Technology continues to be a significant part of our day to day business lives. Just as this is true for our business, the same is true for state taxing authorities. State taxing authorities continue to evolve their audit methodologies to achieve the goals of gaining efficiencies in managing audits and effectively determining the appropriate level of tax liability. As with any “technology change” there are challenges that taxpayers are facing in defending audits where electronic data requests and audit procedures are incorporated into the audit. This article will address some of the challenges faced in handling electronic records requests.
More frequently, sales data and other data can be provided to auditors in formats such as Excel. This benefits the taxpayer in certain cases by reducing the time spent in pulling invoices. However, taxpayers should be aware of certain potential challenges in providing sales and other data electronically.
Be sure to verify the accuracy and completeness of data prior to providing it. Remember electronic data is far easier to sort, filter, and otherwise organize for analysis.
- Do the total dollars of sales provided agree to the general ledger or the sales tax returns provided for the time period in question?
- Is the data complete? For example, are there missing invoice numbers? Can that be explained?
Electronic data will never provide supporting documentation necessary to establish the nature of the transaction. It will always miss handwritten comments on the invoice and documents attached to the invoice in support of the transaction. Taxpayers need to be aware that they will have to research transactions questioned when auditors review only electronic data files so that they may support for the treatment of questioned transactions.
Streamlined process – or not?
When data files are provided to the auditor, it becomes far easier for an auditor to merely list transactions as questioned without requesting further information. This can put the taxpayer in the position of spending additional time providing support for the treatment of a transaction(s) that could be easily addressed with a limited discussion.
When practical, more states are opting to apply statistical sampling techniques to their audit. Properly handled, a statistical sample will provide valid results while still reviewing fewer transactions. The statistical sampling process should be handled diligently and its intricacies are beyond the scope of this discussion. That said, taxpayers should prepare themselves for the additional time that will be required to pull the necessary documents for the auditor’s review. It is generally much more time consuming to pull documentation for a statistical sample than for a block or other non-statistical method of sampling.
General Ledger Access
In a growing trend, auditors are requesting electronic copies of the taxpayer accounting records. These requests seem to more heavily impact smaller taxpayers who utilize accounting software programs such as QuickBooks. When auditors have access to these files, they are better able to perform additional data verification procedures. Below is a small sampling of procedures they might perform:
- Review invoice coding – Does the coding of the invoice to the general ledger support taxpayer assertions as to how that item is used?
- Review miscellaneous income accounts – Do they include taxable sales?
- Review vendor lists – Have at least some invoices from all vendors been available for review as part of the sample unless deemed not necessary?
- Perform income reconstruction procedures – Does the information in the file support the fact that all income has been reported?
General ledger access also provides the auditor with the ability to perform procedures not related to either the type of audit being performed, or the time period for which the audit is performed. Does this create the likelihood to expand an audit from sales tax only to sales and income tax? Perhaps. Auditors will argue that that has always been their prerogative, and they would be correct. But one wonders if it may happen more often in the future. Certainly, taxpayers should expect additional information requests and time spent to respond to these inquiries when the auditors perform the procedures above.
One might also question the equity of requiring this information of a smaller taxpayer when it is not requested from a larger taxpayer with a more sophisticated accounting system that a state agency cannot purchase and license to their auditors.
Electronic Record Access
As more companies store their records electronically, it may become beneficial to have auditors review records on screen. If your company chooses to go this route, be sure to consider how to present these records to the auditor.
- Will you allow complete access to your system?
- Are there records that the auditor will be able to review that are outside scope?
- What rights will you allow to the auditor in terms of copying and saving data and documents?
The state of Minnesota recently released information on its new MN Virtual Audit Room. Minnesota outlines the potential benefits to this system to include:
- Audit documentation is centralized in one location
- All files are on Revenue’s servers and are fully encrypted
- Time needed for on-sites visits is reduced or eliminated
- An overall greener solution for the audit process
The process is currently in a testing phase and appears to be voluntary in nature. We would expect to see more initiatives of this type as states look to use technology to become more efficient in their process. Questions remain, including but not limited to:
- What level of access might both sides have to the data?
- What documents, if any, will auditors post to the Virtual Audit Room?
- What notifications will both sides receive when documents are posted?
- Once posted, can documents be removed?
Discussions of issues surrounding technology might leave us saying – can we just tell the auditor no? The answer will often be no – though one should always check the guidelines of a particular state. Auditors are generally granted broad authority to compel the production of records. That said, if you have concerns about the requests from auditors, be sure to discuss those requests with your professional advisors or give us a call. There may be ways to cooperatively work with auditors to reduce the volume of requested information and gain better understanding of the reasons for the request. We feel strongly, that an auditor should always be able to provide a reasonable explanation for their need for the data and how it will be used. Data should also never replace communication from the auditor.