Chapter 7 - Tobacco tax

Issued: 2014/02; Revised: 2019/06/15

Overview

Wholesale dealers and retail dealers of tobacco pay tobacco tax security on tobacco they obtain for sale. The security is equal to tobacco tax that applies when the tobacco is sold to a consumer. A tobacco tax retailer collects, and in most cases retains, tobacco tax when the dealer sells tobacco to a consumer. The tobacco tax security scheme is similar to the motor fuel and carbon tax schemes.

Returns and remittances are reviewed for accuracy by the tobacco section in Victoria.

Due to the unique nature of tobacco tax audits, the auditor should check with their supervisor and the industry specialist for advice before starting any work. 

Audit risk areas – Tobacco tax (TT)

The following are some of the common risk areas related to this industry. This is not an exhaustive list.

Accounting records

Some retail dealers do not maintain accounting ledgers or documented inventory control systems. Such dealers tend to operate on a 'cash and carry' basis.

Retail dealers who purchase tobacco products from registered wholesale dealers may have invoices or cash register receipts from the wholesale dealers. However, invoices and receipts from wholesale dealers may not show TT as a separate item. 

Every collector must, on or before the 20th day of each month, file a return in respect of the previous month and remit all tax and security computed on that return. A collector whose accounting periods do not coincide with a calendar month and are not longer than five weeks can apply for permission to report and remit tax and security on or before the 20th day following each of those periods. 

Whenever there is a tobacco tax rate change, retail dealers and wholesale dealers who, at the time of the change, hold inventory on which they paid security must file inventory reports and remit the difference between security they paid on the inventory and security they calculate on the inventory based on the new rate. The wholesale dealer must complete the Wholesale Dealer’s Inventory Return form (FIN 227) and the retail dealer must complete the Retail Dealer’s Inventory Return form (FIN 225). 

Audit objectives

The primary objectives of TT audit are:

• To verify TT has been correctly accounted for by the dealer 
  • For example, every dealer who is not a collector and who buys tobacco from a person other than a collector must prepare a report giving particulars of the purchase and forward the report, together with all taxes collected with respect to the tobacco, to the director within 20 days of the retail sale of the tobacco. Failure to do so can be grounds for an assessment and penalty
•  To verify the calculation and remittance of TT on tobacco inventory during tax rate changes are correct
•  To verify the calculation of TT on cigars (based on taxable price) is correct
•  To resolve any discrepancies noted during a desk audit or field audit
• To raise a proposed assessment if non compliance is noted

Audit procedures

General

• If auditing a wholesale dealer, confirm the wholesaler is in possession of a valid wholesale dealer permit issued under Tobacco Tax Act (TTA) regulation 4 or (if the dealer sells only cigars) a valid permit issued under TTA regulation 5
• Review the dealer's compliance history. Check whether the dealer's authority to sell was, or is currently, under suspension, or was cancelled during the audit period
• Review the retail dealer's audit history

Wholesale dealers

• Review records of wholesalers to ensure the security equivalent to tax has been reported and remitted
• Review inventories to ensure there is segregation between tax paid tobacco and unmarked (non tax paid) tobacco
• Review purchase invoices from manufacturers and reconcile them with the reported amount purchased to ensure the amount of security calculated is correct
• Review TT remittances
• If the dealer stores particular tobacco products in and outside B.C., review calculations and remittances of tax and security that applies to the products stored in B.C.
• Review wholesale dealer sales of tobacco products to customers located outside the province
• Review TT credits generated from returns of tobacco to manufacturers

Retail dealers

1. Determine the audit period

To determine the audit period, it is important to look at a number of factors, including:

• Start of business date
• Close of business date 
• End date of previous audit
• Sale of business date

If another audit has been conducted on the retail dealer, the audit period for the current audit will begin on the day after the other audit period end date. If there have been no previous audits on the retail dealer but there has been at least one seizure of contraband tobacco, the start date of the audit period will be the date of the first seizure of contraband tobacco. The start date can be earlier if the taxpayer's purchase records from before the first seizure of contraband tobacco indicates the purchase of contraband tobacco prior to the first seizure. Once the audit period has been determined, the number of days in the audit period must be calculated.

2. Conducting the audit

Tobacco product inventory has a high rate of turnover. Generally, a retail dealer's tobacco product purchasing trends mirror the retail dealer's tobacco products sales volume.

Select a period of relative stability from the compiled schedule of tobacco product purchases. Determine the average daily purchase volume. Compare that average daily volume to the audit period and note periods that show significantly low or high volumes of purchases.

If the dealer sold at retail tobacco the dealer purchased from a supplier other than a collector, ensure that the dealer reported and remitted the applicable tax within 20 days of the sale.

The tobacco section regularly conducts desk audits of taxpayers with stamping privileges. Consequently, a routine audit of a retail dealer will not involve reconciling indicia inventory with tobacco sold.

3. Calculating an assessment

The auditor’s main concern is whether the retail dealer's tobacco products were purchased from an authorized wholesaler and that the security was paid.

The audit and refund steps for retail dealers of tobacco products must be tailored to each business. Procedures can't be easily generalized. The auditor will have to evaluate each case independently. Information may not be available or reliable. The auditor may need to gather information from sources other than accounting records.

Evidence to support an audit assessment may come in many forms, such as files from RCMP referrals, special investigation reports, tobacco inspection reports, tobacco seizure reports or video tapes, and court decisions. The TTA requires the auditor to assess the dealer if it appears the dealer did not comply with the act, and it puts the onus of proving otherwise on a dealer who is liable to pay an amount assessed or levied. The policy is to have supporting evidence beyond a reasonable doubt before we assess.

Method of calculating an assessment on a retail dealer:

• Totaling cashier tapes and other sales records seized by police for illegal tobacco sales
• Average on hand inventory (total weight of tobacco seized / number of seizures) X number of days (period when inspectors found illegal tobacco on a regular basis) - the quantity of tobacco seized = the total tobacco sold without TT in the period. The quantity sold x tax rate = audit assessment
• Totaling amounts shown on airway bills for similar boxes received by the person who was arrested for illegal tobacco shipment

The above represents only some of the common methods of calculating assessments. The auditor must use whatever information is available and reasonable in the circumstances as the audit assessment may need to be defended at the ministerial appeal level and possibly in court.

Finalizing the audit 

Use the already created schedules to enter information into the relevant audit working papers in TACS. Ensure any schedules created outside of TACS are attached to the relevant audit case.

Upon completion of an audit, review all results with a senior representative of the firm who has the authority to agree with the proposed assessment. If the contact person for the audit is not the senior representative, the auditor should request both individuals be present during the review.

Refunds

Generally the following formula is used for refunds: 
Open inventory + purchases - sales = ending inventory

The auditor can use the inventory counts by inspectors or the accounting records provided by the dealers. In addition, the auditor may ask for a police report, insurance claim forms and payment records. A trend analysis of purchases by the dealer prior to, and after, the theft can help the auditor to determine whether the dealer may have sold tobacco the dealer claims was stolen.

Relevant information

• Tobacco tax