State & Local Tax Bulletin (August 2003)
Legislation Permits Sales and Use
California's Managed Audit Program
E. Nielsen, of counsel in the
San Francisco office of Pillsbury Winthrop
Shaw Pittman LLP.
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On July 22, 2003, the Governor signed Assembly Bill No. 1043 that allows taxpayers to audit themselves in connection with sales and use taxes under the supervision of the State Board of Equalization ("Board"). The bill
re-establishes the Managed Audit Program ("MAP") that the Board administered from 1998 to 2002 but it also eliminates certain provisions from the prior law that should result in more taxpayers being eligible to participate in the program. The Board was the sponsor of the bill.
Managed audits are essentially self-audits by the taxpayer of its sales and use tax liability. The original MAP, effective January 1, 1998, contained a sunset provision of January 1, 2001 which was subsequently extended to January 1, 2003. No further legislation was introduced to extend the sunset date beyond January 1, 2003. Thus, the Board was no longer able to utilize the MAP which necessitated the introduction of A.B. 1043. The new law takes effect January 1, 2004, and sunsets January 1, 2009.[fn.
What Is A Managed Audit?
Managed audits are essentially self-audits. Accounts selected as part of the Board's routine audit program are reviewed to determine if the taxpayer is eligible for the MAP. If the taxpayer is eligible, the auditor provides the taxpayer with written and oral instructions to enable the taxpayer to perform the audit verification, prepare the working paper schedules necessary to complete a particular portion of the audit and sets a time frame within which the audit is conducted. To be eligible, a taxpayer's business must involve few or no statutory sales and use tax exemptions, and a single or small number of clearly defined taxability issues.
A taxpayer must have the resources necessary to comply with the Board's MAP instructions. Participating taxpayers must examine their books, records, and equipment to determine if there is any unreported tax liability, and make all audit information available to the Board. Taxpayers that participate in the MAP receive a 50 percent reduction in interest due on unpaid liabilities discovered during the audit.
Eligibility Provisions Effective January 1, 2004
Revenue and Taxation Code ("RTC") section 7076(a) provides that the Board determines which taxpayer's accounts are eligible for the MAP in a manner that is consistent with the efficient use of its auditing resources and the maximum effectiveness of the program. It is further provided that taxpayers are not required to participate in the managed audit program.
RTC section 7076.1 provides that a taxpayer's account is eligible for the managed audit program only if the taxpayer meets all of the following criteria:
- The taxpayer's business involves few or no statutory exemptions.
- The taxpayer's business involves a single or small number of clearly defined taxability issues.
- The taxpayer is taxed pursuant to this part and agrees to participate in the managed audit program.
- The taxpayer has the resources to comply with the managed audit instructions provided by the Board.
Differences Between Original and Current MAP
The new MAP statutory provisions differ from the original MAP in two important respects:
- Eliminates the provision that specified that any taxpayer that is on a prepayment reporting basis does not qualify for the MAP; and
- Eliminates the provision that specifies that RTC section 6596 (provides relief of tax, interest, and penalty in cases where the taxpayer relied on erroneous advice from the Board) shall not apply to any managed audit conducted.
Benefits of MAP Program Lower Interest Rate
An incentive for the selected taxpayer to participate in the MAP is that upon completion of the managed audit and verification by the Board, interest on any unpaid liability shall be computed at one-half the rate that would otherwise be imposed for liabilities covered by the audit period. RTC § 7076.4. The decreased interest rate is applicable even if the entire audit is not performed under a MAP audit and even if the portion performed by the auditor results in a tax liability. In addition, MAP audits that result in a credit or refund compute interest using the standard running balance method. That is, if the audit has both debit and credit periods, the one-half interest rate would apply for debit periods and the full statutory credit interest rate applies for credit periods.
Other advantages that have been advanced in support of the MAP legislation included:
- Resolution of questions about taxability during the audit process, thus reducing the number of audits requiring resolution through the administrative appeals process.
- More efficient allocation of audit resources to audits and other revenue generating activities.
- Reduction in litigation of protested audits.
- Decreased disruption of a taxpayer's regular business activities since an auditor is likely to spend fewer hours at the taxpayer's place of business.
- Promotion of an ongoing cooperative relationship between the taxpayer and the Board.
- Increased understanding on the part of the taxpayer about the application of sales and use tax to his or her business.
Logistics of the Managed Audit
RTC section 7076.2(a) provides that if the Board selects a taxpayer's account for a managed audit, the following applies:
RTC section 7076.4 provides that payment of the liabilities and interest shall be made within the time period specified by the Board. If the requirements for the managed audit are not satisfied, the Board may proceed to examine the records of the taxpayer in a manner to be determined by the Board under law.
- The Board shall identify:
- The audit period covered by the managed audit.
- The types of transactions covered by the managed audit.
- The specific procedures that the taxpayer is to follow in determining any liability.
- The records to be reviewed by the taxpayer.
- The manner in which the types of transactions are to be scheduled for review.
- The time period for completion of the managed audit.
- The time period for the payment of the liability and interest.
- Any other criteria that the Board may require for completion of the managed audit.
- The taxpayer shall:
- Examine its books, records, and equipment to determine if it has any unreported tax liability for the audit period.
- Make available to the Board for verification all computations, books, records, and equipment examined pursuant to subparagraph (A).
Finally, RTC section 7076.3 provides that nothing in the MAP provisions limits the Board's authority to examine the books, papers, records, and equipment of a taxpayer under RTC section 7054.
The Future of MAP
It is contemplated that reinstating the MAP without the restrictive criteria with respect to prepayment accounts will mean that more audits will eligible for the MAP.[fn.
2] A survey by the Board indicated participation was limited in the original MAP primarily because of the restrictions contained in the prior law with respect to taxpayer eligibility to participate in the program. Also, taxpayers were reluctant to participate due to the provision which prohibited the Board from granting relief of liability under RTC section 6596 in cases where taxpayers participated in the MAP relied on erroneous advice from the Board and failed to pay amounts due. Elimination of this provision is expected to provide consistency with the relief provisions extended to those taxpayers who have been audited by the Board under its normal audit selection process.
- Effective January 1, 2003, the MAP expired. However, any managed audit started before January 1, 2003, will be completed by the Board and the person whose account is audited shall remain eligible for the adjusted interest rate for that audit. [return to text]
- 151 MAP audits were initiated during the period 1/1/99 to 6/30/00. The Board estimates that without such restrictions there would have been 584 MAP audits during the same period. [return to
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