King Crab Restaurant, Inc. v. Chu

• Decision Date: 30 December 1987
• Citation: 134 A.D.2d 51,522 N.Y.S.2d 978
• Parties: In the Matter of KING CRAB RESTAURANT, INC., Petitioner, v. Roderick G.W. CHU, as Commissioner of the State Tax Commission of the State of New York, Respondent.
• Court: New York Supreme Court — Appellate Division

Page 978

522 N.Y.S.2d 978

134 A.D.2d 51

In the Matter of KING CRAB RESTAURANT, INC., Petitioner, v. Roderick G.W. CHU, as Commissioner of the State Tax Commission of the State of New York, Respondent.

Supreme Court, Appellate Division Third Department.

Dec. 30, 1987.

Kalina & Guido, New York City (Robert Kalina, of counsel), for petitioner.

Robert Abrams, Atty. Gen., Albany (Lew A. Millenbach and Wayne L. Benjamin, of counsel), for respondent.

Before KANE, J.P., and MAIN, MIKOLL, YESAWICH and HARVEY, JJ.

KANE, Justice Presiding.

Petitioner operates a restaurant and bar located in New York City. The Audit Division of the Department of Taxation and Finance notified petitioner that it was conducting an audit of petitioner's sales tax returns covering the period of June 1, 1979 through May 31, 1982. Thereafter, the Department's tax auditor determined that the records supplied by petitioner for the audit were incomplete and inaccurate and thus were insufficient to conduct a detailed audit. Therefore, the auditor used a "test period" analysis which resulted in an estimated tax only. Based upon this audit, petitioner received a notice of determination and demand for payment of sales and use taxes in the amount of $27,524.85, plus interest and a penalty. Petitioner challenged this determination claiming, inter alia, that complete books and records were available and therefore the use of a test period to get an estimated tax was improper. A hearing was held at which the only witness to testify was the auditor. The State Tax Commission, in holding that the use of a test period to compute petitioner's tax liability was justified, found that the records provided by petitioner were indeed inadequate to conduct a complete audit. However, in accordance with a prehearing conference agreement, the Tax Commission reduced the assessment to $18,629.87 and canceled the penalty imposed. Petitioner then commenced the instant CPLR article 78 proceeding which was transferred to this court.

In this proceeding, petitioner again contends that the audit was improperly conducted because there was no showing that its records were insufficient so as to justify the use of a test period to determine the amount of tax due. We agree with this contention and, accordingly, annul the Tax Commission's determination. Tax Law § 1135 requires a vendor to maintain records of his sales for audit purposes; when it is shown that the records of a business are unreliable and incomplete, a test period audit resulting in an estimated tax is permissible ( Matter of Korba v. New York State Tax Commn., 84 A.D.2d 655, 444 N.Y.S.2d 312, lv. denied 56 N.Y.2d 502, 450 N.Y.S.2d 1023, 435 N.E.2d 1099). However, an auditor cannot simply ignore a taxpayer's records and conduct such an audit if the records made available do in fact provide an adequate basis on which to determine the amount of tax due (id.)

In the instant case, the auditor was presented with guest checks, bank statements, a general ledger, a cash disbursements journal and purchase invoices for the entire audit period, except for the first seven months. Since petitioner did not maintain cash register tapes, these were not made available. Bank statements were made available for the first seven months. The auditor testified that he spot-checked one box of guest checks and found them to be out of chronological order. He did not check to see whether guest checks were available for the first seven months of the audit period. Based on his spot check and the lack of cash register tapes, he determined that petitioner's records were inadequate. He also testified that because it was his view that complete records were not available for the first seven months of the audit period, he "automatically assumed inadequacy of [all] records" and he decided to estimate petitioner's food markup because "it was too time consuming" to do a complete markup.

In our view, the auditor did not make a sufficient investigation of the records made available to him to justify his conclusion that the records were incapable of supporting a complete audit. As a result the estimate procedures adopted were arbitrary and capricious and lacked a rational basis ( see, Matter of Hard Face Welding & Mach. Co. v. State Tax Commn., 81 A.D.2d 967, 439 N.Y.S.2d 744; Matter of Chartair, Inc. v. State Tax Commn., 65 A.D.2d 44, 411 N.Y.S.2d 41). There is no requirement that guest checks be...