A New York State Administrative Law Judge (“ALJ”) recently rejected an attempt by the Division of Taxation (“Division”) to change its theory of liability after the record was closed, raising its new theory of liability for the first time in its post-hearing brief. Matter of Super PC Systems, Inc., DTA No. 830355 (N.Y.S. Div. Tax. App., Feb. 22, 2024).

Super PC Systems (“Petitioner”) sold point-of-sale equipment such as cash registers and bar code scanners. It did not pay sales tax on the purchase of the equipment because the equipment was purchased for resale. One of the ways Petitioner sold the equipment was through a penny sale contract under which the purchaser would agree to a payment plan of one penny for 48 months and would also agree to use certain credit card processing vendors that would pay Petitioner certain amounts for the sales it processed in connection with that point-of-sale equipment.

The Division audited Petitioner and asserted use tax due on the equipment sold through penny contracts on the basis that the penny contract sales were not real sales. The Division calculated the amount of use tax due on the purchase price paid by Petitioner for the products under a cost-of-goods-sold method (“COGS”).

In its post-hearing brief, the Division changed course completely and conceded that the penny contract sales were sales, but nevertheless asserted use tax was due under the COGS method.

In determining whether the assessment should be upheld, the ALJ noted that the Division’s original assessment was based on a COGS calculation under one theory of liability, but it was now attempting to apply that same COGS calculation to a very different theory of liability. The ALJ further found that the Division had been aware of the residual income from the penny contract sales on Petitioner’s records throughout the audit but made no effort to determine what portion of that income related to the penny sale contracts. The Division also did not pursue its newfound theory for the liability at the hearing or attempt to gather information about the residuals from the penny contracts, despite having access to Petitioner’s witnesses who could have offered insight and information on the issue.

The ALJ deemed the assessment unreasonable because the record did not establish a “compelling connection” between the use tax liability calculated based upon the COGS method and the relevant residual payments and penny contracts at issue. Additionally, the ALJ pointed out that Petitioner was not able to effectively address the Division’s new liability theory since the issue was not raised until after the record was closed, potentially raising due process concerns.

As the ALJ noted, the hallmarks of due process are notice and an opportunity to be heard. Where, as here, the Division did not reveal the theory for the tax liability until after the hearing on the matter was over and the record was closed, the Petitioner was not provided with either.