California Proposes Significant Revisions to Sales & Use Tax Statistical Sampling Audit Policies and Procedures

The California Department of Tax and Fee Administration held its second interested parties meeting concerning the Department’s proposed revisions to its sales and use tax Audit Manual Chapter 13 (Statistical Sampling) and Chapter 4 (General Audit Procedures).  The Department relies on statistical sampling during audits of large taxpayers to determine and project audit errors.  The meeting and comments focused primarily on three proposed revisions by the Department: (1) elimination of the three-error rule; (2) treatment of progress payments; and (3) nonrecurring errors.Capture-300x64


Three-Error Rule

Most significantly, the Department proposed eliminating the three-error rule.  Historically, if a sample test did not result in at least three errors, the auditor was directed not to project two or less errors for the selected strata.  The Department’s position, which appears unlikely to change, is that there is no basis for the three-error rule—that the proper selection of the strata, sample size, etc., should not require ignoring one or two errors.  Also, the Department contends elimination of the rule will permit the selection of smaller sample sizes.

Progress Payments

The meeting participants also discussed the proper treatment of progress or installment payments that arise as an error in a sample.  For example, should the selected payment amount be ignored, should only the selected payment be projected, should the selected payment be removed from the sample errors and the entire transaction reviewed on an actual basis, or should the entire transaction related to the progress payment be treated as an error and be projected?  Among the many possible alternatives, the Department proposed projecting the entire transaction value if title has transferred by the time the selected progress payment was made and ignoring the selected progress payment if title has not passed.  For instance, if a $200,000 progress payment arises as an error in a sample and it is determined title has passed, then the entire $1,000,000 transaction should be projected.  If title has not passed, then the error is ignored.

Nonrecurring Errors

Finally, the discussion focused on the proposed treatment of a purported nonrecurring error.  The Department, concerned with how a taxpayer could establish a particular error item is indeed nonrecurring, is of the opinion that there is no reason to exclude nonrecurring errors because there may be other purported nonrecurring items outside of the sample.


The Department expects to finalize and publish the revisions to its Audit Manual by March 31, 2023, with the revisions becoming operative thereafter for audits that have not yet held their opening conference by April 1, 2023.  Written comments regarding the Department’s proposed amendments or suggestions for additional amendments to the Audit Manual are due by February 15, 2023.