The Pennsylvania Department of Revenue has performed a partial “about face” on the audit treatment of sales tax overpayments to vendors. Previously, taxpayers under audit could request credit in the audit for overpayments made to vendors, but Pennsylvania’s auditors were not permitted to take such credits into account in projecting deficiencies. With the issuance of Sales and Use Tax Bulletin 2013-01 on May 28, 2013, the Department has indicated that it will allow such overpayments to be included in projections developed through stratified random sampling. Inexplicably, however, the Department will continue to refuse projection when audit deficiencies are developed by block sample methodology.

General Background

The Department of Revenue is authorized to examine a taxpayer’s books and records to verify the accuracy and completeness of any return filed with the Department.¹  The Department may utilize a “reasonable statistical sample or test audit performed in accordance with the regulations of the Department if the individual being audited does not have complete records of transactions or if the review of each transaction or invoice would place an undue burden on the Department to conduct an audit in a timely and efficient manner.”²  The Department’s regulations have long provided for the development of underpayment deficiencies by use of different sorts of sampling. However, the regulations made no provision for projection of overpayments to vendors or, for many years, even for offset of individual vendor overpayment amounts against the final deficiency within the audit process.³  Taxpayers, of course, were always free to seek refunds of overpayments by filing a refund petition under the standard three-year statute of limitations, but since audit periods often extend back more than three years, taxpayers sometimes lost the ability to seek a refund by the time they found the overpayment.

The McNeil Case

The Department was forced to make a change in its practices by the Pennsylvania Supreme Court’s 2003 decision in McNeil-PPC v. Commonwealth,⁴  in which the court allowed a taxpayer to offset overpayments within the audit period, even though credit or refund was requested beyond the regular three-year refund statute of limitations. The court recognized that “it is the duty of the auditor to ensure that the proper amount of tax was collected, which necessarily requires that the audit take into account situations where the taxpayer overpaid tax or paid tax where it did not have to during the audit period.”⁵

2004 Bulletin

The Department reacted to McNeil by issuing Sales Tax Bulletin 2004-02, which indicated that auditors would grant credits for overpayments discovered in the course of an audit examination, or pointed out by the taxpayer during that examination. However, the bulletin expressly provided that vendor overpayments would only be credited against the final deficiency; no projection was allowed even where the auditor used a sampling method to produce the audit deficiency. This rule applied whether the sampling was conducted by block sample or statistical sampling.

Bulletin 2013-01⁶

After issuance of the 2004 bulletin, taxpayers and their representatives, from time to time, requested projection of overpayments made to vendors. These requests were sometimes granted in administrative appeals and in negotiated settlements of court cases, but there was no official recognition by the Department and auditors continued to deny such requests at the audit level. Bulletin 2013-01 finally, at least partially, has recognized the inequity in allowing the Department to use a sampling methodology to project underpayments of tax to vendors and use tax to the Department but not allowing the taxpayer a similar right to project overpayments made to vendors.

The Bulletin provides that projection of vendor overpayments will be allowed if:

1. The taxpayer is currently under audit by the Department or has entered into an agreement with the Department to conduct a managed audit;
2. Verifiable electronic purchase records are made available to the Department;
3. The volume of records supports the need for use of sampling procedures;
4. An agreement is reached … on the use of the sampling method;
5. Sufficient evidence is provided to allow the Department to determine whether … tax is overpaid for each transaction in the sample.

If the auditor does not grant credits sought by the taxpayer, a petition for refund may be filed with the Department’s Board of Appeals within the later of six months from the date of the assessment or three years from the date the tax was paid to the vendor. On appeal, the Board of Appeals “will only project an overpayment if it relates to a sample selected by the Department during an audit or during an agreed-upon managed audit process.” If tax was overpaid on a transaction not in the selected sample but within the sampled population, “the petitioner may request refund or credit, but has the burden to prove that the credit requested exceeds the amount of credit granted due to the audit projections.” As for overpayments on transactions not within the sampled population, the traditional rules continue to apply – requiring proof of payment and adequate support to establish that each transaction was not taxable.

Why Not Project Under Block Sampling?

Bulletin 2013-01 provides no explanation for why the Department will allow projection of overpayments to vendors when the auditor uses a statistical sampling approach, but not when the auditor uses block sampling. If block sampling produces a reliable projection of underpayments, why is the taxpayer not allowed to use the same methodology to obtain credit for vendor overpayments?

¹  72 P.S. §§ 7272, 10003.21(a).
²  72 P. S. § 10003.21(b).
³  See, 61 Pa. Code §§ 8a.1-8a.9.
⁴  575 Pa. 50, 834 A. 2d 515 (2003).
⁵  575 Pa, at 64, 834 A. 2d at 523,
⁶  The complete text of Sales and Use Tax Bulletin 2013-01 is
   available on the website of the Pennsylvania Department of  
   Revenue (www.revenue.state.pa.us).