State tobacco tax laws are often dated and seldom reviewed in the modern economy. In many states, we have been able to obtain tobacco tax refunds on taxes paid by distributors on nontaxable charges such as federal excise tax reimbursements. Similarly, most states still tax tobacco products on the price the tobacco is sold from the manufacturer to the distributor. However, modern supply chains often include multiple levels of distributors and tax ends up erroneously getting paid on profit, sometimes on multiple levels of profit.
Consider that imported tobacco, such as cigars is sold for $10 to a distributor and then sold by the distributor for $20. Assuming the first sale was from a manufacturer, the first sale would be taxed at a percentage of the $10. In the modern economy, assume the same cigar is sold for $10 to a distributor, then $15 to another distributor and then $20 to a retailer. Should the tax be due on the $10 or $15?
Example A – Manufacturer à $10 à Distributor A à $20 à Retailer à consumer
Example B - Manufacturer à $10 à Distributor A à $15 à Distributor B à $20 à Retailer à consumer
While many states take the position that the tax should be applied on the $15 in example B, under many state laws such as Alaska, California, Colorado, Connecticut, Delaware, Indiana, Iowa, Maine, Montana, New Hampshire, New York, Oregon, North Dakota, Utah, and Wisconsin, it arguably should be on the $10.
Armed with proprietary information, we were able to obtain the manufacturer’s prices and get millions of dollars of refund back in New York! In fact, because of this issue, New York issued TSB -M-13 that allowed a 38% adjustment ratio for imported cigars after 2013 because that represented the average markup on the multi-distributor supply chain.
In a recent case, a tobacco distributor claimed roughly $8 million in refund based on New York’s adjustment ratios. New York allowed about $6.6 million of the claim but denied about $1.5 million. Among the reasons for reducing the refund was because the taxpayer was unable to show a further reduction in the adjustment ratio to 31%. A portion of the refund was also denied because of statute of limitations reasons. Ultimately, the amount at issue by the time the case wound up in the New York Division of Tax Appeals was about $350,000.
New York law requires that a refund claim be made within 2 years after the tax was paid to the state, except if an extension is agreed to by the taxpayer and the agency. Here, the taxpayer signed three waivers during an assessment audit, but failed to extend the period to claim a refund. Therefore, the agency properly denied the refund claims.
The taxpayer also advanced a taxpayer bill of rights argument, which tend to be uphill battles against the state. Essentially, the taxpayer claimed that the Department has an obligation to disclose any discovered overpayments of tax during an audit. While there was an audit and an overpayment, the ALJ determined that the Department never discovered it during the assessment audit. As a result, the remaining $350,000 refund was denied.
This case highlights the difficulty that goes along with making refund claims. It serves as a reminder that if there is a chance of a refund, file it early because administrative courts tend to not give taxpayer’s the benefit of the doubt. Further, it also serves as a reminder that if you are buying tobacco from anyone other than a manufacturer and paying state tax on that price, you might be due a significant refund.
About the Author: In his law practice Mr. Donnini's primary practice is multi-state sales and use tax as well as state corporate income tax controversy. Mr. Donnini also practices in the areas of federal tax controversy, federal estate planning, Florida probate, and all other state taxes including communication service tax, cigarette & tobacco tax, motor fuel tax, and Native American taxation. Mr. Donnini obtained his LL.M. in Taxation at NYU. Mr. Donnini is licensed to practice law in Florida. If you have any questions, please do not hesitate to contact him via email [email protected] or phone at 954-639-4496