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A Whiff of Fraud?

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The New Jersey Tax Court recently addressed, for the first time, the State’s civil fraud tax penalty. The New Jersey Division of Taxation may impose a civil fraud penalty if any part of a state tax assessment is due to the taxpayer’s fraud. The penalty is 50% of the assessment and is imposed in lieu of certain other penalties.

In Cigar Stop, Inc. v. Director, (N.J. Tax Ct. Aug. 9, 2017) a New Jersey wholesaler and retail dealer of tobacco products challenged an assessment of tobacco products tax, interest, and the amnesty and civil fraud penalties. The Division estimated its tax assessment because the taxpayer failed to maintain adequate books and records.

The court first considered the underlying tax assessment. Looking to cases under the State’s sales and use tax law, the court agreed that because the taxpayer failed to keep detailed records required under the tobacco products tax, the Division’s determination of tax was entitled to a presumption of correctness.

The court found the taxpayer did not keep credible, let alone adequate, records. Sample invoices offered by the taxpayer were incomplete, inaccurate, and questionable. Without documentary evidence or records or corroborative testimony, the taxpayer could not overcome the presumption of correctness and the court upheld the tobacco products tax assessment.

Next, the Court considered the civil fraud penalty. It observed the Division’s regulations, issued in 2014, are patterned after federal tax law as to the standard and burden of proof required to impose the fraud penalty. The regulations provide a non-exclusive list of fraud indicators.

The court accepted without discussion the parties’ agreement that regarding fraud with intent to evade tax, the burden of proof is on the Division, and that burden of proof is to be carried by clear and convincing evidence.

A taxpayer’s entire course of conduct must be reviewed to determine whether there was an intent to evade payment of tax and commit fraud. The court found the taxpayer did not fail to cooperate willfully with Taxation during the audit and, while the taxpayer’s records were inadequate, there was not a “paucity of books and records” to merit an inference of attempted concealment.

To support imposition of the fraud penalty, the Division pointed to several fraud indicators. The court observed that incorrectly filed returns were not themselves enough to prove fraud. Claims the taxpayer altered or fabricated invoices were disputed by the taxpayer. Further the Division’s mere allegations of the taxpayer’s industry knowledge and history of prior audits, without the presentation of evidence, could not support the penalty assessment. Interestingly, the Division claimed support for its finding of fraud with respect to the tobacco products tax assessment from the taxpayer’s deduction, for income tax purposes, of personal expenses such as car and credit card payments. The court did not address the potential relevance of these allegations.

The court ordered a hearing to receive evidence of the taxpayer’s conduct and to decide whether there is clear and convincing evidence of the taxpayer’s intent to commit fraud by claiming all its sales to be exempt from the tobacco products tax.

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