IFTA/IRP AUDIT WORKSHOP 2010 FUEL TAX EVASION DISCOVERY TECHNIQUES

DEFINITIONS Before we can begin to understand how to identify fraud or tax evasion, we need to explore what constitutes fraud or tax evasion. It is critical to understand that instances of fraud are rare and not easily proven. It is equally important to identify the differences between fraud and negligence.

DEFINITIONS NEGLIGENCE. The ‘Lectric Law Library defines negligence as “The failure to use reasonable care. The doing of something which a reasonably prudent person would not do, or the failure to do something which a reasonably prudent person would do under like circumstances. A departure from what an ordinary reasonable member of the community would do in the same community.

NEGLIGENCE Some thoughts on negligence: –Failure to do something (or comply with prescribed rules) does not constitute (necessarily) an intent to do so for personal gain. –Negligence is generally not purposeful or deliberate in its intent. –Negligence indicates an absence of using reasonable care.

DEFINITIONS FRAUD OR INTENT TO EVADE. West’s Encyclopedia of American Law defines fraud as “A false representation of a matter of fact-whether by words or by conduct, by false or misleading allegations, or by concealment of what should have been disclosed-that deceives and is intended to deceive another so that the individual will act upon it to her or his legal injury.”

FRAUD Fraud has been further defined as “A deception deliberately practiced in order to secure unfair or unlawful gain.” Proving the existence of fraud requires a high degree of specific evidence. Generally, fraud must be proven by illustrating that the subject party’s actions contained five separate elements per West’s: –A false statement of a material fact –Knowledge on the part of the subject that the statement is untrue –Intent on the part of the subject to deceive the victim –Justifiable reliance by the victim on the statement –Injury to the victim as a result

FRAUD The five elements identified in West’s contain nuances that may not be easily proven. For example, not all false statements are fraudulent. A false statement must relate to a material fact. A false statement that is mistaken is not fraudulent. To be considered fraudulent, a false statement must be made with an intent to deceive the victim. The false statement must be made with the intent to deprive the victim of some legal right. The victim’s reliance on the false statement must be reasonable. Reliance on an absurd false statement will not generally support the notion of fraud. The false statement must cause the victim some injury that leaves the victim in a worse position than she or he was in before the fraud.

Negligence vs Fraud With those definitions in mind, here’s some basic differences between negligence and fraud: Negligence: –Generally not purposeful –Generally not deliberate –Not designed to deceive for gain –Indicates an absence of reasonable care Fraud: –Deliberate deception –Intent to deceive for personal gain –Intent to deprive the victim of some legal right –Knowledge that the false statement is untrue

EXAMPLES Negligence –Failure to maintain certain records or data elements (i.e. odometers or routes of travel) –Misallocation of jurisdictional distance (i.e. the discovery of typical error rates) –Missing data Missing retail fuel receipts Missing trip records –Mathematical errors –Poorly maintained records –Gap distance identified –Missing bulk fuel withdrawals –Missing information on fuel receipts (i.e. jurisdiction, fuel type, etc.) –Exemptions taken in error

EXAMPLES Fraud –NOTE: Keep in mind that the list below may not necessarily indicate fraud; the 5 fraud “elements” must exist and be proven Erasures, alterations to fuel receipts “Manufactured” fuel receipts (see Case History #1) Discovery through independent verification that the subject’s tax return and records are false and untrue (see Case History #2) Filing “no activity” returns Discrepancies in distance documents (i.e. entries on various documents do not match) Documents that appear legitimate but cannot be based on clear evidence (see Case History #3) Tax returns filed where the supporting documents either maintained or discovered show an entirely different result. NOTE: This is different than an incorrectly filed return. This is the discovery of a “manufactured” return that deliberately results in a lower tax liability (this must meet the “5 elements of fraud” test).

CASE HISTORY #1 The taxpayer purchases fuel at retail locations. Several receipts appear legitimate (they contain all of the information required under P560). These receipts are generated electronically (i.e. through the use of “swiping” a credit card). Other fuel receipts have hand written information (the receipt is pre-printed). The auditor discovers these “receipts” in every period subject to audit. The jurisdiction in which the fuel was “purchased” has one of the highest tax rates of the jurisdictions in which the fleet traveled. The “hand written” receipts include fuel that would not normally need to be purchased (the interval between fuelings is suspect). The auditor independently contacts the jurisdiction in which the fuel was “purchased” to determine whether the retail location exists. The auditor discovers that no such location existed during the subject period.

CASE HISTORY #1 Do we have fraud? Let’s use the “5 elements” to test the theory: –Is the false statement a material fact? The discovery of multiple “receipts” in each period subject to audit would be material. –Did the subject have knowledge that the statement is untrue? It would appear so; the receipts were manufactured and not representative of an actual purchase. –Was there an intent to deceive the victim? There are multiple victims; the base jurisdiction, the affected jurisdictions, and most importantly, the jurisdiction in which the suspect “purchases” were made. By deliberately constructing these “receipts”, there is a clear intent. –Was there justifiable reliance by the victim to believe the statement? Yes, as a general rule a fuel receipt is relied upon to be accurate and valid. –Was the victim injured by the action? Yes, the jurisdiction in which the “purchase” occurred granted credit (initially) for purchases that had never happened. Therefore the tax liability in that jurisdiction was reported and presented as less than which was actually owed. In this case, it would appear that there are sufficient grounds to indicate that a fraudulent act had taken place.

CASE HISTORY #2 A taxpayer files tax returns with either no activity or very limited activity outside of the base jurisdiction. The taxpayer admits that he does not maintain any odometers or traditional trip records. He says that all of his fuel is bought at retail in the base jurisdiction. His “trip records” consist of invoices he generates to bill his customers (it has the location of deliveries and/or pickups). He uses a distance software to determine total and jurisdictional distance. The auditor performs the audit and comes up with a no change. Several months later, the bookkeeper for the company calls the auditor and informs him that the company wasn’t truthful about their operations. She claims that the company’s vehicles travel in numerous jurisdictions that are never reported on a tax return. She claims that there are numerous invoices (at least three per week) that were never presented to the auditor. She admits that no odometers are maintained and claims that fuel receipts associated with these “unreported” trips were deliberately withheld from the auditor. She tells the auditor that the fuel receipts can be tracked through the company’s credit cards. She gives the auditor the names of several customers that are for the trips that were never disclosed. The auditor follows up independently with these customers and they provide the auditor with their copies of the invoices they received from the taxpayer.

CASE HISTORY #2 Do we have fraud? Let’s use the “5 elements” to test the theory: –Is the false statement a material fact? The discovery of multiple withheld trips each period subject to audit would be material. –Did the subject have knowledge that the statement is untrue? It would appear so; the unreported trips (invoices) were withheld from the auditor. –Was there an intent to deceive the victim? There are multiple victims; the base jurisdiction and the affected jurisdictions. Deliberately not presenting these invoices and failing to report the activity on the tax returns indicates that there is a clear intent to deceive. –Was there justifiable reliance by the victim to believe the statement? Yes, despite the inadequate recordkeeping the jurisdictions believed that the returns were true and correct; the documents presented verified what had been reported on the returns. –Was the victim injured by the action? Yes, the jurisdictions in which the unreported travel occurred did not receive the fuel use tax associated with that travel. In this case, it would appear that there are sufficient grounds to indicate that a fraudulent act had taken place. The independent verification with third parties serves as substantial evidence that fraud had occurred.

CASE HISTORY #3 Taxpayer has a 5,000 gallon bulk fuel tank. The tank is metered with a very elaborate computer system that tracks all receipts and disbursements. The system also maintains an inventory. Weekly and monthly reports can be generated to account for all activity related to the tank. The withdrawal records detail the vehicle being fueled in addition to the date, gallons and all information required under P570. The taxpayer receives a metered ticket from the fuel supplier and a weekly invoice for all purchases made. The taxpayer reports fuel on the IFTA return based on the withdrawal reports. The auditor vouches the purchase invoices and metered tickets from the fuel supplier against the data recorded by the computer fuel inventory system. The auditor discovers that there are several fuel purchase invoices that cannot be traced to an actual delivery into the bulk tank (through the computer system). The auditor finds that of the four weekly deliveries of fuel, one “delivery” isn’t accounted for in the computer system. The auditor asks for the cancelled checks for all of the purchases and finds that the checks for the questionable “purchases” are made out to the name of the fuel supplier but endorsed by the owner of the fuel company. The bank account is different than that of the checks made out for the other three (legitimate) purchases.

CASE HISTORY #3 Is this fraud? Were the IFTA returns filed fraudulently by the taxpayer? If so, how? The answer to this case is that there was no apparent wrongdoing by the IFTA licensee. The IFTA returns (fuel) was based on the specific withdrawal records which were clearly accurate and could be verified. Then, was it fraud at all?

CASE HISTORY #3 Yes, it was fraud; but of a different kind. The party that was defrauded was the IFTA licensee. They paid for fuel “purchases” that they had never actually received. The party that perpetuated the fraud was the fuel supplier. Let’s test the theory that this is fraud by using the “5 elements”:

CASE HISTORY #3 –Is the false statement a material fact? The discovery of weekly “deliveries” of fuel that had never occurred is material. –Did the subject have knowledge that the statement is untrue? It would appear so; by issuing a delivery ticket and a corresponding invoice and by accepting payment the subject clearly had knowledge that the statement was untrue. –Was there an intent to deceive the victim? Yes, by presenting the carrier with a metered ticket and an invoice for the “purchase” there was a deliberate attempt to make the “phony” delivery look like every other purchase. –Was there justifiable reliance by the victim to believe the statement? Yes, since many of the deliveries were in fact traceable and the documents presented looked exactly the same as those presented for the legitimate purchases, the victim relied on the fact that the fourth “purchase” was also legitimate. –Was the victim injured by the action? Yes, the carrier paid for fuel that they never received.

POSTSCRIPTS Case History #1 –The audit resulted in an increase to the fleet MPG (since the phony receipts were not actual fuel purchases). The audit resulted in a substantial reduction of the tax paid credit taken in the jurisdiction the “purchases” were claimed to have been made. The penalty for intent to evade was applied and enforced. Case History #2 –The audit resulted in the inclusion of distance in each jurisdiction through which the fleet traveled for the withheld invoices. The audit revealed fuel purchases that had not been reported. Credit was given where applicable. The fleet MPG was established at 4.00 because the auditor was uncertain that even with the tip from the bookkeeper he had seen all of the activity. The penalty for intent to evade was applied and enforced.

POSTSCRIPTS Case History #3 –While there was no impact upon the IFTA audit, the discovery of fraudulent activity led the auditor to refer the issue to the motor fuel tax section to follow up on the supplier’s reporting of taxable sales. There is also a pending investigation on possible state and federal personal income tax implications (since the aberrant payments were endorsed by the fuel supplier’s owner and deposited into what appears to be a personal bank account). The fuel must have been delivered somewhere; the Department is following up leads to determine where the fuel may have actually been delivered. As a final thought, the taxpayer has estimated that he has overpaid for his fuel by as much as $800,000 over the past 8 years or so. Approximately $100,000 per year was “minimal” given how much fuel the carrier buys over the course of a year in both bulk and retail (the carrier spends over $1 million per year). This case is still pending.