Travia's Inc. v. State

• Citation: 194 Vt. 585,2013 VT 62,86 A.3d 394
• Decision Date: 19 September 2013
• Docket Number: No. 12–422.,12–422.
• Court: United States State Supreme Court of Vermont
• Parties: TRAVIA'S INC. and Robert and Jill Mellion v. STATE of Vermont, DEPARTMENT OF TAXES.

194 Vt. 585

86 A.3d 394

2013 VT 62

TRAVIA'S INC. and Robert and Jill Mellion

v.STATE of Vermont, DEPARTMENT OF TAXES.

No. 12–422.

Supreme Court of Vermont.

Aug. 9, 2013.

Motion for Reargument Denied Sept. 19, 2013.

Erin Miller Heins of Langrock Sperry & Wool, LLP, Burlington, for Plaintiffs–Appellants.

William H. Sorrell, Attorney General, and Danforth Cardozo, III, Assistant Attorney General, Montpelier, for Defendant–Appellee.

Present: REIBER, C.J., DOOLEY, SKOGLUND and BURGESS, JJ. and TOOR, SUPR. J., Specially Assigned.

SKOGLUND, J.

¶ 1. Taxpayers are owners and operators of an S-corporation known as Travia's Inc., a small bar and grill in Hinesburg, Vermont. They appealed the Department of Taxes' (DOT) assessment of meals tax and alcoholic beverage tax for the audit years 2006, 2007, and 2008, and corporate income and personal income tax for the audit years 2005, 2006, and 2007. Following a hearing at the Department, the Commissioner of Taxes affirmed the Department's assessments. Pursuant to 32 V.S.A. § 9275, taxpayers appealed the Commissioner's determination to the civil division, which affirmed the assessment against Travia's of additional alcohol, meals, and income tax. Taxpayers now challenge the assessment before this Court. We affirm.

¶ 2. As found by the trial court, Travia's Inc., is an S-corporation, so the bulk of its income and losses pass through to its shareholders for reporting on their personal income tax returns. Mr. Mellion owns 100 percent of Travia's shares and asserts that he is the sole operator of the business, preparing and serving all meals and alcohol. Mrs. Mellion, the secretary of the corporation, maintains the books for the business. Travia's has no other employees. In early 2009, DOT initiated an audit of Travia's corporate income tax records for tax years 2005, 2006, 2007, and 2008. An experienced DOT auditor conducted the audit.

¶ 3. The auditor discovered several issues that required further investigation. First, Travia's cost-of-goods (COG) to gross receipts ratio was approximately fifty-six percent, an abnormally high percentage, more than double the industry average for the bar and restaurant business. Typically, the COG ratio for restaurants is between twenty-eight and thirty-two percent, and the COG ratio for bars is sixteen to twenty-four percent. According to the Department, a high cost-of-goods ratio sometimes indicates overstated costs or understated income. Also of concern, Travia's listed $500 worth of inventory each year, suggesting that the business had no inventory accounting controls in place.

¶ 4. As a result of the preliminary examination, the Department had the auditor conduct an on-site audit of Travia's. Travia's has a single cash register, which produces two types of paper tapes. One is a “running tape,” which records each sale as it is rung in, and the other is a “Z tape,” which can be produced at the end of the day and shows a summary of that day's sales. Travia's Z tapes summarize total sales of liquor including tax, and food not including tax. Mr. Mellion testified that he produces a Z tape showing the daily totals and puts it in an envelope at the end of each day and writes the daily totals of food and alcohol sales on the envelope. Mrs. Mellion then transfers the amounts written on the envelope to a weekly summary of sales, one page per week.

¶ 5. The auditor testified that he looked at three running tapes. The running tapes were in large rolls, not dated or labeled, and the ink was too faded to read on the three he examined. He also looked at a sample of seven weekly envelopes and the forty-two Z tapes inside those envelopes. The auditor found that the totals on the Z tapes did not always match the totals recorded on the envelopes. There were handwritten adjustments on the Z tapes where some numbers were crossed out and others written in. Of the forty-two Z tapes examined, fourteen of them showed different totals than the corresponding totals noted on the envelopes. On eight of the fourteen tapes with discrepancies, the Z tape total and the envelope total differed by multiples of $100. When asked about these discrepancies, Mr. Mellion told the auditor that the cash register had problems throughout the three-year audit period and did not produce accurate Z tapes, that he would put down his recollection of the day's total rather than what the tapes said, and that what he wrote on the envelopes was accurate. He further testified that he ignored the Z tapes and instead wrote the running tape totals on the weekly envelopes. However, of the running tapes for the fourteen dates examined, only four matched what was written on the envelope.

¶ 6. Taxpayers met with DOT staff and complained about the initial assessments. They tried to convince the Department to use the running tapes and Z tapes, along with weekly summary sheets. The Department declined to use the records provided, finding that Travia's hand-altered records did not match what Travia's reported on its meals tax returns and that taxpayers could not adequately explain the conflicting information on the running tapes, Z tapes, handwritten alterations, envelopes, and summary sheets. The Department determined that further investigation was necessary.

¶ 7. After concluding that the running tapes and the Z tapes were too unreliable to serve as a basis for the audit, the auditor chose to estimate Travia's income using other information and an alternative method to recalculate the assessment. As noted above, Travia's cost-of-goods to gross receipts ratio was approximately fifty-six percent, combining the ratio for food and drink. The average COG ratio for restaurant food is twenty-eight to thirty-two percent and for alcoholic beverages is sixteen to twenty-four percent. Travia's showed a ratio of seventy-two percent for food and forty percent for alcohol. The auditor could find “no logical explanation” for the high ratios and investigated further.

¶ 8. Using industry averages of goods sold and drink sizes, the auditor calculated what Travia's COG ratio would be based on the income recalculated for Travia's alcohol purchase records. He obtained actual sales records from Travia's beverage vendors and attempted to reconstruct Travia's income using a routine audit procedure. He considered the average price of Travia's drinks as stated by taxpayers and the average costs of alcoholic drinks based on a review of Travia's vendor invoices, and calculated a COG ratio for beer, for wine, and for liquor. He used a weighted average of these three ratios and determined the COG ratio for all alcohol would be twenty-seven percent. The auditor then applied a food ratio of fifty percent, based on industry ranges and taking into account Mr. Mellion's assertions that he purchased all the food at retail. Combining the twenty-seven percent and the fifty percent gave an overall COG ratio of thirty-eight and one-half percent, which the auditor rounded up in the taxpayer's favor to forty percent. Based on these estimates, the auditor assessed an additional meals tax of $2,673.29, an additional alcohol tax of $11,388.23, and an additional personal income tax for the taxpayers of $7,290.03, plus interest and penalties.

¶ 9. At the hearing before the Department, taxpayers did not dispute that they are officers of the Travia's corporation and therefore responsible for Travia's meals and alcoholic beverage taxes. They also agreed that they filed their tax returns based on their register tapes and weekly envelope totals. They further agreed that if there is a valid adjustment to those taxes owed by Travia's, there is a valid corresponding adjustment to their personal income taxes.

¶ 10. The Commissioner of Taxes approved the holding of the hearing officer and assessed the taxes as determined by the Department. The total revised assessment was $26,254.30 for alcoholic-beverage tax, $6,186.45 for meals tax, and $20,016.00 for personal income tax.¹ The taxpayers appealed the new assessments.

¶ 11. On appeal, taxpayers raise the same issues as presented to the Department. They assert that DOT had no authority to look beyond their business records for a calculation of their tax liabilities, and that even if DOT was authorized to look beyond their business records, DOT's computation is incorrect.

¶ 12. Where there is an intermediate level of appeal from an administrative body, this Court reviews the case under the same standard as applied in the intermediate appeal. Tarrant v. Dep't of Taxes, 169 Vt. 189, 195, 733 A.2d 733, 738 (1999). We review the Commissioner's decision independent of the superior court's findings and conclusions. See Devers–Scott v. Office of Prof'l Regulation, 2007 VT 4, ¶ 4, 181 Vt. 248, 918 A.2d 230. The Commissioner's findings will not be set aside unless clearly erroneous. Morton Bldgs., Inc. v. Dep't of Taxes, 167 Vt. 371, 374, 705 A.2d 1384, 1386 (1997). It is the taxpayer's burden to show that the assessment is erroneous, In re DeCato Bros., Inc., 149 Vt. 493, 496, 546 A.2d 1354, 1356 (1988), and that showing must be “clear and convincing.” In re Williston Inn Grp., 2008 VT 47, ¶ 11, 183 Vt. 621, 949 A.2d 1073 (mem.).

¶ 13. Taxpayers claim that the only authority for the Commissioner to “estimate” taxes is found in 32 V.S.A. § 9273(a) and that section applies only when a taxpayer has failed to make a return.² However, § 9273(b) clearly allows for the Commissioner to “examine[ ]” a return after it is filed and to “make such further audits or investigation as he or she may deem necessary.” Further, it provides that if the Commissioner determines that there is a deficiency with respect to the payment of any tax due under the chapter, “he or she shall assess the taxes and interest due the state.” Id. Where, as here, the source documents used to prepare returns suggest inaccuracies, it follows that the returns filed are not “as ... required,” and the Commissioner may proceed to make an...