CIRIACO GATTA v. DIRECTOR, DIVISION OF TAXATION

            NOT FOR PUBLICATION WITHOUT APPROVAL OF
              THE TAX COURT COMMITTEE ON OPINIONS

_______________________________
                               :
CIRIACO GATTA, MARIE           :              TAX COURT OF NEW JERSEY
GATTA, & MARIA GATTA, LLC,                   DOCKET NO: 008649-2016
                               :
               Plaintiffs,     :
                               :
               vs.             :
                               :
DIRECTOR,                      :
DIVISION OF TAXATION,          :
                               :
               Defendant.      :
_______________________________:


            Decided: December 14, 2018.

            Scott E. Becker for Plaintiff.

            Heather Lynn Anderson for Defendant (Gurbir S. Grewal, Attorney
            General of New Jersey, attorney).


CIMINO, J.T.C.

      The Director of the Division of Taxation filed for summary judgment as to the

taxpayer Maria Gatta, LLC’s challenge to a sales tax audit determination. 1 For the



 1
  There was also a “spin-off” audit of Ciriaco Gatta and Marie Gatta as to gross
income tax.
                                        -1-
reasons set forth herein, the court determines that there are sufficient facts in dispute

to preclude the entry of summary judgment.

      The taxpayer, Maria Gatta, LLC, is an Italian-style restaurant trading as the

Red Room Cafe, located in the shore-side community of Ventnor immediately south

of Atlantic City. The taxpayer was audited for the final three quarters of 2009

through the first quarter of 2013. When the taxpayer failed to, or could not, provide

adequate books and records, the Director resorted to what is commonly called a

mark-on method, which essentially allows the Director to extrapolate sales based

upon a comprehensive review of a sample period which is then applied to the entire

audit period.

      Typically, the sample period is within the audit period. However, it has to be

remembered that on October 29, 2012, the New Jersey seashore areas, including

Ventnor, suffered damage from Superstorm Sandy. As a result, the taxpayer’s

records were lost. The last quarter of the audit period was the first quarter of 2013.

With considerable damage from the storm, it is understandable why the Director did

not use the first quarter of 2013 for the sample period since it may not be fully

representative of the prior audit periods.




                                             -2-
      Rather than selecting a sample period within the audit period, the Director

selected the first quarter of 2014.2 While the goal of the Director is to perform a

comprehensive review for the selected sample period of both the product cost (with

adjustment for inventory) as well as total sales, the taxpayer failed to provide

complete purchase invoices for the first quarter of 2014. The taxpayer also did not

provide sufficient information to determine the mix of menu items sold.

      Undeterred, menus were obtained from the taxpayer, and the Director’s

auditor, using his expertise and experience, approximated the proportion which each

menu item constituted towards total sales by multiplying the quantity of each menu

item sold times the selling price. This approximation consisted of $56,360.17 of

sales. It is unclear what period of time this approximation represents (i.e., weeks,

days, hours).

      For each menu item, the auditor listed the main ingredient, as well as a general

listing of supplementary ingredients. The unit prices of said ingredients were

determined by the taxpayer’s invoices, and for ingredients that were not listed on the


2
   The court need not decide at this time whether the selection of the 2014 sample
period was representative of sales prior to Superstorm Sandy. Specifically, it will
remain for trial as to whether there were changes to the dynamics or to the
community subsequent to the storm. There has not be any evidence presented as to
this issue, one way or another. See Yilmaz, Inc. v. Dir., Div. of Tax’n,  22 N.J. Tax 204, 226 (Tax 2005), aff’d,  390 N.J. Super. 435,  23 N.J. Tax 261 (App. Div. 2007)
(each audit period stands on its own). Compare Id. at 238 (use of invoices from
period later than audit reasonable), Kramer v. Dir., Div. of Tax’n,  24 N.J. Tax 105,
109, 113-14 (Tax 2008) (use of previous audit records reasonable).
                                         -3-
invoices because the invoices were incomplete, the auditor relied upon his expertise

in determining the unit prices (i.e. price per pound) for each item. The auditor then

multiplied the unit price of each ingredient by the amount each item was used in the

mix of menu items as determined by the auditor. This resulted in the Director

determining that it cost the taxpayer $11,323.32 for $56,360.17 of menu items

served.

      Dividing the $56,360.17 in sales by $11,323.32 in costs results in a mark-on

ratio of 4.98. After accounting for beverages, spoilage and other loss, the mark-on

was adjusted to 4.891062.3 With the mark-on ratio, the Director was able to multiply

the total product cost as reported on taxpayer’s audit period tax returns (second

quarter of 2009 through first quarter of 2013) by the ratio of 4.891062 to arrive at a

total audited sales amount.

      For the audit period in question, taxpayer reported $1,037,643 in taxable sales

resulting in sales tax remitted of $72,635. The product cost for the same period

according to taxpayer was $634,288.4 Based upon the taxpayer, this would place the



3
   The Director’s audit papers indicate spoilage and other loss to be ten percent.
However, the actual calculation in the audit papers is closer to twelve percent. For
purposes of consistency, the court utilized the latter amount in its calculations set
forth later in the opinion.
 4 The amounts for 2009 and 2013 were temporally adjusted proportionally to reflect
less than four full quarters. For example the audit period for 2009 covered three
quarters. Thus, the auditor adjusted his numbers to seventy five percent of the total.
                                         -4-
mark-on ratio at 1.64. However, the Director multiplied the total product cost of

$634,288 by the mark-on ratio he determined to be 4.891062. This resulted in an

audited sales amount of $3,102,342 and total sales tax liability of $217,164 at the

seven percent sales tax rate. Since taxpayer only remitted $72,635 in sales tax, the

Director issued a deficiency for $144,529 plus interest and penalties.

       Taxpayer challenges the mark-on ratio based upon the data used for portions,

product cost and selling price as well as a number of missing ingredients in the

compilation of menu items compiled by the Director. However, a taxpayer cannot

hope to avoid taxation by failing or refusing to provide or maintain adequate books

and records. Moreover, a taxpayer cannot expect to obtain some sort of advantage

by not maintaining or providing adequate books and records.

       Long ago, when the Legislature adopted the Sales and Use Tax Act, it

anticipated that situations would arise in which taxpayers had insufficient or

incorrect records. To that end, the Legislature plainly provided “[i]f a return required

by this act is not filed, or if a return when filed is incorrect or insufficient, the amount

of tax due shall be determined by the director from such information as may be

available. If necessary, the tax may be estimated on the basis of external indices,

such as stock on hand, purchases, . . . location, scale of . . . charges, comparable . . .

charges, type of . . . service, number of employees or other factors.”  N.J.S.A.

54:32B-19. In other words, the Director is given broad discretion in reaching the


                                            -5-
amount of tax which is due and owing. This information may be obtained “from the

seller or from any other source.” N.J.A.C. 18:24-2.15(b). Likewise, “[i]t is a well

established principle, that where the records are deemed insufficient, 'the Director

is given broad authority to determine the tax from any available information and, if

necessary, to estimate the tax from external indices.’” Coliseum Pizzeria, Inc. v.

Dir., Div. of Tax’n,  24 N.J. Tax 369, 375 (Tax 2008) (quoting Yilmaz, Inc. v. Dir.,

Div. of Tax’n,  390 N.J. Super. 435, 441,  23 N.J. Tax 361, 366 (App. Div. 2007)).

      To that end, “the Director’s assessments of tax are presumed to be correct and

the plaintiff has the burden of overcoming the presumption.” Yilmaz,  390 N.J.

Super. at 440,  23 N.J. Tax at 366. It has long been held that a mere naked assertion

by taxpayer is insufficient to rebut the presumption. Ridolfi v. Dir., Div. of Tax’n,

 1 N.J. Tax 198, 202-03 (Tax 1980). See also Yilmaz,  390 N.J. Super. at 440,  23 N.J.

Tax at 366.

      The power conferred by the Legislature upon the Director in setting the

amount of tax due is not absolute. As has been oft-stated, the government in dealing

with the taxpaying public, must turn square corners. F.M.C. Stores, Co. v. Borough

of Morris Plains,  100 N.J. 418, 426 (1985). In the context of sales tax audits, such

as the one before the court, this means that “the absence of adequate tax records does

not give the [Director] carte blanche to impose Draconian absolutes.” Duncan Truck

Stop, Inc. v. Dir., Div. of Tax’n,  4 N.J. Tax 367, 377 (Tax 1982). While the court


                                         -6-
recognizes the possible frustration of the Director and its auditors in attempting to

ensure that everyone pays their fair share, it is important to realize that the fair share

is a requirement for everyone regardless of the condition of their books and records,

or, their attempts to evade taxes. A wildly incorrect assessment could become a de

facto penalty on the taxpayer. The court is by no means suggesting that has occurred

here.    However, it is the Legislature that determines and has determined the

appropriate penalties. See, e.g.,  N.J.S.A 54:49-4(a) (underpayment penalty of five

percent);  N.J.S.A. 54:53-18, -19, -20 (failure to utilize amnesty penalty of five

percent);  N.J.S.A. 54:49-9.1 (civil fraud penalty of fifty percent).

        On the other hand, the taxpayer cannot expect an assessment to be exact, when

it is the taxpayer who has failed to provide the necessary records. An audit which is

merely imperfect is acceptable so long as it is not aberrant. Yilmaz,  390 N.J. Super.

at 442,  23 N.J. Tax at 368 (citing Charley O’s Inc. t/a Scotty’s Steakhouse v. Dir.,

Div. of Tax’n,  23 N.J. Tax 171, 186 (Tax 2006)). A naked assertion by the taxpayer

without support is insufficient to rebut an audit determination. Yilmaz,  390 N.J.

Super. at 440,  23 N.J. Tax at 366. The taxpayer needs to either set forth a

particularized issue concerning the data utilized or the soundness of the

reconstruction methodology. Coliseum Pizza,  24 N.J. Tax at 376. Such challenge

must consist of evidence that is definite, positive and certain in quality and quantity.

Yilmaz,  390 N.J. Super. at 440,  23 N.J. Tax at 366. As summarized by the Appellate


                                           -7-
Division, there must be evidence that the amount of the assessment is far wide of the

mark for the taxpayer to overcome the presumption. Yilmaz,  390 N.J. Super. at 441,

 23 N.J. Tax at 366. The Director does not have to establish that he used the best

possible method to estimate the taxpayer’s receipts, when it was the taxpayer’s

failure to comply with the statutory mandate of maintaining adequate records that

forced the Director to resort to the mark-on method in the first place. Yilmaz,  22 N.J. Tax at 235-36. The Director has wide latitude in fulfilling this mandate. Id. at

235.

       In this case, the audit period covered both periods before and after Superstorm

Sandy. The taxpayer alleges that the records were destroyed in Superstorm Sandy,

but fails to explain why it could not produce records for the periods after Superstorm

Sandy. What is troubling is that taxpayer, probably inadvertently, included amongst

its bank records a point of sale report from its computerized cash register system for

one particular quarter, which revealed that the taxpayer had $38,824 in credit card

sales and $55,877 in total sales. Curiously, the amount of sales tax reported for the

quarter only included the credit card sales. In other words, on this evidence alone,

the taxpayer underreported the amount of income by about a third for that quarter.

       It must be remembered in this case that, unlike Yilmaz which was a decision

after a trial, this is a motion for summary judgment in which all reasonable inferences

must be in the taxpayer’s favor. Brill v. Guardian Life Ins. Co. of Am., 142 N.J.


                                         -8-
520, 536 (1995). See Yilmaz,  22 N.J. Tax at 217-19. Moreover, one must remember

that taxation is a practical matter, never losing sight of common understanding and

experience. In re Estate of Lichtenstein,  52 N.J. 553, 569 (1968).

      The court does not have a problem with the approach which the Director has

undertaken to determine the fair amount of tax which is due and owing from the

taxpayer. Taxpayer’s records were woefully inadequate. The concern of whether

this lack of records was by choice, or the chance of Superstorm Sandy is irrelevant.

The actual concern is whether the tax assessed against the taxpayer is a fair

approximation of what is due and owing.

      The taxpayer failed to even provide a complete selection of purchase invoices

for a quarter. Accordingly, the Director should not be hamstrung as to completing

the mark-on procedure. Instead, the Director was forced to estimate sales based

upon the auditor’s common understanding and experience. There is no evidence in

the record for the court to quarrel with this method utilized, and there is nothing even

facially to challenge the method utilized. The Director is recognized as having a

certain expertise in dealing with the audit matters. Criticare, Inc. v. Dir., Div. of

Tax’n,  28 N.J. Tax 169, 183 (Tax 2014).

      As stated previously, the auditor went through the menu items one-by-one,

and listed their proportionate share of the total sales of the taxpayer. The taxpayer

has no reasonable expectation of the auditor doing something else, or avoiding


                                          -9-
taxation all together, by not providing sufficient documentation to arrive at some

other product mix. It has to be remembered that it is the taxpayer in the first instance

that controls this information, and not the Director. The Director can only do the

best that he can with the information that is available to him. In other words, this

estimation of menu item sales may be imperfect, but it is certainly not aberrant, and

therefore appropriate in these circumstances.

      As to the pricing of ingredients and menu items which the taxpayer failed to

provide invoices, the Director’s auditor can fairly price those ingredients based upon

experience. For example, none of the invoices provided list ground beef, an

ingredient which the taxpayer does not dispute it uses in some of its dishes. As a

result, the auditor, based upon his experience, utilized common market prices for

this item as well as other items which the taxpayer failed to provide invoices. Once

again, this may be imperfect, but is certainly not aberrant.

      However, the court does have some concerns about the list of ingredients

constituting the menu items. This does not go to the soundness of the reconstruction

methodology, but rather, it plainly appears that there are some particularized issues

concerning the data utilized. Coliseum Pizza,  24 N.J. Tax at 376. As it more

specifically pertains to this case, there is concern as to the lack of data utilized. A

review of the ingredients constituting the menu items from the menu itself, reveals

a number of significant items being overlooked. This is not by any means to suggest


                                         -10-
that every last pinch of salt must be included when the Director is reconstructing

product cost to determine a mark-on ratio. However, the omission of key ingredients

raises questions of the audit from a qualitative standpoint.

      The Director determined it cost $11,323.32 to serve up $56,360.17 of menu

items. The Director seemed to focus upon the major ingredient for each menu item

while not fully listing other ingredients which are key to the dish.

      For example, for the entrée veal saltimbocca, the auditor does not account for

prosciutto, a type of ham, and an essential ingredient to veal saltimbocca listed on

the menu. Needless to say, the prosciutto in pizza prosciutto is not included.

Another example is the entrée veal fungi [sic]. Funghi is the Italian word for

mushroom.      In any event, the menu lists mushrooms as an ingredient.               No

mushrooms are listed on the compilation of ingredients. There is also a caesar salad

listed, but not any listing for romaine lettuce, nor any type of lettuce.

      Some of the other items which are not listed, but are clearly part of the items

sold which are relied upon by the Director in formulating the mark-on include

romano cheese, parmigiano cheese, provolone cheese, eggplant, roasted peppers and

onions. Once again, this is not to say that it is necessary for the Director to list every

last pinch of salt utilized in every single dish. That would certainly be ridiculous

and unreasonable, and is made even more unreasonable by the taxpayer’s failure to

provide adequate books and records. However, there must be some reasonable


                                          -11-
attempt to capture essential food items utilized by the taxpayer to reach a fair

approximation of the taxpayer’s tax obligation. Not including the multitude of items

which were plainly listed on the menu relied upon by the Director calls into question

the accuracy of the approximation.

      While, the court accepts the proportionate mix of menu items as an

appropriate representation of sales, the court is concerned whether all substantial

ingredients in this menu mix were accounted for in the audit. Missing items increase

the mark-on and are magnified when applied to the full audit period.

      Through the extrapolation of the mark-on method, a small change in

ingredients can effect a large change in the amount of tax owed. In this case, the

mark-on ratio is 4.98, which the auditor adjusted for beverages, spoilage and other

loss to 4.891062.5 If there were about $1,700 more in menu ingredients, the ratio

would be reduced to 4.40, which would translate to a $21,803 reduction in tax

liability.6 Roughly speaking, this fifteen percent increase in ingredients results in an



5
  The auditor used a different mark-on for beverages based upon his experience.
For purposes of argument, the court accepts the auditor’s beverage mark-on.
6
   With a $1,700 addition in food costs, the cost of goods would be $13,023.32.
$56,360.17 in sales divided by $13,023.32 in costs yields an initial mark-on ratio of
4.33. Adjusting for beverages and spoliation would result in a mark-on of 4.40.
Multiplying the mark-on by the product cost during the audit period of $634,288
results in audited sales of $2,790,867 for a total sales tax liability of $195,361. This
is $21,803 lower than the sales liability calculated by the Director using the mark-
on ratio of 4.891062.
                                         -12-
approximate fifteen percent reduction in tax liability. To reiterate, this is not to

suggest that every dash of salt needs to be accounted for, yet, on the other hand,

based upon the overall amount of ingredients missing, there is sufficient basis to

deny the defendant’s motion for summary judgment with the issue below being

considered as well.

      In addition, the taxpayer quantitatively raises particularized issues concerning

the data utilized by Director. While this is a common refrain of taxpayers in these

types of cases, giving all reasonable inferences to taxpayer, there appears to be

significant errors in the Director’s compilation of data that render the audit more

than just imperfect. For example, the taxpayer indicates that the cost of the bronzino

fish in the bronzino entrée is $11.25 versus the Director’s estimate of $3.43.7

Moreover, the Director lists the price of the dish as $14.99 instead of $36.00 as

indicated by the taxpayer.      The taxpayer does not challenge the Director’s

methodology.

      Thus, changing the selling price from $14.99 to $36.00 increases the total

sales from $56,360 to $65,859. Likewise, the increase in product costs goes from

$11,323 to $14,857. This results in an initial mark-on of 4.43. Adjusting for

beverages, spoilages and other losses, the mark-on becomes 4.48. Multiplying this


7
  This is due to the director alleging an eight-ounce serving. On the other hand, the
taxpayer indicates it uses a two-pound whole fish, and after fileting, yields a twenty-
four-ounce serving.
                                         -13-
mark-on by the cost of goods during the audit period of $634,288 results in audited

sales of $2,841,610 for a total sales tax liability of $198,913. This is $18,251 lower

than the sales liability calculated by the Director using the mark-on ratio of

4.891062. Giving all reasonable inferences to the taxpayer, this difference coupled

with the missing ingredients on the product cost compilation is sufficient basis to

deny plaintiff’s motion for summary judgment.

      Finally, it is noted that the taxpayer’s accountant arrived at a mark-on of 2.04.

However, no support for this number was provided rendering it a naked assertion.

Rather, the certification of taxpayer’s principal indicates “[o]n the whole, it [the food

cost] averages 33% [of the selling price] which is consistent with our type of

restaurant in the industry.” A food cost of 33% translates to a mark-on ratio of 3.0

(100%/33%).8 Conversely, the Director determined the mark-on to be 4.891062.

      To summarize, the parties disagree as to whether the mark-on ratio should be

3.0, or closer to 5.0. However, buried in the record is the auditor’s notes from

January 12, 2014, in which he indicates “I explained to the representative that

without invoices or register tapes I would use the goods available for sales and




8
  While this is a naked assertion as applied to the facts of this case, in Yilmaz, the
mark-on of the Director of 2.8388 was upheld, and in Coliseum Pizza the mark-on
of 3.1613 was also upheld. Yilmaz,  22 N.J. Tax at 225, 243. Coliseum Pizza,  24 N.J. Tax at 372, 377.
                                          -14-
multiply them by an industry average [mark-on ratio] of 4 to arrive at the audited

gross receipts.”

      While the taxpayer does indeed have the burden of overcoming the

presumption, the court looks at the evidence of the taxpayer through rose-colored

glasses. MSGW Real Estate Fund, LLC v. Borough of Mountain Lakes,  18 N.J. Tax
 364, 379 (Tax 1998). Giving all reasonable inferences to taxpayer as to the factual

data presented, the taxpayer could overcome the presumption at trial. Thus, there is

sufficient reason to set this matter down for trial to resolve the factual disputes as to

the underlying data, including its completeness. For the foregoing reasons, the

Director’s motion for summary judgment is denied.




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