State Sales and Use Tax Liability of Pam Oil, Inc., Matter of, s. 51-12390-5S and 51-17459-3S

• Decision Date: 25 April 1990
• Docket Number: Nos. 51-12390-5S and 51-17459-3S,No. 16875,s. 51-12390-5S and 51-17459-3S,16875
• Citation: 459 N.W.2d 251
• Parties: In the Matter of the STATE SALES AND USE TAX LIABILITY OF PAM OIL, INC. and Pam Warehouse, Inc., 200 Petro Avenue, Sioux Falls, South Dakota License . Considered on Briefs
• Court: South Dakota Supreme Court

Page 251

459 N.W.2d 251

In the Matter of the STATE SALES AND USE TAX LIABILITY OF PAM OIL, INC. and Pam Warehouse, Inc., 200 Petro Avenue, Sioux Falls, South Dakota License Nos. 51-12390-5S and 51-17459-3S.

No. 16875.

Supreme Court of South Dakota.

Considered on Briefs April 25, 1990.

Decided Aug. 15, 1990.

Timothy T. Weber, Dept. of Revenue, Pierre, for appellant; Roger A. Tellinghuisen, Atty. Gen., Pierre, on the brief.

John E. Burke, Sioux Falls, for appellee.

WUEST, Chief Justice.

The Department of Revenue (Department) appeals from a circuit court judgment which reversed a judgment entered by the Secretary of Revenue (Secretary) against Pam Oil, Incorporated (Pam Oil) and Pam Warehouse, Incorporated (Pam Warehouse) (collectively referred to as "Pam"). We reverse the judgment of the circuit court.

Pam Oil, a corporation located in Sioux Falls, South Dakota, is a wholesaler and retailer of automobile supplies such as oil, grease, antifreeze, batteries, automobile parts, parts cleaning solvent, paper products, hand cleaner and related items. Pam Warehouse, also a corporation located in Sioux Falls, South Dakota, is a wholesaler and retailer of automotive supplies such as batteries, water pumps, alternators and related items. In November of 1987, the Department conducted a sales and use tax audit of Pam Oil and Pam Warehouse for the periods of September, 1984 through August, 1987, and November, 1984 through October, 1987, respectively. The purpose of the audits was to verify the gross receipts, deductions and use tax that Pam Oil and Pam Warehouse had reported to the Department on their sales and use tax returns for these periods.

With respect to the sales tax portion of the audits, the Department conducted a sample audit rather than a detailed audit. Out of the three-year audit period, two reporting periods were randomly selected to compute an error factor to apply to the entire audit. Initially, the Department verified Pam's gross receipts with the amounts reported on its sales tax returns and found them to be correct. The Department then proceeded to review Pam's reported deductions. The deductions claimed by Pam were reported as sales for resale and out-of-state sales. Pursuant to this review, the Department examined every sales invoice for the two sample periods to insure that Pam had either charged the proper sales tax or had a resale certificate on file. If sales tax was not charged on a particular transaction, but a resale certificate was on file, the Department then attempted to determine whether the resale certificate on file was accepted by Pam in good faith. If it was, then Pam was relieved of sales tax liability for such transaction pursuant to SDCL 10-54-1.

Having conducted this review, the Department found several invoices for which Pam did not charge a sales tax nor did it have a resale certificate on file. The gross receipts from these invoices were noted as errors, generating additional sales tax due from Pam. This determination was not disputed by Pam. In addition to these errors, the Department also found that Pam had resale certificates on file with respect to other invoices, but, according to the Department, some of these resale certificates were not accepted in good faith by Pam. The Department reasoned many of the businesses which provided resale certificates to Pam were using the items sold to them by Pam and not reselling them in the regular course of business. According to the Department, Pam knew or should have known that such items were not being purchased for resale. Hence, the Department concluded that insofar as these items were concerned, the resale certificates were not accepted in good faith by Pam. As a result, the resale certificates were not allowed for these particular items and, hence, the deductions taken for these items were disallowed and subsequently noted as errors, generating additional sales tax due from Pam. ¹

Approximately three months after the commencement date of Pam's audit, Pam presented evidence to the Department which it claimed substantiated some of the deductions previously disallowed by the Department. This evidence was in the form of telephone records which indicated several of Pam's larger customers informed Pam they had reported use tax to the State on several items sold to them by Pam. According to Pam, since use tax was allegedly being paid on these items, then Pam must be absolved of sales tax liability on such items. Thus, Pam argued the deductions taken for these items were proper. In spite of Pam's efforts, the Department refused to consider the telephone records for audit purposes because they were not submitted to the Department within thirty days after the commencement of the audit as required by SDCL 10-59-3 and SDCL 10-59-7. As a result, the Department made no changes in its calculations with respect to the sales tax portion of the audit.

As noted previously, the Department also conducted a use tax audit of Pam. Pursuant to this audit, the Department examined Pam's purchase invoices and depreciation schedules to determine if any use tax liability existed. After conducting this examination, the Department determined that Pam was using certain items for which no use tax was being paid. The Department discussed this matter with a Pam representative who subsequently agreed that use tax was due with respect to these items.

After the Department had completed its audits, a Certificate of Assessment was prepared assessing Pam Oil and Pam Warehouse. The Certificate showed a sale and use tax assessment of $78,762, while the Certificate assessing Pam Warehouse showed a sale and use tax assessment of $5,453. After receiving these Certificates, Pam filed a protest to the assessments and requested a hearing. In its request for hearing, Pam specifically stated it did not contest the use tax portion of the audit. Instead, Pam asserted the sample audit technique applied by the Department was not a reasonable audit. Also, Pam asserted the Department erred in refusing to consider the telephone records which, according to Pam, substantiated a number of deductions which were disallowed by the Department. Finally, though not specifically stated in its request for hearing, Pam asserted that its mere acceptance of a resale certificate was sufficient to relieve Pam of sales tax liability unless the Department could prove that such certificates were not accepted in good faith.

Pam's request for hearing was granted and an administrative hearing was subsequently held on April 21, 1988. After this hearing, a judgment was rendered by the Secretary in favor of Department. In rendering this judgment, the Secretary determined the audit technique applied by the Department was reasonable and proper. The Secretary further concluded the Department did not act improperly in refusing to accept Pam's telephone records because such records were not timely submitted to the Department according to SDCL 10-59-3 and SDCL 10-59-7. Finally, the Secretary held the mere fact Pam obtained resale certificates from purchasers did not relieve Pam of tax liability with respect to those items covered by the resale certificates. The Secretary held that Pam had to establish the resale certificates were accepted in good faith in order for Pam to be relieved of tax liability for items covered by such certificates. Pam failed to establish this good faith acceptance according to the Secretary. Based upon this reasoning, the Secretary found the resale certificates at issue were not accepted in good faith and no errors were committed by the Department with respect to Pam's audits. As a result, a judgment was rendered directing Pam to pay the tax assessments set forth by the Department.

In December of 1988, Pam appealed this matter to the circuit court. Again, Pam claimed the audit technique employed by the Department was unreasonable and improper. Pam also asserted the Secretary erred in holding Pam had the burden to prove the resale certificates were accepted in good faith. In addition, Pam submitted the Department erred in refusing to consider Pam's telephone records for audit purposes. Upon this foundation, Pam requested the circuit court to reverse the judgment of the Secretary in its entirety.

In August of 1989, the circuit court entered a judgment reversing the judgment of the Secretary in its entirety, including that portion of the judgment which directed Pam to pay the use tax assessment. The circuit court found the audit technique applied by the Department was reasonable. However, with respect to the resale certificates, it determined that the Department had the burden to prove that Pam had not accepted resale certificates in good faith. The court stated if the Department was unable to meet this burden, Pam was relieved of sales tax liability for any items covered by resale certificates in Pam's possession. Having made this determination, the court then found the Department failed to establish Pam had not accepted the resale certificates in good faith. Thus, it held that all of Pam's resale certificates were accepted in good faith. For this reason, the circuit court reversed the Secretary's judgment which ordered Pam to pay the State sales and use tax as set forth in the Certificates of Assessment. The circuit court provided no reasoning for reversing that portion of the Secretary's judgment directing Pam to pay the use tax assessment which Pam agreed was due. Department now appeals the circuit court judgment.

On appeal, Department argues the circuit court erred in determining as a matter of law the Department had the burden to prove that Pam did not accept the resale certificates in good faith. Due to this misstatement of the law, Department submits the circuit court erred in holding Pam had accepted its resale certificates in good faith. Finally, Department submits the circuit court erred in reversing that portion of the Secretary's judgment which directed Pam to...