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Luxury Audits: Empty Boxes Full of Champagne Wishes & Caviar Dreams

author photo of Lloyd Geggatt

When someone is considering spending thousands of dollars on an item, saving 6% or more on the deal can make the difference between pulling the trigger and walking away. So it is not surprising that some salespersons will suggest shipping the purchase out of state to avoid paying sales tax. This is a legitimate option as long as the neither the buyer nor an agent of the buyer takes possession in the state. Depending upon the state and the product involved, there may be additional requirements for exemption such as the goods remaining outside the state for a specified period of time and/or the goods being “functionally used” while outside the state. But the suggestion is also made when it is known that the goods will not be shipped at all or that they will be shipped but the item will immediately come back into the state. Jewelry stores, art dealers, and retailers of high end automobiles, motor homes and boats are examples of industries where I have encountered cases where the facts do not support the claimed exemption.

The first step when auditing these industries is to review all documents related to the sale and looking for anything that might indicate that the purchaser is a resident of the state where the sale took place, rather than the state where the goods were allegedly delivered. Sometimes simply looking in the local telephone book will reveal a local address for the buyer. The auditor is also looking to see if the item was insured and for how much. The weight of the package can also help prove or disprove the exemption. With auto sales there may also be information on trade-ins and a copy of the buyer’s driver’s license. There should also be delivery documents—notarized statements at point of delivery, expense reports for the driver and the chase car if dealership made delivery or bills of lading if a third party carrier was used.

In an audit of an art dealer, these audit techniques revealed the manager of the store solicited out of state addresses from customers and then shipped empty uninsured boxes while the art work was carried home by the buyer.  I never understood why someone would go to all this effort and then to fail to put something in the box and spend a few dollars to insure it. Or why they would accept a local check from the buyer and retain it with the other paperwork. I also found several auto dealerships whose service department had worked on cars that were allegedly sold and shipped to customers who lived in neighboring states. But it isn’t always local residents who are involved. An excellent example involves a friend of my wife who came to visit us in California not long after I started work as a sales tax auditor. The friend purchased an expensive gold necklace which she wore all during her visit. Problem was the seller “saved” her 6.5% tax by mailing an empty box to her home in Florida. Needless to say, the seller was contacted shortly thereafter for a “routine” audit.

The most blatant offender I encountered was a jeweler specializing in selling investment-grade diamonds. The audit began as a routine examination of the previous three years’ activity but I had serious concerns after a brief review of the sales transactions. Many shipments were not insured and most had obvious references to local addresses. The audit was quickly expanded to cover an eight year period and I began corresponding with the buyers to determine the facts behind their purchases. About one third indicated that empty boxes had indeed been mailed while another third explained the diamond was shipped to a contact out of state. The contact simply removed the wrapping paper and underneath was an already wrapped package with adequate postage. They simply dropped it in the mail and the diamond was shipped to the buyer in the state.  The final third was comprised of legitimate sales to true out of state residents and buyers who insisted theirs were also legitimate. This last group of buyers had audit billings assessed against them as they were considered to be equally liable as the seller. Some of the buyers paid the bill and put the episode behind them. Others appealed the billing and over the next several months they appeared before a hearing officer who listened to their testimony and either upheld the liability or removed the buyer from inclusion in the audit.

An example of when shipment outside the state is not sufficient to secure the exemption can be found in an audit of a company selling motor homes.  There were some sales to California residents where the motor home was properly delivered to the buyer in Arizona. But California also requires the property be “functionally used” outside the state and if it returns within 90 days of the date of purchase it is presumed to be subject to California sales tax. This is a “rebuttable presumption” that can be overcome by proving the property was functionally used outside the state more than 50% of the time for the first six months after it first enters the state. Therefore these California residents had to provide documents that would show

1)     The motor home was used outside California for at least 90 days and

2)     That it was used during that time.

Some were able to provide receipts from points outside California along with mileage statements to show they really were traveling with the motor home. Some were snowbirds who rented a space at a motor home park in another state. But some simply had the motor home sit at the home of friend or relative for 91 days and then driven back to California. The exemption was denied for this last group because no functional use occurred outside California.

Other than the situation involving my wife’s friend I personally have never had anyone suggest this option to me. Probably because none of my purchases justify it. I’m wondering if any of the readers have encountered this and if so, under what circumstances.

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