In re Nat'l Catastrophe Restoration, Inc.

Decision Date21 September 2012
Docket NumberNo. 106,700.,106,700.
PartiesIn the Matter of the Appeal of NATIONAL CATASTROPHE RESTORATION, INC. from an Order of the Division of Taxation on Assessment of Retailers' Sales and Use Tax.
CourtKansas Court of Appeals


Syllabus by the Court

1. A sales tax assessment based on an examination of records under K.S.A. 79–3610 is entitled to a presumption of validity, and the taxpayer has the burden to prove the invalidity of any resulting tax assessment.

2. Under K.S.A. 79–3610, any determination of tax liability may be made on the basis of a generally recognized valid and reliable sampling technique, whether or not the taxpayer being audited has complete records of relevant transactions and whether or not the taxpayer consents. When sampling is the basis for a sales tax assessment, it is incumbent upon the taxpayer to show that the technique was not in accordance with generally recognized sampling techniques.

3. When a sampling technique is employed to determine sales tax liability for an expansive period, a taxpayer's attempt to reduce any tax due within the sample months by payment after the audit begins distorts the error rate and otherwise invalidates the conclusions of the sampling.

4. So long as out-of-state transactions are not treated as taxable within the sample months, the error rate so derived must be applied to a general population where the out-of-state transactions are not removed.

5. Sampling itself is not intended to result in precise identification of sales tax liability on each and every transaction within the audit period, but rather to calculate an error rate for a small period of time and then apply that rate to the entire period of the audit. The statutory goal of K.S.A. 79–3610 is to achieve a result that is reflective of the taxpayer's actual tax liability.

6. A statute is presumed constitutional and all doubts must be resolved in favor of its validity. If there is any reasonable way to construe a statute as constitutionally valid, the court has the authority and the duty to do so.

7. The Kansas Court of Tax Appeals (COTA) is not empowered to decide constitutional questions. When constitutional issues are raised before an administrative agency that is not empowered to address them, the factual predicate for any constitutional analysis must be established in the agency proceeding.

8. Under the facts of this case, the lack of a factual predicate precludes this court's analysis of constitutional issues framed on appeal.

9. For purposes of compliance with Due Process and Commerce Clause dictates, apportionment of state sales tax liability of an entity conducting business both within and outside a state can be achieved by a sampling technique if reasonably designed after consultation with the taxpayer to determine any tax deficiency within the best judgment and information available to the taxing authority.

10. K.S.A. 79–3610 is a reasonable approach to measuring sales tax liability when a portion of the sales occur out of state. Particularly where a taxpayer has failed to carefully document its business transactions, sampling such as that contemplated by K.S.A. 79–3610 is a necessary remedy. To require precise measurement and exclusion of each out-of-state transaction would benefit the taxpayer's poor recordkeeping.

11. Action is arbitrary and capricious if unreasonable, without foundation in fact, not supported by substantial evidence, or without adequate determining principles.

12. COTA need not accept every stipulation submitted to it by the parties to a proceeding, but when COTA fails to question the adequacy of the documentation submitted to support the stipulation or to give the parties any notice that it is electing to reject their stipulations, this is a denial of due process. Where a party has been led to believe that it need not provide exhaustive evidence because all parties agree it is entitled to the relief requested, COTA must notify the parties should it decide to reject the stipulations of the parties and must conduct a full and complete hearing on the applicable issues.

Gerald N. Capps, Jr., of Wichita, for appellant National Catastrophe Restoration, Inc.

Alice Leslie Rawlings, of Legal Services Bureau, Kansas Department of Revenue, of Topeka, for appellee Kansas Department of Revenue.



National Catastrophe Restoration, Inc. (NCRI) appeals from an order of the Kansas Court of Tax Appeals (COTA) affirming an assessment issued for unpaid retailers' sales taxes due for the period May 1, 2003, to December 31, 2004. NCRI contends that COTA erred in presuming the assessment valid, in disregarding undisputed evidence that the sampling technique employed in the audit was flawed, and in rejecting three stipulations after the hearing was closed. NCRI also contends the assessment amounted to an unconstitutional assessment of sales taxes on out-of-state sales. We reject the constitutional challenge and affirm COTA's affirmation of the assessment except to the extent that stipulations requiring adjustments to the error rate must be honored in part and reconsidered in part.


NCRI is a retailer of goods and services sold to repair and restore Kansas and out-of-state property damaged by natural and man-made disasters. NCRI is based in Wichita and registered with the Kansas Department of Revenue (KDOR) as a retailer. NCRI's Kansas sales and purchases are subject to tax assessment under the Kansas retailers' sales tax act and the Kansas compensating use tax. The record reflects that NCRI filed sales tax returns from May 2003 to December 2004 certifying that no tax was owed.

In November 2004, KDOR initiated an audit of NCRI's financial records for sales and use taxes for the period January 1, 2002, to December 31, 2004. NCRI, through attorney Jerry Capps of Allen, Gibbs & Houlik (an accounting firm), responded to a pre-audit questionnaire; Capps was designated as NCRI's representative for purposes of the audit. NCRI had no explanation for its failure to remit taxes. Prior to KDOR's field audit work, however, NCRI voluntarily reviewed its books and records and admitted there were numerous untaxed or undertaxed transactions.

In February 2005, KDOR's auditor met with Capps and another NCRI representative who provided the auditor with access to NCRI's records. Because of the voluminous records provided, the auditor and NCRI agreed that using a sampling method would be the best process for an audit. Upon reviewing the records, the auditor determined that a 3–month block sample would work best. Capps advised the auditor that NCRI did not have seasonal variations, therefore any 3 months chosen would be representative of NCRI's business. The auditor then randomly chose the months of November 2002, May 2003, and February 2004 to serve as the sample months for the audit.

In March 2005, Capps executed a formal notice from KDOR that a sample audit would be performed to determine whether NCRI had remitted all sales taxes due on taxable Kansas sales transactions. The audit was to cover the period of January 1, 2002, through December 31, 2004. NCRI was notified of the sampling methodology that would entail a sample base and population of all NCRI's gross sales and all tax-free sales in the sample months. Based on this population, the results were to be determined as follows:

“The total dollar value of the error revealed by the sample will be divided by the total dollar value of the sales in the three months transactions in the sample to obtain a percent of error. This percent of error will be multiplied by audited sales in each reporting period within the audit period that is not included in the sample to determine the additional amounts subject to sales tax. For the sample months, actual error amounts will be assessed.” (Emphasis added.)

NCRI never objected to the sampling methodology announced by KDOR during the audit procedure or at any time prior to the COTA hearing.

Between November 2004 and July 2006, KDOR performed the sales tax audit. The business records provided by NCRI for the audit period were voluminous. NCRI admitted the business records were not complete because it did not have a good bookkeeping system. Job files contained reports in which sales figures did not match invoice amounts for the materials sold and worked performed. In some instances, sale proceeds received by NCRI were overreported and some were underreported to KDOR. NCRI treated some invoice amounts as estimates and later adjusted the figures. Moreover, sales report entries did not actually reflect the final amount of the invoice, and there was no documentation tracing adjustments made. In addition, NCRI's income statements compiled from sales reports did not match the income reported on income tax returns. Some of NCRI's job files and sales reports were missing, and its sales reports and cash receipts did not match.

In January 2007, KDOR sent notices of final assessment to NCRI reflecting assessments of $236,669 in retailers' sales tax (plus interest and penalties) and $4,567 in compensating use tax (plus interest and penalties). NCRI requested an informal conference with KDOR regarding the assessments. The use tax portion of the assessments has not been disputed and is not before us in this appeal.

On October 31, 2007, after failing to receive a written determination from KDOR, NCRI filed an application for review of the final sales tax assessment with the Board of Tax Appeals (BOTA). NCRI asserted the assessment was invalid because: (1) KDOR used November 2002—which was outside the statute of limitations—as one of the “sample” months for calculating the assessment; (2) KDOR did not credit sales taxes actually paid during the sample months; (3) KDOR did not hold a personal or telephone conference with NCRI; and (4) KDOR did not identify the KDOR employee, the employee's identification number,...

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