Travia’s Inc., and Mellion v. State of Vermont, Department of Taxes, 2013 VT 62
Someone once said that the only things certain in life are death and taxes. This case, to a degree, disproves the latter. The Department of Taxes gets to “guesstimate” taxes when business records are questionable.
Taxpayers, husband and wife, own and operate a small bar and grill as an S-corporation (which means that only the profits passed to the owners are taxed; this is known as a pass-through basis in the trades). The records they kept were not exactly impeccable. In fact, there were some—perhaps a lot of—discrepancies. The Department of Taxes (Department) audited the corporation and found an outside-the-norm cost-of-goods-to-gross-receipts ratio. During its investigation, the Department found some discrepancies between cash-register receipts and handwritten accounts. Long story short—according to the Department, something didn’t add up.
So the Department assessed additional taxes for three years on meals and alcohol based primarily on its determination of appropriate cost-of-good-to-gross-receipts ratios. Taxpayers requested an administrative hearing, which did not go in their favor. An appeal to the civil division ensued, where the trial court upheld the assessment. And . . . yep, you guessed it . . . that’s how we end up at the SCOV.
The standard of review is as follows in bulleted form:
· Same standard as applied in the intermediate appeal at the superior court;
· Commissioner’s decision is reviewed independent of the superior court’s findings and conclusions;
· Commissioner’s findings are not set aside unless clearly erroneous; and
· Taxpayer’s burden is to prove that the assessment is erroneous by a “clear and convincing” showing.
“An uphill battle” is putting it mildly.
Taxpayers first make a statutory argument that the Commissioner has no authority to estimate taxes except when a taxpayer has failed to make a return. A “however” and “clearly” in the SCOV’s response to this argument shows us the direction we’re heading. The SCOV explains that the very next subsection provides the Commissioner authority to do what he did here. Basically, the SCOV says that if a return is sketchy, then it’s pretty much the same thing as not filing a return “as required and the Commissioner has authority to correct that. The Taxpayers’ “But other courts say!” argument goes nowhere.
Taxpayers’ next argument is that the estimation methodology was flawed. This is an interesting argument because as anybody who’s been to more than three bars in their lifetime knows, drink strength can vary tremendously. Husband testified that the average pour of a liquor drink is four ounces. But the assessment was based on industry averages—where an average drink is one-and-a-half ounces. Apparently, the auditor was also once a bar manager. [Editorial Note: judging from the 1.5 ounces claim, probably at a chain restaurant where the drinks, in the colloquial sense, suck—this illustrates the importance of expert testimony in certain situations and expert barkeeps in others]. There is also an issue with the cash register being broken and handwritten adjustments having been made to the register tape. At any rate, the SCOV goes the not-clearly-erroneous-to-give-more-weight-to-the-Department’s-witness-so-we’re-just-gonna-move-on route.
The SCOV reasons that the Department’s method of reconstructing gross receipts is commonly accepted, and so concludes that “Taxpayers have not shown by clear and convincing evidence that the method was arbitrary or invalid.”
The SCOV notes that the Taxpayers had a duty to maintain reliable records. Because the Taxpayers did not, the SCOV reasons that the Commissioner’s calculation of taxes due was properly completed. The SCOV holds that the Taxpayers have not met their burden of demonstrating the assessments are incorrect, and upholds the Commissioner’s determination.
So if you own a business, make sure to keep airtight books. You don’t want the Department of Taxes second-guessing your filings.
That’s right. I’m here all week, folks. Don’t save your applause until the end.