Beginning October 2012, the Audit Division of the Comptroller’s Office very quietly and without notice changed their policy related to Mixed Beverage tax audits. The policy change almost guarantees that if you are selected for an audit, you will be assessed a liability.
Since the inception of the tax in 1971 (which was conducted by TABC until 1994) the auditing agency has used the alcoholic beverage depletion analysis (ABDA) as its estimation method. The agency’s take on this is that most businesses responsible for mixed beverage gross receipts tax are cash intensive and there is the possibility of having problems with misappropriated sales and inventory pilferage. In addition, source records may be incomplete, non-compliant, or fraudulent. The ABDA estimates the total amount of mixed beverage sales based on the quantity of alcoholic beverages purchased.
Prior to the policy change in October 2012, if a taxpayer with good records had reported within 7.5% of what the auditor estimated, no liability was assessed. If the taxpayer had bad records, the allowed variance was 5%. This was referred to as the “error rate variance policy”.
The policy change in 2012 did away with looking at those error rates and set a materiality threshold instead. Now, the auditor calculates the estimated tax due which includes a 5% allowance off the assessment. In essence, the agency believes that they are building in the error rate variance into the estimate. If the resulting tax due is over $2,000, tax is assessed.
Why will an assessment most likely be made?
There are several important variables which determine the calculation of tax due in the depletion analysis. Pour size, identifying secondary liquors, identifying and proving wine, beer and liquor used in cooking, glass sizes, average selling prices, comped and spilled drinks, and beginning and ending inventories. All of these variables have to be determined with a degree of specificity that is not always easily or accurately determined. One variable doesn’t have to be off much in order to get over the $2K tax due materiality threshold.
So why did audit division change their policy?
In 2011, a judge in the State Office of Administrative Hearings ruled that the audit division’s policy was not a policy, but a “discretionary resource management tool”. In other words; a tool the auditor uses at their own discretion to manage the money derived by an audit. Unfortunately, the taxpayer in this hearing did not challenge the ruling by SOAH in District Court and once they failed to challenge the ruling, the audit division changed their policy to match what the judge had ruled. The agency knew this meant an increase in revenue that would now flow to the State from Mixed Beverage permit holders.
Clearly, the Comptroller has the legal right to audit Mixed Beverage permit holders. However, Administrative Procedures Act (APA) guidelines are to be followed when the agency adopts rules that affect the assessment and collection of taxes. The depletion methodology has been in use for years and hearings have upheld the agency’s right to use it. However, the spreadsheets used in the depletion method previously had the built in error rate benchmarks that required auditors to “no tax due” audits falling into an acceptable range. Removing the range changes the dynamics of the equation. The agency is ascribing a level of precision to the depletion methodology now that simply does not exist in real life business practices. It would seem that when the agency removed the variance policy in favor of a materiality policy, they circumvented the legislative process. They changed their own job description from one of tax compliance to that of revenue generation.