taxes

Cigar & Tobacco Products Tax Manual

Chapter 4 – Audit Procedures for Texas Distributors

Internal Controls

As in any audit, test internal controls before proceeding with fieldwork. Randomly select six months to use as test months. Evaluate the taxpayer's process of recording purchases and reconcile the amounts to the summary records and to the reports. Analyze the effect of any discrepancies. If adjustments are necessary, decide whether to proceed in detail or to consider a sample and projection.

Purchases

One of the most important elements of auditing distributors is verifying that all cigars and other tobacco products acquired have been reported and can be accounted for. Distributor's and manufacturer's reports are used to facilitate a reconciliation of reported products.

Distributor's and Manufacturer's Reports

Each distributor submits a "Texas Distributor Monthly Report of Cigar and Tobacco Products" (Form 69-133), effective 09/01/2009, which reflects all purchases and sales of tobacco products by class. They also file a monthly supplemental report entitled "Distributor Receiving Record of Cigar and Tobacco Products" (Form 69-136), effective 09/01/2009. This receiving report lists the manufacturer, received date, invoice number and number of cigars or the value of the other tobacco products for each purchase. This report can be used as a starting point for verifying cigar and tobacco purchases.

As of September 1, 2009, Class A was discontinued and Class W was established to change the tax base from 40% of manufacturer's list price to weight based reporting with tax change amounts each fiscal year. Form 69-134, Texas Distributor Monthly Report of Cigar and Tobacco Products Class W worksheet, was added to the required monthly reports.

The Class W worksheet categorizes tobacco purchases in two categories, number of packages and total ounces. There are five types of Class W loose tobacco including chewing tobacco, snuff, pipe tobacco and roll-your-own and other.

Each type of Class W loose tobacco is included on Class W worksheet and are categorized as either:

  • 1.2 ounce or less packages, are totaled by number of individual packages
  • Packages greater than 1.2 ounces are totaled by the total ounces of individual packages, rounded to the nearest one-hundredth of an ounce.

Manufacturers report the product they ship to Texas distributors on a monthly basis. There is no set form for these reports. The reported numbers can no longer be obtained using CICS and the inquiry XIRPTS for the four largest tobacco manufacturers. The larger manufacturers began sending electronic reports, instead of tape, in 2010. Currently, the manufacturer reports are being received in spreadsheet and/or pdf format and are available by contacting Audit Headquarters. Most current and historical manufacturer's reports may be viewed through the Filenet imaging system using the applicable DLN number. The DLN number can be obtained using CICS and the inquiry MTIGDI.

Product Class Definitions

Distributors must report based on the classification of the cigar or tobacco product. The classifications are:

  • Class A: Tobacco including snuff, pipe tobacco, twist, plug, and chew (prior to 09/01/2009)
  • Class W: Tobacco includes snuff, pipe tobacco, twist, plug, chew and roll-your own (effective 09/01/2009)
  • Class B: Little cigars with a weight of not more than 3 pounds per thousand.
  • Class C: Cigars weighing more than 3 pounds per thousand selling for 3.3 cents or less each.
  • Class D: Cigars weighing more than 3 pounds per thousand of natural leaf selling for over 3.3 cents each.
  • Class F: Cigars weighing more than 3 pounds per thousand of substantial non-tobacco filler selling for over 3.3 cents each.

Product Class Reporting Definitions

Class A tobacco reported by taxable value. (prior to 09/01/2009)

Class W tobacco (effective 09/01/2009) reported by weight and has two categories:

  • Packages weighing 1.2 ounces or less packages reported at a tax rate equal to a 1.2 ounce package
  • Packages weighing greater than 1.2 ounces reported at a tax rate per ounce and fractional parts of an ounce.

Class B – F cigars reported by volume or number of cigars.

Reconciliation of Reported Cigars and Other Tobacco Products

As mentioned in Chapter 2, Pre-Audit Research, the auditor should prepare a Manufacturer's Comparative Reconciliation prior to starting fieldwork. Using the 6 month sample selection, a list of exceptions will be prepared by the auditor during the pre-audit a review of invoices of shipments. The purchase exceptions listed will be examined during the initial fieldwork.

Complete as much of the reconciliation of the reported amounts to the comparative statements as possible. Then trace the differences to purchase invoices and related bills of lading. Sometimes differences occur because an order is short due to damaged cases that were returned to the manufacturer. The distributor may maintain other internal receiving records that are beneficial in tracing the actual total received. If receiving reports appears to be incomplete, use purchase journals and general ledgers to supplement the available information.

Prepare a schedule of any discrepancies by invoice and bill of lading. Obtain copies of invoices and bills of lading to support shortages, damaged products, or clerical reporting errors, if possible.

Promotional Incentives

Manufacturers sometimes give a distributor an allowance on the invoice which lowers the price the distributor pays for the product. This allowance, called a promotional incentive, may take many forms. An example of a promotional incentive is "buy one get one free" or "buy two save 50 cents." Another example is 25 cents or 50 cents off the list price. These incentives typically apply to Class A tobacco products.

Prior to September 1, 2009, per Section 155.0211 of the Tax Code, tax was imposed on the manufacturer's list price exclusive of any trade discount, special discount, or deal. A common error is reporting the purchase price net of the promotional incentive. An important audit procedure is to verify that the manufacturer's list price is reported. For example, if a promotional incentive is "40 cents off" and the invoice is for $2.60 per item, verify the item was reported at $3.00.

In the past, manufacturer's such as Conwood, National Tobacco and Swedish Match gave promotional incentives of 25, 40 or 50 cents off the list price. Although they have discontinued this type of incentive, some of the promotions may be found at the beginning of the audit period.

Promotional incentives may still be given to the distributor by the manufacturer, but these only affect the tax base for Class A tobacco and audit periods through August 31, 2009, with the report being due on September 30, 2009. Beginning with September 1, 2009, report due October 31, 2009, promotional incentives do not affect the tax base for Class W tobacco, under the weight based reporting.

A common reporting error for Class W tobacco:

A distributor may be reporting Class W, other tobacco products, by type of product, in ounces only.

1.2 ounce or less packages should be reported by total volume of those individual packages, by product type, commonly known as "eaches."

Packages of Class W, other tobacco products packages weighing over 1.2 ounces, should be reported by total ounces of all packages.

Totaling packages 1.2 ounces or less and reporting under the ounces category will under report tax on these packages. 1.2 ounce or less packages are taxed at the effective rate of an individual 1.2 ounce package.

Deductions

Another important element of auditing distributors is verifying reported deductions. Each distributor is required to keep records of all cigar and other tobacco products sales and exemption forms for a period of at least four years.

Tax code section155.110, was amended by Senate Bill 1, 82nd Legislature, 1st Called Session to require taxpayers to keep their records open for inspection for at least four years, and with respect to records related to a taxpayer's claim, longer than four years during any period when tax, penalty or interest may be assessed, collected or refunded by the Comptroller or while an administrative hearing or judicial proceeding is pending.

Allowed deductions for distributors include sales to Native American Reservations and Federal organizations. Deductions are also allowed for interstate sales and cigars and other tobacco products lost in shipment.

Sales into Interstate Commerce

Each sale of cigars and/or tobacco products in interstate commerce by a distributor must be accompanied by a Distributor Report of Interstate Sales of Cigar and Tobacco Products (Form 69-135). The number of cigars or value of tobacco products reported should include only those sold or distributed in interstate commerce.

Sales to Native American Reservations and Federal Organizations

Each sale of cigars and tobacco by a distributor to a Native American Reservation or a Federal organization must be supported by a separate sales invoice and a properly completed Texas Certificate of Tax Exempt Sale (Form 69-315). Verify these documents during fieldwork.

Cigars and Other Tobacco Products Lost in Shipment

This category includes cigars and other tobacco products that are listed on shipping documents but were not with the shipment when received at the distributor's location. To take the deduction, the distributor must first report the number of cigars and/or value of tobacco products on their return. In most cases, the distributor will make a note on the shipping document to file a claim with the manufacturer and report the number of cigars and/or tobacco product which they actually received (report the invoice short). Documentation from the manufacturer showing credit for the tobacco product not received should be available to substantiate the deduction. A tax affidavit will not be issued for product lost in shipment. Deductions for products lost in shipment may be denied if credit memos are not available for review by the auditor during fieldwork.

Cigars and Other Tobacco Products Returned to the Manufacturer

The distributor must return stale and/or damaged products to the manufacturer. The manufacture will issue a credit memo and tax affidavit form. The distributor should complete a "Tobacco Products Worksheet" (Form 69-114) and send the worksheet, along with the tax affidavit form, to the Account Maintenance section of the Comptroller's office. Account Maintenance will issue to the distributor an "Authorized Credit Letter." After receipt of the letter, the distributor may take the authorized credit on their return (line 13). Authorized credits are limited to the net amount due on line 12 of the return. The Authorized Credit Letter must be attached to the return to support the credits claimed. Accounts Maintenance keeps track of available credits and used credits. Credits should not be given in the audit for tobacco products returned to the manufacturer.

Sampling

Prior to September 1, 2009, the most common error in a tobacco audit was reporting Class A tobacco net of promotional incentives. We do not sample this particular error. Due to the nature of the various promotional incentives available to distributors, it is necessary to perform a detailed audit on this error. Sampling procedures may be used on errors related to Class W tobacco and cigar purchases.

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(Revised 07/2012)