In our last two posts, we described the concept of the “responsible person” under NY’s sales tax law, and how such an individual may become personally liable for the unpaid sales tax of a business. We also explored the factors that are considered in determining one’s status as a responsible person, as well as some planning options.

 Today we end our discussion of the “responsible person” concept with a recent decision that illustrates the practical application of the concept and affirms how difficult it can be to avoid personal liability.

 In particular, it considers whether an officer and shareholder may not be held responsible where he or she was precluded from taking action with regard to the financial and management activities of the corporation. The significance of one’s officer and shareholder status, in other words, may be offset by the circumstances relating to control of the corporation – could he or she have acted but chose not to, or was he or she precluded from acting altogether? Did the facts show that others effectively precluded this person from exercising any authority?

In the Matter of Patrick Kieran 

New York (“NY”) assessed Corp.’s sales tax deficiencies against Taxpayer as a responsible person. Corp. operated a GM car dealership. Taxpayer had extensive experience with car dealerships. His involvement with Corp. began when he and some investors bought a franchise from GM with financing by GMAC. At that time, Taxpayer executed a dealer sales and service agreement with GM, pursuant to which he was required to engage GMAC, or some other creditworthy financial institution reasonably acceptable to GM, to support Corp.’s floor plan line and its purchase of new vehicles. Corp. opted to finance its purchases through a financing agreement with GMAC, along with additional working capital financing. The financing agreement included a “sweep arrangement” that afforded GMAC access to Corp.’s general bank account. This account held payments by customers for the purchase of vehicles, parts, accessories, and repair services. It also held sales taxes collected from customers.

 Corp. failed to timely file its sales and use tax returns for several quarters. As a consequence, NY issued notices of determination to Taxpayer as a responsible officer of Corp. The notices also assessed penalties and interest.

 In support of its position, NY demonstrated that Taxpayer  was a shareholder and the president of Corp., that he was responsible for the day-to-day operations of Corp., that he dealt with GM and GMAC on all significant business matters, that he ordered inventory and hired and fired employees, and that he signed tax-related and other checks, sales tax returns and bank documents.

 NY subpoenaed GM, requesting the production of documents concerning Corp. Pursuant to that request, NY received a GMAC dealer sales and service agreement signed by Taxpayer, pursuant to which the parties agreed that Taxpayer would be the dealer operator of Corp. and that he would provide personal services in this regard by exercising full managerial authority over dealership operations.

 A dealer statement of ownership for Corp. was also submitted as part of the record. It listed Corp.’s owners, including Taxpayer. Each of the owners of Corp. except Taxpayer were described as a “financial investor.” Taxpayer was the only owner listed as “dealer owner/operator.”

 When the business met with financial troubles, Corp.’s general account was effectively controlled by GMAC through the sweep arrangement. GMAC exercised its rights under the sweep arrangement, collecting what was due from the dealership directly from Corp.’s general bank account, including amounts representing sales taxes collected from customers. GMAC would contact Corp.’s controller to determine how much money would be needed to cover payroll and essential bills, such as insurance and utilities, and would make funds available to cover those costs.

 Taxpayer testified that GMAC’s sweeping of  Corp.’s general account resulted in the dealership’s nonpayment of sales tax collected from customers. However, the Court noted that there was no evidence in the record that Taxpayer ever contacted GMAC in an effort to gain access to the sales tax collected from customers in order to pay such tax over to NY. Nor was there any evidence that Taxpayer took any other affirmative steps to protect the sales taxes collected from customers.

 An ALJ reviewed the relevant criteria for determining whether an individual is a person required to collect tax on behalf of a corporation and therefore personally liable for the sales tax obligations of that corporation. Applying such criteria to the present matter, the ALJ determined that Taxpayer was a person required to collect tax on behalf of Corp. and, therefore, personally liable for Corp.’s sales tax obligations.

 Taxpayer argued that the ALJ was wrong, asserting that the taxes at issue accrued after GMAC began to take control under the sweep arrangement. Taxpayer argued that he lacked the requisite control over the affairs of Corp. to be liable as a responsible officer.

 The ALJ rejected this contention, and noted that Taxpayer voluntarily entered into the arrangement with GMAC and therefore could use the arrangement to shield himself from any sales tax liability arising as a consequence thereof.

 The Tax Appeals Tribunal (the “Court”) affirmed the determination of the ALJ.

According to the Court, NY Tax Law imposes personal liability upon any person required to collect the sales tax. A person required to collect tax is defined to include, among others, corporate officers who are under a duty to act for such corporation in complying with any requirement of the sales tax law. Regulations provide that “[e]very person required to collect any [sales tax] . . . acts as a trustee for and on account of the State with respect to taxes collected by such person.” Among other things, such trustees are required to “properly safeguard the interests of the State with regard to such taxes” and to “remit the taxes with timely filed returns.”

 Taxpayer, the Court said, had to show, by clear and convincing evidence, that he was not a person required to collect tax. Whether a person is responsible for collecting and remitting sales tax for a corporation so that the person would have personal liability for the taxes not collected or paid depends on the facts of each case. The Court looked to various factors in making this factual determination. It found that the facts in the present matter strongly supported the ALJ’s conclusion that Taxpayer was a responsible person and, therefore, personally liable for sales taxes due from Corp. He had knowledge of and, at least until GMAC began to sweep the operating account, unquestioned control over its financial affairs.

 Taxpayer contended that, upon GMAC’s exercise of its rights under the sweep arrangement, he no longer had control over Corp.’s finances, and his check-signing authority and authority to pay creditors was under the direction and control of GMAC. Taxpayer thus asserted that he was precluded from exercising his authority and, consequently, was not a responsible person.

 The Court recognized that Corp.’s economic difficulties were the root cause for its failure to remit sales tax collected from customers. Such economic difficulties led to GMAC’s sweeping of the general account, which diverted the collected sales tax to other purposes. In the Court’s view, neither of these related causes for Corp.’s failure relieved Taxpayer from his duty as a responsible person to see that sales tax collected by the dealership was turned over to NY.

 It is well settled, the Court said, that economic difficulties do not excuse an individual from his or her responsibility to collect and remit sales tax on behalf of a corporation. As to the sweep arrangement, a consequence of the dealership’s economic problems, the Court noted that individuals may not continue to operate a business “at the expense of ensuring that sales tax was paid.”  Here, the sweep arrangement had that very effect, as it allowed a creditor, GMAC, to divert collected sales taxes to pay other liabilities while the business continued to operate.

 The Court noted further that Taxpayer petitioner voluntarily entered into the sweep arrangement on behalf of Corp. and thereby “voluntarily created the scenario which led to [the dealership’s] inability to pay . . . sales and use taxes. The sweep arrangement in the present matter also may be viewed as a responsible officer’s dereliction of duty. That is, [Taxpayer], on behalf of the dealership, gave a creditor the authority to determine which corporate liabilities would be paid and to use trust fund taxes to pay such liabilities. Such a grant of authority was in direct contravention of [Taxpayer’s] duty as a trustee to “properly safeguard the interests of the State with regard to such taxes.” Taxpayer’s failure does not relieve him of responsibility, for “an officer cannot relieve himself of his responsibility for operating his corporation and expect that he will be relieved of sales tax liability.”

Taxpayer voluntarily entered into the agreement with GMAC and acceded to its terms at all times, notwithstanding his knowledge that, under the arrangement, GMAC was using sales taxes collected from customers for other purposes.

 The Court noted that there was no evidence in the record that Taxpayer took any affirmative steps to ensure that the sales taxes collected by the dealership were paid over to NY. It noted further that the sales taxes were to be “held in trust for and on account of the State.” Finally, it noted that it did not appear that GMAC ever took legal control of the dealership and its funds, and that the power to sign checks remained with the dealership (not GMAC).

 Accordingly, the Court rejected Taxpayer’s claim that GMAC’s sweeping of the general account relieved him from his duty as a responsible person to see that sales tax collected by Corp. was turned over to NY.

Conclusion

Was the Court’s decision unexpected?  No. Was it harsh? In light of the sweep arrangement, probably. However, it does highlight the very difficult choice that confronts the responsible person in  a struggling business: either pay the sales tax and give up the business, or continue to operate and risk personal liability. I would hate to be in those shoes.