Taxpayer Not Entitled to Relief Based on Advice from Previous California Audit

A taxpayer’s protest against an assessment of California sales and use tax liability was denied since the taxpayer could not establish that it was entitled to relief based on written advice that was provided in a prior California audit of the taxpayer. California tax law provides that if a person’s failure to make a timely return or payment was due to that person’s reasonable reliance on written advice from the California Department of Tax and Fee Administration (CDTFA), the person may be relieved of any sales or use taxes imposed. If a previous audit of the person requesting relief contains written evidence demonstrating that the issue in question was examined, either in a sample or census (actual) review, such evidence will be considered written advice from the CDTFA.

The transactions in question were software transactions involving the transfer of a required dongle. In California, a charge for software that includes the transfer of a required dongle is taxable without regard to the manner the software is transferred. In seeking relief on the tax and interest due, the taxpayer did not dispute the taxability of the transaction. Rather, the taxpayer argued that because the CDTFA treated three transactions involving dongles as nontaxable in the prior audit, relief of the tax and interest at issue was warranted. In the prior audit, the CDTFA improperly accepted as nontaxable three transactions involving the transfer of dongles. However, in the same audit, the CDTFA treated 14 similar transactions as taxable. In addition, the verification comments from the prior audit indicated that such transactions were taxable.

The Office of Tax Appeals stated that a taxpayer’s reliance on written advice must be objectively reasonable. After the prior audit, the taxpayer changed its reporting practices and ceased charging or remitting tax on transactions involving the transfer of a dongle. In light of the 14 transactions that were properly taxed in the prior audit as well as the verification comments, the Office of Tax Appeals found that it was not reasonable for the taxpayer to rely on the comparatively small number of errors (three) in the prior audit. Further, the Office of Tax Appeals stated that a reasonably prudent businessperson would have sought written advice from CDTFA once the prior audit was concluded, or sought written clarification from the auditor, which the taxpayer failed to do so. As such, the taxpayer failed to establish that it was entitled to relief. (EMA Design Automation, Inc., California Office of Tax Appeals, No. 18114022, March 4, 2020, released August 2020)

Posted on August 13, 2020