Having spent more than a decade working with taxpayers and Department employees on sales and use tax audits and refund requests, I find that responding to documentation requests from the Department can either be an exercise in pragmatism or an exercise in preventing auditors from murdering a taxpayer’s business by a thousand cuts. The reality is that accumulating and providing documentation is easier for some taxpayers than for others. Similarly, the requirements laid out by some states, or by some auditors, are more burdensome than by others.
With that backdrop in mind, let’s look at the impact and shortcomings of a new proposed Minnesota Rule (Minn. R. 8130.7501) that tries, but fails significantly, to update and modernize authorized record-keeping and documentation requirements. As you’ll see, interested Minnesota taxpayers and their tax advisors must weigh in now, and multiple parties have to concurrently request a hearing on this proposed rule.
Minnesota’s Audit Records Issue
The types of records taxpayers must provide in an audit or as part of a refund claim are governed by Minnesota Statutes and Minnesota Rules. The statute (Minn. Stat. § 297A.77, subd. 5) provides:
Records must be kept. Every person liable for any tax imposed by this chapter, or for the collection thereof, shall keep such records, render such statements, make such returns, and comply with such rules, as the commissioner may from time to time prescribe. (Emphasis added.)
In the recordkeeping statute, the Legislature delegated broad rulemaking authority to the Department of Revenue. Under this authority, the Department historically enacted rules that carry quasi-statutory authority and prescribed the types of records taxpayers must retain. The most recent enactment of the Department’s recordkeeping rule was on July 15, 2014, in Minn. R. 8130.7500. While the context of the current rule purports to be the commissioner’s description of what qualifies as adequate and complete records, it falls substantially short (even for a rule which was last reviewed in 2014) and clearly doesn’t reflect the advancements in technology, electronic record-keeping, etc.
The current rule requires that taxpayers provide items that have minimal connection to sales or use tax (i.e., general ledgers, gross receipts, and deductions) but permit exhausting auditor overreach. Further, while the current rule attempts to allow things like “electronic data processing records,” it fails when describing them as “punched cards, magnetic tapes, magnetic disk packs, computer disks, and other machine-sensible data media.” As comedic as that definition may be, what is not so humorous is the perceptible bias towards hardcopy records, evident in phrases like “[a]n electronic data processing system must include a method of producing visible and legible paper records.” This bias towards hardcopy records, in particular, has led to numerous disputes between the Department and Minnesota taxpayers.
One example in Minnesota of auditors misusing this current documentation standard is when auditors attempt to disallow refund claims through unreasonable record requests related to taxpayers’ use of Electronic Data Interchange (“EDI”) systems. EDI is a manner of exchanging information between one machine and another. In the invoicing space, this method is used by a large and growing number of organizations to record purchases and issue payments to vendors for goods and/or services. What this means is that when a vendor sells a widget to the company for $10 (plus tax of $0.76 for a total of $10.76), there is an electronic bill sent to the company which includes details such as what was purchased, when it was purchased, the amount of the purchase and any corresponding sales tax collected, etc.
The use of EDI systems provides an incredible safeguard against the type of under-the-table transactions that taxing authorities purport to be concerned with. Yet, time and again, auditors refuse to accept and review these EDI transactions, either implicitly or explicitly challenging the integrity of systems which have no interest in hiding transactions or obfuscating the details of those transactions. In Minnesota, the response from taxpayers was first to create internal “invoices” which provide the EDI transaction details in a format that auditors recognize as an “invoice” (yet is identical for all vendors). But for some auditors, even that was not enough. The auditors wanted “original” invoices that resemble the traditional paper invoices that they are used to seeing—with the vendor logo on top. Next, Minnesota taxpayers were asked to obtain and provide attestations and affidavits in lieu of the invoices with the information that the auditors were interested in. However, for those taxpayers unfamiliar with those techniques, the option was simply to pay the assessment or relinquish the right to recover a refund for tax overpayments.
On September 20, 2021, the Department proposed to repeal Minn. R. 8130.7500 and to replace it with Minn. R. 8130.7501. While the proposed rule does expand the description of the records taxpayers must make available for review and does modernize the definition of “electronic data processing records,” it has several unacceptable shortcomings. It is these shortcomings that trigger this call to action.
Like its predecessor, the proposed rule fails to provide any real standard as to what is “necessary to determine the correct tax liability” or to acknowledge that records need not be “duplicative” to be “redundant” (and therefore permit a taxpayer to dispose of one piece of documentation that provides the same information as another type of documentation, e.g., disposing of shipping receipts when the taxpayer already has invoices with customer ship-to information). This failure to permit efficient record-keeping implicitly authorizes audit staff to continue to request documentation until taxpayers cannot oblige, and it then would seem to support assessments that do not reflect the “correct tax liability.”
Further, the proposed rule again (as did Minn. R. 8130.7500) requires taxpayers to maintain records that have little or nothing to do with Minnesota sales or use tax and are ripe for possible auditor overreach (i.e., general ledger, gross receipts, and deductions). However, the most egregious failure in the proposed rule is the ongoing preference for and mandate that taxpayers retain “hardcopy records.”
If we have learned anything over the past seven years (since the previous rule was issued), it is that EDI systems are less subject to fraud, more accurate, and must be seen as an acceptable form of records to support sales and use tax audits and refund claims. However, while the proposed language of Minn. R. 8130.7501 provides an updated consideration of “electronic records,” it then provides:
[t]he department may require taxpayer to produce such visible and legible records in the form of hardcopy records if such records are necessary to determine the correct tax liability or provide a more efficient means of determining the correct tax liability. (Minn. R. 8130.7501, Subp. 4.D.)
The discretion granted to audit staff, while not defining what is “necessary to determine the correct tax liability” or by permitting such a clear burden be placed upon taxpayers simply because it “provide[s] a more efficient means,” is patently unjust. Whereas the Minnesota Department implies they cannot efficiently audit EDI transactions, the U.S. Department of Veterans Affairs has mandated its suppliers use EDI when submitting invoices since 2013. Finally, the language of Minn. R. 8130.7501, Subp. 5.A. provides an exception to the hardcopy records requirements but limits that exception to documentation which has been deemed “redundant” under the ambiguous terms discussed above. The exclusions within Subp. 5.A. ought to permissibly include transactions accounted for within a qualifying EDI system, just as the Federal government has seen fit to do.
Clearly, more discussion is needed surrounding this proposed rule, and a public hearing is necessary.
Call to Action: Request a DOR Hearing
While these issues warrant further discussion, the Department is currently attempting to adopt this rule without a public hearing. However, taxpayers and their representatives can require a public hearing on the issue – if 25 or more people submit separate written requests for a hearing by 4:30 p.m. on Friday, November 5, 2021, the Department will hold a virtual public hearing on the proposed rule changes at 9:30 a.m. on Friday, November 19, 2021. As such, we encourage all of you to email the Department’s representative, Jim Jordan, to request a public hearing on this proposed rule. In that email, you MUST provide the following: (1) your name; (2) your address; (3) your request for a public hearing/concerns with the proposed rule (citing Prop. Minn. R. 8130.7501) – please feel free to copy/paste the content from the “Minnesota’s Audit Records Issue” portion of this post.
Thank you all!
- What? Another Supreme Court Tax Case? Yup, but you really ought to watch THIS one…
- The Tangled Web of Worker Classification: Different Legal Standards Weave Confusion
- How to Undermine Your Tax Positions: Let’s Talk About Privilege
- Professor Moriarty Is Going to Make an Appearance at the U.S. Supreme Court
- Minnesota Ends COVID-19 Nexus Relief
- Less Than Meets the Eye: SCOTUS Holds Tax Court Petition Deadline Not Jurisdictional
- The Glory of Junk Mail
- Double, Double Toil and Trouble: DOL and IRS Penalties for Failure to File Form 5500
- As Sherlock Holmes Would Say, “The Game’s Afoot”: A Possible SCOTUS Tax Case?
- Down the Rabbit Hole: Should Companies Let Employees Work from Other States?