIT MEAS.
<12C>
<12D>
<12B>
1
1Q-02
-100,000
60,000
70,000
2
2Q-02
-20,000
10,000
0
3
3Q-02
-80,000
10,000
30,000
4
4Q-02
-50,000
110,000
10,000
5
1Q-03
-50,000
10,000
60,000
6
2Q-03
-220,000
10,000
30,000
7
3Q-03
-30,000
60,000
140,000
8
4Q-03
-90,000
120,000
10,000
9
1Q-04
-40,000
10,000
10,000
10
2Q-04
-120,000
20,000
10,000
Claim Period Total
-800,000
420,000
370,000
11
3Q-04
-50,000
12
4Q-04
-220,000
13
1Q-05
-30,000
14
2Q-05
-150,000
15
3Q-05
0
16
4Q-05
0
17
1Q-06
0
18
2Q-06
0
19
TOTALS
-1,250,000
420,000
370,000
REF
PERIOD
C
F
G
TOTAL
DEBIT
MEAS.
(D+E)
130,000
10,000
40,000
120,000
70,000
40,000
200,000
130,000
20,000
30,000
790,000
0
0
0
0
0
0
0
0
790,000
NET
MEAS.
(C+F)
30,000
-10,000
-40,000
70,000
20,000
-180,000
170,000
40,000
-20,000
-90,000
-10,000
-50,000
-220,000
-30,000
-150,000
0
0
0
0
-460,000
H
I
J
K
CREDITS
AVAILABLE
TO OFFSET
OUTLAWED OUTLAWED
MEASURE
DEBITS
DEBITS
OFFSETS PER AUDIT
30,000
-10,000
-40,000
70,000
20,000
-180,000
170,000
40,000
-20,000
-90,000
-340,000
0
0
0
0
0
0
0
0
-340,000
330,000
0
0
0
0
0
0
0
0
330,000
-30,000
10,000
40,000
-70,000
-20,000
180,000
-170,000
-40,000
20,000
80,000
0
0
0
0
0
0
0
0
0
0
0
-10,000
-10,000
-50,000
-220,000
-30,000
-150,000
0
0
0
0
-460,000
There is a net refund for the claim period. All debits may be offset and the net credit amount for the claim
period is subject to refund or offset to periods still open under the statutes.
The difference between the totals of Column C and Column F must be equal to either a credit amount or
zero (0). It cannot be a debit amount.
The difference between the total of Column C and Column F must equal Column K for the Claim Period
(1Q02-2Q04).
The totals in Column K reflect the credit allowed after applying all offsets as well as that portion of the
refund for which either a waiver of limitation was secured or the periods are still open under the three
year statute.
March 2010
General Audit Procedures
Application of Overpayments to Expired
Liabilities But Within the Claim for Refund Period
(Cont. 2) 0434.30
In Example 2, total debit measure of $830,000 is disclosed for the claim period. Of that amount,
$800,000 is offset by available credits. The balance of $30,000 cannot be assessed or offset
and is excluded from Col K, “Measure per Audit.”
SCHEDULE: 12 A
012-345678
Auditor: J. Smith
01/10/09
EXAMPLE #2: Period of Timely Claim for Refund is 1/1/02 to 6/30/04.
A
B
REF
PERIOD
1
1Q-02
2
2Q-02
3
3Q-02
4
4Q-02
5
1Q-03
6
2Q-03
7
3Q-03
8
4Q-03
9
1Q-04
10
2Q-04
Claim Period Total
11
3Q-04
12
4Q-04
13
1Q-05
14
2Q-05
15
3Q-05
16
4Q-05
17
1Q-06
18
2Q-06
19
TOTALS
C
D
E
F
CREDIT
TOTAL DEBIT
MEAS.
DEBIT MEAS. DEBIT MEAS.
MEAS.
<12C>
<12D>
<12B>
(D+E)
-100,000
60,000
70,000
130,000
-20,000
10,000
0
10,000
-80,000
10,000
30,000
40,000
-50,000
110,000
10,000
120,000
-50,000
10,000
60,000
70,000
-220,000
10,000
30,000
40,000
-30,000
60,000
140,000
200,000
-90,000
120,000
10,000
130,000
-40,000
10,000
10,000
20,000
-120,000
20,000
50,000
70,000
-800,000
420,000
410,000
830,000
-50,000
0
-220,000
0
-30,000
0
-150,000
0
0
0
0
0
0
0
0
0
-1,250,000
420,000
410,000
830,000
G
H
I
J
K
CREDITS
AVAILABLE
TO OFFSET
MEASURE
OUTLAWED OUTLAWE
PER
NET MEAS.
DEBITS
D DEBITS OFFSETS
AUDIT
(C+F)
30,000
30,000
-30,000
0
-10,000
-10,000
10,000
0
-40,000
-40,000
40,000
0
70,000
70,000
-70,000
0
20,000
20,000
-20,000
0
-180,000
-180,000
180,000
0
170,000
170,000
-170,000
0
40,000
40,000
-10,000
0 (1)
-20,000
-20,000
20,000
0
-50,000
-50,000
50,000
0
30,000
-300,000
330,000
0
0
-50,000
0
0
-50,000
-220,000
0
0
-220,000
-30,000
0
0
-30,000
-150,000
0
0
-150,000
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
-420,000
-300,000
330,000
0
-450,000
(1) Offsets can only be applied to debits using credits within the claim period. The available
credits during the claim period totalled $300,000 and the debits disclosed were $330,000. The
remaining debit measure of $30,000 cannot be assessed due to the statute of limitations. The
measure of tax will only include post claim period credits and debits.
The difference between the total of Column C and Column F during the claim period must be
equal to either a credit amount or zero (0). It cannot be a debit amount. In the example above,
the $30,000 remaining debit amount on Line 8 was eliminated because there was no remaining
credit measure in the claim period.
The difference between the total of Column C and Column F will not equal Column K for the
claim period (1Q02-2Q04). The totals in Column K reflect the credit allowed after applying all
offsets as well as that portion of the refund for which either a waiver of limitation was secured
or the periods are still open under the three year statute.
March 2010
Audit Manual
OFFSETTING INTEREST ON CLAIMS FOR REFUND
FILED DURING AN AUDIT 0434.32
The efficiency of the audit process is improved by discussing the possibility of claims for refund
with the taxpayer at the opening conference. To avoid delaying the timely completion of an audit,
the auditor should make every effort to obtain any claims for refund as soon as possible.
Refund claims filed with supporting documentation are to be included as part of the audit report
when there is sufficient time to address the adjustments in the AWPs. Generally, if a taxpayer
files a claim for refund prior to the completion of the audit (i.e., the exit conference), and the
taxpayer provides complete and acceptable supporting documentation, the auditor should process
the refund claim as part of the audit report with credits offsetting the liabilities during the audit
period. Districts should consider whether to hold or transmit the audit based on the best interest
of the board and the taxpayer, considering such issues as the size of the account, number of claims
involved, etc. If the claim is filed prior to completion of the audit but additional time is requested to
compile supporting documentation which, when considering the time to verify the documentation,
will delay the audit more than ninety (90) days, the claim should generally be processed separately
as a reaudit. If the refund claim includes periods outside of the audit period, the portion of the
claim outside the audit period should be processed as a Field Billing Order (FBO). Hours spent
verifying refund claims should be noted in the “General Audit Comments” section of the audit
report as set forth by the policy in AM section 0206.48, Overpayment Comments.
Requests for extensions to provide supporting documentation should follow the policy set forth in
AM section 0402.25, Waiver of Credit Interest Policy. There may be instances where it is appropriate
to obtain a waiver of credit interest, however, the taxpayer is entitled to an offset of debit interest
on the original audit liability when the claim is processed in a reaudit. If the taxpayer cannot
provide supporting documentation within the timeframes set forth in AM section 0402.25, the
claim should be denied.
In cases where a claim for refund is filed after the completion of the audit and is therefore not
addressed in the original AWPs, and the liability is in petition status, adjustments shall be included
as part of the reaudit when warranted. Claims for refund within the audit period filed within
six months of the date the determination became final are open to a credit offset adjustment and
shall be processed as part of a reaudit in accordance with AM section 0703.05.
For more detailed information regarding credit offset adjustments, refer to AM section 0434.00,
Credit Offsets.
January 2014
General Audit Procedures
MANAGED AUDIT PROGRAM
0435.00
The board’s first Managed Audit Program (MAP) was available to taxpayers from January 1,
1998 to January 1, 2003. There was no MAP in 2003. Beginning January 1, 2004, the MAP was
reinstated through December 31, 2009. The new MAP differs from the previous program in that
in the new program:
• Prepayment accounts may participate.
• The Board may grant relief of liability under Revenue and Taxation Code section 6596 in
cases where taxpayers who have participated in the MAP rely on erroneous advice from
the Board and fail to pay amounts due.
The information in the following sections reflects the provisions of the MAP beginning January
1, 2004.
MANAGED AUDIT PROGRAM – GENERAL
0435.05
A managed audit is essentially a self-audit. Under the direction of the auditor, an eligible taxpayer
is provided written and oral instructions to enable the taxpayer to perform the audit verification
and prepare the AWPs necessary to complete a particular portion of the audit. The advantages
to the taxpayer and to the state include the following:
• It is less likely that the taxpayer will feel it necessary to take audit issues through the
administrative appeals process or litigate audit findings.
• The auditor will spend fewer hours on the audit and fewer hours at the taxpayer’s business.
• Questions of taxability are more likely to be resolved during the audit process.
• The taxpayer is likely to become more knowledgeable about how the sales and use tax
affects his/her business.
• Because of the knowledge gained from the managed audit, it is less likely that the taxpayer
will be out of compliance in those areas he/she has audited.
• The taxpayer will be more familiar with the audit process.
• It is likely that a more cooperative, ongoing relationship with the Board will be established.
• Where a liability is disclosed, interest will be computed at one-half the normal rate.
• RTC section 6596 relief may be provided in cases where taxpayers who have participated
in the MAP rely on erroneous advice from the Board and fail to pay amounts due.
August 2008
Audit Manual
ELIGIBLE ACCOUNTS
0435.10
It is extremely important that the auditor conduct a thorough review of the taxpayer’s operations
prior to proceeding into the managed audit process. Taxpayers should not be considered a candidate
for the managed audit process if their business operations consist of transactions which require
an in depth knowledge of the law.
While it is the auditor’s responsibility to determine whether a taxpayer is eligible to participate
in a managed audit, a taxpayer may initiate the review process by requesting a managed audit be
conducted. For example, taxpayers seeking a tax clearance or who have been notified of audit may
wish to conduct a managed audit to expedite the clearance or routine audit process. The auditor
should consider all reasonable requests for participation, keeping in mind our primary goal is
the cost savings in audit hours that can be used to perform other productive audits. Accordingly,
interested taxpayers should submit their request for participation to the appropriate District
Administrator/District Principal Auditor. In that application, the taxpayer is required to clearly
explain how they meet the statutory requirements of RTC section 7076.
Accounts that may be eligible for the MAP shall include those meeting all of the following criteria:
• Any person whose business involves few or no exemptions;
• Any person whose business involves a single or small number of clearly defined taxability
issues;
• Any person who agrees to participate in the MAP; and,
• Any person who has the resources to comply with the managed audit instructions provided
by the Board.
Examples of situations in which a managed audit should not be used include cases where:
•
•
•
•
•
The taxpayer’s books and records are inadequate;
The taxpayer has complex issues relating to the allocation or reallocation of local tax;
The taxpayer is a business with inadequate achieved markups;
The issues involved are very complex (for example, research and development contracts); or
There is a question regarding negligence or intentional under reporting (fraud).
Although eligibility provisions contain some restrictive language, this should be balanced with the
taxpayer and/or representative’s level of sophistication in understanding and dealing with any
issues that may arise. Any inquiries regarding the eligibility of an account for the MAP should be
sent by the District Principal Auditor to the Chief, Tax Policy Division, with a copy to the Deputy
Director, Field Operations Department (FOD).
August 2008
General Audit Procedures
APPLICATION OF INTEREST AND PENALTIES
0435.15
(a) Interest
If a tax liability is disclosed as a result of an approved MAP audit, and the audit is completed
pursuant to the participation agreement, interest will be computed at one-half the normal
statutory interest rate for the total unreported tax liability. Interest will be calculated
using the standard interest rate calculation rules, but at one-half the normal rate until
the tax liability is paid in full unless the Board voids the agreement.
The one-half interest rate will apply even if the entire audit was not performed under a
MAP audit and even if the portion performed by the auditor results in a tax liability. For
example:
• An audit is conducted on a manufacturer whose only deduction is for sales for resale.
• It is agreed that the taxpayer will perform a managed audit of sales for resale and
asset purchases, which discloses additional tax liability. This review would normally
comprise a substantial portion of the audit if performed by the auditor.
• The review of lease transactions by the auditor also discloses additional tax liability.
This portion of the audit is not deemed to be conducive to taxpayer review, and does
not entail much expenditure of time by the auditor.
Under these circumstances the entire tax liability would be computed at the one-half
interest rate since there was a MAP Participation Agreement. If the Board determines
that the taxpayer fails to comply with the provisions of the agreement or complete its
portion of the MAP and the auditor finds it necessary to perform a significant amount of
verification, the one-half interest rate will not apply. This will also be true if a negligence
or fraud penalty is imposed during the audit period. (See AM section 0435.20(b).)
If the MAP audit results in a credit or refund, the standard net running balance method
will be used to compute interest. If the audit has both debit and credit periods, the onehalf interest rate would apply for debit periods and the full statutory credit interest rate
would apply for credit periods.
(b) Penalties
There is no change to procedures for applying penalties as warranted under the MAP.
However, if after their preliminary review of records, the auditor believes that the taxpayer
was negligent, a managed audit should not be conducted. Nor should the managed audit
be used if the auditor believes there was fraud during the audit period.
(c) Petitions for Redetermination or Claims for Refund
There is no change to procedures for filing timely petitions or claims for refund for managed
audits.
August 2008
Audit Manual
AUDIT PROCEDURE
0435.20
The MAP can be a valuable tool in streamlining the audit process. It is designed to reduce the
time it takes to complete an audit and minimize the burden on taxpayers. When planning the
audit, supervisors and auditors should evaluate whether the taxpayer is eligible for the use of a
MAP. This evaluation should be conducted whether or not the taxpayer has already requested
the use of a MAP.
It is primarily the responsibility of the auditor to determine whether a taxpayer should be
considered for the MAP. However, it is the The auditor’s immediate supervisor who is responsible
for approval of the auditor’s recommendation. If the taxpayer is eligible for use of a MAP, the
auditor should discuss the MAP with the taxpayer as soon as possible rather than wait for the
taxpayer to request using a MAP. The date of the discussion with the taxpayer and the taxpayer’s
response should be documented on Form BOE-414-Z. A decision that the taxpayer is not eligible
should also be explained and documented on Form BOE-414-Z.
(a) Preliminary Review
As part of the normal audit procedure, auditors will review the taxpayer’s operations and
determine whether the taxpayer meets the minimum eligibility requirements described
in AM section 0435.10. This includes a facility tour (if appropriate); a review of the chart
of accounts, general ledger, Federal Income Tax returns, sales journals, sales invoices,
depreciation schedules, purchase invoices, sales and use tax returns, and reporting
procedures; and an evaluation of the taxability of the sales and/or purchases, as well as of
the taxpayer’s knowledge and understanding of the tax laws applicable to the transactions
being reviewed. In addition to the minimum eligibility requirements for the MAP, the
taxpayer must also agree to perform a significant portion of the audit.
The auditor may also consider the use of a Computer Audit Specialist to improve audit
efficiency (reduce audit hours) if the account meets the criteria outlined in AM section
1304.40.
If all or a portion of the audit is allowed under MAP, any resulting tax liability, even for
those areas of non-MAP, will be computed at the one-half interest rate. For this reason,
the auditor must exercise good judgment in considering accounts for eligibility under the
MAP.
Following is an example of a taxpayer that would not be eligible under the MAP:
• An audit is conducted on a manufacturer whose only deduction is for sales for resale.
• After initial review of records, the auditor finds significant problems with the taxpayer’s
internal controls, missing sales invoices, and/or a total lack of documentation to support
claimed resales.
• It is necessary for the auditor to perform the test of resales, and this will involve a
significant amount of time — similar to time that would normally be expended on the
audit.
• Also during the review, the auditor finds there are very few purchases that may be
subject to use tax and that this will involve an amount of time similar to that on an audit.
In this case, the taxpayer should not be considered for a MAP audit or receive the benefit
of the one-half interest rate because participation in a MAP would be of little benefit to
the state in reduction of audit hours.
September 2012
General Audit Procedures
Audit Procedure
(Cont. 1) 0435.20
(b) Managed Audit Program Participation Agreement
After the auditor has discussed the taxpayer’s eligibility for the MAP with his/her supervisor
and they are in agreement with the taxpayer’s participation, the taxpayer should be
presented with Publication 53, Guide to the Managed Audit Program which includes the
Form BOE–526, Managed Audit Program Participation Agreement. The provisions of the
MAP should be explained to the taxpayer. If the taxpayer agrees to participate in the
MAP, Form BOE–526 will be completed by the auditor with the following information:
• Taxpayer’s name and account number;
• Audit period;
• A reasonable time period (generally within 90 days) the taxpayer is allowed to complete
the work. However, the auditor should use his or her discretion to accommodate larger
business operations;
• Deadlines to complete the review of each transaction type or record, e.g., claimed
deductions, purchases of consumable supplies, etc.;
Information on the types of transactions and records to be reviewed; and
• The method for review and the periods for the records to be reviewed.
This agreement will then be signed and dated by the taxpayer and the District Principal
The MAP participation agreement will then be signed and dated by the taxpayer and the
District Principal Auditor. A copy of the signed agreement will be provided to the taxpayer.
The original signed agreement and a copy must be attached to the audit report (see AM
section 0213.03).
The Board may void the MAP participation agreement if it determines that:
• The taxpayer has failed to complete the managed audit by the due date in accordance with
the provisions in this agreement;
• The apparent nature and/or complexity of the taxpayer’s operations and/or transactions
require greater levels of review, research or verification than was originally anticipated;
• The taxpayer has refused to cooperate with the Board during the verification process
described in paragraph 4 of the agreement or has refused to cooperate with the Board if
it audits any transactions pursuant to paragraph 5 of the agreement;
• Any penalties for negligence or fraud are imposed during the audit period under RTC
sections 6484, 6485, 6485.1, or 6514.1;
• There is jeopardy of collection under 6536; or
• The payment of the liabilities and interest was not made within the time period specified
by the Board.
At least 15 days prior to the completion date indicated in the MAP participation agreement, the
auditor’s supervisor will send the taxpayer a letter reminding the taxpayer that the managed
audit must be completed and documented by the mutually agreed upon completion date. If the
review is not completed by the agreed upon date, the MAP participation agreement will be voided
and the full interest rate will apply to any audit liability.
If the taxpayer requests an extension of the agreed upon completion date, they must obtain
approval from the District Principal Auditor. If an extension is approved, the MAP participation
agreement should be revised to reflect the new completion date.
The auditor will document the taxpayer’s actions on Form BOE–414–Z, Assignment Contact
History.
August 2008
Audit Manual
Audit Procedure
(Cont. 2) 0435.20
Before the Board voids a MAP participation agreement, a summary of the specific circumstances
of the case and reasons for voiding the agreement must be provided to the Deputy Director, FOD.
Upon approval by the Deputy Director, FOD, the District Principal Auditor will send the taxpayer
a written notification of the termination of the MAP participation agreement, and the reasons
for such termination. The front of the audit report should continue to be marked as MAP for
program evaluation purposes with an explanation for the termination shown on the back of the
audit report. Also, the AUD MC screen in IRIS should have the flag set to “N” for managed audit,
otherwise, the reduction in the interest rate will be triggered.
Participation in the MAP is voluntary on the part of the taxpayer. None of the above actions by
the taxpayer should have a negative impact on how the audit is completed or the scope of the
audit verification to be performed by the auditor. The only impact will be that the taxpayer will
not receive the benefit of the one-half interest rate should the audit result in a tax liability.
(c) Verification of Taxpayer’s Examination
A very important factor for the success of the MAP is the verification of work performed by
the taxpayer. While it is not expected, nor necessary, that the auditor check 100 percent of
the work performed by the taxpayer, the auditor should conduct a review of the work to the
extent that the auditor is satisfied that the work performed is accurate. This verification
should confirm that the instructions provided to the taxpayer were followed accurately
and that any problem areas of taxability were sufficiently addressed. The auditor should
instruct the taxpayer to separately maintain the records (sales invoices, purchase orders,
resale certificates, etc.) that the taxpayer used in its examination until the auditor verifies
the taxpayer’s examination.
(d) Audit Comments
The verification comments should describe test and verification procedures used by the
taxpayer and auditor. In addition, comments should be made regarding any discussions
with the taxpayer regarding areas of under reporting.
(e) Audit Report
The audit report should be prepared by the auditor and transmitted using normal
procedures; however, a notation should be made on the top right corner on the front page
of the audit report indicating that this is a managed audit.
The Audit Determination and Refund Section will ensure that the interest calculation is correct
for all managed audits and that the “interest through date” is correct prior to billing. Once the
audit report is approved for billing, a copy of the audit report and the MAP participation agreement
will be made and forwarded to the Chief, Tax Policy Division with a copy to the Deputy Director,
FOD for evaluation of the MAP.
August 2008
General Audit Procedures
ALTERNATIVE METHOD OF REPORTING USE TAX
0436.00
GENERAL0436.01
Ex-tax purchases subject to use tax are ultimately the tax liability of the purchaser storing,
using or otherwise consuming the property in this state. Similarly, ex-tax purchases subject to
transactions and use tax (district tax) are ultimately the liability of the purchaser when purchased
for use in a district imposing such a tax and thereafter used there.
The Alternative Method for Reporting Use Tax (AMRUT) Program is a process whereby a taxpayer
can write to the State Board of Equalization (BOE) and propose a prospective use tax reporting
method for qualified purchases subject to use tax (see AM section 0436.04, item B). The alternative
reporting method replaces the usual method of reporting use tax on a transaction-by-transaction
basis. The alternative reporting method will not allow a taxpayer to issue resale or exemption
certificates to vendors solely for the purpose of directly reporting the use tax under the AMRUT
Program. The taxpayer’s proposal must address the following matters:
• The remittance of use tax directly to BOE on certain mutually agreed-upon categories of
purchases.
• The application of a mutually agreed-upon taxable percentage to the taxpayer’s total
purchases for these categories to determine the tax.
If BOE concludes the proposed reporting method accurately reflects the taxpayer’s use tax liability
for the defined population, BOE will prepare a written response to the taxpayer approving (subject
to certain conditions) the use of the proposed reporting method. This written correspondence is
required for an approved AMRUT.
In general, audits of purchases covered by a BOE-approved reporting method will not ascertain
whether or not tax was overpaid or underpaid on a transaction-by-transaction basis. Instead,
the audit will determine whether or not the taxpayer complied with the criteria specified in the
BOE-approved AMRUT. Audits of purchases outside the scope of the BOE-approved AMRUT,
such as purchases of fixed assets, should be examined in accordance with procedures described
in this manual.
ELIGIBILITY0436.02
BOE encourages participation in AMRUT and will not restrict eligibility to any particular taxpayer,
regardless of the size or type of business. In order to be eligible to participate in the program,
the taxpayer must be registered with BOE to report sales and use tax, be in good standing, and
maintain acceptable accounting records and internal controls in accordance with the provisions of
Regulation 1698, Records. Taxpayers requesting approval must provide the necessary accounting
records (including electronic data files) upon request in a timely manner.
Ideal candidates for this program include taxpayers who typically have large volumes of recurring
purchases subject to use tax. The taxpayer’s business and purchasing practices must be consistent.
January 2014
Audit Manual
AMRUT APPROVAL PROCESS
0436.03
The taxpayer initiates the request to participate in the AMRUT Program by submitting a written
request to the District Principal Auditor (DPA) in the taxpayer’s district of account. Requests
must include:
• The taxpayer’s name, address and seller’s permit number,
• The period for which the request is being made,
• An assurance that the taxpayer’s accounting records and internal controls are acceptable
pursuant to the requirements of Regulation 1698, and
• Identification of any records that are maintained electronically.
BOE will only consider written requests for participation where the taxpayer is identified. Within
10 business days of receiving a request for participation, the district of account will send an
acknowledgment letter to the taxpayer providing information about the program, outlining the
implementation process and soliciting additional information, if needed. The taxpayer will be
provided Form BOE-472, Use of Sampling in Auditing, to complete prior to beginning the taxable
percentage calculation. Auditors will work with the taxpayer to determine the agreed-upon
categories of purchases and the taxable reporting percentage. This process should be completed
within 90 days after the taxpayer’s accounting records are made available.
After completion of the taxable percentage calculation, the DPA will prepare a memo to
the Supervisor, Audit and Information Section (AIS) containing the district of account’s
recommendation regarding the taxpayer’s participation in AMRUT. The memo should include all
details regarding the taxable percentage calculation and a copy of the completed Form BOE-472.
The AIS Supervisor will review the materials and notify the DPA in writing of approval or denial
of the taxpayer’s participation in AMRUT. The DPA will then furnish a letter to the taxpayer,
with a copy to the AIS Supervisor, approving or denying the taxpayer’s request for participation
in AMRUT. If approved, the letter to the taxpayer must also include all details regarding the
AMRUT, such as the taxable percentage to be used, the purchases the taxable percentage applies
to, and the time period AMRUT is effective (AM section 0436.05, Term). In addition, general
information about the program, such as termination or the definition of a significant business
change, must be provided to the taxpayer.
January 2014
General Audit Procedures
TAXABLE PERCENTAGE CALCULATION
0436.04
A. Base Period Selection
It is essential to select a mutually acceptable base period and scope of purchases covered
by the proposed AMRUT. If currently under audit, the base period is typically the current
audit period. However, the taxpayer and the auditor may select transactions occurring
over some other period if necessary. At a minimum, 12 months of detailed accounting
records, which include the most recent reporting period, should be used to calculate the
taxable percentage. When this minimum is used, summary accounting records from the
two preceding years must be provided for comparison purposes.
When selecting a base period, it is essential the tested purchases are representative of
the taxpayer’s normal purchasing activity and anticipated activity in future filing periods.
B. Taxable Percentage Calculation
The most important element of this reporting method is the calculation of the taxable
percentage to be applied prospectively to purchases within the defined population. Under
this method, the taxpayer will calculate (with auditor involvement) a taxable percentage to
be applied to purchases from specific categories of transactions. Percentages are calculated
as follows:
1.
Determine which of the examined purchases in the base period are subject to
use tax.
2.
Divide the resulting taxable purchases by total purchases in the base period.
The total purchases subject to use tax for the approved period is calculated by applying the
taxable percentage to total purchases from the same specified categories of transactions.
The taxable percentage calculation may be based on statistical sampling, non-statistical
sampling or a detailed review of the transactions in the base period. However, the taxpayer
and the auditor must agree on the sampling plan and procedures used to calculate the
taxable percentage.
The taxable percentage calculation and application are limited to qualified purchases.
This excludes specific categories of transactions such as fixed asset acquisitions and other
accounts or transactions the taxpayer or the auditor believes are atypical (e.g., resale
inventory withdrawals, inter-company purchases, etc.) and should not be included in the
defined population. Fixed asset acquisitions are excluded since these purchases generally
are one-time transactions. Atypical purchases skew the taxable percentage calculation
and negate the validity of the sample.
It may be necessary to calculate more than one taxable percentage to be applied to different
categories of purchases. Computation of different percentages may be established by:
• Account number(s)
• Subsidiary
• Location
• Division
• Computer accounting system
• District tax
• Other criterion that makes business sense and produces a reliable and
verifiable estimate of the taxpayer’s use tax liability.
January 2014
Audit Manual
Taxable Percentage Calculation
(Cont.) 0436.04
C. Sample Selection
To establish a prospective taxable percentage, a sample may be drawn from transactions
that occurred in prior periods. Whenever sampling techniques are used, an estimate is
made instead of using the actual result from a detailed review of the population. Therefore,
the sample must be representative of the population. It is expected that the sample results
will approximate the use tax currently being reported on a transaction-by-transaction basis
for qualified purchases after considering BOE audit adjustments (if applicable).
The auditor must be involved in the sample selection process. Prior to beginning the process,
the taxpayer will complete a preliminary Form BOE-472. Both the taxpayer and the auditor
must agree to the sampling plan and then a final Form BOE-472 will be completed.
If statistical sampling techniques are used, the sample results will be evaluated to determine
how accurately the sample reflects the population. Statistical sampling techniques must
be in accordance with AM Chapter 13, Statistical Sampling.
RTC section 6406 credits and atypical transactions encountered during base period testing
will be reviewed and evaluated by the auditor on a transaction-by-transaction basis.
D. Electronic Records
Generally, taxpayers that wish to report use tax using AMRUT will maintain and provide
access to their accounting records in electronic format. The auditor will be involved in the
analysis of these records during the review and approval process. The taxpayer will be
required to provide to the auditor a data download of the necessary electronic accounting
records, including control totals, in a format prescribed by the auditor.
E. Disputed Transactions
BOE will not issue a letter approving a taxpayer’s proposal if the taxpayer and the
auditor cannot agree on a sampling plan or resolve disputes regarding individual sample
transactions.
TERM0436.05
The taxpayer will be notified of the specific period for which the applicable percentage may be
relied upon. Generally, this will be a 36-month period corresponding with the taxpayer’s reporting
basis. This information will be included in the DPA’s letter to the taxpayer outlining the specific
details of the AMRUT.
January 2014
General Audit Procedures
RENEWAL0436.06
BOE’s approval to use AMRUT is not automatically renewable. BOE may approve an extension
for subsequent time periods. BOE retains the right to audit the taxpayer’s records to determine
if the taxpayer’s business practices or operations have changed.
Renewals or extensions will be handled in the same manner as initial requests for participation
as provided in AM section 0436.03, AMRUT Approval Process. The taxpayer must initiate an
extension or renewal request by submitting a written request to the DPA. At the discretion of the
DPA, the auditor may recommend using the existing taxable percentage based on a review, to
the extent deemed appropriate by the DPA, of the taxpayer’s records or the auditor may calculate
a new taxable percentage as provided in AM section 0436.04, Taxable Percentage Calculation.
After determining the taxable percentage, the DPA will prepare a memo to the AIS Supervisor
containing the auditor’s recommendation regarding the taxpayer’s continued participation in
AMRUT and all details regarding the taxable percentage calculation. The AIS Supervisor will
notify in writing the DPA of approval or denial of an extension in AMRUT for the taxpayer. The
DPA will then furnish a letter to the taxpayer, with a copy to the AIS Supervisor, approving or
denying the taxpayer’s extension request to participate in AMRUT. The letter to the taxpayer
must also include all details regarding the AMRUT, such as the taxable percentage to be used,
the purchases the taxable percentage applies to, and the time period AMRUT is effective.
TERMINATION OR CANCELATION
0436.07
BOE may rescind its approval of the reporting method if the taxpayer fails to comply with any of
the program’s conditions. In addition, the written approval of the use tax reporting method is void
if the taxpayer files a claim for refund for tax that had been reported based upon this reporting
method.
Upon written notification to the taxpayer, the approved AMRUT is rescinded. The notification
shall be effective as of a date specified by BOE. Accordingly, the approved AMRUT becomes invalid
the first day of the subsequent quarterly filing period, but no less than thirty (30) days after the
effective date of BOE’s written notification.
At any time, the taxpayer may elect to discontinue reporting use tax based upon the approved
AMRUT. The taxpayer must notify BOE in writing of the election to discontinue the alternative
reporting method within the quarterly filing period of the election.
Once the AMRUT is rescinded, cancelled, voided, or discontinued the AMRUT can no longer be
relied upon as advice that may qualify for relief under RTC section 6596 except to the extent that
a transaction examined as part of the taxable percentage calculation is incorrectly classified as
not being subject to use tax.
January 2014
Audit Manual
REVISED PERCENTAGES
0436.08
A. Notification Requirements
The taxpayer is responsible for monitoring and advising BOE of any activities that
significantly change the facts and circumstances upon which BOE’s previous approval of
AMRUT was based. The taxpayer is required to notify BOE of significant changes including,
but not limited to:
• Changes in accounting policy – changes that affect the distribution of use tax
transactions in the accounts covered under the AMRUT that would significantly
affect the agreed-upon percentage.
• Changes in purchasing practices – changes in purchasing activities that would
significantly affect the agreed-upon percentage.
• Other significant business changes, as discussed in item B below.
Notification to BOE must be in writing and addressed to the DPA in the district of account
within 90 days of the significant change. The taxpayer will be allowed a reasonable time
in which to provide supporting documentation. A significant business change affecting
the taxable percentage will terminate the approved AMRUT and the taxpayer will be
required to request approval to use the revised taxable percentage. The taxpayer’s request
shall be subject to BOE’s review and approval based on the new information. If the revised
taxable percentage is approved, the letter discussed in AM section 0436.03 will be sent to
the taxpayer. The revised taxable percentage will become effective commencing the first
day of the quarterly filing period following BOE’s approval.
If the taxpayer fails to report a significant business change within the specified period, the
approved AMRUT may be rescinded and the taxpayer may be liable for any unreported use
tax due from the first day of the quarterly filing period following the date of the significant
business change.
The use of the revised taxable percentage without BOE’s approval will not serve as basis
for RTC section 6596 relief.
B. Significant Business Changes
This program does not relieve the taxpayer of his or her responsibility to report in accordance
with changes in the California Sales and Use Tax Law and the accompanying regulations.
Changes in laws may occur during the period when the approved AMRUT is in effect. During
the period the approved AMRUT is in effect, the taxpayer is responsible for monitoring its
purchasing practices and the California Sales and Use Tax Law to ascertain any changes
that may significantly affect the taxable percentage.
Events which may result in a significant business change that are likely to affect the
taxable percentage include, but are not limited to the following:
• Change in the product line,
• Change in purchasing procedures (for example, implementation of cost
containment programs),
• Merger or acquisition,
• Discontinuation or start up of manufacturing or support facilities,
• Change in application of tax due to statutory change, regulatory change or a
change in the application of the law due to a court decision, or
• Change in the financial or accounting system (for example, utilization of a
different software program to record purchases).
January 2014
General Audit Procedures
Revised Percentages
(Cont.) 0436.08
When the taxpayer makes a change in business practices, procedures or operations,
including but not limited to those described above, the taxpayer must determine whether
the event(s) results in a significant change to the agreed-upon percentage. For purposes of
audit, the taxpayer should retain the documentation he or she used to determine whether
the event is significant.
If a change in business practices, procedures or operations occurs, the following thresholds
will be used to determine whether the event is significant. A significant business change
has occurred when, over a 12-month period:
1. An increase in purchases subject to use tax for the agreed-upon categories of
purchases results in unreported purchases subject to use tax of $100,000 or
more in measure; or
2. For this same period, the taxable percentage calculation used to determine use
tax reporting increases by 10 percent or more from the previously agreed-upon
taxable percentage.
For example, if the agreed-upon taxable percentage was determined to be 10 percent,
and thereafter, over a 12-month period, based upon a change in vendors from an in-state
vendor to an unregistered out-of-state vendor, the actual taxable percentage increased
to 12 percent, this would be regarded as a significant business change that requires the
taxpayer to notify BOE of the change. This change represents a 20 percent increase in
the taxable percentage (2 percentage points difference between actual and agreed-upon
taxable percentages divided by the agreed-upon taxable percentage).
If the taxpayer utilizes multiple taxable percentages for reporting, each taxable percentage
should be examined individually to determine if a significant business change has occurred.
Therefore, changes in business operations may result in a significant business change
occurring for one or more of the taxable percentages, but not for all taxable percentages.
The taxpayer may continue to utilize approved taxable percentages that were not affected
by a significant business change requiring BOE notification.
Although the thresholds provided for determining whether a change is significant require
the use of 12 months of purchases, this does not allow the taxpayer to wait 12 months after
the event occurred that is deemed a significant business change before notifying BOE. The
time period to notify BOE remains within 90 days of a significant business change. The
thresholds are provided as a means of quantifying whether an event is significant.
The taxpayer is required to retain documentation he or she used at the time of the business
change to determine whether the event is significant. This may require the taxpayer to look
forward or project how the change would impact the taxable percentage over the next 12
months. If this documentation supports the fact that the change qualifies as a significant
business change, the taxpayer must provide notification to the BOE within 90 days of
the event. If this documentation supports the fact that the change was not expected to be
significant, and later found to be significant, the taxpayer should notify BOE within 90
days of this discovery.
If the taxpayer anticipates that the reporting percentage is likely to fluctuate and is not
likely to remain stable, the business may not be an appropriate candidate for AMRUT.
January 2014
Audit Manual
POST REVIEW AND EVALUATION
0436.09
The district office may choose to review the records any time during the term of the AMRUT to
monitor the integrity of the program or in conjunction with a sales and use tax audit.
BOE will verify the taxpayer is in compliance with the AMRUT. This includes verifying the
mechanical accuracy and appropriateness of accounting procedures for all applicable accounts
within the defined population.
The taxpayer’s records will be reviewed to determine if there has been an unreported change in
business practices or operations during the applicable period. The review will determine if any
unreported business changes have a significant impact on the agreed-upon percentage. This may
include a comparison of vendors from the original test with the list of current vendors to determine
if there has been a significant change in the in-state versus out-of-state vendor distribution.
BOE will perform a detailed (transaction-by-transaction) test of purchases if it has previously
established that one or more events have taken place that may have resulted in a significant
business change. Prior to initiating a detailed test of purchases, the DPA will review the preliminary
analysis that determined a significant business change has occurred.
January 2014
GENERAL AUDIT PROCEDURES
APPLICATION OF TAX TO SPECIFIC TRANSACTIONS
FOOD SALES AT MOVIE THEATERS
0437.00
0437.05
GENERAL
In audits of movie theaters, the admission policy of the theater may affect the application of tax
to the sale of food products at the theater. Sales and Use Tax Regulation 1603, Taxable Sales
of Food Products, provides guidance to establishments that make taxable sales of food products.
Regulation 1603, subdivision (d), Places Where Admission is Charged, provides in pertinent part
that:
Tax applies to sales of food products when sold within, and for consumption within, a place
the entrance to which is subject to an admission charge, during the period when the sales
are made, except for national and state parks and monuments, and marinas, campgrounds,
and recreational vehicle parks.
Regulation 1603, subdivision (f) Food For Consumption at Facilities Provided by the Retailer,
provides in pertinent part that:
Tax applies to sales of sandwiches, ice cream, and other foods sold in a form for consumption
at tables, chairs, or counters or from trays, glasses, dishes, or other tableware provided by
the retailer or by a person with whom the retailer contracts to furnish, prepare, or serve
food products to others.
APPLICATION OF TAX
Movie theaters that require customers to first purchase tickets before entering the area where
food is served must report tax on all sales of food and beverages, including popcorn, in accordance
with Regulation 1603(d).
In audits of movie theaters, the issue of an “open lobby” policy must be considered. A theater
with an “open lobby” is one where a customer may enter the theater lobby area for other purposes,
such as playing video games or purchasing food or drink, without requiring the purchase of a
theater ticket.
In determining whether or not a movie theater has an “open lobby” policy, auditors should
consult with theater management and review written policies, if available, before making the
determination. Since customers who patronize movie theaters without the purchase of a ticket
to view a movie may be infrequent, auditors should rely on more than the actions of an individual
employee in the theater lobby to determine the theater’s admission policy and if the theater has
an “open lobby.” Just because an individual employee may require a ticket to enter the theater
does not conclusively mean the theater does not have an “open lobby.” Thus, auditors cannot rely
solely upon the use of standard observation tests to determine whether or not a ticket is required
to enter the theater lobby.
If a movie theater has an “open lobby” policy, the next consideration regarding whether or not tax
applies to sales of food is whether or not the movie theater provides facilities for the consumption
of the food sold. For example, some theaters may provide tables and chairs for consumption of
food and beverages near an arcade or otherwise within the lobby area. As set forth above, under
Regulation 1603, subdivision (f), all food and beverages sold for consumption at such facilities are
subject to tax. Many theaters provide benches for general seating. These benches do not constitute
facilities for consumption of food and beverages.
February 2016
Audit Manual
Food Sales at Movie Theaters
(Cont.) 0437.05
Additionally, under Regulation 1603, subdivision (f), theater seats do not constitute facilities
intended for consumption of food and beverage. Even if the movie theater provides facilities
for consumption within the lobby area, sales of cold food “to go,” such as for consumption in the
theater, are not taxable.
Thus, when auditing a movie theater, the following applies:
1) Sales of all food items are subject to tax in theaters that do not have an open lobby policy
(Regulation 1603(d)).
2) In theaters with an “open lobby” policy,
• The theater does not constitute a place where admission is charged (Regulation
1603(d)).
• Sales of cold food items are not subject to tax unless the items are for consumption
at facilities specifically provided for consumption (i.e., tables and chairs).
• Seats in the viewing area of a movie theater are not considered facilities for
consumption of food and beverages. (Regulation 1603(f)).
• Where tables and chairs are furnished for eating, the theater has the option to elect
to separately account and not remit tax on sales of cold food “to go” per Regulation
1603(c)(1)(A).
APPLICATION OF TAX TO MULTI-USE CONTAINERS
0437.10
This section clarifies the application of tax to returnable pallets used to hold both food products
and other non-food products, as well as containers used to bake and ship bread. For information
on how tax generally applies to returnable or non-returnable containers in other situations, see
Regulation 1589, Containers and Labels.
FOOD PRODUCT CONTAINERS
Revenue and Taxation Code section 6364(d) (see also Regulation 1589(b)(1)(E)), provides a sales
and use tax exemption for the sale or purchase of all containers when sold or leased without the
contents to persons who place food products for human consumption in the containers for shipment,
provided the food products will be sold. The exemption applies without regard to whether the food
products are sold in the same container or not, or whether the food products are remanufactured
or repackaged prior to their sale.
PALLETS
Under Regulation 1589(a), pallets, among other items, are included in the definition of “containers.”
Returnable Pallets for Other than Food Products
Tax applies to the initial sale of returnable pallets whereby the pallets are returned for reuse.
Tax does not apply to the sale of returnable pallets when the pallets are sold with the contents
in connection with the retail sale of the contents, or when resold for re-placement of the contents
on the pallets.
For example, a taxpayer purchases pallets to ship its product to its customer. Tax applies to
the sale of the pallets to the taxpayer. When the taxpayer sells its product to its customer
and requires the customer to return the pallet to the taxpayer, any charge (deposit) for the
return of the pallet by the taxpayer’s customer is not taxable, whether or not the charge
(deposit) is forfeited.
February 2016
GENERAL AUDIT PROCEDURES
Application of Tax to Multi-Use COntainers
(Cont.) 0437.10
Returnable Pallets Used For Food Products for Human Consumption
When pallets are sold as containers for the purpose of holding food products for human consumption,
the sale or purchase of the pallets is exempt from tax.
When tangible personal property, other than food products for human consumption, is placed in
or on the pallets, the use of the pallets is considered to be outside the scope of the exemption and
any such sales or purchases of those pallets is subject to tax. The exemption set forth in section
6364(d) does not apply to sales of pallets that are used to hold both food products for human
consumption and other tangible personal property (non-food products). Therefore, when pallets
are used to hold both food and non-food products the sales of pallets are subject to tax. Taxpayers
may not exempt a portion of the pallet sales based upon a percentage of use.
ALUMINUM BREAD PANS
Regulation 1589(a), defines “containers” to mean the articles in or on which tangible personal
property is placed for shipment and delivery, such as wrapping materials, bags, cans, twines,
gummed tapes, barrels, boxes, bottles, drums, carboys, cartons, sacks, pallets, and materials from
which such containers are manufactured.
When aluminum bread pans are used to hold food products, i.e., bread, such pans are considered
“containers” as defined in Regulation 1589(a). The use of the containers for baking bread does not
supersede the use of the containers for shipment of the food products for human consumption.
For example, if the aluminum bread pans are shipped holding raw bread dough via
refrigerated trucks and then the bread is baked after delivery, the containers qualify for
the exemption and may be purchased ex-tax.
Similarly, baking the bread in the aluminum bread pans prior to shipment does not preclude
the use of the aluminum bread pans as containers.
TAXABILITY OF MEAL REPLACEMENT PRODUCTS
0437.15
This section clarifies the interpretation of Revenue and Taxation Code (RTC) sections 6359 and
6369 (see also Regulation 1602, Food Products, and Regulation 1591, Medicines and Medical
Devices) as they apply to meal replacement products.
GENERAL
The exemption for certain sales of meal replacement products is addressed in Regulation 1602(a)
(4) and Regulation 1591. Regulation 1602(a)(4), provides that if the meal replacement product sold
is a complete dietary food providing the user with the appropriate amounts of vitamins, proteins,
and minerals including the minimal count of at least 900 calories per day, the product may be
claimed as an exempt food product. If the item does not qualify as an exempt food product, staff
may look to whether the product qualifies as an exempt medicine. If the requirements under
either Regulation 1602(a)(4) or Regulation 1591 are met, the meal replacement products are
exempt from tax.
February 2016
Audit Manual
Taxability of Meal Replacement Products
(Cont.) 0437.15
COMPLETE DIETARY FOODS
Regulation 1602(a)(4), in part, provides that tax does not apply to products which are complete
dietary foods and the complete dietary food must provide the user with the following daily
minimums:
1. 70 grams of high quality protein
2. 900 calories
3. Minimum daily requirements as established by the regulations of the Federal Food and
Drug Administration of the following vitamins: A, B1, C, D, Riboflavin, and Niacin, or
Niacinamide; and the following minerals: Calcium, Phosphorus, Iron, and Iodine.
A critical element of the example of a complete dietary food is that the food item contains at least
900 calories per day if taken (consumed) in the recommended daily dosage (e.g. 1 can per day at
900 calories or 3 cans per day at 300 calories each). As provided in Regulation 1602, a product
with fewer than 900 calories per day by itself cannot qualify as a complete dietary food.
To determine whether the product being examined is a complete dietary food for purposes of
Regulation 1602(a)(4), the daily nutritional content offered by the product is determined by
multiplying the nutritional components of a single serving by the number of servings recommended
per day on the label. If no such recommendation is noted, a determination will be based on three
servings.
Meal Replacement Products May Qualify as Exempt Medicines
RTC section 6369 and Regulation 1591 provide that the gross receipts from the sale or use of
medicines furnished by a licensed physician to his or her own patient for treatment of the patient
are specifically exempt from taxation. Also, the gross receipts from the sale or use of medicines
furnished by a “health facility” for treatment of any person pursuant to the order of a licensed
physician are specifically exempt from tax. A “health facility” is defined in Regulation 1591(a)(4).
Meal replacement products are considered medicines when furnished by a physician to his or
her patient as part of a medically supervised weight loss or gain program. When a physician
furnishes to his or her patient meal replacements as part of a medically supervised weight loss or
gain program, the sale of the meal replacement products are exempt from tax under RTC section
6369 and Regulation 1591.
RECORDS
Retailers making exempt sales of food products must maintain proper documentation to support
the exemption. Pursuant to Regulation 1591(g)(1), any deduction on account of sales of medicines
shall be supported by appropriate records which include, but is not limited to: the name of the
purchaser, name of doctor or health facility, date of sale, item sold, and the sales price.
February 2016
GENERAL AUDIT PROCEDURES
MOTION PICTURE INDUSTRY - RELEASE PRINTS
0437.20
GENERAL
Generally, release prints first exhibited in California are subject to either the sales or use tax.
This section provides guidance on the application of tax to release prints first exhibited outside
the State of California and is intended to apply to the motion picture industry. Due to the unique
nature of transactions pertaining to the motion picture industry, this section applies exclusively
to issues pertaining to release prints. See Regulation 1529, Motion Pictures, subdivision (d)(11)
for a specific definition of “release prints.”
RELEASE PRINTS FIRST EXHIBITED OUTSIDE OF CALIFORNIA
Regulation 1620, Interstate and Foreign Commerce, sets forth the conditions which determine
whether merchandise brought into this state is subject to sales tax or use tax. As provided in
Regulation 1620, subdivision (b)(3), it is presumed that property used outside the state for a
period less than 90 days has a continued useful life, hence the deference to the primary use of the
property for the following six-month period to determine the proper application of tax.
Release prints first exhibited outside of California are rarely exhibited for more than 90 days.
Due to their limited physical life, a release print does not possess a useful life in excess of 90 days.
Since release prints are unable to sufficiently meet the 90 day test criteria if returned to California
at the end of its useful life, the entry or reentry of the release print does not automatically render
the property subject to use tax. Accordingly, release prints cannot be deemed for use in California
merely because they enter or reenter the state within 90 days.
After initial exhibition out-of-state and entry or reentry into California, release prints are often
destroyed then shipped out-of-state for recycling; or refurbished for subsequent release into
secondary markets. In either scenario, the first functional use via the initial out-of-state exhibition
establishes that the release print was purchased for use outside the state and neither the sales
nor use tax applies in California. As such, it is not the purchaser’s intent to “use” the release
prints in California, since their use outside the state generally renders them unfit for further use
as release prints upon return to California. Thus, release prints which are initially exhibited
outside of California are not deemed purchased for use in California.
RELEASE PRINTS PURCHASED FROM OUT-OF-STATE LABORATORY
In situations where a studio orders a release print from a laboratory that produces the release
print and delivers it either directly to an out-of-state theater or a California based service company
(who subsequently delivers the release prints to theaters outside California), the application of
tax differs depending upon whether the laboratory is located in California or out of state.
February 2016
Audit Manual
Motion Picture Industry - Release Prints
(Cont.1) 0437.20
The California service company, sometimes referred to as a “depot” by the industry, performs
services which may include:
• Transportation of prints from the film laboratory to and from distribution centers, theaters,
film warehouses, and salvage facilities.
• Total quality management to assure the highest print quality is delivered to the theaters.
• Complete inventory management from the time the print leaves the film laboratory to the
time the print is destroyed.
• Integrated information systems including order entry, print control and tracking, defective
print reports, and other management reports.
• Customer service to interface with exhibitors.
• Print rejuvenation services including inspection and cleaning.
• Logistics management for all matters related to shipment, delivery, inspection, retrieval,
and storage of prints.
• Storage of used prints.
• Security control procedures to minimize potential for piracy, theft, or other loss of prints.
Tax does not apply to any release prints delivered to the California service company provided the
release print is first exhibited out-of-state. The activities associated with the services identified
above do not render the tax applicable in cases where the release print is first exhibited outside
the State of California.
Upon return to California, the retention and subsequent “destruction” of the release print, including
“de-reeling” and “chopping” of the release print for packaging, even when done to protect the
intellectual interest of the release print, will not make the release print taxable in cases where
the release print is first exhibited outside the State of California.
When refurbishing prints for subsequent release into secondary markets, it is common for
portions of release prints to be spliced and combined to make copies suitable for distribution.
This activity may include combining portions of release prints that were first distributed in
California, and thus originally taxed with release prints which may have been first distributed
outside the State of California. For the purpose of assessing tax on the refurbished release print,
it will be presumed that a refurbished release print is tax paid as long as the percentage of all
release prints distributed in the secondary market in California does not exceed the percentage
of all release prints originally first exhibited in California. As long as this criteria is met, the
subsequent distribution of refurbished release prints into the secondary market is exempt from
tax. In cases where the release print is originally first exhibited outside the State of California,
tax does not apply regardless of the fact that refurbishing of the release print is subsequently
done in California.
However, if there is a sale of the refurbished release print, tax will apply to refurbished release
prints first distributed in California.
February 2016
GENERAL AUDIT PROCEDURES
Motion Picture Industry - Release Prints
(Cont.2) 0437.20
RELEASE PRINTS PURCHASED FROM A CALIFORNIA LABORATORY
When a California laboratory delivers release prints to theaters for first exhibition inside California,
such prints are generally subject to sales tax. However, delivery by the laboratory or California
service company to an out-of-state theater for first exhibition is not subject to tax provided the
release print is first exhibited out-of-state.
There are situations where a laboratory may deliver release prints to a California service company
for subsequent delivery to theaters outside California. In cases where the California service
company does in fact deliver the prints outside California via common carrier, the transaction
qualifies as a sale in interstate commerce. As previously discussed, release prints which are
originally first exhibited outside of California are not deemed purchased for use in California.
The activities associated with the services identified in the prior section do not render the tax
applicable when the release print is first exhibited outside the State of California.
Upon return to California, the retention and subsequent “destruction” of the release print, including
“de-reeling” and “chopping” of the release print for packaging, even when done to protect the
intellectual interest of the release print, will not make the release print taxable in cases where
the release print is first exhibited outside the State of California.
REPORTING
In many cases, there is adequate documentation available to track the movement of the release
prints for the purpose of assessing sales tax. However, for administrative ease, we will permit the
reporting of tax based upon the use of a pre-approved percentage of release prints first distributed
in California in cases where it is in the best interest of both the taxpayer and the State.
If approved, the established percentage may be used for a period of time which must be identified
in the request (up to a maximum of three years). Three years was permitted to allow the district to
review subsequent requests in conjunction with the taxpayer’s eligibility for audit. The use of an
approved percentage reporting method will constitute a “safe harbor” from additional assessments
for liabilities in excess of the amounts reported based upon the approved reporting method.
The use of a percentage reporting method must be requested by the taxpayer in writing with a
detailed description of the calculation of the percentage and computation of the base to which it is
to be applied. The District Principal Auditor will forward the request along with a recommendation
for approval or denial with explanation to the Chief, Tax Policy Division. After a response is received
from the Chief, Tax Policy Division, the District Principal Auditor will send an acknowledgement
letter to the taxpayer outlining the terms of agreement (if approved) or an explanation of the denial.
February 2016
Audit Manual
REBATES AND INCENTIVES
0437.25
GENERAL
This section explains the application of tax to payments received by retailers from rebate, incentive,
buy-down and other promotional programs (third-party rebates) offered by manufacturers, vendors,
and other third parties to promote the sale of their products.
Retailers often engage in marketing and sales promotions in which they issue coupons or
other indicia to their customers that entitle them to a reduction in their purchase amounts.
Manufacturers, vendors and other third parties offer various programs that result in credits or
payments made to retailers with respect to a retailer’s taxable sale of products to a customer.
Regulation 1671.1, Discounts, Coupons, Rebates, and Other Incentives, addresses this topic, provides
definitions for terms used and includes several examples of when rebates and incentives are and
are not included in gross receipts.
If the records of a retailer who participates in rebate and incentive program are lacking or
incomplete, the Internal Revenue Service Form 1099-Misc (1099) may be used to determine the
taxable portion of the retailer’s income when the 1099 is issued by a third-party who entered into
a rebate or incentive program with the retailer that required a specific price reduction. However,
a 1099 does not always represent taxable rebate payments that satisfy the conditions of the
regulation. The amounts could, in whole or part, represent payments for nontaxable display,
advertising or other nontaxable promotional allowances, as well as rebate payments that satisfy
one, but not all, of the conditions of the regulation. The 1099 may also contain specific coding
that will assist in the determination of the portion of the 1099 income that is received under a
rebate or incentive program requiring a price reduction, earned for providing display space or for
advertising the third-party’s products.
TAXABLE GROSS RECEIPTS
Third-party rebates are included in taxable gross receipts or the sales price of the sale when all
of the following conditions are satisfied:
• The retailer is required to reduce the selling price of certain products in order to receive
the third-party rebate,
• The rebate payment is certain (not contingent on other factors), and
• The rebate is for a like amount that reimburses the retailer for the amount of the price
reduction, on a transaction-by-transaction basis.
That is, the rebate payment received as part of a promotional program (e.g., buy-down program)
must be traceable to a specific sale of a particular product and reimburse the retailer for the specified
amount of the required reduction in selling price. A rebate payment is considered certain when
fulfillment of the requirements of the contract between the retailer and the third party are within
the control of the retailer at the time of the underlying retail sale (e.g., requiring the retailer to
set up promotional signage in order to get the rebate).
There are also promotional programs and marketing strategies that do not require a reduction of
the selling price of products by the retailer. Others that require a price reduction tie the rebate
payments to the retailer’s wholesale purchases and not their sales of the product at the reduced
price. In any case in which the promotional price reduction is not required by a third-party or
where the rebate revenue is not based on retail sales on a transaction-by-transaction basis, the
revenue is not included in taxable gross receipts.
May 2016
GENERAL AUDIT PROCEDURES
Rebates and Incentives
(Cont. 1) 0437.25
Some promotional programs (e.g. graduated rebate agreements) may require the retailer to sell
a certain quantity of product at a specified reduced price for a set period to receive a wholesale
price reduction or, in some cases, reimbursement for all, or a portion of the reduced selling price.
Multiple thresholds, with an increase in rebate revenue for each threshold exceeded, may exist.
This means the total rebate payment the retailer receives is not certain at the time of the retail
sale. When the receipt of rebate payments or a portion of them are contingent and uncertain at
the time of the retail sale of the specified products, the portion that is contingent and uncertain is
not subject to tax. Regulation 1671.1, subdivision (d)(2)(D) provides an example of this situation.
Advertising and Display Allowances
Additional income received by retailers for the display or advertising of the third-party products
is not included in taxable gross receipts. Display payments are earned by providing the display or
shelf space, not by making retail sales of taxable products on a transaction-by-transaction basis.
Advertising allowances, which are a reimbursement for a retailer’s advertisement of particular
products, are not included in gross receipts.
Third-Parties
A third-party is defined in Regulation 1671.1, subdivision (c)(1)(C) as a person other than the
retailer or their customer, such as a manufacturer or retailer’s vendor. Therefore, rebate revenues
received by the retailer from a retailer’s vendor are subject to tax in the same manner as rebate
revenues received from manufacturers and other parties that do not sell the promotional products
directly to the retailers.
Rebuttable Presumption
Although it is generally understood that all gross receipts are subject to tax unless the contrary
is established, Regulation 1671.1 subdivision (c)(3)(A), provides a rebuttable presumption that
consideration received by a retailer from a third-party related to promotions for sales of specified
products is subject to tax, until the contrary is established. This subdivision provides a nonexhaustive list of examples that illustrate how this presumption can be rebutted.
Subdivision (c)(3)(A) provides specific regulatory support to include rebate revenue in taxable gross
receipts when the retailer does not provide the necessary records and documentation to establish
otherwise. This does not mean, however, that the retailer should not be given the opportunity to
establish that such revenue may represent a purchase discount, advertising allowance, or some
other nontaxable allowance. The presumption does not relieve staff of its responsibility to ensure
that the retailer is aware of the type of documentation that will generally rebut the presumption
or providing support in obtaining such documentation when requested.
The burden of establishing the taxable nature of rebate payments is on the retailer. However,
this should not be interpreted as relieving staff of their auditing responsibility. At times, it may
be easier for the auditor to verify the taxable nature of the rebates or have access to resources a
retailer may not have to make the determination. The rebuttable presumption should not deter
audit staff from providing support when requested or warranted.
May 2016
Audit Manual
Rebates and Incentives
(Cont. 1) 0437.25
Disclosure to Customers
Regulation 1671.1, (c)(3)(A) provides specific regulatory support for the inclusion of rebate
revenue in taxable gross receipts when the retailer does not provide the necessary records and
documentation to establish otherwise. Subdivision (c)(3)(B) states that when a retailer collects
sales tax reimbursement (or use tax when applicable) from its customer, the retailer must disclose
to the customer the amount upon which tax is collected, including the amount of any taxable
discounts, rebates, or incentives offered or paid to the retailer by third parties. The regulation
discusses the ways a retailer may satisfy its disclosure requirement. Staff should verify that the
amount of any taxable rebates upon which a retailer is collecting tax is disclosed to customers.
If not, the retailer should be informed of the requirement. It is recommended that auditors note
in the audit working papers that these disclosure requirements were discussed with the retailer.
May 2016
GENERAL AUDIT PROCEDURES
REASSIGNMENT / TRANSFER OF AUDIT ASSIGNMENTS
0442.00
The completion of an audit assignment may require reassignment of the audit to another auditor
within the district office or transfer of the audit to another district office. The transfer of an audit
to another district office may be done with transfer of control, see AM section 0403.07, Transferring
an Audit to Another District or without transfer of control, see AM section 0442.04, Interdistrict
Cooperative Audits.
REASSIGNMENT OF AUDITS WITHIN A DISTRICT OFFICE
0442.02
The reassignment of an audit to another auditor generally occurs when the auditor currently
assigned to the audit is not able to complete the audit (e.g., departing auditor). The following
procedures are intended to minimize the impact of audit reassignments to taxpayers,
representatives, and the audit program.
Upon receipt of notice of an impending employee departure or extended absence, the supervisor
and the DPA must immediately review all assignments in process with the departing auditor and
assess the likelihood of the completion of the audit assignments.
In the case of an employee promotion or lateral transfer to another district, if the audit assignments
cannot be completed prior to the auditor’s proposed departure date and district management does
not foresee the audits taking an extended period of time to complete, district management will
request the auditor be permitted to complete existing assignments after the promotion or lateral
transfer date (i.e., loaned back). Each audit assignment should be addressed on a case-by-case
basis, as a loan back may not always be feasible. Care should be taken not to delay promotion
dates for employees.
If the departing auditor is not able to complete the audit assignments prior to the departure date,
the supervisor must immediately reassign the audits to another auditor, taking into account the
complexity of the assignments. The departing auditor, the auditor receiving the reassigned audits
(new auditor) and the supervisor must discuss the status of the audits, including audit procedures
used, records examined, schedules prepared and audit findings to date.
Departing Auditor’s Responsibilities
• For each reassigned audit, prepare verification comments discussing in detail the completed
areas of the audit and the records or transactions that remain to be reviewed.
• Introduce the new auditor to the taxpayer and/or taxpayer’s representative.
• Hold a discussion with the taxpayer and/or the taxpayer’s representative regarding the
status of the audit. Everyone involved should have a clear understanding of the completed
areas of the audit and the tasks that remain to be performed.
• Assist the new auditor as needed.
Responsibility of the New Auditor
The new auditor is responsible for the timely and accurate completion of the reassigned audit and
must address the remainder of the audit appropriately. The examinations already completed by
the departing auditor are not to be repeated. If the new auditor identifies significant problems
with the work completed by the departing auditor, the new auditor should bring them to the
attention of the audit supervisor immediately.
February 2016
Audit Manual
Reassignment of Audits within a District Office
(Cont.) 0442.02
Responsibilities of the Supervisor
When an auditor leaves without notice, the audit supervisor must:
• Review all audits to be reassigned.
• Timely reassign the audits and contact the respective taxpayers to explain the necessity
of the reassignment.
• Accompany the new auditor to the taxpayer’s location for the initial meeting and discussion.
• Make several subsequent field calls in the initial stages of the reassignment and/or hold
meetings with the taxpayer and new auditor to ensure satisfactory progress is being made,
discuss any problems that the new auditor may encounter, and give the taxpayer assurance
of continuity and someone to contact if there is a problem.
If the departing auditor completes all audit assignments prior to the scheduled departure or
promotion/transfer date, the auditor’s remaining time must be augmented by miscellaneous
audit activities such as minor investigations, preparing written responses to taxpayer inquiries,
or assisting on other audits. The departing auditor must not be assigned new audits.
INTERDISTRICT COOPERATIVE AUDITS
0442.04
An audit transferred without transfer of control occurs in interdistrict cooperative audits where the
controlling district office assigns a portion of an audit or a related audit to one or more cooperating
district offices. In this case, the controlling district office consolidates the audit findings and
transmits the completed audit to ADRS.
An interdistrict cooperative audit is an audit with participation by auditors from more than one
district office. It occurs under the following conditions:
• A district office starts and audit and transfers that audit to another district office for
completion.
• A portion of an audit or a related audit is assigned to another district office.
Where the taxpayer’s or related account’s records are located in more than one district office, the
audit is coordinated by the controlling district office. Generally the controlling district office is in
the best position to obtain information with regard to the overall functioning of the operations of
the accounts involved. In most cases, the DOA is the controlling district.
February 2016
GENERAL AUDIT PROCEDURES
RESPONSIBILITIES OF THE CONTROLLING DISTRICT OFFICE
0442.06
The controlling district office assigns a portion of an audit or a related audit to cooperating district
offices, consolidates the findings and transmits the completed interdistrict cooperative audit to
ADRS. In addition, the controlling district office is responsible for the following:
1. Audit Control moves the cooperative district’s audit workpaper folder to the appropriate
auditor’s Go-Back folder and notifies the auditor and supervisor that the cooperative audit
workpaper folder is ready.
2. General review to verify that the cooperating district offices followed the procedures outlined
and made their respective portion of the audit in a consistent and uniform manner.
3. Completion of the final Form BOE-204, Interdistrict Cooperative Audit — Audit Verification.
4. Conducting an exit conference to discuss consolidated audit findings.
5. Transmittal of the completed audit to ADRS.
Instructions to cooperating district offices should contain sufficient detail to ensure all phases of
an audit are handled uniformly and for the same audit period. The anticipated degree of difficulty
or complexity of an audit must be taken into account when providing cooperating district offices
such instructions.
Assignments to cooperating district offices are electronically transmitted using Form BOE-204.
Form BOE-204 should include specific instructions, including the following information:
1. A brief description of the taxpayer’s operations.
2. The name and phone number of the person to be contacted at the taxpayer’s office.
3. Audit procedures that have been or will be performed by the controlling or cooperating
district offices.
4. Specific verification instructions, such as test periods. The cooperating district office should
follow these instructions unless there is a compelling reason why this cannot be done.
When the cooperating district office finds that any of the instructions are not appropriate,
it should discuss alternatives with the controlling district office.
5. Informative matter that may pertain to unusual transactions, such as areas of potential
error. This may include information on the taxability of fixtures and equipment when the
audit is a close-out, selling prices, type of clientele, etc.
6. Information pertaining to Form BOE-122, Waiver of limitation.
February 2016
Audit Manual
RESPONSIBILITIES OF THE COOPERATING DISTRICT OFFICE
0442.09
A cooperating district office will give priority to requests from a controlling district. It must
follow the specific instructions as expeditiously as possible. Any significant deviations must be
discussed with the cooperating district. In addition, the cooperating district office is responsible
for the following:
1. Discussion of the audit findings with the local representative of the taxpayer, with electronic
copies of AWPs provided to the representative.
2. Initiating the email approval chain in Outlook when the cooperative audit is complete.
(See Chapter 2, section 0213.06 for instructions).
3. Review of the work assigned to and completed by the cooperating district office. It is the
responsibility of the cooperating district office reviewer to ensure that the partial audit
is accurate and complete in the same manner as a completed audit report. The reviewer
should also ascertain that the partial audit was completed as instructed by the controlling
district office.
4. Preparation of Form BOE-204 (include Auditor ID, Class, Name and hours).
5. After the audit is reviewed, placing the audit workpapers in a subfolder with the following
name:
District Code_Case Id_Taxpayer Name_Coop AWPs
6. Placing the above subfolder in the controlling district’s folder located within the Transfer
Documents to Other Districts folder located on the J:\drive.
7. E-mail notification to controlling district’s Audit Control that the completed cooperative
audit workpaper folder is ready to be retrieved.
Interdistrict AWPs must conform to procedures set forth in AM Chapter 3, Audit Working Papers.
In addition, the AWPs must include a summary of differences established by each cooperating
district office and the letters identifying the district office must precede the index on the AWPs.
February 2016
General Audit Procedures
GLOSSARY OF TERMS
0490.00
ADEQUATE
Fulfilling minimal requirements; satisfactory; acceptable; sufficient.
ANALYZE
To determine or examine the composition of an item, account or amount, usually by reference
to its historical origin; particularly (auditing) to review and set forth in a working paper
the details or classified summary of items in an account, obtained or substantiated, where
necessary, by reference to sources, and accompanied by explanations of major items and
by cross-references to related accounts. See SCAN; VERIFY; AUDIT.
APPROPRIATE
Suitable, desirable, reasonable, or necessary in a particular context; often used by
accountants as signifying conformity with the value judgments implicit in current practices.
See SIGNIFICANT; PROPER.
APPROXIMATE
Containing error; a quantity or verbal characterization which cannot validly be claimed
to coincide in all respects with results which might be secured by more precise treatment.
ARITHMETIC MEAN
The result obtained by dividing the sum of two or more quantities by the number of items;
usually denoted by a symbol such as Y. It is often intended as a representative quantity
or as a measure of the central tendency of a group of items. See AVERAGE; MEAN.
AUDIT
An exploratory, critical review by an auditor of the underlying internal controls and
accounting records of a business enterprise or other economic unit, precedent to the
expression by him of the opinion of the propriety of its tax returns; often accompanied by
a descriptive adjective or phrase indicating scope and purpose.
AVERAGE
1. Arithmetic mean.
2. Any central tendency of a series of quantities.
See ARITHMETIC MEAN; MEDIAN; MODE; WEIGHTED AVERAGE.
AVERAGE DEVIATION
A measure of the variation of a group of numerical data from a designated point; the
arithmetic mean of the differences between each item and the arithmetic mean of the data
or other selected point where the differences are added without regard to sign. Thus, the
arithmetic mean of 5, 6, and 7 is (5 + 6 + 7)/3 = 6 and the average deviation, taken without
regard to sign, is (1 + 0 + 1) /3 = 2/3. The smaller the result the more representative the
data. See STANDARD DEVIATION: DISPERSION.
BREAK-EVEN POINT
1. The volume point at which revenues and costs are equal: a combination of sales and costs
that will yield a no-profit, no-loss operation.
2. That point in the cost of a variable factor of production at which one or more alternatives
are equally economical.
January 2000
Audit Manual
Glossary of Terms
(Cont.) 0490.00
CENTRAL TENDENCY
The pattern displayed by a collection of interrelated data when plotted as coordinates.
CHECK
This is a loose term used in auditing to indicate examination or verification. As a verb,
the word has no exact meaning and its use without a descriptive qualification is usually
avoided. More descriptive words, such as verify, examine, or prove, are preferable. See
TESTCHECK.
CLASSIFICATION
Grouping of transactions, entries, or accounts under a common head or heads; a list of
such groupings.
CLERICAL ERROR
As applied to books of account, any incorrect entry or posting, especially when involving
routine transactions; typical causes are wrong coding, faulty computation — as in an
extension or footing, a failure to enter or post, a posting to a wrong account, and posting
to the wrong side of an account.
COMPARE
To establish the correspondence or similarity of differently located items.
CONFIRM
A procedure used to obtain added proof through contracts or communications with
independent sources to establish the correctness of situations or transactions; for example,
establishing losses of merchandise from fire or theft.
CROSSCHECK
1. To add horizontally as well as vertically in order to assure the accuracy of totals.
2. To perform one operation, as in auditing, which will have the effect of aiding in determining
the accuracy, property, or other characteristic of another operation.
DETAILED AUDIT
An examination of the books of account, or a portion thereof, whereby all or substantially
all entries and transactions are reviewed and verified, as contrasted with an examination
by means of tests or samples. See AUDIT; SAMPLE; TESTCHECK.
DISCREPANCY
Any observed difference between opinions or facts, often with the implication of an error
or other impropriety in one or more of them.
DISPERSION
A measure of the variation of a group of numerical data from a central tendency, such
as arithmetic mean, by determining the range of such data or their average deviation or
standard deviation. See these terms.
EXAMINE
To probe records or inspect securities or other documents, procedures and scope, for the
purpose of arriving at opinions of accuracy, propriety, sufficiency, and the like.
January 2000
General Audit Procedures
Glossary of Terms
(Cont.) 0490.00
INTERNAL CONTROL
This consists of measures and methods employed within an organization to safeguard cash,
inventories and other assets as well as to maintain the accuracy and proper functioning of
the accounting system. This is of paramount importance in tax auditing since an efficient
system of internal control can make the auditor’s tests easier and more reliable.
JUDGMENT SAMPLE
A sample whose size and items composing it has been determined by someone who is
familiar with the universe undergoing the test and capable of exercising informed and
unbiased discretion in making the selection. Such samples are sometimes necessary when
data are needed quickly or when interest is confirmed to only a part of the universe. They
are usually less reliable for estimation and prediction purposes than are samples selected
on a wholly random basis.
MARKDOWN
The reduction of an originally established selling price.
MARKDOWN CANCELLATION
The portion of original markon restored after a markdown has been made.
MARKON
The amount added to cost, in setting selling prices, to cover operating expenses and profit
margin; the ratio to selling price of the amount added to cost, expressed as a percentage;
also known as “markup” (see below).
MARKUP
1. The amount added to an established selling price for the purpose of determining a new
and higher selling price; the percentage of markup is based on the previously established
selling price.
2. The total amount by which established selling prices are increased during a given period
in setting new selling prices.
3. = markon.
The Board usage of markup is synonymous with the meaning of markon and is the amount
added to cost to obtain the sale price, and generally is referred to in terms of percentages.
The percentage of markup is computed by dividing gross profit by cost of sales: G.P./C.G.S.
= % of M.U. Businessmen often discuss gross profit in terms of percentages, but seldom
discuss markup in these terms. Care should be exercised by auditors to make certain
they are on common ground with the taxpayer when discussing gross profit and markup
percentages.
MARKUP CANCELLATION
The elimination of a markup or such portion thereof as pertains to referent unsold
merchandise. The removal of a previous addition to an established selling price. Markup
cancellation is not to be confused with Board’s usage of the “markup” definition. See
MARKUP.
January 2000
Audit Manual
Glossary of Terms
(Cont.) 0490.00
MARKUP FACTOR
This is the factor by which cost of sales is multiplied to determine total sales: C.G.S. x
M.U.F. = S. The markup factor always will be the percentage of markup plus 100%. In
computing sales, the markup factor should be used as it saves one step (adding the amount
of the markup to cost of sales) in the computation of sales. The markup factor is obtained
by dividing sales by cost of sales: S./C.G.S. = M.U.F.
MATERIALITY
1. The relative importance or relevance of any item included or omitted from a financial
statement, or of any procedure or change in procedure that conceivably might effect such
a statement.
2. The characteristic attaching to a statement, fact, or item whereby its disclosure or the
method of giving it expression would be likely to influence the judgment of a reasonable
person.
3. The relative importance of any audit coverage, such as the testing of certain accounts. The
opinion can be reached only by a value judgment on the part of the auditor.
MEAN
A midpoint in an array of numbers. See ARITHMETIC MEAN.
MEDIAN
The central item in a list of numbers arrayed according to size; the value at which on equal
number of items fall on either side in a list of numbers so arrayed; often represented by
the symbol Md.
MODE
The item of most frequent occurrence in a group of numbers; often represented by the
symbol Mo; the class of greatest frequency in a frequency distribution. See MEDIAN;
ARITHMETIC MEAN; AVERAGE.
OBJECTIVE
Having a meaning or application apart from the investigator, the peculiarities of his
experience, or of the environment, and substantiated or capable of being substantiated by
the findings of independent investigators; said of a fact, judgment, or inference; as objective
evidence. See SUBJECTIVE.
PRELIMINARY AUDIT
In an initial engagement, the investigation of the business and its accounting system and
operating methods preceding the determination of the scope of the audit procedures to be
employed.
PROBABILITY SAMPLE
A random sample with a computable sampling error. The computed error indicates the
degree of representativeness (or lack thereof) which should be taken into consideration in
interpreting the sample results.
PROCEDURAL AUDIT (or REVIEW)
The critical examination by an auditor of internal controls and other procedures employed
within an organization, (a) looking at recommendations for their improvement whether
by simplification, elaboration, or readaptation, or (b) as a regular feature of a periodic
examination. Frequently, the review involves procedures other than accounting.
January 2000
General Audit Procedures
Glossary of Terms
(Cont.) 0490.00
PROPER
In line with common practice; meeting specifications deemed fitting in the circumstances;
ethical as well as legal.
PROVE
To verify or subject to a satisfactory test.
PROVE FOOTINGS
Footings are the sums obtained from vertical or horizontal additions, or both, and are used
by the auditor to establish the accuracy of the totals. It usually is sufficient for tax audit
purposes to verify the additions on most taxpayer’s records to the closest $100. However,
where the footings being verified are used to compute percentages based on tests, they
should be verified to the closest dollar.
RANDOM
Arising from chance alone, in contrast with haphazard or systematic. Randomization
requires careful planning to make certain that only chance elements are present, or that
bias, if present or introduced, is known and measurable.
RANDOM NUMBERS
A set of numbers formed at random; generally arrayed in tabular form to assist in sample
selection.
RANDOM SAMPLE
A sample in which all the elements have been drawn at random, or according to the laws
of chance. The procedure by which the sample is constructed characterizes a random
sample, rather than its specific content. See STRATIFIED SAMPLING; SYSTEMATIC
SAMPLING; REPLICATION.
RANDOM VARIATION
A fluctuation resulting from chance alone.
RANGE
The difference between the largest and smallest items in a group of numerical data. See
DISPERSION.
RECONCILE
To account for difference between separate sources of information for the same transaction.
The tax auditor often will be confronted with differences between the taxpayer’s records,
tax work sheets, and returns filed.
RELIABILITY
1. (Auditing) The measure of confidence that may be placed in a set of records or reports. See
REPLICATION.
2. (Statistics) Relative ability to repeat results in a given set of trials or experiments.
REPLICATION
The repetition of methods by which evidence is gathered. Thus, if under similar conditions
of selection and verification, two independent examinations are made of a group of vouchers,
each is a replication of the other, although the particular vouchers examined may not be
the same.
The replication of audit methods may be regarded as a test of precision with which the
procedures were carried out. See VALIDITY.
January 2000
Audit Manual
Glossary of Terms
(Cont.) 0490.00
REPRESENTATIVE SAMPLE
Any random sample selected for observation, whether or not containing a determinable
error. See PROBABILITY SAMPLE.
REVIEW
To examine critically any operation, procedure, condition, event, or series of transactions.
SAMPLE
A portion of a group of related transactions, financial statements, or other universe of data
chosen to reflect or assist in determining the accuracy, propriety, or other characteristics of
the whole. Sampling is an important element in the process of auditing. See TESTCHECK.
SAMPLING ERROR (Statistics)
Standard error of a sampling distribution.
SCAN
To look at the entries in an account, accounting record, or a group of accounts or records,
for the purpose of testing general conformity to pattern, noting apparent irregularities,
unusual items, or other circumstances appearing to require further study. The term
indicates a general and rapid review as opposed to a detailed examination or substantiation
of each item, and often a review requiring the skill of a practiced auditor and having as its
purpose the discovery of the qualitative aspects of a procedure, classification, or account.
See ANALYZE.
SCOPE
The character of an audit, primarily with reference to the procedures utilized in a particular
audit, or the extent to which the transactions, records, or accounts examined serve as a
basis of adequate testing and substantiation.
SHELF TEST
This is a general term for procedures used to determine the unit price of merchandise sold.
In many instances, this is done by examining unit prices of merchandise on the shelves of
the retailer. Unit sales prices also may be determined by examining catalogs, sales tickets,
menus, contracts, etc.
SIGNIFICANT
1. Of sufficient magnitude, as measured by a departure from some norm or standard, to
raise doubt that the deviation is the result of chance, random, or compensating factors;
hence, indicating behavior calling for a better awareness or understanding of the cause,
the removal of the cause, or a modification of the standard because of its inadequacy.
2. Of sufficient importance to warrant disclosure or the treatment accorded larger or more
important items; likely to influence judgments or decisions; said of individual transactions,
transaction groups, or other events or conditions peculiar to a given establishment.
SIGNIFICANT AMOUNT
A rounded-off number, as of dollars, conveying to the observer the same impression as
would the fully expressed quantity.
January 2000
General Audit Procedures
Glossary of Terms
(Cont.) 0490.00
SPECIAL AUDIT
An audit, having a special or general scope, for other than the regular periods or for other
than customary purposes; a limited audit. See AUDIT.
STANDARD DEVIATION (Statistics)
A measure of dispersion: the square root of the average of the squares of the differences
between a group of numbers and their arithmetic mean.
While other measures of dispersion, such as range and average deviation, are available,
the preferred measure of dispersion in statistics is the standard deviation.
STATISTIC
Any value, such as an arithmetic mean, median, or standard deviation, calculated from a
sample rather than a universe.
In accounting practice, “statistics” are sometimes distinguished from accounting data
by the fact that the former may not tie in directly with the books of account and thus be
subjected to the discipline of double-entry bookkeeping.
STRATIFIED SAMPLING (Statistics)
Drawing of random samples within strata of relatively homogeneous subgroups of the
population. Generally, the strata are sampled independently so that sample results in one
strata do not affect sampling procedures in other strata. The data may also be classified
into strata on the basis of cost, ease, facility of handling materials, and other criteria, as
well as statistical homogeneity.
SUBJECTIVE
Having a meaning or application reflecting the characteristics of the investigator, the
peculiarities of his experience, or of the environment, and not substantiated by independent
investigators: said of a fact, judgment, or inference.
SUBSTANTIATE
To insure the accuracy of, by weight of evidence; to verify.
SYSTEMATIC SAMPLING (Statistics)
A sample design or set of sampling procedures, frequently employed, wherein sampling
units are selected at some fixed and designated interval, e.g., every fifth file card in a file
system. A systematic sample qualifies as a random sample if the starting element is selected
at random and every k th element (k, an integer) of the frame is selected thereafter.
TEST
1. A specified procedure or set of procedures, including rules or assembling evidence,
interpretation, and significance for accepting or rejecting hypotheses.
2. As applied to the quality of a commodity or of a performance, a sample or sampling.
TESTCHECK
To verify selected items in an account or record for the purpose of arriving at an opinion
of the correctness of the entire account or record; to sample. See SAMPLE; TEST.
TESTED
Records are examined to the extent deemed appropriate.
January 2000
Audit Manual
Glossary of Terms
(Cont.) 0490.00
TESTING
The justification for testing rests largely upon the probability that irregularities are
recurrent; that, once committed, they will be reported.
TRACE
To ascertain whether an item has been disposed of in accordance with source indications.
The tracing of transactions is a necessary phase of the tax auditor’s verification and is
particularly important when establishing differences in test periods.
UNIVERSE
1. The whole of the subject matter of whatever is under consideration.
2. (Statistics) The entire matrix or group of data from which samples may be drawn; sometimes
referred to as a population.
VALIDATE
1. To test for or to certify or attest to accuracy, precision, reliability, and relevance.
2. To do what is necessary to make effective or legal.
VALIDITY
As used in deductive logic; propriety established by a strong inference in which no
inconsistency appears.
VERIFICATION
1. The procedure by which validity is ascertained.
2. The process of substantiation involved in providing by customary audit procedures that
a statement, account, or item is accurate and properly stated, or to be within permissible
or reasonable limits.
VERIFICATION OF POSTINGS
Verification of postings involves tracing original records to the books or original entry
whose totals are then traced to postings in the general ledger.
VERIFY
To confirm the truth, accuracy, or probability of, by competent examination; to substantiate.
WEIGHTED AVERAGE
A simple average of items reduced to a common basis.
ACKNOWLEDGMENT
The principal source of the definitions included in this glossary appears below:
January 2000
Eric L. Kohler, A DICTIONARY FOR ACCOUNTANTS,
3rd Ed., (C) 1963. Reprinted by permission of
Prentice–Hall, Inc., Englewood Cliffs, New Jersey.
General Audit Procedures
Table of Exhibits
Audit Process Flow Chart........................................................................................................ Exhibit 1
Form BOE–1164 — Audit Memorandum
of Possible Tax Liability..................................................................................................... Exhibit 2
Sample Memo, Report of Suspected
Money Laundering Activity................................................................................................. Exhibit 3
Policy and Procedure for Subpoena Requests....................................................................... Exhibit 4
Example of Prior Audit Percentage Memo.............................................................................. Exhibit 5
Sample Sales Tax Working Paper
(Whole Dollar Auditing)...................................................................................................... Exhibit 6
Form BOE–503–A/B/C — ABC Letter Procedure................................................................... Exhibit 7
Form BOE–504–A/B/C — XYZ Sample Letter........................................................................ Exhibit 8
Federal Acquisition Regulations (FAR’s)
Clause Definitions............................................................................................................Exhibit 9A
Federal Acquisition Regulations (FAR’s)
Progress Payments.........................................................................................................Exhibit 9B
Federal Acquisition Regulations (FAR’S)
Performance-Based Payments....................................................................................... Exhibit 9C
Federal Acquisition Regulations (FAR’S)
Government Property (Fixed Price Contracts)............................................................... Exhibit 9D
Decision Table ......................................................................................................................Exhibit 9E
Sample Audit Program.......................................................................................................... Exhibit 10
Form BOE–837 — Affidavit for Section 6388
or 6388.5 Exemption ...................................................................................................... Exhibit 11
Form BOE–52 — Certificate of Verification
Out of State Delivery ...................................................................................................... Exhibit 12
Form BOE–52–L — Sample Letter,
Seller Receipt of Goods in Interstate Commerce..........................................................Exhibit 12A
Form BOE–52–L1 — Sample Letter, Auditor......................................................................Exhibit 12B
Form BOE–52–L2 — Sample Letter for Seller Notice
of Pending Refund of Excess Sales Tax Reimbursement............................................ Exhibit 12C
Form BOE-698-A - information Document
Request -- Initial IDR....................................................................................................... Exhibit 13
Form BOE-698-A - Information Document
Request -- Second IDR................................................................................................... Exhibit 14
Form BOE-698-C, Information Document
Request Master Log........................................................................................................ Exhibit 15
Form BOE-699-B, Formal Notice and Demand
Completed Example........................................................................................................ Exhibit 16
Form BOE-699 - Audit Findings Presentation Sheet............................................................. Exhibit 17
Form BOE-699-A, Audit Findings Presentation
Sheet Master Log............................................................................................................ Exhibit 18
Examples of Tax Exemption Cards........................................................................................ Exhibit 19
August 2016
Audit Manual
AUDIT PROCESS FLOW CHART
1. Headquarters prepares
a list of accounts
eligible for audit.
2. District selects
accounts from list and
notifies headquarters of

accounts selected.
EXHIBIT 1
3. District prints a copy
of the transcript.


6. Auditor makes
telephone contact to
make appointment, ask 
questions, and sends
letter confirming start
date.

7. Initial contact and
examination of records
is made.
12.Field auditor holds
discussion with
taxpayer field Audit
Supervisor involved
if necessary.

13.Auditor completes and
submits audit report
and disks to field Audit
Supervisor.
August 2005
5. Auditor makes preaudit review of district
file and appropriate

regulations.
8. Audit plan developed
based upon preliminary
examination.


4. Field Audit Supervisor
assigns audit to field
auditor.


11.Auditor summarizes
audit data — prepares
appropriate memos.

14.Audit report sent to
taxpayer — if T.P.
disagrees, hearing

process is initiated.
9. Audit data selected and
examined.
10.Taxpayer reviews
audit data and
provides supporting
documentation.

15.Audit transmitted to
headquarters for
billing.
General Audit Procedures
FORM BOE–1164 — AUDIT MEMORANDUM
OF POSSIBLE TAX LIABILITY
EXHIBIT 2
June 2014
Audit Manual
SAMPLE MEMO, REPORT OF SUSPECTED
MONEY LAUNDERING ACTIVITY
State of California
Board of Equalization
Memorandum
To
: Deputy Director
Field Operations Department (MIC 47)
From
: District Administrator
Date:
Subject : Report of Suspected Money Laundering Activity
An <investigation/audit> of <taxpayer name, permit number> by <auditor/tax
representative>, disclosed information which indicates possible money laundering
activity as defined under various provisions of the Penal Code.
During the period from <mm/dd/yy> to <mm/dd/yy>, there were money transactions that
appear unrelated to the normal business operations of a <type of business> with sales of
money orders, travelers checks and/or check cashing operations.
The total amount of all transactions was <dollar amount>. The average transaction
amount was <dollar amount>. Each transaction was made in the form of <cash, money
orders, etc.>. A summary of these transactions is attached.
The detected activities took place at <business address> and funds were deposited in <list
bank(s)> during the period from <mm/dd/yy> to <mm/dd/yy>.
Exhibit 3_Sample
February
2016 Memo_Money Laundering.docx
EXHIBIT 3
General Audit Procedures
POLICY AND PROCEDURE FOR SUBPOENA REQUESTS
EXHIBIT 4
Page 1 of 2
POLICY AND PROCEDURE FOR SUBPOENA REQUESTS
SUBPOENAS DUCES TECUM
Authority and Use. The Board of Equalization is authorized by Section 15613 of the Government
Code to issue a subpoena for the attendance of witnesses or the production of books, records,
accounts and papers. A subpoena requiring a person to bring books, records, accounts and papers
with them is called a “subpoena duces tecum.” When in the course of a field audit or investigation
of a taxpayer’s business, the Board’s representative is denied access to business records which are
necessary in order to carry out the functions of the Board, the subpoena power may be invoked.
The subpoena should be considered only when the records are known or believed to exist, the
potential liability to be revealed by the records is significant, and all other methods of obtaining
the records have been unsuccessful.
Procedure. All subpoenas will be prepared by the Legal Department in Headquarters utilizing
information provided by the district. Districts should prepare the request in the form of a
memorandum from the District Administrator to the Chief, Field Operations Division or the Chief,
Collections and Third District Operations Division. The Chief, Field Operations Division or the
Chief, Collections and Third District Operations Division will forward approved requests to the
Legal Department for drafting and issuance.
Information Needed. The memorandum should include the following information:
a) The taxpayer(s) name, dba(s), address, and tax number(s) applicable to the records being
requested.
b) The name and address of the person or entity upon whom the subpoena is to be served.
c) The name and title of the Board employee who will examine the documents.
d) The Board address where the documents are to be examined.
e) If necessary, a date and or time when the records are to be produced or examined. A date/
time may be appropriate if the employee who will examine the records will be available
only before or after a certain date. Normally the Legal Division will calculate and specify
the appropriate dates based on time frames which are controlled by statute.
f) The time period covered by the documents that are being requested.
g) The specific documents that are being requested. Request only the records needed for the
audit. Do not state “any and all records” or similar omnibus requests.
h) The efforts that have already been made to obtain the documents being sought. Attach
copies of letters written, and indicate whether the request was ignored or refused.
August 2005
Audit Manual
Policy and Procedure for Subpoena Requests
(Cont.) Exhibit 4
Page 2 of 2
i) If service is being made on a financial institution for production of a customer’s financial
records, the California Right to Financial Privacy Act requires that the customer affected
also be served with a copy of the subpoena, and have a period of time in which to notify
the financial institution of intent to move to quash the subpoena. Therefore, the following
additional information is required:
• customer’s name, address, and account number at the financial institution
• character of the customer —
•
•
•
•
•
•
•
•
•
•
corporation
corporation that has forfeited its charter or right to do business or that has dissolved
joint stock company or association
partnership
unincorporated association
public entity
minor
fiduciary — guardian, conservator, trustee, executor, etc.
candidate for election for public office
any other natural person not described above.
The above information is necessary in order that the subpoena and the declaration of materiality
under penalty of perjury supporting the issuance of the subpoena may be prepared with the
degree of particularity necessary to insure against infringements of the taxpayer’s constitutional
guarantees relating to unreasonable search and seizure and due process of law.
Preparation and Service of Subpoena and Declaration. The Legal Division will prepare
the Subpoena Duces Tecum, Declaration, Notices and Acknowledgment of Receipt, and Proofs
of Service. The documents will be sent to the District Administrator together with complete
instructions for serving the subpoena. Subpoenas being served on financial institutions for the
production of customer records include instructions to the financial institution to estimate and
obtain approval of their research and copying charges before complying with the subpoena. The
instructions provided by Legal must be followed exactly to protect the rights of both the taxpayer
and the Board.
January 2000
General Audit Procedures
EXAMPLE OF PRIOR AUDIT PERCENTAGE MEMO
EXHIBIT 5
Board of Equalization
Business Tax and Fee Department
State of California
Memorandum
Distributed Electronically
To
: District Principal Auditor*
From
: Audit Supervisor
Subject : Request to Use a Prior Audit Percentage
Date:
December 1, 20XX
ABC Company
SR KH 180-345678
We would like to use a prior audit percentage in the current audit of ABC
Company. Staff has reviewed their accounting procedures and determined that
there has been no change since the last audit. In addition, there have been no
changes to the personnel handling their accounts payable and there have been no
changes to any laws or regulations affecting their business. The following is an
outline of our proposal as specified in Audit Manual Section 0405.33:
(a) ABC Company
SR KH 180-345678
(b) The taxpayer is a manufacturer and distributor of consumer electronics.
(c) The audit period is 1/1/10 - 12/31/12
(d) The prior audit percentage would be used in the paid bills portion
of the audit.
(e) For the prior audit period, 1/1/07 - 12/31/09, the percentage of
error was 2.01 percent.
(f) For the prior audit period, 1/1/07 - 12/31/09, the population was
$4,100,000.
(g) We propose the use of 2.01 percent in the current audit.
(h) The population to which this percentage of error will be applied is
$5,600,000.
We have discussed this approach with the tax manager and she is agreeable to the
use of the prior percentage of error. The tax manager was informed that this
approach may only be extended to two subsequent audits. We both agree that
given the relative consistency in the error rates, populations, accounting
procedures, internal controls and personnel, the use of a prior percentage of error
would save significant audit time while achieving substantially the same result as
a new test.
Thank you for your consideration. Please let me know if you have any questions.
cc:
I. M. Auditor
* In the case of a second subsequent audit, the memo is sent to the District Principal Auditor
and the Deputy Director, Field Operations Department for approval by both.
April 2015
Audit Manual
SAMPLE SALES TAX WORKING PAPER
(WHOLE DOLLAR AUDITING)
WHOLE DOLLAR AUDITING
(schedule name)
EXHIBIT 6
SRAC 12-121212
J.C. Conlon
09/09/99
A
B
C
D
E
F
G
H
(B+C)
<414>
(D-E)
<C>
REF PERIOD
SALES
AUDITED TOTAL
Analysis of Differences
PER
SALES OF AUDITED
W/D
SALE OF
RECORDS FIXED
SALES REPORTEDDIFFERENCE VARIANCES ASSET
1
2–xx 428,465428,465 428,466
3–xx 475,150475,150 475,145
4
4–xx 367,48110,000377,481 367,482
5
1,271,096 10,0001,281,096 1,271,093
2
3
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
January 2000
COPY PROVIDED TO TAXPAYER
DATE ____________
–1
5
9,999
10,003
–1
0
5
0
–1 10,000
3
10,000
General Audit Procedures
FORM BOE–503–A/B/C — ABC LETTER PROCEDURE
EXHIBIT 7
Page 1 of 3
STATE OF CALIFORNIA
STATE BOARD OF EQUALIZATION
BETTY T. YEE
First District, San Francisco
450 N STREET, SACRAMENTO, CALIFORNIA
PO BOX 942879, SACRAMENTO, CALIFORNIA 94279-00XX
916-XXX-XXXX • FAX 916-XXX-XXXX
BILL LEONARD
Second District, Ontario/Sacramento
www.boe.ca.gov
MICHELLE STEEL
Third District, Rolling Hills Estates
JUDY CHU, Ph.D.
Fourth District, Los Angeles
JOHN CHIANG
State Controller
_______
RAMON J. HIRSIG
Executive Director
Tax Permittee
Use of “ABC” Letter Procedure to Verify Payment of Use Tax by Out-of-State Sellers
This letter summarizes the sample letter procedure explained to you by our auditor. The auditor
questioned certain ex-tax purchases made by you. Under the California Sales and Use Tax Law, you as
the purchaser are liable for payment of the tax unless you can present satisfactory evidence (e.g., a
receipt) that the tax was paid to a seller holding a California seller’s permit or a Certificate of
Registration-Use Tax.
The “ABC” letter procedure outlined in this document is recommended by the Board as a method by
which you, the purchaser, can help to satisfy your use tax obligation. You are not bound to use these
procedures and can present any other satisfactory evidence, such as a receipt.
The attached sample letter (BOE-503-B) and statement form (BOE-503-C) are provided for your
convenience. You may reproduce the statement form and send it to the vendor(s) in question to obtain
their signed statements regarding the payment of use tax. If you choose the recommended procedure to
have the forms returned directly to the Board, the auditor will provide return envelopes. However, if you
decide to use the “ABC” process and you choose to have the forms returned directly to you instead of the
Board, the likelihood of having staff contact your vendor or sending an additional mailing will be greater.
In order to communicate fully with your vendor(s), you may:
•
Customize the letter by placing the text on your letterhead.
•
Choose the recommended procedure to have the responses sent directly to the Board,
and add a statement in the letter to your vendor(s) asking that your vendor(s) send
you a copy of their response by fax or mail.
Please note that any changes you make to the sample letter or form must be approved by Board staff
before mailing.
The auditor will allow a four week period for you to send the statements and for your vendor(s) to reply.
If you have chosen the recommended procedure to have the responses sent directly to the Board, the
auditor will timely provide you with copies of the responses received. While the auditor will carefully
consider the statements received within the allowed period, late responses may be reviewed and allowed
if appropriate.
Please be aware that a statement will not be accepted as satisfactory proof if incomplete, if found to be
untrue, or if the Board has or receives information that refutes such statement. An “ABC” response
merely acts as one form of evidence of possible tax payment by the vendor and does not preclude further
analysis and verification by the auditor.
STATE BOARD OF EQUALIZATION
Sales and Use Tax Department
BOE-503-A (10-96)
August 2008
Audit Manual
Form BOE–503–A/B/C — ABC Letter Procedure
(Cont.) Exhibit 7
Page 2 of 3
BOE-503-B REV. 1 (8-99)
STATE OF CALIFORNIA
BOARD OF EQUALIZATION
SAMPLE LETTER
Requesting Vendor’s Statement
ABC Company
1234 5th Street
Any Town, CA 90000
Auditors of the California State Board of Equalization are currently examining our records in
connection with the California Sales and Use Tax Law. They have questioned certain nontaxed
sales made by you, as covered by the invoices listed on the attached sheet.
Since the Board audits both the seller and the purchaser, it is very important that you respond to
the enclosed document in order to assure that tax is assessed only once on each transaction.
Would you please review the enclosed document and complete the appropriate portions of it. As
noted on the document, you may need to check more than one box for a transaction. The Board
will not accept the statement if it is not filled out completely and signed by an authorized
representative.
Your prompt response is necessary for us to determine if tax has been paid on this/these
transactions. Please return the enclosed document within 10 days using the enclosed envelope or
fax to (_____) ______________.
January 2000
General Audit Procedures
Form BOE–503–A/B/C — ABC Letter Procedure
(Cont.) Exhibit 7
Page 3 of 3
BOE-503-C REV. 1 (8-99)
STATE OF CALIFORNIA
STATEMENT CONCERNING PROPERTY PURCHASED
WITHOUT PAYMENT OF CALIFORNIA USE TAX
BOARD OF EQUALIZATION
DMA
Auditor’s Initials
Please complete this inquiry statement regarding certain non-taxed sales you made to the customer listed below. Please fill out the form
completely, check all the appropriate boxes, and sign as your company’s authorized representative. The form should be returned within
10 days.
NAME OF CUSTOMER TO WHOM YOU SOLD ITEMS WITHOUT USE TAX
Invoice Date
Invoice Number
Amount
Description
Response
List all boxes (a) through (g) that apply
Please mark all applicable boxes below and list in response area above.
a.
The tax was paid directly to the Board of Equalization as a result of an audit determination dated _______________ covering the
period _______________ to _______________. The Board’s audit specifically included the above transaction in the audit
assessment.
b.
The tax was paid directly to the Board of Equalization as a result of an audit determination dated _______________ covering the
period _______________ to _______________. The Board’s audit examined our sales on a test basis with a percent of error
computed and applied. The sales sampled in the audit were similar in nature to the above transaction. Accordingly, as a result of this
audit we believe tax on the above transaction has been paid to the Board.
c.
The Board of Equalization is in the process of auditing our company for the period _______________ to _______________. The
Board is examining our sales to California customers. Accordingly, as a result of this audit we believe that tax on the above
transaction(s) may be questioned by the Board.
d.
I was engaged in business in the special tax district where the sold property was shipped or delivered and tax was or will be assessed
as part of an audit by the Board of Equalization. This option should be used in conjunction with Item a, b or c above.
e.
The property described on the above listed invoices was shipped from the city of _______________ in the State of
_______________.
f.
No sales or use tax was charged by our company on the above questioned document(s), however, the tax was reported and remitted
by our company to the Board of Equalization on our tax return for the period _______________.
g.
Our company has not paid the California sales or use tax to the Board of Equalization and we have not been audited for the same
period for the transactions listed above.
COMMENTS
SELLER’S PERMIT NO.
SELLER’S NAME
SIGNATURE
TELEPHONE NO.
TITLE (Owner, Partner, President, etc.)
DATE
The information provided above is subject to verification by the State Board of Equalization.
January 2000
Audit Manual
FORM BOE–504–A/B/C — XYZ SAMPLE LETTER
EXHIBIT 8
Page 1 of 9
STATE OF CALIFORNIA
STATE BOARD OF EQUALIZATION
[ADDRESS 1]
[ADDRESS 2]
[REQUESTER PHONE NUMBER] • FAX [OFFICE FAX NUMBER]
www.boe.ca.gov
BETTY T. YEE
First District, San Francisco
BILL LEONARD
Second District, Ontario/Sacramento
MICHELLE STEEL
Third District, Rolling Hills Estates
JUDY CHU, Ph.D.
Fourth District, Los Angeles
JOHN CHIANG
State Controller
_______
RAMON J. HIRSIG
Executive Director
Tax Permittee
Use of "XYZ" Letter Procedure to Verify Claimed Sales for Resale
This letter summarizes the sample letter procedure explained to you by our auditor. The auditor questioned certain sales claimed on your tax
returns as sales for resale because they were not supported by a valid resale certificate taken in good faith at the time of sale.
Under the California Sales and Use Tax Law, you as the seller are liable for payment of the tax unless you can present satisfactory evidence that
the property was in fact purchased by your customer for resale or that your customer paid the tax directly to this state.
If the auditor has also questioned sales other than resale, such as sales in interstate and foreign commerce, sales to the United States Government,
or transportation charges, documentation to support the claimed exemption must also be provided. The auditor will provide you with an
information sheet describing how the law applies and the type of supporting documentation required to support the questioned claimed exempt
sale.
The "XYZ" letter procedure outlined in this document is recommended by the Board as a method by which you, the seller, can help to satisfy the
burden of proving that a sale was not at retail even though a resale certificate was not timely obtained, or your customer paid the tax directly to
the state. This procedure should only be used when you cannot locate the appropriate supporting documentation, such as resale certificates,
purchase orders, sales contracts, etc., within your company records.
It is recommended that the “XYZ” response forms be returned directly to the Board. However, you may choose to have the letters returned to
you for forwarding to the Board. In either case, the auditor will review all documentation submitted. Because the XYZ letter is not a substitute
for a timely resale certificate, you or your customer may be required to submit additional documentation or information to your auditor. You
should be aware that if the auditor determines the "XYZ" process is appropriate and you choose to have the forms returned directly to you
instead of to the Board, the likelihood of having staff contact your customer or sending an additional mailing will be greater.
The attached sample letter and statement form are provided for your convenience. If the statement form does not fit your particular
circumstances, the auditor will work with you to customize the form. You may reproduce the statement form and send it to the customers in
question to obtain their signed statements regarding the disposition of the purchased property. If you choose the recommended procedure to have
the forms returned directly to the Board, the auditor will provide return envelopes.
In order to communicate fully with your customers, you may
• Customize the letter by placing the text on your letterhead.
• If you choose the recommended procedure to have the responses sent directly to the Board, you may add a statement in
the letter to your customer asking that your customer send you a copy of the response by fax or mail.
• If your agreement of sale permits it, ask your customer to forward payment of tax if the transaction is identified as
taxable. You should clearly indicate that the tax should be forwarded to you and not to the Board of Equalization.
Please note that any changes you make to the sample letter or form must be approved by Board staff before mailing.
The auditor will allow a four week period for you to send the statements and for your customers to reply. If you have chosen the recommended
procedure to have the responses sent directly to the Board, the auditor will timely provide you copies of the responses received. While the
auditor will carefully consider the statements received within the allowed period, late responses may be reviewed and allowed if appropriate.
Please be aware that a statement will not be accepted as satisfactory proof if incomplete, if found to be untrue, or if the Board has or receives
information that refutes such statement. Unlike a valid resale certificate, a purchaser's statement of resale taken after the sale does not relieve the
seller of liability for the tax if it is found that the property was purchased for the buyer's use and the applicable tax was not paid to the state prior
to the date of your letter to your customer.
STATE BOARD OF EQUALIZATION
Sales and Use Tax Department
BOE-504-A REV. 12 (1-97)
August 2008
General Audit Procedures
Form BOE–504–A/B/C — XYZ Sample Letter
(Cont.) Exhibit 8
Page 2 of 9
BOE-504-B REV. 11 (1-97)
STATE OF CALIFORNIA
BOARD OF EQUALIZATION
SAMPLE LETTER
Requesting Purchaser’s Statement
XYZ Company
1234 5th Street
Los Angeles, California 90013
Auditors of the California State Board of Equalization are currently examining our records in
connection with the California Sales and Use Tax Law. They have questioned certain nontaxed
sales made to you, as covered by the invoices listed on the attached sheet.
Would you please indicate the disposition of this property by checking the appropriate box and
completing the statement. The board will not accept the statement if it is not filled out
completely and signed by an authorized representative.
Your prompt response is necessary to support any claims for exemption that are in order. Please
return the inquiry statement within 10 days using the enclosed envelope or fax to
(_____) ______________.
January 2000
Audit Manual
Form BOE–504–A/B/C — XYZ Sample Letter
(Cont.) Exhibit 8
Page 3 of 9
BOE-504-C REV. 12 (1-97)
STATE OF CALIFORNIA
STATEMENT CONCERNING PROPERTY PURCHASED
WITHOUT PAYMENT OF CALIFORNIA SALES TAX
BOARD OF EQUALIZATION
DMA
Auditor’s Initials
Please complete this inquiry statement to indicate the disposition of certain non-taxed purchases you made from the seller listed
below. Please fill out the form completely, check the appropriate boxes, and sign as your company’s authorized representative.
The form should be returned within 10 days.
NAME OF SELLER FROM WHOM YOU PURCHASED ITEMS WITHOUT SALES TAX
PURCHASE
ORDER
NUMBER
INVOICE
NUMBER
DATE
SELLER’S PERMIT NUMBER
AMOUNT
DESCRIPTION
Please check the appropriate box(es) below. If none of these apply, please explain below.
The above property was purchased for resale and was resold in the form of tangible personal property. It was not used for
any purpose other than retention, demonstration, or display while being held for sale in the regular course of business.
The above property was purchased for resale and is presently in resale inventory. It has not been used for any purpose other
than retention, demonstration, or display while being held for sale in the regular course of business.
The above property was purchased for leasing and tax measured by rental receipts has been paid directly to the Board with
our sales tax returns.
The above property was purchased for our own use and not for resale; and
tax in the amount of _______________ was paid directly to the Board with our sales tax return for the reporting period
_______________.
tax in the amount of _______________ was added to the billing and remitted to the Seller.
the purchase is a taxable transaction and tax is applicable.
COMMENTS
NATURE OF BUSINESS
PURCHASER’S SALES TAX PERMIT NUMBER
PURCHASER’S NAME
SIGNATURE
TITLE
DATE
PHONE
CITY
The information provided above is subject to verification by the State Board of Equalization.
January 2000
General Audit Procedures
Form BOE–504–A/B/C — XYZ Sample Letter
(Cont.) Exhibit 8
Page 4 of 9
BOE 504-CLS (1-97)
STATE OF CALIFORNIA
STATEMENT CONCERNING PROPERTY PURCHASED
WITHOUT PAYMENT OF CALIFORNIA SALES TAX
BOARD OF EQUALIZATION
DMA
Auditor’s Initials
Please complete this inquiry statement to indicate the disposition of certain non-taxed purchases you made from the seller listed
below. Please fill out the form completely, check the appropriate boxes, and sign as your company’s authorized representative.
The form should be returned within 10 days.
NAME OF SELLER FROM WHOM YOU PURCHASED ITEMS WITHOUT SALES TAX
DATE
INVOICE
NUMBER
PURCHASE
ORDER
NUMBER
SELLER’S PERMIT NO.
AMOUNT
DESCRIPTION
Please check the appropriate boxes below. If none of these apply, please explain below.
†
The above property was purchased for resale and was resold in the form of tangible personal property. It was not used for
any purpose other than retention, demonstration, or display while being held for sale in the regular course of business.
†
The above property was purchased for resale and is presently in resale inventory. It has not been used for any purpose
other than retention, demonstration, or display while being held for sale in the regular course of business.
†
The above property was purchased for leasing and tax measured by rental receipts has been paid directly to the Board with
our sales tax returns.
†
The above property was purchased for leasing and tax measured by the purchase price has been paid directly to the Board
with our sales tax return for the period in which the property was first leased.
†
The above property (not “mobile transportation equipment”) was purchased for leasing to a sublessor.
†
The above property (“mobile transportation equipment”) was purchased for leasing and tax measured by the fair rental value
has been paid directly to the Board with our sales tax return for the period in which the equipment was first leased.
†
The above property was purchased for our own use and not for leasing or resale, and
† tax in the amount of __________ was paid directly to the Board with our sales tax return for the reporting period
____________________.
† tax in the amount of __________ was added to the billing and remitted to the Seller.
† the purchase is a taxable transaction and tax is applicable.
______________________________________________________________________________________________________
COMMENTS
______________________________________________________________________________________________________
NATURE OF BUSINESS
PURCHASER’S SALES TAX PERMIT NUMBER
PURCHASER’S NAME
SIGNATURE
TITLE
DATE
PHONE
CITY
The information provided above is subject to verification by the State Board of Equalization.
January 2000
Audit Manual
Form BOE–504–A/B/C — XYZ Sample Letter
(Cont.) Exhibit 8
Page 5 of 9
BOE-504-BPA (11-02)
STATE OF CALIFORNIA
BOARD OF EQUALIZATION
SAMPLE LETTER FOR SPECIAL PRINTING AIDS
Requesting Purchaser’s Statement
XYZ Company
1234 5th Street
Los Angeles, California 90013
The California State Board of Equalization is currently examining our records for compliance with the
California Sales and Use Tax Law. They have questioned certain nontaxed sales of special printing
aids made to you as indicated on the invoices listed on the attached sheet. These nontaxed sales are
not supported by a valid resale certificate.
Please indicate the disposition of these special printing aids by placing the applicable letter in the
corresponding response column for each invoice listed.
Unless printers specifically state that they are retaining title to the special printing aids on their
customer’s contract or sales invoice, printers are considered the retailers of the special printing aids
and may purchase special printing aids for resale. However, special printing aids are considered
purchased for the purchaser’s own use and not for resale if the purchaser:
•
Only resells printed material and not special printing aids. For example, book/newspaper
publishers or manufacturers purchasing product labels or packaging for resale with the product.
The printed material is resold, but the publisher or manufacturer is the end user of the special
printing aids
•
Buys the printed matter for their own use
•
Is a print broker who resells the printed material but maintains ownership of the special printing
aids
Your prompt response is necessary to support any claims for exemption. The board will not accept the
statement if it is not filled out completely and signed by an authorized representative. Please return the
inquiry statement within 10 days using the enclosed envelope or fax to (_____)
__________________.
Sincerely,
Encl:
August 2008
General Audit Procedures
Form BOE–504–A/B/C — XYZ Sample Letter
(Cont.) Exhibit 8
Page 6 of 9
BOE-504-CPA REV. 3 (4-03)
STATEMENT CONCERNING PROPERTY PURCHASED
WITHOUT PAYMENT OF CALIFORNIA SALES TAX – SPECIAL PRINTING AIDS
STATE OF CALIFORNIA
BOARD OF EQUALIZATION
DMA
Auditor’s Initials
Please complete this inquiry statement to indicate the disposition of certain non-taxed purchases you made from the seller listed below.
Please fill out the form completely and sign as your company’s authorized representative. The form should be returned within 10 days.
NAME OF SELLER FROM WHOM YOU PURCHASED ITEMS WITHOUT SALES TAX
DATE
INVOICE
NUMBER
PURCHASE
ORDER NUMBER
SELLER’S PERMIT NO.
AMOUNT
DESCRIPTION
RESPONSE
List boxes (a) through (i) that apply
Please place the appropriate letter and information in Response area above. If none of these apply, please explain in Comments
below.
Note: Manufacturers purchasing product labels or packaging for resale with a product are considered end
users of special printing aids and should select either D or E even though the printed material is resold. (See
the cover letter accompanying this form for more information.)
A. A special printing aid was purchased for resale and resold in a sale subject to California tax.
B. The special printing aid was purchased for resale and resold to the US government.
C. The special printing aid was purchased for resale and sold with a nontaxable sale of printed material other than US
Government (ie. Interstate commerce, newspaper, printed sales message). Our sale of the special printing aids
was:
C1. a sale for resale. We separately stated the sale price of the special printing aids and obtained a resale
certificate for the special printing aids from our customer. The separately stated sales price was at least the
amount of the sales price we paid for the special printing aids or their components.
C2. subject to tax. Tax was paid to the Board with our sales tax return. Indicate amount of tax and period
reported under Response above.
C3. subject to tax. Tax was paid to the Board as a result of an audit that included the above purchases either on
an actual basis or as a result of a percentage of error based upon a test. The purchases sampled in the
audit were similar in nature to the above transaction; we believe tax on the above transaction has been paid
to the Board as a result of the audit. Indicate amount of tax and audit period under Response above.
C4. subject to tax. However, we did not pay tax with our sales tax return or through an audit.
D. The special printing aid was not purchased for resale. However, tax was paid directly to the Board with our sales
tax return. Indicate amount of tax and period reported under Response above.
E. The special printing aid was not purchased for resale and tax is applicable.
COMMENTS
NATURE OF BUSINESS
PURCHASER’S SALES TAX PERMIT NUMBER
PURCHASER’S NAME
SIGNATURE
TITLE
#
DATE
PHONE
CITY
The information provided above is subject to verification by the State Board of Equalization.
March 2001
Audit Manual
Form BOE–504–A/B/C — XYZ Sample Letter
(Cont.) Exhibit 8
Page 7 of 9
BOE-504-CFS REV. 1 (9-02)
STATE OF CALIFORNIA
STATEMENT CONCERNING PROPERTY PURCHASED
WITHOUT PAYMENT OF CALIFORNIA SALES TAX
BOARD OF EQUALIZATION
DMA
Auditor’s Initials
Please complete this inquiry statement to indicate the disposition of certain non-taxed purchases you made from the seller listed below.
Please fill out the form completely, check the appropriate boxes, and sign as your company’s authorized representative. The form should
be returned within 10 days.
NAME OF SELLER FROM WHOM YOU PURCHASED ITEMS WITHOUT SALES TAX
INVOICE
NUMBER
DATE
PURCHASE
ORDER NUMBER
SELLER’S PERMIT NO.
AMOUNT
DESCRIPTION
Please check the appropriate boxes below. If none apply, please explain on the “Comments” line.
Miscellaneous items purchased for resale
I have sold the property. I did not use it for any purpose other than resale inventory, demonstration, or display. It was for sale from
the time I bought it until I sold it.
I currently hold the property in my resale inventory. I have not used it for any purpose other than demonstration or display and it has
been for sale at all times.
Feed purchased to feed animals
I purchased the feed listed above
To feed animals I sell in my business or whose offspring I sell.
To feed animals commonly used to produce food (meat, dairy products, eggs, etc.).
Seed and plants purchased to plant or feed to animals
I purchased the seeds or plants listed above to grow products I will sell.
I purchased the seed listed above to feed directly to, or to produce feed for, (1) animals I sell in my business, or (2) animals
commonly used to produce food (meat, dairy products, eggs, etc.).
Fertilizer
I purchased the fertilizer listed above for applying to land or plants to grow (1) feed for animals commonly used to produce food,
(2) plant products I will sell in my business, or (3) food crops.
Items purchased for your own use
I purchased the items listed above for my own use, not for resale, and
I paid tax to the Board of Equalization in the amount of
period
.
with my sales and use tax return for the reporting
Tax in the amount of
was added to the billing and paid to the seller listed above.
The purchase is a taxable transaction and no tax has been paid on it.
COMMENTS
NATURE OF BUSINESS
PURCHASER’S SALES TAX PERMIT NUMBER (If you are not required to hold a permit, please note.) PURCHASER’S NAME
SIGNATURE
TITLE
#
DATE
PHONE
CITY
The information provided above is subject to verification by the State Board of Equalization.
January 2000
General Audit Procedures
Form BOE–504–A/B/C — XYZ Sample Letter
(Cont.) Exhibit 8
Page 8 of 9
BOE 504-CUS (1-97)
STATE OF CALIFORNIA
STATEMENT CONCERNING PROPERTY PURCHASED
WITHOUT PAYMENT OF CALIFORNIA SALES TAX
BOARD OF EQUALIZATION
DMA
Auditor’s Initials
Please complete this inquiry statement to indicate the disposition of certain non-taxed purchases you made from the seller listed
below. Please fill out the form completely, check the appropriate boxes, and sign as your company’s authorized representative.
The form should be returned within 10 days.
NAME OF SELLER FROM WHOM YOU PURCHASED ITEMS WITHOUT SALES TAX
DATE
INVOICE
NUMBER
PURCHASE
ORDER
NUMBER
SELLER’S PERMIT NO.
AMOUNT
DESCRIPTION
Please check the appropriate boxes below. If none of these apply, please explain below.
†
The above property was purchased for resale and was resold in the form of tangible personal property. It was not used for
any purpose other than retention, demonstration, or display while being held for sale in the regular course of business.
†
The above property was purchased for resale and is presently in resale inventory. It has not been used for any purpose
other than retention, demonstration, or display while being held for sale in the regular course of business.
†
The above property was purchased for leasing and tax measured by rental receipts has been paid directly to the Board with
our sales tax returns.
…
The above property was purchased for resale to the United States Government. In accordance with the title provisions of
the U.S. Government supply contract, the U.S. Government took title to the property prior to any use of the property by us.
†
The above property was purchased for our own use and not for resale, and
† tax in the amount of __________ was paid directly to the Board with our sales tax return for the reporting period
____________________.
† tax in the amount of __________ was added to the billing and remitted to the Seller.
† the purchase is a taxable transaction and tax is applicable.
COMMENTS
NATURE OF BUSINESS
PURCHASER’S SALES TAX PERMIT NUMBER
PURCHASER’S NAME
SIGNATURE
TITLE
DATE
PHONE
CITY
The information provided above is subject to verification by the State Board of Equalization.
January 2000
Audit Manual
Form BOE–504–A/B/C — XYZ Sample Letter
(Cont.) Exhibit 8
Page 9 of 9
BOE 504-COS (1-97)
STATE OF CALIFORNIA
STATEMENT CONCERNING PROPERTY PURCHASED
WITHOUT PAYMENT OF CALIFORNIA SALES TAX
BOARD OF EQUALIZATION
DMA
Auditor’s Initials
Please complete this inquiry statement to indicate the disposition of certain non-taxed purchases you made from the seller listed
below. Please fill out the form completely, check the appropriate boxes, and sign as your company’s authorized representative.
The form should be returned within 10 days.
NAME OF SELLER FROM WHOM YOU PURCHASED ITEMS WITHOUT SALES TAX
DATE
INVOICE
NUMBER
PURCHASE
ORDER
NUMBER
SELLER’S PERMIT NO.
AMOUNT
DESCRIPTION
Please check the appropriate boxes below. If none of these apply, please explain below.
†
The above property was purchased for resale and was resold in the form of tangible personal property. It was not used for
any purpose other than retention, demonstration, or display while being held for sale in the regular course of business.
†
The above property was purchased for resale and is presently in resale inventory. It has not been used for any purpose
other than retention, demonstration, or display while being held for sale in the regular course of business.
†
The above property was purchased for leasing and tax measured by rental receipts has been paid directly to the Board with
our sales tax returns.
†
The above property was purchased for our own use and not for resale, and
† tax in the amount of _____________ was paid directly to the Board with our sales tax return for the reporting period
____________________.
† tax in the amount of __________ was added to the billing and remitted to the Seller.
† tax was paid directly to the Board as the result of an audit determination dated ____________________ covering the
period ____________________ to ____________________. The Board’s audit specifically included the above
transaction in the audit assessment.
† tax was paid directly to the Board as the result of an audit determination dated ____________________ covering the
period ____________________ to ____________________. The Board’s audit examined our purchases on a test
basis with a percent of error computed and applied. Because the purchases sampled in the audit were similar in nature
to the above transaction, we believe tax on the above transaction has been paid to the Board as a result of this audit.
† the purchase is a taxable transaction and tax is applicable.
______________________________________________________________________________________________________
COMMENTS
______________________________________________________________________________________________________
NATURE OF BUSINESS
PURCHASER’S SALES TAX PERMIT NUMBER
PURCHASER’S NAME
SIGNATURE
TITLE
DATE
PHONE
CITY
The information provided above is subject to verification by the State Board of Equalization.
January 2000
General Audit Procedures
FEDERAL ACQUISITION REGULATIONS (FAR’S)
CLAUSE DEFINITIONS
2.101. Definitions
EXHIBIT 9A
FAR CLAUSE DEFINITIONS
“Direct cost” means any cost that is identified specifically with a particular final cost objective.
Direct costs are not limited to items that are incorporated in the end product as material or labor.
Costs identified specifically with a contract are direct costs of that contract. All costs identified
specifically with other final cost objectives of the contractor are direct costs of those cost objectives.
“Indirect cost” means any cost not directly identified with a single final cost objective, but identified
with two or more final cost objectives or with at least one intermediate cost objective.
“Special test equipment” means either single or multipurpose integrated test units engineered,
designed, fabricated, or modified to accomplish special purpose testing in performing a contract.
It consists of items or assemblies of equipment including foundations and similar improvements
necessary for installing special test equipment, and standard or general purpose items or
components that are interconnected and interdependent so as to become a new functional entity
for special testing purposes. Special test equipment does not include material, special tooling, real
property, and equipment items used for general testing purposes or property that with relatively
minor expense can be made suitable for general purpose use.
“Special tooling” means jigs, dies, fixtures, molds, patterns, taps, gauges, and all components
of these items including foundations and similar improvements necessary for installing special
tooling, and which are of such a specialized nature that without substantial modification or
alteration their use is limited to the development or production of particular supplies or parts
thereof or to the performance of particular services. Special tooling does not include material,
special test equipment, real property, equipment, machine tools, or similar capital items.
45.101 Definitions
“Contractor-acquired property” means property acquired, fabricated, or otherwise provided by the
contractor for performing a contract and to which the Government has title.
“Equipment” means a tangible item that is functionally complete for its intended purpose, durable,
nonexpendable, and needed for the performance of a contract. Equipment is not intended for sale,
and does not ordinarily lose its identity or become a component part of another article when put
into use. Equipment does not include material, real property, special test equipment or special
tooling.
“Government-furnished property” means property in the possession of, or directly acquired by,
the Government and subsequently furnished to the contractor for performance of a contract.
Government-furnished property includes, but is not limited to, spares and property furnished
for repair, maintenance, overhaul, or modification. Government-furnished property also includes
contractor-acquired property if the contractor-acquired property is a deliverable under a cost
contract when accepted by the Government for continued use under the contract.
“Government property” means all property owned or leased by the Government. Government
property includes both Government-furnished property and contractor-acquired property.
Government property includes material, equipment, special tooling, special test equipment, and
real property. Government property does not include intellectual property and software.
“Material” means property that may be consumed or expended during the performance of a
contract, component parts of a higher assembly, or items that lose their individual identity through
incorporation into an end-item. Material does not include equipment, special tooling, special test
equipment or real property.
May 2012
Audit Manual
FEDERAL ACQUISITION REGULATIONS (FAR’S)
PROGRESS PAYMENTS
EXHIBIT 9B
CODE OF FEDERAL REGULATIONS
TITLE 48
FEDERAL ACQUISITION REGULATIONS SYSTEM
52.232-16 Progress Payments.
52.232-16 (d)
Progress Payments
As prescribed in 32.502-4(a), insert the following clause:
PROGRESS PAYMENTS (APR 2012)
(d) Title.
(1) Title to the property described in this paragraph (d) shall vest in the Government.
Vestiture shall be immediately upon the date of this contract, for property acquired
or produced before that date. Otherwise, vestiture shall occur when the property is
or should have been allocable or properly chargeable to this contract.
(2)“Property,” as used in this clause, includes all of the below-described items acquired
or produced by the Contractor that are or should be allocable or properly chargeable
to this contract under sound and generally accepted accounting principles and
practices.
(i) Parts, materials, inventories, and work in process;
(ii) Special tooling and special test equipment to which the Government is to acquire title;
(iii) Nondurable (i.e., noncapital) tools, jigs, dies, fixtures, molds, patterns, taps, gauges, test
equipment, and other similar manufacturing aids, title to which would not be obtained as
special tooling under paragraph (d)(2)(ii) of this clause; and
(iv) Drawings and technical data, to the extent the Contractor or subcontractors are required
to deliver them to the Government by other clauses of this contract.
(3) Although title to property is in the Government under this clause, other applicable
clauses of this contract; e.g., the termination clauses, shall determine the handling
and disposition of the property.
(4) The Contractor may sell any scrap resulting from production under this contract
without requesting the Contracting Officer’s approval, but the proceeds shall be
credited against the costs of performance.
(5) To acquire for its own use or dispose of property to which title is vested in the
Government under this clause, the Contractor must obtain the Contracting Officer’s
advance approval of the action and the terms. The Contractor shall (i) exclude the
allocable costs of the property from the costs of contract performance, and (ii) repay
to the Government any amount of unliquidated progress payments allocable to the
property. Repayment may be by cash or credit memorandum.
(6) When the Contractor completes all of the obligations under this contract, including
liquidation of all progress payments, title shall vest in the Contractor for all
property (or the proceeds thereof) not—
(i) Delivered to, and accepted by, the Government under this contract; or
(ii) Incorporated in supplies delivered to, and accepted by, the Government under this contract
and to which title is vested in the Government under this clause.
(7) The terms of this contract concerning liability for Government-furnished property
shall not apply to property to which the Government acquired title solely under this
clause.
May 2012
General Audit Procedures
FEDERAL ACQUISITION REGULATIONS (FAR’S)
PERFORMANCE-BASED PAYMENTS
CODE OF FEDERAL REGULATIONS
TITLE 48
FEDERAL ACQUISITION REGULATIONS SYSTEM
EXHIBIT 9C
52.232-32 (f)
Performance-Based Payments
52.232-32 Performance-Based Payments.
As prescribed in 32.1005, insert the following clause:
PERFORMANCE-BASED PAYMENTS (APR 2012)
(f) Title.
(1) Title to the property described in this paragraph (f) shall vest in the Government.
Vestiture shall be immediately upon the date of the first performance-based
payment under this contract, for property acquired or produced before that date.
Otherwise, vestiture shall occur when the property is or should have been allocable
or properly chargeable to this contract.
(2) “Property,” as used in this clause, includes all of the following described items
acquired or produced by the Contractor that are or should be allocable or properly
chargeable to this contract under sound and generally accepted accounting
principles and practices:
(i) Parts, materials, inventories, and work in process;
(ii) Special tooling and special test equipment to which the Government is to acquire title;
(iii) Nondurable (i.e., noncapital) tools, jigs, dies, fixtures, molds, patterns, taps, gauges, test
equipment and other similar manufacturing aids, title to which would not be obtained as
special tooling under paragraph (f)(2)(ii) of this clause; and
(iv) Drawings and technical data, to the extent the Contractor or subcontractors are required
to deliver them to the Government by other clauses of this contract.
(3) Although title to property is in the Government under this clause, other applicable
clauses of this contract (e.g., the termination clauses) shall determine the handling
and disposition of the property.
(4) The Contractor may sell any scrap resulting from production under this contract,
without requesting the Contracting Officer’s approval, provided that any significant
reduction in the value of the property to which the Government has title under this
clause is reported in writing to the Contracting Officer.
(5) In order to acquire for its own use or dispose of property to which title is vested
in the Government under this clause, the Contractor shall obtain the Contracting
Officer’s advance approval of the action and the terms. If approved, the basis for
payment (the events or performance criteria) to which the property is related shall
be deemed to be not in compliance with the terms of the contract and not payable (if
the property is part of or needed for performance), and the Contractor shall refund
the related performance-based payments in accordance with paragraph (d) of this
clause.
(6) When the Contractor completes all of the obligations under this contract, including
liquidation of all performance-based payments, title shall vest in the Contractor for
all property (or the proceeds thereof) not—
(i) Delivered to, and accepted by, the Government under this contract; or
(ii) Incorporated in supplies delivered to, and accepted by, the Government under this contract
and to which title is vested in the Government under this clause.
(7) The terms of this contract concerning liability for Government-furnished property
shall not apply to property to which the Government acquired title solely under this
clause.
May 2012
Audit Manual
FEDERAL ACQUISITION REGULATIONS (FAR’S)
GOVERNMENT PROPERTY (FIXED PRICE CONTRACTS)
.CODE OF FEDERAL REGULATIONS
EXHIBIT 9D
Page 1 of 3
TITLE 48
FEDERAL ACQUISITION REGULATIONS SYSTEM
52.245-1 (a) and (e) and Alternate II
Government Property
52.245-1 Government Property.
As prescribed in 45.107(a), insert the following clause:
Government Property (Apr 2012)
(a) Definitions. As used in this clause—
“Cannibalize” means to remove parts from Government property for use or for installation on
other Government property.
“Contractor-acquired property” means property acquired, fabricated, or otherwise provided by the Contractor
for performing a contract, and to which the Government has title.
“Contractor inventory” means—
(1) Any property acquired by and in the possession of a Contractor or subcontractor
under a contract for which title is vested in the Government and which exceeds the
amounts needed to complete full performance under the entire contract;
(2) Any property that the Government is obligated or has the option to take over under
any type of contract, e.g., as a result either of any changes in the specifications or
plans thereunder or of the termination of the contract (or subcontract thereunder),
before completion of the work, for the convenience or at the option of the
Government; and
(3) Government-furnished property that exceeds the amounts needed to complete full
performance under the entire contract.
“Contractor’s managerial personnel” means the Contractor’s directors, officers, managers, superintendents,
or equivalent representatives who have supervision or direction of—
(1) All or substantially all of the Contractor’s business;
(2) All or substantially all of the Contractor’s operation at any one plant or separate
location; or
(3) A separate and complete major industrial operation.
“Demilitarization” means rendering a product unusable for, and not restorable to, the purpose for which it
was designed or is customarily used.
“Discrepancies incident to shipment” means any differences (e.g., count or condition) between the items
documented to have been shipped and items actually received.
“Equipment” means a tangible item that is functionally complete for its intended purpose, durable,
nonexpendable, and needed for the performance of a contract. Equipment is not intended for sale, and does
not ordinarily lose its identity or become a component part of another article when put into use. Equipment
does not include material, real property, special test equipment or special tooling.
“Government-furnished property” means property in the possession of, or directly acquired by, the
Government and subsequently furnished to the Contractor for performance of a contract. Governmentfurnished property includes, but is not limited to, spares and property furnished for repair, maintenance,
overhaul, or modification. Government-furnished property also includes contractor-acquired property if the
contractor-acquired property is a deliverable under a cost contract when accepted by the Government for
continued use under the contract.
May 2012
General Audit Procedures
Federal Acquisition Regulations (FAR’S)
Government Property (Fixed Price Contracts)
(Cont.) Exhibit 9D
Page 2 of 3
“Government property” means all property owned or leased by the Government. Government property
includes both Government-furnished and Contractor-acquired property. Government property includes
material, equipment, special tooling, special test equipment, and real property. Government property does
not include intellectual property and software.
“Loss of Government property” means unintended, unforeseen or accidental loss, damage or destruction to
Government property that reduces the Government’s expected economic benefits of the property. Loss of
Government property does not include purposeful destructive testing, obsolescence, normal wear and tear
or manufacturing defects. Loss of Government property includes, but is not limited to—
(1) Items that cannot be found after a reasonable search;
(2) Theft;
(3) Damage resulting in unexpected harm to property requiring repair to restore the
item to usable condition; or
(4) Destruction resulting from incidents that render the item useless for its intended
purpose or beyond economical repair.
“Material” means property that may be consumed or expended during the performance of a contract,
component parts of a higher assembly, or items that lose their individual identity through incorporation into
an end item. Material does not include equipment, special tooling, special test equipment or real property.
“Nonseverable” means property that cannot be removed after construction or installation without substantial
loss of value or damage to the installed property or to the premises where installed.
“Precious metals” means silver, gold, platinum, palladium, iridium, osmium, rhodium, and ruthenium.
“Production scrap” means unusable material resulting from production, engineering, operations and
maintenance, repair, and research and development contract activities. Production scrap may have value
when re-melted or reprocessed, e.g., textile and metal clippings, borings, and faulty castings and forgings.
“Property” means all tangible property, both real and personal.
“Property Administrator” means an authorized representative of the Contracting Officer appointed in
accordance with agency procedures, responsible for administering the contract requirements and obligations
relating to Government property in the possession of a Contractor.
“Property records” means the records created and maintained by the contractor in support of its stewardship
responsibilities for the management of Government property.
“Provide” means to furnish, as in Government-furnished property, or to acquire, as in contractor-acquired
property.
“Real property” See Federal Management Regulation 102-71.20 (41 CFR 102-71.20).
“Sensitive property” means property potentially dangerous to the public safety or security if stolen, lost, or
misplaced, or that shall be subject to exceptional physical security, protection, control, and accountability.
Examples include weapons, ammunition, explosives, controlled substances, radioactive materials, hazardous
materials or wastes, or precious metals.
“Unit acquisition cost” means—
(1) For Government-furnished property, the dollar value assigned by the Government
and identified in the contract; and
(2) For contractor-acquired property, the cost derived from the Contractor’s records that
reflect consistently applied generally accepted accounting principles.
(e) Title to Government property.
May 2012
Audit Manual
Federal Acquisition Regulations (FAR’S)
Government Property (Fixed Price Contracts)
(Cont.) Exhibit 9D
Page 3 of 3
(1) All Government-furnished property and all property acquired by the Contractor, title
to which vests in the Government under this paragraph (collectively referred to as
“Government property”), is subject to the provisions of this clause. The Government
shall retain title to all Government-furnished property. Title to Government
property shall not be affected by its incorporation into or attachment to any property
not owned by the Government, nor shall Government property become a fixture or
lose its identity as personal property by being attached to any real property.
(2) Title vests in the Government for all property acquired or fabricated by the
Contractor in accordance with the financing provisions or other specific
requirements for passage of title in the contract. Under fixed price type contracts,
in the absence of financing provisions or other specific requirements for passage
of title in the contract, the Contractor retains title to all property acquired by the
Contractor for use on the contract, except for property identified as a deliverable end
item. If a deliverable item is to be retained by the Contractor for use after inspection
and acceptance by the Government, it shall be made accountable to the contract
through a contract modification listing the item as Government-furnished property.
(3) Title under Cost-Reimbursement or Time-and-Material Contracts or CostReimbursable contract line items under Fixed-Price contracts.
(i) Title to all property purchased by the Contractor for which the Contractor is entitled
to be reimbursed as a direct item of cost under this contract shall pass to and vest in
the Government upon the vendor’s delivery of such property.
(ii) Title to all other property, the cost of which is reimbursable to the Contractor, shall
pass to and vest in the Government upon—
(A).Issuance of the property for use in contract performance;
(B).Commencement of processing of the property for use in contract performance; or
(C).Reimbursement of the cost of the property by the Government, whichever
occurs first.
Alternate II (Apr 2012). As prescribed in 45.107(a)(3), substitute the following for paragraph (e)
(3) of the basic clause:
(e)(3) Title to property (and other tangible personal property) purchased with funds available for
research and having a unit acquisition cost of less than $5,000 shall vest in the Contractor
upon acquisition or as soon thereafter as feasible; provided that the Contractor obtained
the Contracting Officer’s approval before each acquisition. Title to property purchased with
funds available for research and having a unit acquisition cost of $5,000 or more shall vest
as set forth in this contract. If title to property vests in the Contractor under this paragraph,
the Contractor agrees that no costs shall be allowed for any depreciation, amortization,
or use under any existing or future Government contract or subcontract thereunder. The
Contractor shall furnish the Contracting Officer a list of all property to which title is vested
in the Contractor under this paragraph within 10 days following the end of the calendar
quarter during which it was received. Vesting title under this paragraph is subject to civil
rights legislation, 42 U.S.C. 2000d. Before title is vested and by signing this contract, the
Contractor accepts and agrees that—
“No person in the United States or its outlying areas shall, on the ground of race, color, or
national origin, be excluded from participation in, be denied the benefits of, or be otherwise
subjected to discrimination under this contemplated financial assistance (title to property).”
May 2012
General Audit Procedures
DECISION TABLE EXHIBIT 9E
Fixed Price Contracts *
FAR Clause Inserted in Contract1
Government
Progress
Property 52- Payment
245-1(e)(2) 52.232-16(d)
PerformanceBased
Application
2
Payment
of tax
52.232-32(f)
N
Taxable
N
Non-Taxable
Y
Non-Taxable
Direct and Indirect Costs and
Y or N
N
Contract Deliverables if Used by the
Y or N
Y
Contractor Prior to Delivery3
Y or N
N
Cost Reimbursable Line Item in
Y or N
Y or N
Y or N
Contract
1 A contract may also contain a custom clause that transfers title.
Non-Taxable
2 Title transfers after first performance payment. Milestone payments are a form of
performance-based payments when the contract includes a performance-based payment
clause.
3
• Tax is not due if there is no use of the deliverable prior to delivery
• Excludes contract reimbursable line items
• Includes special tooling and special test equipment, if financed by the
Government.
* The table applies to Fixed Price Contracts. Other types of contracts include:
• Cost reimbursement and time and material contracts: Title passes prior to use for
reimbursable direct and indirect (i.e., overhead materials) consumable supply costs.
• Commercial Contracts: These contracts are non-qualified contracts in the contractor’s
rate calculation.
• Independent Research and Development (IRAD) and Bid and Proposal (B&P): Although
some contractors may treat them as contracts, these are indirect consumable supply costs
and are allocated to contracts similar to other reimbursable costs and not considered
contracts.
May 2012
Audit Manual
SAMPLE AUDIT PROGRAM
EXHIBIT 10
Page 1 of 4
General Retailers
Step
Task
1
Locate all books and records available for audit.
2
Get a description of the product sold. Visit the store if the audit is not performed on-site.
Find out who prepared the returns during the audit period. Have them show you the
3
source(s) of their figures
Run AUD TR to obtain a transcript of returns (414-M). Close to when you turn in the audit
4
run it again to verify that no adjustments have been made that affect your audit results.
Review the sales tax return worksheets for accuracy, consistency, and method of
5
reporting.
6
Reconcile reported sales per 414-M to books, FITRs, and financial statements.
7
Perform a sales tax accrual analysis.
Verify sales detail. Spot test sales invoices/Z-tapes to sales journal. Compare sales
8
journal to general ledger on an actual basis.
Compute book markups by year.
9 a. Determine if markups are acceptable.
b. If not acceptable, conduct a markup test.
Verify the accuracy of claimed deductions:
a. Sales for resale - Resale certificates, qualifying purchase orders, auditor judgment.
Labor - Watch for fabrication/assembly labor, services in connection with the sale of
b.
tangible personal property.
10
c. Government - Federal government only. Check for purchase orders.
d. Interstate Commerce - Bills of lading, shipping documents.
e. Bad Debts - Taxable sales only.
f. Freight - Separately stated freight out, no handling fee.
Check for potential use tax liability (usually minimal):
a. Fixed assets
11
b. Consumable supplies
c. Withdrawals from inventory
NOTE: These audit programs are general in nature, and will not cover all potential situations
that could be encountered. They should only be used as a starting point for a customized audit
program for each taxpayer
August 2005
General Audit Procedures
Sample Audit Program
(Cont.) Exhibit 10
Page 2 of 4
Manufacturers and/or Wholesalers
Step
Task
1
Locate all books and records available for audit.
2
Get a description of the product sold. Visit the store if the audit is not performed on-site.
3
Find out who prepared the returns during the audit period. Have them show you the
source(s) of their figures
4
Run AUD TR to obtain a transcript of returns (414-M). Close to when you turn in the
audit run it again to verify that no adjustments have been made that affect your audit
results.
5
Review the sales tax return worksheets for accuracy, consistency, and method of
reporting.
6
Reconcile reported sales per 414-M to books, FITRs, and financial statements.
7
Look for miscellaneous sales - sales of assets, sales to employees, etc.
8
Sales tax accrual analysis.
Verify the accuracy of claimed deductions:
a. Sales for resale - Resale certificates, qualifying purchase orders, auditor judgment.
Labor - Watch for fabrication/assembly labor, engineering charges, services in
b.
connection with the sale of tangible personal property.
9
c. Government - Federal government only. Check for purchase orders.
d. Interstate Commerce - Bills of lading, shipping documents.
e.
Freight - Separately stated freight out, no handling fee.
Verify the accuracy of claimed deductions:
a. Fixed assets
b. Consumable supplies
10 c. Research and development
d. Manufacturing aids
e. Withdrawals from inventory
f. Sample
August 2005
Audit Manual
Sample Audit Program
(Cont.) Exhibit 10
Page 3 of 4
Liquor Stores
Step
Task
1
Locate all books and records available for audit.
Find out who prepared the returns during the audit period. Have them show you the
2
source(s) of their figures.
Run AUD TR to obtain a transcript of returns (414-M). Close to when you turn in the audit
3
run it again to verify that no adjustments have been made that affect your audit results.
Review sales tax return worksheets to verify accuracy, consistency and method of
4
reporting.
Reconcile sales:
a. Reported sales per 414-M to books, FITRs, and Profit & Loss Statements (P & L).
5 b. Recorded sales per the P & L to the FITRs.
and nontaxable sales per P & L to reported/claimed amounts. Note: Analyze deli
c. Taxable
sales and purchases separate from liquor store sales and purchases.
6
7
8
9
10
Analyze the FITRs for overall markup.
Verify sales correctly posted to P & L. Trace from register tape to sales journal to general
ledger to P & L.
Verify purchases correctly segregated and posted (taxable vs. nontaxable). Trace from
purchase invoices to cash disbursements journal to P & Ls.
Calculate markup for taxable and nontaxable sales.
If all of the above is acceptable, with no reconciliation, segregation, or posting errors, and
markups are reasonable, write up the audit. Note: Markups vary depending on location and type of
business.
If the markups are reasonable, but a material reconciliation difference exists between
taxable sales recorded and reported, schedule the differences and assess in the audit.
If purchases need to be segregated, segregate them into the same categories as sales
12
and recalculate markups.
If the markups are unacceptable, do a shelf-test
If both the overall and taxable markups are low and there are no posting entry errors
a. noted, impeach total sales and do a taxable shelf-test. Markup taxable purchases
(adjusted for pilferage and self-consumption)
If the overall markup is acceptable and there are no posting errors noted, but the taxable
markup is low, accept total sales as reported and do a shelf-test on nontaxable items
13
b. (food). Compute audited food sales using the shelf-test markup and compare to claimed
exempt amounts. Disallow over-claimed amounts. Note: This type of situation indicates a key11
ring error. This type of audit is done on a total sales basis and makes the taxpayer support his/her claimed
deduction.
If both the overall and nontaxable markups are low and there are no posting errors
c. noted, but the taxable markup is reasonable, accept reported/claimed figures. The overall
markup is pulled down due to nontaxable sales.
August 2005
General Audit Procedures
Sample Audit Program
(Cont.) Exhibit 10
Page 4 of 4
Step
14
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
Liquor Stores
Task
Miscellaneous items
When computing audited sales using a shelf-test markup, be sure to adjust purchases
for inventory fluctuations, segregation errors, actual theft of inventory (supported by
documentation), self-consumed, and 1% pilferage. Watch for climbing inventories.
Watch self-consumption of taxable items. Include unreported items at cost in audit
findings. Amounts can be estimated, but make sure they are reasonable. Claimed selfconsumed items should be itemized by category (soda, liquor, beer, wine, cigarettes,
cleaning and paper supplies) and analyzed in the working papers, to determine if
amounts appear reasonable.
Remove non-merchandise sales (lottery sales, money orders, check cashing, etc.) prior
to markup calculation.
Shelf-tests should compare current costs with current selling prices. Make sure if CRV
is included in cost, it is also included in selling price and vice versa. Comment as to
whether CRV is or is not included in the markup computation.
Note any changes in the type of business during the audit period (for example, added
deli).
Based on internal controls (or lack of), a bank reconciliation may be necessary.
Are there material amounts of unclaimed bad debts/checks? Write-off only allowed on
taxable portion.
Check sales and purchases of assets and consumable supplies (usually minor).
Verify cigarette indicia.
Verify cigarette rebates are properly reported.
August 2005
Audit Manual
FORM BOE–837 — AFFIDAVIT FOR SECTION 6388
OR 6388.5 EXEMPTION BOE-837 (FRONT) REV. 3 (4-03)
EXHIBIT 11
STATE OF CALIFORNIA
AFFIDAVIT FOR SECTION 6388 OR 6388.5 EXEMPTION
FROM CALIFORNIA SALES AND USE TAX
BOARD OF EQUALIZATION
Revenue and Taxation Code (RTC) sections 6388 and 6388.5 provide exemptions from the taxes imposed on the sale, storage, use, or
other consumption of certain new and remanufactured vehicles and trailers. The RTC section 6388 exemption applies to the sale or use
of certain new or remanufactured vehicles. The RTC section 6388.5 exemption applies to the sale or use of certain new or remanufactured
trailers. Additional information about these exemptions and additional requirements to meet these exemptions is available on the back
of this form and in Regulation 1620.1, Sales of Certain Vehicles and Trailers for Use in Interstate or Out-Of-State Commerce.
CHECK AND/OR FILL IN ALL APPROPRIATE BOXES AND BLANKS BELOW
6388
I have purchased a vehicle or trailer the sale and use of which is exempt from California sales and use tax per section
6388.5.
Vehicle or Trailer Information:
The vehicle is a
truck,
truck tractor,
MAKE & MODEL
trailer,
semitrailer,
trailer coach, or
VIN/ SERIAL NO.
MANUFACTURER / REMANUFACTURER
YEAR
auxiliary dolly, described as:
PURCHASE PRICE
UNLADEN WEIGHT
PLACE OF MANUFACTURE / REMANUFACTURE
The vehicle or trailer was moved outside California within
30
DATE OF DELIVERY
75 days of delivery (check one). Date moved:
Seller and Deliverer of Vehicle or Trailer:
I hereby certify that the vehicle or trailer described above was purchased from
located at
(name of dealer or mfr. / remfr.)
, and was delivered by
(dealer or mfr. / remfr.’s address - street, city, state, zip code)
, located at
(name of California dealer or mfr. / remfr.)
(California dealer or mfr. / remfr.’s address - street, city, state, zip code)
Leasing and Registration Information:
The vehicle or trailer described above
Vehicle or trailer is licensed or registered in
is
is not
being leased. If being leased, name and address of lessee:
(state where registered)
(If a trailer is registered in California, provide owner’s or lessee’s USDOT number or FMC number)
Purchaser Information:
The purchaser is a
corporation
limited liability company
partnership
sole proprietor, which
is
is not a resident
of California. The vehicle was purchased for use outside California (section 6388) or the trailer was purchased for use exclusively
outside California or exclusively in interstate and foreign commerce, or both (section 6388.5). If the trailer or vehicle is registered
outside California, a copy of the purchaser’s or lessor’s out-of-state registration, or license and registration, will be provided
within 60 days from the date of this affidavit. If the trailer is registered in California under the PTI program, a copy of the
purchaser’s or lessee’s USDOT number, FMC number, or current SSRS filing is attached.
I understand that if I do not meet the requisite exemption provisions detailed on the back of this form, I am required by the California
Sales and Use Tax Law to report and pay tax, and interest and penalties (if appropriate), directly to the California State Board of
Equalization, the tax to be measured by the purchase price of the above listed vehicle or trailer even though I have furnished an
affidavit of exemption to the manufacturer, remanufacturer, or dealer.
PURCHASER’S NAME
SIGNATURE OF PURCHASER OR PURCHASER’S AGENT
TITLE
✍
PRINT NAME OF SIGNATOR
PHONE NUMBER
(
DATE
)
For exemption requirements and instructions on completing this affidavit, please see back of form.
CLEAR
January 2000
PRINT
General Audit Procedures
FORM BOE–52 — CERTIFICATE OF VERIFICATION
OUT OF STATE DELIVERY BOE-52 (11-99)
EXHIBIT 12
STATE OF CALIFORNIA
CERTIFICATE OF VERIFICATION
OUT-OF-STATE DELIVERY
BOARD OF EQUALIZATION
Please complete this inquiry statement to indicate the disposition of certain non-taxed
purchases you made in this state from the seller listed below:
NAME OF SELLER
PERMIT NUMBER
STREET ADDRESS (city, state, zip code)
NAME OF PURCHASER
STREET ADDRESS (city, state, zip code)
DESCRIPTION OF TANGIBLE PERSONAL PROPERTY
INVOICE NUMBER
DATE OF INVOICE
ITEM(S) (description)
TOTAL SALES PRICE
$
PURCHASER’S DECLARATION
The undersigned purchaser, or authorized representative thereof, declares that the property described above was
delivered directly to the purchaser outside California at the place and on the date indicated below. If you did not
purchase the item(s) or have the item(s) listed above shipped to you, or if you took delivery in California, please
mark the applicable box below and complete the comments section.
PLACE OF OUT-OF-STATE DELIVERY (city and state)
Did not purchase or take delivery
DATE
Took delivery in California (location and date)
LOCATION
DATE
SIGNATURE OF PURCHASER OR AUTHORIZED REPRESENTATIVE
PRINT NAME OF PURCHASER OR AUTHORIZED REPRESENTATIVE
TELEPHONE
(
)
COMMENTS
This form is to be completed in triplicate. ORIGINAL AND SECOND COPY TO BE RETURNED TO THE BOARD. THIRD COPY IS
FOR SELLER’S RECORDS.
January 2000
Audit Manual
FORM BOE–52–L — SAMPLE LETTER,
SELLER RECEIPT OF GOODS IN INTERSTATE COMMERCE
BOE-52-L REV. 1 (3-00)
EXHIBIT 12A
STATE OF CALIFORNIA
BOARD OF EQUALIZATION
SAMPLE LETTER FOR SELLER
Requesting Purchaser’s Statement
Regarding Receipt of Goods in Interstate Commerce
Purchaser’s Name
Address
City, State, Zip
Salutation:
Auditors of the California State Board of Equalization are currently examining [Business Name]
records to verify that untaxed sales made to you were properly claimed as exempt sales in interstate
commerce under the California Sales and Use Tax Law. Specifically, they would like to verify: (1)
that you purchased the item(s) listed on the enclosed Form BOE-52, Certificate of Verification, Outof-State Delivery, and (2) the method of delivery. If these items were purchased by you, please
indicate the place of delivery and date you took possession of the item(s) on the enclosed certificate.
If you did not purchase, take delivery or receive the item(s) in question, or if you took delivery in
California, please check the applicable box on the certificate and provide us with your comments.
Please complete and sign the certificate and return it, using the enclosed envelope, directly to the
State Board of Equalization within 10 days of the date of this letter. Your prompt response in this
matter is necessary for us to support our claims for exemption. Thank you for your cooperation.
Sincerely,
Name
Title
Enclosure: BOE-52, Certificate of Verification, Out-of-State Delivery
August 2005
General Audit Procedures
FORM BOE–52–L1 — SAMPLE LETTER, AUDITOR
EXHIBIT 12B
STATE OF CALIFORNIA
STATE BOARD OF EQUALIZATION
BETTY T. YEE
First District, San Francisco
[STREET ADDRESS]
[MAILING ADDRESS]
XXX-XXX-XXXX • FAX XXX-XXX-XXXX
BILL LEONARD
Second District, Ontario/Sacramento
www.boe.ca.gov
MICHELLE STEEL
Third District, Rolling Hills Estates
JUDY CHU, Ph.D.
Fourth District, Los Angeles
JOHN CHIANG
State Controller
_______
RAMON J. HIRSIG
Executive Director
[Purchaser's Name]
[Address]
[City, State, Zip]
[Salutation]:
The California State Board of Equalization would appreciate your assistance in verifying that
untaxed sales made to you by [Business Name] were properly claimed as exempt sales in
interstate commerce under the California Sales and Use Tax Law. Specifically, please verify:
(1) that you purchased the item(s) listed on the enclosed Form BOE-52, Certificate of
Verification, Out-of-State Delivery, and (2) the method of delivery. If these items were
purchased by you, indicate the place of delivery and date you took possession of the item(s)
on the enclosed certificate. If you did not purchase, take delivery or receive the item(s) in
question, or if you took delivery in California, please check the applicable box on the
certificate and provide us with your comments.
We ask that you complete and sign the certificate and return it, using the enclosed envelope,
directly to the State Board of Equalization within 10 days of the date of this letter. Your
prompt response in this matter is necessary for us to support any valid claims for exemption.
Thank you for your cooperation.
Sincerely,
[Name]
[Title]
Enclosure:
BOE-52, Certificate of Verification, Out-of-State Delivery
BOE-52-L1 REV. 1 (3-00)
August 2008
Audit Manual
FORM BOE–52–L2 — SAMPLE LETTER FOR SELLER NOTICE
OF PENDING REFUND OF EXCESS SALES TAX REIMBURSEMENT
BOE-52-L2 (8-03)
EXHIBIT 12C
STATE OF CALIFORNIA
BOARD OF EQUALIZATION
Sample Letter for Seller
Notice of Pending Refund of Excess Sales Tax Reimbursement
[Customer Name]
[Address]
[City, State, Zip Code]
[Date]
Dear [Customer],
A review of our sales records disclosed that we erroneously collected excess tax reimbursement from you in the amount of
[
] for the period [xx-xx-xx] to [yy-yy-yy]. Excess tax reimbursement occurs when the sales tax reimbursement is
overstated due to a mathematical or clerical error or when reimbursement is computed on a transaction, which is not
subject to tax or on an amount in excess of the amount subject to tax. Excess tax reimbursement also occurs when a
retailer uses a tax rate higher than the rate imposed by law.
We have filed a claim for refund with the State Board of Equalization for the excess tax collected. Once we receive a refund
from the Board, we will refund the money to you. Please indicate if you would like the amount sent to you or credited to your
account.
send the refund to me
credit my account
Please acknowledge receipt of this notice by completing the information below, and returning it to our office promptly. Keep
a copy of this form for your files. In accordance with Sales and Use Tax Regulation 1700, the Board of Equalization will not
issue a refund for this tax to us until we have your signed acknowledgement that we are obligated to return the
overpayment of sales tax to you.
The validity of all refund claims is subject to review and approval by the Board of Equalization.
COMPANY NAME
BY (print name)
SIGNATURE
TITLE
DATE
TELEPHONE

(
)
Sincerely,
[Name]
[Title]
August 2005
General Audit Procedures
FORM BOE-698-A - INFORMATION DOCUMENT
REQUEST -- INITIAL IDR
EXHIBIT 13
February 2016
Audit Manual
FORM BOE-698-A - INFORMATION DOCUMENT
REQUEST -- SECOND IDR
February 2016
EXHIBIT 14
06/21/13
Tax Accrual
Account
Asset Purchases
Paid Bills
3
4
06/06/13
Second IDR
06/05/13
05/05/13
Initial IDR
DUE DATE
04/308/13
ISSUE DATE
Formal Notice
06/10/13
05/10/13
Initial IDR
Second IDR
04/30/13
04/01/13
Verbal Request
06/25/13
06/10/13
Second IDR
06/10/13
05/10/13
Initial IDR
Formal Notice
04/30/13
03/20/13
Formal Notice
Verbal Request
05/30/13
05/01/13
Initial IDR
Second IDR
04/30/13
04/01/13
Verbal Request
Formal Notice
05/15/13
None
None
06/05/13
None
Withdrawn
None
06/10/13
None
None
DATE
RECEIVED
COMMENTS
STATE OF CALIFORNIA
BOARD OF EQUALIZATION
No response to verbal request.
Documentation provided in
response to initial IDR.
No response to verbal request.
Initial IDR prepared. Taxpayer
responded
to
initial
IDR,
however provided incomplete
records. Second IDR prepared
for missing invoices.
Sufficient alternative documentation
was provided.
No response to initial IDR. Full
response to second IDR.
QRZ COMPANY 5000
JANUARY 1, 2010 - DECEMBER 31, 2012
04/04/13
REQUEST DATE
Resale Certificate Verbal Request
SUBJECT
2
1
IDR NO.
INFORMATION DOCUMENT
REQUEST MASTER LOG
BOE-698-C (8-10)
GENERAL AUDIT PROCEDURES
FORM BOE-698-C, INFORMATION DOCUMENT
REQUEST MASTER LOG
EXHIBIT 15
February 2016
Audit Manual
FORM BOE-699-B, FORMAL NOTICE AND DEMAND
COMPLETED EXAMPLE
February 2016
EXHIBIT 16
GENERAL AUDIT PROCEDURES
FORM BOE-699 - AUDIT FINDINGS PRESENTATION SHEET
EXHIBIT 17
Page 1 of 2
February 2016
Audit Manual
Audit Findings Presentation SheetExhibit 17
Page 2 of 2
February 2016
06/10/13
06/15/13
Tax Accrual
Reconciliation
3
08/10/13
06/01/13
ISSUE
DATE
Asset Purchases
2
Resales
SUBJECT
Resales
1-A
1
AFPS
NO.
AUDIT FINDINGS PRESENTATION
SHEET MASTER LOG
BOE-699-A (8-10)
07/15/13
07/10/13
09/10/13
07/01/13
06/25/13
06/25/13
None
07/01/13
DATE RESPONSE
RECEIVED
No Comment
Agree
Disagree
Disagree
TAYPAYER
AGREE/
DISAGREE
COMMENTS
Taxpayer wishes to withhold agreement until
further investigation.
Taxpayer agrees with assessment.
No additional documentation was provided.
No response to second AFPS.
Taxpayer provided some supporting
documentation. Taxpayer requested 30
additional days to provide additional
documentation. Request granted.
QRZ CORPORATION 5000
January 1, 2010- December 31, 2012
RESPONSE DUE
DATE
GENERAL AUDIT PROCEDURES
FORM BOE-699-A, AUDIT FINDINGS PRESENTATION
SHEET MASTER LOG
EXHIBIT 18
February 2016
Audit Manual
EXAMPLES OF TAX EXEMPTION CARDS
EXHIBIT 19
Page 1 of 2
EXAMPLES OF TAX EXEMPTION CARDS
August 2016
EXHIBIT 19
Page 1 of 2
GENERAL AUDIT PROCEDURES
Examples of Tax Exemption CardsExhibit 19
Page 2 of
EXAMPLES OF TAX EXEMPTION CARDS
EXHIBIT
192
Page 2 of 2
August 2016
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