NOT FOR PUBLICATION WITHOUT APPROVAL OF THE TAX COURT COMMITTEE ON OPINIONS
______________________________ : STATEWIDE COMMERCIAL CLEANING,: TAX COURT OF NEW JERSEY LLC, : Plaintiff, : DOCKET NO: 003504-2015 : vs. : : DIRECTOR, DIVISION OF : TAXATION, : Defendant. : ______________________________:
Decided: October 20, 2017
Scott E. Becker, attorney for plaintiff
Steven J. Colby for defendant (Christopher S. Porrino, Attorney General of New Jersey, attorney)
CIMINO, J.T.C.
I. FACTUAL SUMMARY.
The taxpayer, Statewide Commercial Cleaning, LLC, is in the
business of providing cleaning and restoration services to
properties that have suffered damages as a result of some sort of
casualty. The Director scheduled an audit of taxpayer’s books to
determine if additional sales and use tax would be due and owing
for the period of January 1, 2007 through December 31, 2010. The
parties agreed that the year 2009 would be the sample period for
the audit. A written sampling agreement does not appear to have
been prepared. From the sample period, the auditor would
-1- extrapolate any unpaid tax over the entire audit period. Based
upon the audit report of July 8, 2013, the Director’s auditor
determined that the records were adequate to properly conduct the
audit.
The audit consisted of two general areas which were designated
by the auditor as “use tax” and “sales tax”. As to the “use tax”
portion of the audit, the auditor examined whether the taxpayer
properly and sufficiently paid tax on purchases from vendors. As
to the “sales tax” portion of the audit, the auditor examined
whether the taxpayer properly and sufficiently collected tax on
sales to customers of the taxpayer.
The portion of the audit delineated as a “use tax” audit
focuses upon purchases from vendors of the taxpayer for which taxes
were not paid. To conduct this audit, the auditor listed certain
vendors in alphabetical order for 2009 along with the identifying
information such as the invoice number, date and purchase amount.
For each invoice in question, the auditor then listed the amount
upon which tax was not paid, but purportedly due, as a taxable
exception.
It appears that initially the auditor’s spreadsheet listed
all vendor invoices in question for which tax was not paid. Then
during the course of the audit, certain invoices were deemed exempt
(i.e., school projects, etc.). The invoices that remained as
taxable exceptions were listed and totaled. These invoices totaled
-2- $72,832.46 and were divided by the total expenses of $3,481,561.00
for 2009 yielding a tax payment shortfall percentage of 2.09195%.
Over the audit period from 2007 to 2010, there were total expenses
of $16,462,054.00. Multiplying these taxable expenses by the tax
payment shortfall percentage extrapolates a total taxable invoice
shortfall amount of $344,377.68. Multiplying this by the tax rate
of 7% results in the total “use tax” due on expenses of $24,106.44.
Taxpayer challenges a number of the purported taxable vendor
expenses as being tax exempt since the ultimate consumer was an
exempt governmental entity such as a school. See N.J.S.A. 54:32B-
9. Upon review of the description that is provided on the
auditor’s spreadsheet, a number of invoices had notations in the
description field that indicated schools or other public entities.
It was unclear whether the description entries were gathered from
the taxpayer’s accountant, the taxpayer’s business records, or a
determination made by the auditor.
To calculate the “sales tax” portion of the audit, the auditor
listed the name of each customer alphabetically along with
identifying information such as the invoice date and number. The
auditor also listed the total invoice amount as well as the amount
of sales which were exempt from taxation for reasons such as a
capital improvement. See N.J.S.A. 54:32B-3(b)(4). Of note, the
auditor also had a column delineated as “audited taxable
exceptions” which consisted of invoice sales amounts upon which
-3- tax was not paid, but the auditor was of the opinion that tax
should have been paid. The auditor divided the “audited taxable
exceptions” (those invoices upon which a tax should have been paid
but was not) by the total sales (exceptions or not) to come up
with a percentage rate by which the taxpayer allegedly
underreported the tax due and owing. For the 2009 sample year,
the total sales calculated by the auditor was $2,735,265.00. The
total exceptions for which tax should have been paid, but was not,
amounted to $95,432.58. This resulted in a shortfall percentage
of 3.49%.
The auditor then took the total sales for each year from 2007
through 2010 and multiplied by the tax collection shortfall
percentage of 3.49%. The auditor found that the total sales from
2007 to 2010 were $14,063,878.00. This amount was multiplied by
3.49% resulting in a total taxable sales shortfall of $490,829.00.
Multiplying that amount by 7% results in additional sales tax due
of $34,358.03.
Of the $96,432.58 in taxable exceptions from the 2009 sample
year, the sum of $55,683.44 consists of invoices from Barefoot
Landing, the familial shore home of the principal of taxpayer
located in Ocean City, New Jersey. The allegation is that the
property suffered significant damage from unruly tenants that
required significant restoration, repair and remodeling. The
Director argues that the work done to Barefoot Landing did not
-4- constitute a capital improvement and is thus, taxable. The
taxpayer argues to the contrary. The dispute here is not so much
whether the transaction is taxable in the amount of some
$3,897.84,1 but rather, whether it should be used to calculate the
percentage of audited taxable exceptions that are carried over to
other years. The taxpayer argues that the Barefoot Landing expense
was simply a one-time event that happened in 2009 and did not
repeat itself for the other years of the audit. The taxpayer
alleges this issue has been raised prior to the Final Audit
Determination. Thus, the shortfall percentage which was
extrapolated to the other years must be recalculated which would
result in a significant decrease in taxes.
As a result of the audit, the Director issued a Notice of
Assessment Related to Final Audit Determination on July 25, 2013.
The Schedule of Liabilities attached to the Notice of Assessment
and also dated July 25, 2013 indicates the tax type “S & U” for
the period of January, 2007, through December, 2010, with a tax
liability of $58,464.47. The notes section of the Schedule of
Liabilities indicates “S & U” means “Sales and Use Tax.” A
subsequent page which is labeled “Sales and Use Tax” breaks down
the asserted deficiency as comprised of sales tax of $34,358.03
and use tax of $24,106.44. With the addition of penalties and
1 $55,683.44 multiplied 7% tax rate yields $3,897.84. -5- interest, the total amount sought was $84,142.64. A third sheet
which was a quarter-by-quarter calculation of the amount due for
2007 through 2010 lists the tax as an identical amount of $3,654.00
for each quarter.
On August 8, 2013, the accountant for the taxpayer sent a
letter indicating “[t]hrough the advice of [counsel], we will
continue to process the paperwork necessary to begin to [sic]
appeal process. Please call me at your earliest convenience to
continue to work towards a resolution.” On December 19, 2013, the
accountant sent a follow-up email. The email from the accountant
indicates that he has attached the documents provided previously.
A response to this email was provided two months later on
February 10, 2014 indicating that if the taxpayer desired to
protest the audit, he had to submit a power of attorney “within
the next 30 days” or the Director “will consider the matter
closed.” Moreover, the email indicated that “[i]n order to perfect
your request in accordance with N.J.A.C. 18:1.1.8 [sic] and
N.J.S.A. 54:49-18 the item(s) listed below are REQUIRED and must
be submitted. . .” (emphasis added). The email then listed eight
different submissions detailing the protest to be provided. The
email went on to indicate, “NOTE: Failure to submit this
information along with a copy of this letter within thirty (30)
days of the date of this letter can jeopardize your conference
rights and render your request null and void.”
-6- On April 21, 2014, the Division sent written correspondence
to taxpayer’s accountant indicating the information requested in
the email on February 10, 2014 was not provided. The Division
then reiterated the list of requested submissions as set forth in
the February 10, 2014 email. The Division further indicated that,
“NOTE: Failure to submit the information along with a copy of
this letter within Fifteen (15) days of the date of this letter
can jeopardize your conference rights and render your request null
and void.”
Thereafter, on April 28, 2014, the accountant responded that
the tax being protested is the years 2008 through 2011 and the
protest is based upon the fact that the test year includes a
construction project not subject to “sales tax.” The taxpayer
provided further correspondence by way of telefax on November 5,
2014 pointing out issues with the “use” tax portion of the audit.
A conference report was prepared on December 17, 2014
indicating that a conference hearing occurred telephonically on
September 18, 2014. However, the conferee ruled that the only
type of tax being protested is the “sales” tax for the period in
question and that the taxpayer is out of the time to protest the
“use” tax liability. At the beginning of the report, the conferee
indicates tax type as “sales” for the period ending December 2010
with a total tax liability of $58,464.47. In the final section
of the report under the title “Assessment Adjustment,” the tax
-7- type is once again listed as just “sales” and the total tax
liability is $58,464.47. Notably, this is identical to the total
“sales and use” tax assessment of $58,464.47 noted in the Schedule
of Liabilities attached to the Notice of Assessment of July 25,
2003. As to the “sales” tax portion, the conferee determined that
the taxpayer failed to substantiate the Barefoot Landing
transactions are extraordinary for the entire audit period and the
transactions did not constitute a non-taxable capital improvement.
Thereafter, the taxpayer timely filed an appeal with the New
Jersey Tax Court. The Director has now brought a motion for
summary judgment.
II. CONCLUSIONS OF LAW.
A. Appeal Limitations.
When a taxpayer receives a notice of assessment or finding,
the taxpayer has two and possibly three remedies. First, the
taxpayer may “file a protest in writing. . . and may request a
hearing.” N.J.S.A. 54:49-18(a). In addition, a taxpayer can
forego this informal conference and file an appeal directly with
the Tax Court. N.J.S.A. 54:51A-13; see also N.J.S.A. 54:32B-21(a).
In either case, the filing must be within 90 days after the action
sought to be reviewed. N.J.S.A. 54:49-18(a); N.J.S.A. 54:51A-
14(a); N.J.S.A. 54:32B-21(a). In the alternative, a taxpayer can
pay the assessment within one year of the deadline to file the
-8- protest, and then file a claim for refund within 450 days of
deadline to file the protest. N.J.S.A. 54:49-14(b).
An informal conference hearing resulting from the filing of
a protest is handled by the Conference and Appeals Branch of the
Division of Taxation. N.J.A.C. 18:32-1.1. If the protest and the
hearing, if requested, does not resolve the matter, an appeal can
be filed with the Tax Court. N.J.S.A. 54:49-18(a). The Director
has affirmatively taken steps to encourage taxpayers to take
advantage of the optional protest procedure rather than filing
directly with the Tax Court. The notice of assessment provided to
the taxpayer has form language that states “[s]ince most matters
can be resolved through the protest and hearing process (N.J.A.C.
18:32-1.1 et seq.), it is requested that taxpayers make use of
this informal process.” Hearings are scheduled on a date mutually
acceptable and whenever possible held by telephone. N.J.A.C.
18:32-1.4. A taxpayer may have an attorney or accountant present
at a conference hearing. N.J.A.C. 18:32-1.5.
The plain language of both the statute and regulation
contemplate that the protest and the request for a hearing are
separate and distinct. The statute separately provides that the
taxpayer may “file a protest . . . which shall set forth the reason
therefor . . ., and may request a hearing.” N.J.S.A. 18:49-18(a).
The regulation makes the distinction clear by stating “[a] protest,
and a request for hearing, if any, by a taxpayer . . .” N.J.A.C.
-9- 18:32-1.1 (section 1.1). The regulation further provides “[u]pon
the timely filing of a protest and a request for hearing pursuant
to N.J.A.C. 18:32-1.1, the hearing process shall be commenced with
the submission of a written protest statement as defined by this
section and a request for a hearing, if a hearing is desired.”
N.J.A.C. 18:32-1.2(a) (section 1.2). Reading this language
closely, while section 1.1 only requires a generic protest, the
submission of a “written protest statement as defined by [section
1.2]” is a prerequisite to the commencement of a hearing. Section
1.2 requires the submission of eight items including the payment
of any taxes which are undisputed. The overall thrust of the eight
submissions required by section 1.2 is to enable the Director to
focus the inquiry in anticipation of the conference hearing.
The Director can delay the commencement of a conference
hearing until compliance with the section 1.2 submissions.
However, the Director cannot limit the taxpayer’s further appeal
rights in the Tax Court based upon the scope or breadth of the
section 1.2 submissions. There is simply no statutory or
regulatory authority for such a result. Both the statute and the
regulation treat the protest separate and apart from the hearing.
The section 1.2 submissions are simply a tool to help foster a
productive conference hearing that may lead to a resolution.
The section 1.2 submissions are not intended to be a trap for
the unwary that may be utilized later to destroy the appeal of a
-10- claim in the Tax Court. The Director has billed the process as
informal. If claims would be precluded based upon Section 1.2
submissions, seasoned tax practitioners may well discourage
clients and their accountants from requesting conference hearings.
This undercuts the Director’s statements encouraging parties to
take advantage of the informal conference hearing process in an
effort to avoid litigation in Tax Court.
The court must decide whether the limitation imposed by the
Director for the conference hearing carries over to this appeal
before the Tax Court. The taxpayer’s accountant only indicated
the desire to appeal on August 8, 2013 without further
specification. Technically, the taxpayer only filed a protest and
did not request a hearing. At that juncture, the Director was
free to have the matter reviewed by the Conference and Appeals
Branch and issue a decision based upon the information in the file.
This is the same procedure that is followed in the event a taxpayer
fails to appear at a hearing. N.J.A.C. 18:32-1.4.
Instead of denying the conference hearing, the Director
responded that it wanted the taxpayer to “perfect” the request in
accordance with N.J.A.C. 18:1-1.8 and N.J.S.A. 54:49-18.2 Namely,
the Director sought the eight section 1.2 submissions. It is the
2 Parenthetically, N.J.A.C. 18:1-1.8 was replaced with N.J.A.C. 18:32-1.1, 1.2, 1.4, 1.7, 1.8 in 2006. 38 N.J.R. 3316(b) (Aug. 21, 2006).
-11- responses to these submissions that the Director relies for its
argument that the Tax Court appeal is limited to only the “sales”
tax and not the “use” tax.3 These submissions were provided by
taxpayer’s accountant some six months after the deadline to request
a conference hearing.
Even assuming that the Director’s dichotomy between the “use”
tax and the “sales” tax stands, the Director should have considered
the “use” tax on the merits of the facts documented in the
Director’s file, and considered the “sales” tax on the merits of
the facts documented in the Director’s file and adduced at the
conference hearing. The taxpayer only filed a protest, not a
hearing request. The protest only generically indicates the
taxpayer’s desire to appeal. At the onset, moving this matter
towards a conference hearing seemed to be a good faith attempt by
the Director to utilize the process to resolve taxpayer disputes
and should not be discouraged. However, to now use the hearing
3 While it appears that the audit approach of the Director may be proper in this circumstance, calling the review of purchases from vendors a use tax audit may be a misnomer. The audit was not focused on out of state purchases being used in this state for which use tax would be due. N.J.S.A. 54:32B-6. Rather, the audit was of vendor transactions in which tax was not paid by taxpayer. The law clearly provides that a vendor collects the tax from the customer. N.J.S.A. 54:32B-12. Here, the customer is the taxpayer. If there is a failure of the customer to pay sales tax, it does not only mean that only the vendor is responsible for the tax, but the customer would have an obligation to pay as well. N.J.S.A. 54:32B-14(b). This is an independent obligation, distinct from that of the vendor, to pay sales tax.
-12- process to curtail the scope of a Tax Court appeal is counter-
productive to the goal of encouraging participation in this
informal process. Based upon the foregoing, the section 1.2
submissions do not serve as basis to limit the scope of the appeal
before the Tax Court.
B. The Challenge to the Use Tax Audit.
As stated previously, the “use tax” audit consisted of the
Director reviewing all vendor purchases for the year 2009 and
flagging those purchases upon which the Director contends that a
tax should have been paid, but was not. The Director determined
that there were $3,481,561.00 in purchases and other expenses. Of
these purchases and expenses, the Director identified some
$72,832.46 or 2.09195% of the total for which tax was allegedly
not paid. The Director then applied this percentage to the
purchases and expenses for 2007 through 2010 which total
$16,462,054.00. The product of multiplying the total by 2.09195%
is $344,377.68. Multiplying this amount by the 7% tax rate results
in the total tax due of $24,106.44.
The taxpayer’s primary contention is that a number of vendor
goods and services which were ultimately provided to schools were
included on the Auditor’s work papers as taxable. Specifically,
a description for certain transactions clearly indicates the
transactions were for schools. The record does not reveal, nor
did the argument reveal, how the description on the work papers
-13- was derived (i.e., was it based on information solely provided by
the taxpayer, or was it based upon other information obtained or
verified by the Auditor).
The law provides an exemption for vendor “[r]eceipts from
sales made to contractors or repairmen of materials, supplies or
services for exclusive use in erecting structures or building on,
or otherwise improving, altering or repairing real property of .
. . organizations described in [N.J.S.A. 54:32B-9(a),(b)] . . .
that are exempt from the tax imposed under the ‘Sales and Use Tax
Act.’” N.J.S.A. 54:32B-8.22(a). Exempt organizations include
political subdivisions. N.J.S.A. 54:32B-9(a)(1). There is not
any serious dispute that if the vendor supplied goods and services
that were indeed utilized for certain public schools operated by
a local board of education, a political subdivision, said
transactions would not be subject to tax just as if the school
made the purchase directly from the vendor. See Stubaus v.
Whitman, 339 N.J. Super. 38, 48 (App.Div. 2001)(local board of
education is political subdivision). The dollar amount of the
school transactions listed amount to nearly $7,500.00, which is
about 10% of the transactions flagged in the Director’s audit.
It is well settled that the Director’s assessments are
presumed to be correct. Yilmaz, Inc. v. Director, 390 N.J. Super.
435, 440, 23 N.J. Tax 361, 366 (App. Div. 2007). Atlantic City
Transportation Co. v. Director, 12 N.J. 130, 146 (1953); L & L Oil
-14- Service, Inc. v. Director, 340 N.J. Super 173, 183 (App. Div.
2001). “The presumption in favor of the taxing authority can be
rebutted only by cogent evidence, a proposition that has been long
settled. The strength of the presumption is exemplified by the
nature of the evidence that is required to overcome it. That
evidence must be definite, positive and certain in quality and
quantity to overcome the presumption. . . It is clear that the
presumption is not simply an evidentiary presumption serving only
as a mechanism to allocate the burden of proof. It is, rather, a
construct that expresses the view that in tax matters it is to be
presumed that governmental authority has been exercised correctly
and in accordance with the law.” Pantasote Company v. City of
Passaic, 100 N.J. 408, 413 (1985); see also, United Parcel Service
General Services Co. v. Director, 25 N.J. Tax 1, 12-13 (Tax 2009).4
The above standard must be applied in relation to the
framework of the applicable standard to be applied depending on
the stage of the litigation. This matter comes before this Court
on a motion for summary judgment filed by the Director. The
taxpayer did not cross-move for summary judgment. A cross-motion
may signal that the matter is ripe for adjudication short of a
4 The Court is especially cautious with regard to challenges to audits of cash business. See, Yilmaz, Inc. v. Director, 390 N.J. Super. 435 (App. Div. 2007); Charley O’s, Inc., t/a Scotty’s Steakhouse v. Director, 23 N.J. Tax 171 (Tax 2006). However, this case does not involve the audit of a cash business. Nevertheless, the foregoing does provide guidance. -15- hearing with credibility determinations and the like. See Spring
Creek Holding v. Shinnihon USA, Co., 399 N.J. Super. 158, 177 (App.
Div. 2008). As is often stated, summary judgment provides a prompt
business-like and appropriate method of disposing of litigation
without the parties incurring the time and expense of a worthless
trial. Brill v. The Guardian Life Insurance Company of America,
142 N.J. 520, 540-41 (1995). Summary judgment is also meant to
prevent one party from using the threat of litigation, namely a
trial, as a means to coerce a settlement. Id. at 541. The process
as enunciated by the Brill Court is to sift through the competent
evidentiary materials to determine if there is a material issue of
fact that requires a trial on the merits. Id. at 539-540. At the
summary judgment stage, it is impossible and also improper for the
court to make credibility determinations. Id. at 540. Finally,
all logical inferences that can be gleaned from the record must be
resolved in favor of the non-moving party. Id.
The taxpayer does indeed have the burden of overcoming the
presumption. As to the presumption, the court looks at the
evidence of the non-moving party through rose-colored glasses.
MSGW Real Estate Fund, LLC v. Borough of Mountain Lakes, 18 N.J.
Tax 364, 379 (Tax 1998).
The issue here is the inclusion of the transactions as taxable
which are clearly labeled in the description as pertaining to
schools. The evidence presented does not reveal how this
-16- description was derived. At this stage in the litigation, the
logical inferences must be given to the taxpayer opposing the
Director’s motion. The most favorable inference in favor of the
taxpayer is that the expenses were for school projects, yet through
error or inadvertence, the auditor failed to remove the purchase
from the list of taxable exceptions. There are a number of other
transactions that are listed for schools that have indeed been
removed from the taxable exceptions column. It is unclear at this
point whether the failure to remove the transactions in question
as taxable exceptions is the result of simple inadvertence, the
taxpayer failing to present sufficient evidence to cause removal
of an item or the outright refusal of the auditor to remove the
item. Since this is merely a motion for summary judgment, the
designation of the transactions as being for schools without any
explanation as to whether said descriptions have been rejected or
accepted, leads to the most reasonable inference in favor of the
taxpayer that the transactions are exempt, thus overcoming the
presumption.
At trial, the taxpayer may not be able to rest upon the lack
of clarity in the audit records if the Director is able to credibly
clarify the school transaction notations. In such case, the
taxpayer may have to present evidence explaining these
transactions with the necessary proofs such as tax exemption forms
(i.e., Form ST-4) completed by a school district for a contractor,
-17- or by other credible evidence establishing that the transactions
are exempt.
C. The Challenge to the Sales Tax Audit.
For the “sales tax” portion of the audit, the auditor
collected invoices from customers for the sample year 2009. The
total invoices amounted to $2,735,265.00. Of these invoices, the
auditor noted taxable exceptions upon which it has been alleged
that tax was not paid. According to the auditor, these taxable
exceptions amount to $95,432.58. Taking this amount and dividing
by the previously mentioned $2,735,265.00, results in a taxable
exemption percentage of 3.49%. Multiplying this by the total sales
from 2007 through 2010 of $14,063,878.00, results in total taxable
exceptions for the period of $490,729.00. Multiplying this amount
by 7% results in a tax due of $34,358.03. The taxpayer now contends
that of the $95,432.58 of sales for 2009 which were deemed taxable
exceptions, $55,683.44 was attributable to Barefoot Landing, which
is the familial shore home of the principal of taxpayer, Statewide
Commercial Cleaning. Removing this amount from the calculation
results in a taxable exception rate of 1.45% which would
significantly reduce the tax liability for “sales tax” by half.
The Director argues that the taxpayer waited too long to
challenge the agreed upon 2009 sample period, and is thereby bound
to accept the inclusion of the Barefoot Landing job. On the other
hand, the taxpayer argues that the inclusion of sales to Barefoot
-18- Landing was a taxable one-time event not capable of repetition and
thus should be excluded from the taxable exceptions for the
extrapolation calculation. In the alternative, the taxpayer
argues that the Barefoot Landing job was for non-taxable capital
improvements and thus should not be part of the calculation.
Finally, the taxpayer argues that the Barefoot Landing sales are
not really sales, since both Barefoot Landing and Statewide
Commercial Cleaning are closely held entities controlled by the
same individual, and both reported on the same individual’s income
tax returns as a pass-through entity.
1. Inclusion of Barefoot Landing.
The Director here decided to conduct the audit utilizing block
sampling. “Block sampling is the most common method utilized by
field audit. Block sampling requires the auditor to examine all
invoices (or receipts) for all transactions of a certain type that
occurred during a selected period of time within the audit period,
known as the ‘sample period.’” St. of N.J., Dep’t of the Treas.,
Div. of Tax’n, N.J. Manual of Audit Procedures, 41 (2017). “If
taxable exceptions are found within the sample, the percentage of
error for the sample period is extrapolated over the audit period.
For example, the error rate calculated for the sample period will
be applied to the total amount for the audit period (sales or
expenses) to determine the taxable exceptions for the audit
period.” Id.
-19- As set forth by the manual, “the auditor will prepare a
sampling agreement which sets out the audit period and a sampling
period for each tax and sub-type such as expenses or assets.” Id.
at 42. “The auditor will discuss the agreement with the taxpayer
and/or the authorized representative and give them the opportunity
to include in the sampling agreement any concerns or reservations
with any aspect of the sampling plan and/or propose any
alternatives.” Id. It is contemplated that the agreement is in
writing since the taxpayer is to sign the agreement and there is
a procedure if the taxpayer refuses to sign. Id.
Moreover, the audit manual sets forth a safety valve in the
event the auditor realizes that the original sampling plan needs
to be modified. The auditor can prepare a new sampling agreement
and present it to the taxpayer or the taxpayer’s authorized
representative with a memorandum that states the reasons why it is
necessary to revise the original plan. The audit manual fails to
indicate what is to be done in the event that the taxpayer realizes
that the original sampling plan needs to be modified.
The Director argues that the taxpayer cannot challenge the
agreed upon 2009 sampling plan. The Director has not produced any
written sampling plan. It is also unclear when the taxpayer first
raised the Barefoot Landing issue. Since this is a motion for
summary judgment, the most favorable inference raised by the
certification of taxpayer’s accountant is that the issue was raised
-20- while the audit was being conducted. See Brill, supra, 142 N.J.
at 540 (most favorable inference in favor of non-moving party).
More importantly, though, the Barefoot Landing job was considered
during the conference hearing and found to not be extraordinary.
Thus, this is not the case where the taxpayer is raising the issue
for the first time on appeal to the Tax Court.5 Since this issue
was raised below with the Director, the court will consider the
issue.
The Director’s audit manual provides that “[a]n item is
considered extraordinary or nonrecurring in nature if it is unusual
and not routine in the normal course of taxpayer’s business.
Because it is nonrecurring, it may not be representative of the
sample population. The auditor should remove these items from the
population and audit them separately. The auditor should then
examine the population to search for every occurrence of similar
transactions which should also be pulled from the population and
audited separately. These items will be extrapolated separately.”
N.J. Manual of Audit Procedures, supra, at 42. At least one other
state that has an audit manual has considered this issue and
reached a similar conclusion.
The California audit manual recognizes that non-recurring
errors may become apparent while making a test of the taxpayer’s
5 That is not to say the issue cannot be raised for the first time on appeal. That issue is not before the court. -21- records. St. of Cal., Dep’t of Tax and Fee Admin., Bus. Tax and
Fee Div., Audit Manual ¶ 0405.20(e) (Oct. 3, 2017). In other
words, these cannot be addressed in any sampling period agreement
because they would not be discovered until the actual audit took
place. The manual indicates that non-recurring items are “normally
items of considerable size, and the opposition to including them
in the percentage of error is quite strong.” Id. However, the
purported non-recurring items “should be carefully scrutinized to
determine whether or not they are non-recurring errors.” Id.
The New Jersey manual does not set forth any guideposts for
determining when a non-recurring item should be excluded. The
California manual sets forth guideposts to determine if a
transaction is a non-recurring error. The first of those
guideposts is that the size of the item is much in excess of the
normal item and only occurs at rare intervals. Id. The second
guidepost is that the item was omitted or included due to some
unusual circumstance. Id. The third guidepost is that the item
sold or purchased is of the type not normally handled. Id.
However, the fact that a transaction was the only sale to a
particular customer or purchase from a certain supplier should not
be the sole criteria for eliminating the transaction from the test
period. These guideposts provide reasonable criteria to evaluate
non-recurring errors. There may be other guideposts the parties
may want the court to consider in further proceedings.
-22- The taxpayer’s evidence must focus on the reasonableness of
the underlying data used by the Director and the reasonableness of
the methodology used. Charley O’s, Inc., t/a Scotty’s Steakhouse
v. Director, supra, 23 N.J. Tax at 185. In Charley O’s, the
auditor increased the purchases by an arbitrary amount through a
“plugged number” to conform the purchases with an unaudited
Corporation Business Tax return. Id. at 176-177. The court
determined that the presumption of correctness was overcome since
the methodology was aberrant and not merely imperfect. Id. at
186.
As before, while the taxpayer does indeed have the burden of
overcoming the presumption, the court looks at the evidence of the
non-moving party through rose-colored glasses. MSGW Real Estate
Fund, LLC, supra, 18 N.J. Tax at 379. On summary judgment, the
court must sift through the evidence giving all factual inferences
to the non-moving party.
The Director has not presented any fact or merit based
evidence to challenge the exclusion of Barefoot Landing. Applying
the three guideposts above does help clarify the issue. The
Barefoot Landing sale is more than half of the audited taxable
exceptions for the sample period. With a nonrecurring item of
such considerable size, the opposition to inclusion is quite
strong. Moreover, while the Barefoot Landing job was not included
or excluded for some unusual factor, the sale was to a related
-23- entity controlled by the same principal. This seems to be a sale
outside the normal course of business. Sifting through the
available evidence and giving all reasonable inferences to the
taxpayer, leads to the conclusion that the Barefoot Landing job
could be a non-recurring item thereby overcoming the presumption.
Including such a large non-recurring transaction may not merely be
imperfect, but aberrant.
At trial, the audit must stand upon a factual foundation which
the taxpayer can attempt to topple. If the Director does not
present any merit or fact based rationale for including the
Barefoot Landing job, the Director’s determination without any
factual support may be insufficient to sustain the audit
determination.
2. Capital Improvements vs. Restoration.
The taxpayer also claims that the work done to Barefoot
Landing constitutes capital improvements rather than restoration
work. Under the law, capital improvements would not be taxable,
but restoration work would be taxable. Based upon the records
submitted, and giving the most favorable inference to the taxpayer,
it could be determined at trial that the work was a mix of capital
improvements and restoration work. Without further testimony or
evidence, the Court is unable to differentiate the two. Since an
unknown reduction of the taxable amount would reduce the percentage
-24- used for extrapolation and likewise reduce the amount of tax due
by an unknown amount, this issue is not ripe for summary judgment.
3. Pass through Entity.
Taxpayer also argues that because Statewide Commercial
Cleaning, LLC and Barefoot Landing are pass through entities owned
by the same individual, no sales and use tax is due. A pass
through entity is an income tax concept. See generally Miller v.
Director, 352 N.J. Super. 98 (App. Div. 2002). This does not mean
that the entities lose their separate legal status because of
filing status. Rather, the income of these separate legal entities
is aggregated with the other income of a principal shareholder or
member of the entities. Id. at 104-105.
A taxpayer is free to arrange its affairs as it deems fit.
“Once the taxpayer has chosen the corporate business form under
which it intends to operate, the law must subsequently recognize
that form despite any legal or tax consequences to the parties.”
L.B.D. Constr., Inc. v. Director, 8 N.J. Tax 338, 350 (Tax 1986).
The taxpayer here “[h]aving chosen this method of owning property
and conducting business in this State, it cannot now deny its
existence in order to avoid the tax consequences. . .” Somerset
Apts. v. Director, 134 N.J. Super 550, 555 (App. Div. 1975). The
“administrative burden may well be too much if a state must explore
the ramifications of corporate structures to determine the justice
of recognizing or ignoring corporate entities in each factual
-25- complex.” Household Fin. Corp. v. Director, 36 N.J. 353, 363
(1962). For example, the transfer of an automobile, from the sole
stockholder of a corporation to the corporation met the definition
of a sale for sales tax liability. L.B.D. Constr., supra, 8 N.J.
Tax at 346.
Taxpayer made a choice to create and operate the separate
entities in this case. With that choice comes benefits and
burdens. There is simply no basis in law to disregard these
entities and treat the assets as directly owned by the principal
of the entities.
III. Conclusion
For the foregoing reasons, the Director’s motion for summary
judgment is denied.
-26-