[co-author: Jack Pouchert, Law Clerk]

Bedliner Chemicals Represent a Taxable Sale to the Franchisee Rather than to the Customer

For those of you with bedliners in your trucks or other vehicles, a recent decision from the Alabama Tax Tribunal indicates you may have mistakenly paid sales tax on that purchase. On October 1, 2019, the Alabama Tax Tribunal ruled in Line X, LLC v. Ala. Dept. of Rev. that the chemicals sold to franchisees of Line X for use in creating truck bedliners constituted a separate, final product – making the transactions subject to sales tax when the chemicals were initially sold. Line X, LLC, a company dedicated primarily to auto supplies and equipment, sold the chemicals, related application equipment, and supplies to its customers and also licensed the product to its franchisees. The taxpayer collected sales tax on the equipment and accessories it sold to produce the bedliner but didn’t collect sales tax on the chemicals. The taxpayer argued that since its franchisees charged sales tax on the sale of the final product to their customers, charging sales tax on the chemicals when sold “at wholesale” would result in double taxation. The Alabama Department of Revenue (ADOR) likened the sale of these chemicals to the sale of paint to an auto body shop and argued that sales tax should likewise be charged on the chemicals upon their sale to the user, not the final customer.

The Tribunal agreed with the ADOR’s argument and found that, while the nature of the chemicals was an ingredient of the final product rather than a final product in and of itself (like paint), the chemicals were consumed upon use and nearly impossible to recover once installed and should thus be treated as a taxable sale when they leave the taxpayer’s inventory. The Tribunal’s decision has interesting consequences because it will, as the taxpayer argued, result in double tax if the franchisees continue to charge sales tax to their customers. If the franchisees have indeed done so in the past, their customers may be entitled to a refund (subject to timely filing requirements) from the ADOR and local taxing authorities as well. The Tribunal reached its decisions despite the fact that the taxpayer had implemented good faith policies to account for its tax liability, such as sales tax compliance software to determine the correct rates for various taxing jurisdictions, and apparently maintained complete and accurate records. No penalties were assessed against the company.

So What if our Client Doesn’t Maintain Complete and Accurate Records?

In contrast to the Line X ruling, where the taxpayer was found to have maintained complete records and apparently thought it was complying with the rules, the Tribunal has issued several recent decisions upholding substantial assessments of sales tax and either negligence or fraud penalties on businesses for their failure to maintain adequate sales records. At a minimum, the taxpayers in these cases were assessed tax, interest, and penalties. The most noteworthy aspect of these cases is the common thread: The Tribunal’s almost unwavering support of the methods used by the examiners to assess tax due when they deemed the taxpayer to have failed in its recordkeeping responsibilities.

In Platt Auto Parts, Inc. v. Henry County, the taxpayer couldn’t provide complete monthly sales records or customer exemption certificates it claimed to have so the revenue examiner used a random three-month period as a sample to calculate liability for a period of almost three years. In two other cases, Jai Bajrang, Inc. v. Ala. Dept. of Rev. on appeal and Gridiron 3, LLC v. Ala. Dept. of Rev., the examiners utilized a percentage of error method to determine liability for several months after the examiner decreed there to be incomplete records. The calculations based on these methods resulted in tax assessments upwards of $80,000 each plus negligence penalties. In another recent case, Saku, LLC v. Ala. Dept. of Rev., the taxpayer was found to have substantially underreported its sales figures, so the examiner utilized the standard IRS mark-up on the stores’ purchases to assess $75,000 in tax plus a fraud penalty, both of which the Tribunal upheld.

The Tribunal supported the revenue examiners’ assessment methodology under Alabama Code section 40-2A-7(b)(1)a, which allows an examiner to use the “most accurate and complete information obtainable” when complete and accurate records are not available. As further support, the Tribunal restated that an examiner can use any reasonable method to compute a taxpayer’s liability, “and the taxpayer, having failed in the duty to keep good records, cannot later complain that the records and/or method used is improper or does not reach a correct result.” These cases illustrate the Tribunal’s strong support for the methods used by examiners to calculate the proper tax liability when a business allegedly fails to produce adequate records – and of course therein lies the rub. Tax advisors should warn their business clients of the risk of large assessments and penalties if they don’t maintain a complete set of books and records, including a current list of customer exemption certificates and a complete set of Z tapes (if cash registers are used), since the Tribunal seems determined to hold a business’s feet to the fire over maintaining accurate records. As is evident from this spate of new rulings, the taxing authority often wins these cases, so every effort should be made to resolve the audit at the supervisor level.

City of Birmingham Partners with Avenu Insights & Analytics (RDS) to Handle and Hopefully Streamline Auditing Services

In a coup for the state’s largest private auditing firm, the City of Birmingham recently engaged Avenu Insights & Analytics, formerly known as Revenue Discovery Services or RDS, to provide auditing and administrative hearing services related to municipal sales, use, rental, and business license taxes. As part of those services, beginning in 2020, businesses with existing privilege licenses issued by the City of Birmingham will have the option to renew their business license(s) online.

Upcoming Bradley SALT Team Seminars and Speeches:

November 13, 2019 – Managing Your Assets (Property Tax) - Institute for Professionals in Taxation (IPT) 2019 Credits and Incentives Symposium – Hyatt Regency Hotel, Seattle, Washington – Christopher R. Grissom

November 13-14, 2019 – Recent Alabama Tax Developments and Prognostications for Next Session – 73rd Annual Federal Tax Clinic – Bryant Conference Center, Tuscaloosa, Alabama – Bruce P. Ely

December 16-17, 2019 – Recent Developments in the State Taxation of Partnerships/LLCs and Their Owners – Annual New York University Institute on State and Local Taxation – Grand Hyatt Hotel, New York, New York – Bruce P. Ely with fellow panelists Steve Wlodychak, Todd Hyman and Kelvin Lawrence