taxes

Auditing Fundamentals

Chapter 3 – Audit Planning and Documentation

Introduction

An audit plan is a detailed outline of the auditor's plans and procedures used in conducting an audit. The importance of good detailed documentation in the audit plan cannot be stressed enough. An audit plan (Audit doc, in Comprehensive Audit Tax System (CATS) will include the following items:

  • Pre-audit research performed.
  • A description of the business activities.
  • Entrance conference - persons attending, items discussed, etc.
  • A schedule of planned audit procedures.
  • A summary of the evaluation of the records.
  • A description of special problems to be resolved in the audit.
  • Deviations from the plan if any, and why the deviations were made.
  • The results of the audit.
  • Exit conference - date held, persons attending, discussion of audit adjustments, etc.
  • Listing of events/activities occurring during the audit.

Record of Audit Planning, Activities, and Results

The Record of Audit Planning, Activities, and Results is the form which documents the audit plan for every audit performed. This form is completed on the computer and is located in CATS/Audit doc. The Audit Plan should be completed as the audit progresses.

Form Completion

A few helpful hints to remember while completing the audit plan are:

  • Write N/A in the areas of a page that do not apply.
  • If an entire page does not apply, remove it from the audit plan.
  • Attach the Audit Questionnaire as the last page of the audit plan.

Although the audit plan is self explanatory, instructions have been included to help clarify a few of the sections and topics.

Audit Plan, General Items

  • Taxpayer Number. Use the permanent number, not the temporary number.
  • Organization Type. Make proper selection from drop-down menu in CATS/Assignment Detail.
  • Audit Period. Indicate the beginning period year/month (YYMM), year/quarter (YYQ) or annual (YY0) and the ending period year/month (YYMM) or year/quarter (YYQ) or annual (YY0) of the audit. Audit period is entered in CATS/Assignment Detail.
  • Total Hours. Fill in the total audit hours of all auditors who worked on the audit.
  • Estimated Adjustment (in CATS/Audit Doc/Audit Write-up). This estimate should be as accurate as possible. If no adjustments are made, place a zero here.

Pre-Audit Research

Business Description

  • Describe Taxpayer's Business Operations - Discuss type(s) of business activities conducted, types of customers (general public, contractors, exempt organizations, manufacturers, retailers, etc.), changes in marketing mix of goods/services sold/manufactured, and any other pertinent information. Enter correct NAICS Code.

Taxability Research

  • List law, rules, microfiche, publications, etc., reviewed and researched, even if no additional information is obtained.

History Review

  • Note any material fluctuations in reported amounts.
  • Late returns are indicated on the history with an asterisk beside the report period. Run the DATPMT inquiry to verify that these periods are actually late periods and not amended returns.
  • Note any open collection records and the dollar amount of each one. This information can be obtained from the STCOLL inquiry screen. This inquiry shows open collection records, report periods, and reason for the open collection record.

Prior Audit Research

  • If previously audited, what procedures, errors and adjustments were noted?
  • List audit periods and results of other taxes previously audited.

Active Taxes/Fees

  • List all other taxes/fees for which the taxpayer has been active in prior 5 years.

Entrance Conference

  • Enter date that conference was held
  • List persons attending and their titles
  • List items discussed
  • List details of the plant tour, if applicable. Document information obtained from touring facilities. Items to be noted would be equipment observed, new construction or construction in progress, and the types of business activities being conducted.
  • Related Companies
    • Document information on all related entities
    • Document any other audits which will be generated due to the additional taxes or related entities described. If additional audits will not be generated, explain why not.
  • Potential Computer Audit?
    • Complete 'CAMS Plan' portion of Record Section
  • Under the Records Section, list
    • Types of records, filing system, length of retention
    • Volume, location, and availability of records
    • Reporting methods used and internal controls employed
    • Personnel preparing reports (describe changes and dates of personnel and their knowledge of laws/rules)

Narrative

Thorough and accurate notes in the audit plan help the reviewers in the Processing Center, the attorneys in the hearing process, and aid in answering questions when the auditor is unavailable or has left the agency. Also useful is the dating of the narrative, preferably in chronological order. This provides a timeline of how the audit events occurred and is somewhat different than the timeline provided with the Listing of Events.

Audit Doc/Audit Activities/Planned Activities

The Planned Sales and Planned Purchases sections should include documentation of the planned audit procedures, a summary of the evaluation of the records, preliminary testing and results, description of any problems to be resolved, deviations from the planned procedures, and the results of the audit. This needs to be performed for each outlet or division. The auditor must state whether a sample or a detailed examination will be performed and why.

Other areas to be discussed include but are not limited to:

  • Reconciliation of tax collected to tax paid
  • Reconciliation of tax accrued to tax paid
  • Miscellaneous income; sales of capital assets
  • Local and MTA/CTD taxes

NOTE: See the Audit Checklists in this chapter for additional information.

Exit Conference Section

Complete this page for every audit. Document thoroughly for:

  • Date conference held
  • Each person attending and their titles
  • Agreement code (from drop-down menu)
  • Explanation of taxpayer disagreements
  • Unadjusted minor errors
  • P&I waiver explained to taxpayer or representative
  • Payment information - requested/received
  • Brochures provided to the taxpayer or representative
  • Additional penalty - considered/approved
  • Provide Contesting Disagreed Audits brochure
  • Whether Independent Audit Review Conference was accepted or declined

Independent Audit Review Conference Section (IARC)

Complete this section if an IARC Conference is held. Document the date, time, and location where conference was held. State the correct taxpayer reaction to the conference:

  • All disagreed items were resolved
  • All disagreed items were not resolved
  • Reaction was noncommittal

Supplementary Information Section - Collection Information

This section is not currently available in CATS.

Supplementary Information Section - Bankruptcy Information

Complete this section if the taxpayer has filed bankruptcy. If bankruptcy information cannot be obtained from the LMMAIN inquiry screen, the information can usually be obtained from the bankruptcy court. If the taxpayer has filed bankruptcy and the information is not on the LMMAIN inquiry screen, notify Bankruptcy Division.

Supplementary Information Section - Various Information

Complete the following sections, if applicable:

  • Missing Records
  • Reconciliation Conference
  • Additional Penalty
  • Beyond 4 Years - request is made to extend audit period beyond normal 4 year statute of limitations period
  • Receipt for Records

Listing of Events

This page should include, but is not limited to:

  • Dates and notes regarding phone calls made to taxpayers.
  • Dates when audit schedules, rules, tax brochures, etc., are given to the taxpayer.
  • The dates when letters or other correspondence were sent to the taxpayer.
  • Dates and notes regarding contacts or conversations with the taxpayer.
  • Reasons for any delays in the audit.

The Audit Questionnaire should be attached as the last page of the audit plan.

Audit Checklists

The following are audit checklists which can be used to insure that most areas in an audit have been considered.

Every item on the checklists does not need to be mentioned in the audit plan, nor are they all-inclusive. Do not include the checklist in the audit package.

The General Audit checklist is followed by six specific industry checklists which can be used in conjunction with the general checklist. An audit checklist should be used to supplement professional auditor judgment.

General Audit Checklist

  1. PRE-AUDIT RESEARCH
    1. Examine Agency Work Manager information for:
      • Taxpayer identification and location
      • Reason for audit request
    2. Verify that the Taxpayer's Information Letter and the Audit Questionnaire were sent to the taxpayer and returned - see Chapter 2
    3. Examine the Audit Questionnaire completed by the taxpayer to determine:
      • Contact and location of the records
      • Description of the business activity
      • Availability of computer records
      • Special instructions
      • Person who has authority to sign the Agreement to Extend Period of Limitation
    4. Review History
      1. Review title information
        • Compare information with Agency Work Manager
        • Date of history (should be current)
      2. Review outlet information
        • Trade name(s)
        • Status - active or out of business (OOB)
        • First and last taxable sale dates - within the audit period
        • Within or outside city limits, county, SPD, MTA or CTD jurisdictions and the effective dates
        • How does the taxpayer file city, county, SPD and MTA/CTD returns - by outlet or by list?
        • SIC codes and NAICS Codes - review to determine what business types are involved
      3. Outlet return data - Review gross sales, deductions and taxable purchases for each period of the audit - watch for the following:
        • That all outlets in business were reporting sales amounts - compare to first and last taxable sale dates in outlet information
        • Any outlets reporting zero
        • Watch for large variations in reported gross sales, deductions and taxable purchases from period to period - also, compare each outlet's information from period to period
        • To determine if correct city, county/SPD, MTA or CTD tax was reported:
          • Compare the TOTAL amounts subject to state, city, county, SPD, MTA or CTD tax - compare these by period also
          • Compare to outlet file indicators as to whether inside or outside city limits, in a taxable county or SPD, and inside a MTA or CTD, and effective dates
      4. Look at open collection records and verify late returns
      5. Prior audit information
    5. Review Terminal Inquiry
      • MTSUMM/XISUMM
      • XICHRT - Franchise Tax Charter/COA information
      • XICOLL/XIHIST - for collection balances and for activities and notices per period
      • XILOCA/XISTAT
      • LMMAIN - Bankruptcy system main menu
      • NAMNUM (for taxpayer number and any related entities)
      • Refund inquiries
        • RCSUMI - Refund summary information
        • RCMENI - Lists claim for a taxpayer and tax types
        • RCDATI - Refund claim data inquiry
    6. Examine prior audits, if any, for:
      • Periods audited
      • Business description and types of activities conducted
      • Methods of accounting
      • Errors noted
      • Possible contact and location of records
      • Type of records utilized - computerized or manual
      • Audit procedures used
    7. Examine other documents for additional information including:
      • Account Information/Audit Lead Cards
      • Correspondence with taxpayer or with others in reference to the taxpayer
      • Directory of Corporate Affiliations
      • Any other sources such as newspaper articles, magazine stories, etc.
    8. Review applicable portions of the Sales and Use Tax Law and rules
    9. Set up an appointment via the telephone
      • Inform the taxpayer of the audit period
      • Inform taxpayer of other taxes to be audited, if any
  2. ENTRANCE CONFERENCE
    1. List all of the taxpayer's representatives who attend the entrance conference and their titles
    2. Determine taxpayer's knowledge of the law by discussing the taxpayer's interpretation of both the law and the rules
    3. Discuss the taxpayer's business operations including:
      • Nature of business
      • Location of plants, warehouses and sales offices inside and outside Texas
      • Product line(s)
      • Type of customers
      • Types of records available
        • Sales invoices
        • Purchase invoices
        • General ledgers
        • Sales journals
        • Depreciation schedules
        • Accounts payable journals
        • Bank statements
        • Charts of accounts
        • Tax work papers
        • Tax accrual work papers
        • Resale/exemption certificates/direct payment exemption certificates
        • Federal Income Tax returns
      • Location of records
      • Any missing or incomplete records
      • Related companies
      • Individuals to contact at various locations
      • Accounting methods - cash basis, accrual basis, or hybrid system
      • Other locations in Texas
      • Obtain company literature if available (brochures, annual reports, pamphlets, etc.)
      • How the products are shipped to the customer (common carrier, own truck etc.)
    4. Determine taxpayer's method of compiling and reporting taxable amounts
      • Types of records maintained - computerized or manual
      • Does each division keep records or are they centralized at one location?
      • Types of records utilized in the tax preparation
      • Availability of records
      • Person who prepares the tax returns and document any changes in personnel
      • Review the step-by-step procedures used to prepare the return
      • Determine if organization and volume of records is such that a sample/projection would be feasible
    5. Discuss audit procedures
      • Audit period
      • Sampling and projection procedures
      • Possibility of using CAMS or PC CAMS
      • Possibility of utilizing the taxpayer's computer system
      • Possibility of obtaining statute extension agreement, if necessary
    6. Tour the place of business and note the following:
      • Machinery and equipment
      • New construction or construction in progress
      • Services provided and/or products sold
    7. Discuss data from the history and data from other sources - complete appropriate file maintenance.
      • Changes in ownership
      • Business growth (mergers, plant expansions, etc.)
      • Changes in chart of accounts
  3. GROSS SALES
    1. Compare summary records with reported amounts and account for material differences
      • Examine general ledger, sales journal, and/or return worksheets as the primary summary records
      • Examine financial statements and income tax returns, if possible
      • Make sure that all of the reporting divisions or segments of the company are included on the return - review the NAMNUM computer inquiry
    2. Determine if taxpayer is aware of proper city, county, SPD, or MTA/CTD tax applications if applicable, and if the correct rates are being charged. Make certain that Transit Tax is
      • Effective September 1, 2007, is being collected on all taxable sales of items shipped or delivered in Texas from a place of business within a transit authority
      • Prior to September 1, 2007, is being collected on taxable items delivered within a transit authority but not on deliveries outside of a transit authority
    3. Determine if the taxpayer is reporting on the cash or accrual basis
      • If accrual, analyze the sales and use tax accrual accounts and compare with reported taxable sales - reconcile any significant differences between taxes accrued and taxes reported
      • If cash, analyze the documentation of tax received and compare with reported amounts - reconcile significant differences
    4. Check for capital asset sales and sources of miscellaneous income, especially if a segment of the company was closed, merged or sold - check for potential application of occasional sale rule
    5. Review any period that shows a large variance of gross sales/total sales on the audit history
  4. DEDUCTIONS
    1. Review summary records and, if applicable, related working papers and trace to reported amounts - test internal controls to insure that tax charged on the invoices flows to the summary records and tax returns
    2. Are deductions included in total sales reported? If not, inform the taxpayer of the correct reporting procedures
    3. If deductions are to be sampled, then:
      • Select sample at random
      • Give the taxpayer written notification of sampling procedures to be used prior to completion of preliminary sample
      • Make preliminary tests and list exceptions - if exceptions are significant, complete sample examination and provide taxpayer with schedules
      • Expand sample period or detail if necessary
      • Evaluate validity and availability of summary records for projections
    4. If deductions are to be detailed, then:
      • Select preliminary test periods at random
      • Make preliminary tests and if significant errors are noted, complete the detailed examination
    5. Review taxpayer's records for BAD DEBTS claimed in error or BAD DEBTS not claimed
      • Review general ledger to determine if there is a bad debt account
      • Review taxpayer's Federal Income Tax Returns to determine if bad debts were written off
      • Bad debts should only be allowed if they are written off or if past history indicates that the bad debts recorded in the general ledger will be written off the Federal Income Tax Returns
      • Determine if the bad debt account relates to both taxable and non-taxable sales and determine which debts relate to customers that are charged tax
      • If records are not available to determine which debts relate to taxable customers, then a percentage of total taxable customers may be used
      • Examine the general ledger and/or Income Tax Returns for any recoveries of bad debts which have previously been written off - verify if they have been reported since recovery
    6. Complete Account Information cards on customers who purchase tax-free on a resale or exemption certificate, the validity of which is questionable
  5. TAXABLE PURCHASES
    1. Review reporting procedures for:
      • Person who determines if a purchase is taxable
      • The recording of Taxable Purchases
      • Reporting of taxes on any items withdrawn from a tax-free inventory
      • Investigate both EXPENSE ACCOUNTS (income statement) and ACCOUNTS PAYABLE (balance sheet)
    2. Confirm by preliminary testing that tax accrued, as indicated on the face of purchase invoices, is posted to summary records - examine the summary records and trace to sales tax return
    3. Examine capital asset purchases in detail in order to trace acquisitions from summary to detail records - one or more of the following summary records may be used:
      • Depreciation schedule
      • Asset ledger
      • General ledger
      • Construction in progress folders
      • Federal income tax returns

      Detailed records to examine include:

      • Purchase invoices
      • Purchase vouchers
      • Cancelled checks
      • Purchase orders
    4. Make preliminary tests of taxable expense item purchases, using chart of accounts, disbursements journal, purchase invoices, and other records as needed and as available
      • If expense items are to be sampled then:
        • Select sample at random
        • Give the taxpayer the written notification of sampling procedures to be used prior to completion of a preliminary sample
        • Reconcile accrued tax on expense and supply purchase invoices with summary records
        • Evaluate validity and availability of summary records for projection
        • Examine in detail for each sample period or sample unit expense and supply purchases, and;
          • Verify that state, city, county/SPD, MTA/CTD tax was correctly charged by the vendor, if applicable
          • Verify that tax was correctly accrued and summarized for reporting
          • Verify that items purchased tax free by reason of exemption are used in an exempt manner or used for an exempt purpose
      • Expand sample or detail expenses if needed
  6. EXIT CONFERENCE
    1. Explain in person to the taxpayer the audit procedures and findings - include a discussion of the following:
      • All records examined
      • A detailed description of audit procedures used, audit adjustments and flow of audit package
      • Minor errors for which no adjustments were made
      • Applicable law, rules and proper reporting procedures
      • Additional information the taxpayer may obtain to reduce the liability
      • Taxpayer's disagreements with the audit - disagreements should be clearly understood by the auditor and documented
    2. Other items to discuss with the taxpayer include:
      1. Estimated tax adjustment
      2. The billing process
      3. Payment procedures
      4. Right to a reconciliation and/or a dispute resolution conference
      5. Redetermination procedures
      6. Policies and procedures pertaining to penalty and interest waiver

Specific Industry Checklists

The following are checklists for six specific industries. These should be used in conjunction with the general checklist.

Retailers' and Wholesalers' Checklist

  1. Review applicable portions of Sales and Use Tax Law and rules, including the following:
    • Sales for resale, resale certificates (See Rule 3.285)
    • Seller's responsibilities (See Rule 3.286.)
    • Exemption certificates (See Rule 3.287)
    • Direct Payment Procedures, Qualifications, and necessity to obtain certificates from Direct Payment Permit holders (See Rule 3.288)
    • Transportation, Delivery Charges (See Rule 3.303)
    • Use Tax (See Rule 3.346)
    • Imports and Exports (See Rule 3.323)
  2. If the taxpayer makes installment sales and charges interest on accounts receivable, verify if part of the interest is being reported to the State in accordance with Rule 3.302

Service Companies' Checklist

  1. Review applicable portions of Sales and Use Tax Law and rules, including the following:
    1. 'Sales Price' or 'Receipt' (See Section 151.007(c)(8))
    2. 'Taxable Services' (See Section 151.0101)
      • Amusement services
      • Cable television services
      • Personal services (laundry and dry cleaning services)
      • Motor vehicle parking and storage services
      • Repair, remodeling, maintenance, and restoration of tangible personal property, except:
        • Aircraft
        • Ship, boat, or other vessel, other than
          • A taxable boat or motor as defined by Section 160.001 (Taxes on Sales and Use of Boats and Boat Motors)
          • A sports fishing boat, or
          • Any other vessel used for pleasure
        • Repair, maintenance, and restoration of a motor vehicle
        • Repair, maintenance, creation, and restoration of a computer program, including its development and modification, not sold by the person performing the repair, maintenance, creation, or restoration service
      • Telecommunications services
      • Credit reporting services
      • Debt collection services
      • Insurance services
      • Information services
      • Real property repair and remodeling
      • Security services
      • Telephone answering services
      • Internet access service, and
      • Sale of electricity by a utility company to an end-use customer
    3. Property used to provide taxable services and sale price of taxable services (See Section 151.058)
    4. Applicable rules that pertain to the type of business to be audited. (Examine the rule index.)
  2. Discuss the taxpayer's business operations including:
    1. Determine if the taxpayer performs any taxable services
    2. Determine whether the taxpayer performs any fabrication which is not a service
    3. Determine where the service facilities are located
    4. Determine what types of customers the taxpayer services - commercial, residential, contractors, exempt entities
  3. Determine whether the taxpayer is providing a service, fabricating, or selling tangible personal property

    Note: In the case of tangible personal property, all sales are presumed to be taxable, and the burden is on the seller to prove any exemption. However, since not all services are taxable, the burden is on the Comptroller to prove that a seller has provided a taxable service.
  4. Determine that exemptions (such as exemptions provided for fabricators) aren't erroneously being taken for services - ensure that taxable service providers only claim exemption on items that are transferred to the care, custody and control of customer
  5. If the taxpayer performs nonresidential real property repair and remodeling services, determine that local sales taxes are
    1. As of September 1, 2007,based on the location of the jobsite
    2. Prior to September 1, 2007, based on service provider's place of business

Repairmen Checklist

  1. Review applicable portions of Sales and Use Tax Law and rules, including the following:
    1. Property consumed in repairs and contracts (See Section 151.056)
    2. Repair of tangible personal property (TPP) (See Rule 3.292)
    3. Contractors (See Rule 3.291)
    4. Nonresidential Real Property Repair, Remodeling, and Restoration; Real Property Maintenance (See Rule 3.357)
    5. Repair of motor vehicles (See Rule 3.290)
  2. Determine whether the taxpayer is providing a repair service, fabricating, or selling tangible personal property
  3. Lump-sum or separated billings for automobile repairs and sublet repairs
  4. Verify that the materials charge is equal to or greater than the cost of all materials used in the repair, including any itemized charges from a third party
  5. Verify that parts used on lump-sum repairs of aircraft, motor vehicles, and commercial vessels are tax-paid at the time of purchase or are being reported as taxable purchases - remodeling of a motor vehicle is providing a taxable service, thus the entire charge for the service would be taxable (see Rule 3.292)
  6. Check for the sale of extended warranty contracts
  7. Check for other taxes for which taxpayer may be responsible (i.e., Battery Fee)
  8. Check Audit Procedures for Repairmen and Contractors manual for law changes
  9. If the taxpayer performs nonresidentail real property repair and remodeling services, determine that local sales taxes are
    1. As of September 1, 2007, based on the location of the jobsite
    2. Prior to September 1, 2007, based on the service provider's place of business

Contractors' Checklist

  1. Review applicable portions of Sales and Use Tax Law and rules, including the following:
    1. Property consumed in repairs and contracts (See Section 151.056)
    2. Contractors (See Rule 3.291)
    3. Contractors (See Local Rule 3.379 and MTA Rule 3.429)
    4. Improvements to Realty (See Rule 3.347)
    5. Prior Contract Exemptions (See Rule 3.319 and MTA Rule 3.426)
    6. Nonresidential Real Property Repair, Remodeling, and Restoration; Real Property Maintenance (See Rule 3.357)
    7. Transportation and Delivery Charges (See Rule 3.303)
    8. Real Property Service (See Rule 3.356)
  2. Discuss the taxpayer's business operations including:
    1. Type of construction done
    2. Area of operation (local, state, nation or worldwide)
    3. Type of contractor (general or subcontractor)
    4. Type of customers (exempt, direct payment, resale or owner)
    5. Type of contracts (lump-sum, separated, cost-plus)
    6. Number of contracts involved in audit period
    7. Determine who negotiates contracts and establishes taxability status
  3. Obtain and/or prepare a list of contracts with the following information:
    1. Separated or lump-sum status
    2. Customer
    3. Taxability status (new construction, residential, remodeling, etc.)
    4. Job site location and tax rate for location
    5. Any jobs that are subject to any prior contract exemption
    6. Start and completion dates
  4. Determine jobs done in Texas
    1. Read contracts to verify taxpayer's stated contract interpretations
    2. Examine lump-sum contracts performed out of state to determine if any materials were obtained in Texas
  5. Tax charged for separated contracts
    1. Verify rate charged in order to determine if taxpayer is aware of proper city, county/SPD, MTA or CTD tax applications, based on location of job site
    2. Verify that in-bound freight to job site is not deleted from material selling price
    3. Trace separated contract material values to returns
    4. Verify that tax is charged on all materials physically incorporated into the realty being improved for nonexempt customers
  6. Verify that local sales taxes on nonresidential real property repair and remodeling services are
    1. As of September 1, 2007, based on the location of the jobsite
    2. Prior to September 1, 2007, based on the service provider's place of business
  7. Verify that resale, direct payment or exemption certificates are available for each contract claimed to be non-taxable
  8. TAXABLE PURCHASES
    1. Check to see if tax is being paid or accrued on all purchases for lump-sum contracts with taxable entities
    2. Check to see if tax is being paid or accrued on all indirect material and equipment used on contracts with direct payment permitted customers
    3. Check to see if tax is being paid or accrued on indirect materials and equipment used on contracts with the federal government - an exemption certificate may be issued for qualifying consumables
    4. Verify that tax is accrued based on STORAGE LOCATION and not job site, when:
      1. Materials were purchased on a valid RESALE CERTIFICATE,
      2. Stored, and
      3. Removed from inventory for use on a taxable lump-sum job
    5. Verify that tax is accrued based on JOB SITE, and not storage location, when:
      1. Materials were purchased on a valid EXEMPTION CERTIFICATE,
      2. Stored, and
      3. Removed from inventory for use on a taxable lump-sum job
    6. Verify that all lump-sum subcontracts include installation labor - subcontract may be for the sale of equipment or material and not an improvement to realty
    7. Examine capital asset purchases

      If equipment was used (not just stored) in other states, verify that equipment was out of state for at least ONE YEAR.
      1. The purchase will not be presumed for use in Texas if:
        • Property was purchased out of state and used out of state for more than one year, and
        • Use out of state was substantial and constituted a primary use for which it was purchased.
      2. The 'one year presumption' can be overcome by either the Comptroller or the taxpayer.
    8. Verify that items purchased tax-free by reason of an exempt use are used on an exempt job
    9. See Audit Procedures for Contractors and Repairmen manual

Manufacturers' Checklist

  1. Review applicable portions of Sales and Use Tax Law and rules, including the following:
    1. Property used in manufacturing (See Section 151.318, 151.3181, and 151.3185)
    2. Manufacturing, custom manufacturing, fabricating, and processing (See Rule 3.300)
    3. Natural gas and electricity (See Rule 3.295 and Section 151.317)
    4. Sales for resale, resale certificates (See Rule 3.285 and Sections 151.006 and 151.151)
    5. Seller's and purchaser's responsibilities ( See Rule 3.286)
    6. Exemption certificates (See Rule 3.287 and Section 151.155)
    7. Direct payment, procedures, qualifications, and necessity to obtain certificates from Direct Payment Permit holders (See Rule 3.288 and Sections 151.417 and 151.4171)
    8. Transportation, delivery charges (See Rule 3.303)
    9. Use tax (See Rule 3.346 and Sections 151.011, 151.101, and 151.102)
    10. Imports and exports (See Rule 3.323)
  2. Discuss the taxpayer's business operations including:
    1. Type of manufacturing operations (repair, installation, service, etc.)
    2. Location of manufacturing facilities
    3. Product line(s)
    4. Type of customers (primarily ultimate consumer or sales for resale)
    5. If taxpayer has non-permitted out-of-state locations
  3. While reviewing a manufacturer's sales consider:
    1. Employee sales
    2. Sales of scrap materials
  4. In reviewing manufacturing expenses consider:
    1. Electricity and natural gas
    2. Wrapping and packaging exemption
    3. Necessary and essential materials exemption.- items must directly make or cause a chemical or physical change to the product that is being manufactured and not merely useful to the manufacturing process
    4. Repair/replacement parts for qualifying manufacturing equipment
    5. Displays vs. models
    6. Molds and dies
  5. Consider the following when examining asset purchases:
    1. Verify that the items are directly used during the actual manufacturing process, that the items are necessary or essential to the manufacturing process, and that the items directly cause a chemical or physical change to the product being manufactured
    2. Verify any manufacturing refunds paid by the Comptroller during audit period
    3. Perform a sales tax reconciliation through the most current report period, even if periods are not included in the audit period - this procedure is necessary to ensure that any credits already given by the Comptroller have also not been taken by the taxpayer in subsequent periods

Motor Vehicle Checklist

  1. Review the Motor Vehicle Sales and Use Tax Law and rules, including the following:
    1. Definition of a Motor Vehicle [Sec. 152.001(3)]
    2. Retail sale [Sec. 152.001(2)]
    3. Total consideration (Sec. 152.002)

      Note: Effective October 1, 2006, state law changed the method to calculate motor vehicle sales and use tax upon the purchase of a used motor vehicle:
      • If the vehicle is purchased from a licensed dealer, the tax is 6.25% of the sales price
      • If the vehicle is purchased from a private party (not a dealer), the tax is 6.25% of:
        • The sales price of the vehicle if the price is 80% or more of the vehicle's standard presumptive value
        • 80% of the standard presumptive value if the purchaser paid less than that amount
        • The certified appraisal value of the vehicle if the purchaser paid less 80% of the presumptive value and got a certified appraisal of the vehicle

          Note: Standard presumptive value is determined by the Texas Department of Transportation (TxDot) who publishes a SPV data base for used vehicles
    4. Motor vehicles purchased outside Texas (Sec. 152.022)
    5. Motor vehicles brought into Texas by new Texas resident (Sec. 152.023)
    6. Tax on even exchange of motor vehicles (Sec. 152.024)
    7. Tax on gift of a motor vehicle (Sec. 152.025)
    8. Seller-finance sales of motor vehicles
    9. Collection of taxes (Subchapter C)
    10. Exemptions
    11. Required affidavits (Sec. 152.062)
    12. Records/failure to keep records (Sec. 152.063 and Sec. 152.103)
  2. Contact Roland Ruelas of Audit HQ in order to receive an Excel spreadsheet download of sales made by motor vehicle dealer under audit.
  3. Discuss the taxpayer's business operations including:
    1. Types of vehicles - new, used
    2. Any repair of vehicles
    3. Types of customers - individuals or other dealers
    4. Method of financing sales: dealer-financing or third-party financing
    5. If taxpayer finances own sales - must be permitted for Motor Vehicle Seller-Finance Sales Tax
    6. If taxpayer finances own sales, determine when titles to vehicles transferred to purchaser - within the required 20 working days, within 60 days after sales date, or after all payments have been made by purchaser
    7. Types of records maintained and length of retention
    8. How records are filed
    9. Persons responsible for preparing necessary documents
  4. Verify reported taxable amounts
    1. Compare sales amount on affidavit with sales contract or other sales records
    2. Compare trade-in information on affidavit with sales contract or other sales records
    3. Verify that reported trade-ins were motor vehicles - not boats, land, etc.
    4. Verify that vehicle listed as trade-in not utilized more than once
    5. Obtain title histories through TxDot on any questionable vehicles
    6. Consider alternate methods if taxpayer does not provide sales records - bank deposits, financing contracts, contact purchaser, lienholder information

TOC | Preface | 1 | 2 | 3 | 4| 5 | 6 | 7 | 8 | 9 | 10 | Appendix | Glossary | Timelines

(Revised 10/2021)