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Audit Procedures for Hotel Occupancy Tax

Revised 10/2004


Chapter 4 - Audit Procedures


Introduction

This section discusses audit procedures for hotel tax audits. The actual procedures employed will depend on the records available. The auditor should utilize all available records and worksheets and computer data of the taxpayer. Computer records are considered books and records and may be requested by the auditor if considered necessary to conduct the audit.

Tests should be made in accordance with generally accepted auditing procedures. The auditor will schedule exceptions noted and be prepared to discuss these exceptions with the taxpayer.


Pre-Audit Research

After the audit assignment has been received, certain information concerning the taxpayer's account and the business should be obtained through pre-audit research before an initial contact is made with the taxpayer.

Pre-audit research includes reviewing the following:

  • Taxpayer's response to the Audit Questionnaire
  • Computer Terminal Inquiry (Refer to Appendix A)
  • History
  • Prior audit

Refer to the hotel checklist in this chapter for additional detail on pre-audit research.


History Analysis

The history should be reviewed and analyzed before contacting the taxpayer. Compare the taxable receipts reported for each period and note significant variances. The significant variances might indicate:

  • Over-reported taxable receipts
  • Under-reported taxable receipts
  • Seasonal business
  • Out-of-business for part of a period

The capacity for each outlet should be reviewed to determine if reasonable receipts are reported.

Refer to Appendix A for details of the data on the history.


Entrance Conference

The entrance conference should include a discussion of the following:

  • The taxpayer's interpretation of Hotel Occupancy Tax
  • The taxpayer's business operations
  • The taxpayer's accounting system
  • The taxpayer's reporting procedure
  • The taxpayer's clientele

Outlet data from the taxpayer's history should also be verified in the entrance conference to determine if any file maintenance is necessary. Refer to the checklist for a list of the questions to ask the taxpayer.


Visual Inspection

A tour of the premises should be made prior to beginning the examination of the audit records. Look for:

  • The location of meeting and banquet rooms and facilities
  • Evidence of new construction or remodeling
  • The number of rooms in the hotel as compared to the capacity shown on the history
  • Vending machines (e.g., soft drink machines, etc.)
  • Other sales or services offered to clientele

Examination of Gross Receipts

Total room receipts must be examined and verified by the auditor. The comparison of total room receipts per the taxpayer's records and reported taxable room receipts should indicate:

  • If the taxpayer had deducted any sales, and
  • If taxable receipts were reported correctly.

Total room receipts should be reconciled for the entire audit period. Total room receipts should be reconciled with the general ledger and/or income tax return. Usually, a separate account is set-up for banquet room receipts.

Meeting and banquet receipts from the general ledger should be combined with the room receipts from the general ledger and compared with the reported total room receipts and the reported taxable receipts shown on the taxpayer history.

Differences may be a result of:

  • Bad debts
  • Exempt sales - taxpayer only reports taxable receipts
  • Banquet room receipts not being reported
  • Computation errors
  • Posting errors
  • Bar receipts included in total receipts
  • Restaurant receipts included in total receipts
  • Gift shop receipts included in total receipts
  • Vending machine income included in total receipts
  • Tax collected included in total receipts

The differences from the reconciliation with the general ledger and/or income tax return should be analyzed to determine if further examination of records is necessary. If there are some unexplained differences, then discuss the differences found with the taxpayer. Many of the differences found in the reconciliation may be of no consequence to Hotel Occupancy Tax. The taxpayer may be able to readily explain the differences. The auditor can then verify the taxpayer's explanation rather than spending unnecessary time searching for the nature of the differences.


Reconciliation of Tax Collected to Tax Reported

Analyze the records to determine if there are separate accounts for the different types of taxes collected by the hotel (sales, hotel, mixed beverage taxes). If there are separate accounts, then analyze the Hotel Occupancy Tax account to determine if both state and local taxes are included in the same account. If local tax is included, then the local rate should be determined and the amount separated. If there are not separate accounts for the different types of taxes collected, review the Monthly Summary for the Hotel Occupancy Tax collected. The reconciliation of state hotel tax collected to tax reported will be done for every report period in the audit period. Any exceptions noted in this reconciliation should be scheduled and discussed with the taxpayer.

Reconcile the state tax per taxpayer's records with the reported amount of tax for the entire audit period. The differences may include:

  • Posting errors in the general ledger
  • Non-posting of tax paid
  • Tax reported but not collected
  • Tax collected but not reported

The extent to which the Monthly Summary and the Daily Reports are examined will depend on the analysis and review of the:

  • Taxpayer's history
  • Visual inspection of premises for additional taxable receipts
  • Material errors found in the reconciliation of gross receipts
  • Material errors found in the reconciliation of the tax accrual account

The taxes collected should be scrutinized in detail for all report periods. Anomalies or periods with large under-reporting should be examined to determine the cause of the under-reporting.

If the additional taxes assessed in the audit are greater than 25% of the taxes reported (this is based on a calculation done on a report period basis -not a total calculation) additional procedures may need to be employed. For example, the expansion of the audit period (to earlier periods than originally planned), may be necessary. An under reporting by 25% or more qualifies as an exception to the statute of limitations. Therefore, the audit period may end up covering more than the standard four year period. If this is the case Audit Headquarters personnel should be contacted to obtain written permission to expand the audit period beyond the statute of limitations. Additional penalty may be assessed on the audit adjustments if the taxpayer intentionally under-reported their tax liability to the State or if the audited taxes exceed reported amounts by 25% or more.


Reconciliation of Monthly Summary to General Ledger

The Monthly Summaries should be totaled on a quarterly or yearly basis and compared to the reconciliation of gross receipts. The purpose of this procedure is to check internal control and to verify that no posting errors went undetected.

NOTE:  A formal schedule is not necessary. If differences are noted during the reconciliation then a schedule should be prepared to document any inconsistencies.

A review of the Monthly Summaries may indicate why there is a difference in the reconciliation of receipts. If there is an unexplained difference in the receipts reconciliation, then the Monthly Summaries can be used to narrow the time period in which the differences occurred. The results can indicate the procedures to use to reconcile the daily reports.


Reconciliation of Daily Reports to Monthly Summary

The type and materiality of the differences noted in the reconciliation of the Monthly Summaries to the taxpayer's records will determine the size and type of sample required for daily reports.

The sample may be random or it may cover a specific time period.

Random sampling should be used when the differences are distributed over the entire audit period or when it is desirable to test internal control procedures.

After the sample has been chosen, the daily reports should be compared to the monthly reports to verify posting of the accounts. The daily reports may also be compared to the daily revenue balance sheet to detect errors that were not detected in the taxpayer's accounting system.

For more information regarding sampling procedures, refer to the Audit Division manual, Audit Sampling - Training and Development Course.


Reconciliation of Daily Report to Folios

A reconciliation of the daily report to the taxpayer's folios is not necessary to verify gross receipts unless the taxpayer's internal control is nonexistent or ineffective.

NOTE:  This procedure will more commonly be used to verify non-taxable room receipts.


Alternative Records

If records are not available or insufficient, then the following may be used:

  • City Hotel returns
  • Bank statements
  • Estimated deficiency

The taxpayer's City Hotel returns may be used to compare state amount reported; however, since this is an internal report it may not be reliable. The taxpayer's bank statement may also be used to obtain gross taxable receipts by adding the deposits for each period. When bank statements are used, an allowance should be made for deposits verified as non-receipts such as loans.

If records are not available, then the taxpayer's return must be estimated. To establish an estimate, use room capacity and average room charge.


Deductions

The non-taxable room receipts that a taxpayer may claim are:

  • Bad debts
  • Permanent residents
  • Exempt organizations.

The nature of these non-taxable room receipts and the procedures used to verify them will be discussed in this portion of the chapter.

Bad Debts

The Hotel Occupancy Tax Return does not allow for the deduction of bad debts; even so, it is the policy of the Comptroller's office to allow the deduction. If a taxpayer has not taken a deduction for a bad debt(s), then a credit should be allowed.

Bad debts are allowed when they are written off the taxpayer's Federal Income Tax Return or when past history indicates that the debt recorded in the general ledger will be written off on the Federal Income Tax Return.

The audit procedure used should verify that the bad debt deduction is valid. The procedure should consist of checking the taxpayer records to determine if there is an account related to bad debts. If there is not a bad debt account, determine how bad debts are handled by the taxpayer.

If there is a bad debt account, analyze the account to determine if the bad debt(s) related to hotel receipts can be separated into taxable and nontaxable groups. If a large number of the customers are exempt or permanent residents, the hotel bad debt account must be further analyzed to determine which debts specifically relate to customers that were charged hotel tax. Only the bad debts that were originally treated as a taxed transaction should be written off as a bad debt (for State tax purposes).

The taxpayer records should be examined for recoveries of bad debt(s) which have previously been written off and not subsequently reported. If this is the case the hotel tax should be reported in the period it is recovered.

The State does not allow Credit interest for bad debts. Any refunds due to bad debts should be scheduled on a separate exam so that credit interest can be waived on that particular exam. A footnote needs to be added that this exam contains bad debts and no credit interest will be granted on bad debts.

Permanent Residents

The number of permanent residents is significant at residential hotels and semi-residential hotels. Refer to Chapter 2 for the definition and policies regarding permanent residents.

Some hotels that may cater to permanent residents are residential hotels. These are hotels that cater to a clientele that normally stays longer than 30 days. The clientele may not have a formal lease agreement but usually pays on a weekly or monthly basis with a deposit agreement.

Residential hotels will sometimes have transient tenants when rooms are available.

Semi-residential hotels cater to both the transient and permanent resident clientele. Semi-residential hotels usually designate the number of rooms needed for overnight stay as well as those for permanent residents.

Transient Hotels usually do not have many permanent residents. These hotels cater to clientele who stay overnight or for a short period of time.

NOTE:  In the Entrance Conference and the initial examination of the audit records, the type of hotel should be established. The extent of the audit procedure used will depend upon the type of clientele of the hotel.


Audits on Residential or Semi-Residential Hotels

For a residential or semi-residential hotel, two revenue accounts are usually kept for clientele: one for clientele designated as transient and another for permanent clientele. The revenue accounts will normally be traceable to a monthly receipts journal that summarizes the receipts of each day.

A residential and semi-residential hotel will normally have either a revenue card by room or a Monthly Summary Report instead of a daily revenue balance sheet that should show:

  • The check-in date
  • The occupant of the room
  • The period of payment
  • The base rate, and
  • Possibly the check out date

(An example of a Monthly Summary Report is in Chapter 3.)

The frequency of payment (i.e., weekly, semi-monthly or monthly) would indicate the probability of a resident staying less than 30 days. A client paying monthly is more likely to stay more than 30 days.

If monthly summaries are nonexistent or inadequate, then the deposit agreement should be examined. The deposit agreement normally will show the date of occupancy and vacancy.

Initially, the deposit agreement may be sampled to determine if the number of clientele who remain less than 30 days is significant. If this test indicates that a significant number of the hotel's clientele stay less than 30 days, then the auditor should trace the number of clientele who remained less than 30 days to:

  • The room revenue balance sheets, and
  • Use the average room rate times the length of occupancy.

If these records are not available for residential or semi-residential hotels, then examination of the customer's folios may be required.

Audits on Transient Hotels

Permanent residents are rare in transient hotels; therefore, the taxpayer does not usually keep detail summary records for transient hotels. Information regarding permanent residents may be taken from the Room Revenue Sheet or the folio.

The Room Revenue Sheets will show the customer's name and hotel room number. The auditor may obtain these for the period that the exemption was claimed to determine if the customer stayed for 30 consecutive days.

If the Room Revenue Balance Sheet is inadequate or unavailable, then the folios must be examined.

NOTE:  Extensive examination of folios should not be necessary unless there are no Summary records through which differences can be specifically identified.

Folios are usually filed by the date of the last charges. Therefore, folios can be randomly sampled by days. The folios will show the date of arrival and the date of departure for determining if a customer qualifies as a permanent resident. The registration card may indicate the client's expected length of stay. It may be necessary to examine the registration cards to determine if the first 30 days are exempt.

A transient hotel may claim a substantial amount of deductions if it caters to companies such as railroads or airlines. These companies reserve rooms for their personnel. The number of rooms contracted or paid for are usually not the same each day. Refer to Chapter 2 for treatment of permanent residents.

The records necessary to determine the minimum number of rooms rented include the:

  • City ledger (billing)
  • Daily revenue balance sheet
  • Folios

Sampling auditing techniques may be used if the records are numerous or unavailable.

Exempt Organizations

Some organizations that contract and pay the hotel directly for rooms are exempt from Hotel Occupancy Tax. Refer to Chapter 2 for the definition and policies regarding exempt organizations. Some organizations exempt from sales tax ARE NOT exempt from paying hotel occupancy tax. These organizations may contract for a banquet or meeting room within a hotel as well as for room rentals; both need to be verified. When an exempt organization contracts and pays for a room, the taxpayer should obtain a Hotel Occupancy Tax Exemption Certificate. (Refer to Hotel Occupancy Tax Rule 3.161.)

Non-taxable room rentals must be verified. To determine if these non-taxable room rentals are valid a sample may be taken. The size and nature of the sample would depend on the materiality of the exemptions claimed and the summary records available for verification of the exemptions. If a material error is found, then the sample period may be expanded.

Some hotels may summarize the exemptions claimed on a monthly or daily report. Additional sources of verification are:

  • City ledger (billing), and
  • Texas Hotel Occupancy Tax Exemption Certificates

The folios may need to be examined if there are no summary records. Some taxpayers may attach the exemption certificates to the folios.


Sampling Procedures

The taxpayer's records may indicate that it will be necessary to perform a sample audit because the records are one of the following:

  • Detailed, voluminous or complex
  • Inadequate or insufficient

The sample period should be randomly selected. Refer to the Auditing Fundamentals Manual and the Audit Sampling - Training and Development Course manual for details on how to sample. A "Notification of Sampling Procedures for State Tax Audit" must be completed and given to the taxpayer prior to implementation of the sample procedures.

If an estimated audit is performed rather than a sample, a "Notification of Estimation Procedures for State Tax Audit" must be completed and given to the taxpayer prior to implementation of the estimation procedures.


Exit Conference

At the conclusion of the audit, the auditor must explain to the taxpayer the audit procedures and results. If the taxpayer disagrees with the audit results, the auditor should be certain to understand the disagreements voiced by the taxpayer.

The billing, request for payment and redetermination procedures should also be discussed at this time. Refer to the exit conference section of the Auditing Fundamentals Manual for more information on what items need to be discussed with the taxpayer during the exit conference.


Audit Plan

The Record of Audit Planning, Activities, and Results is the form that documents the audit plan for every hotel audit and should be completed as the audit progresses. Continuation pages are available for use and generally will be necessary to record all information. It is important for the auditor to document all appropriate and pertinent information. Refer to the Auditing Fundamentals Manual for documentation that is required.


Hotel Occupancy Tax Checklist

The checklist is only an aid to the auditor to ensure that all areas have been considered. The auditor will need to adapt and check areas as the taxpayer's business activity and records warrant. Use this checklist to complete the audit plan.

I.   PRE-AUDIT RESEARCH
A.   Examine Work Item Detail of Agency Work Manager for:
1.   Taxpayer under audit
2.   Reason for audit request
3.   Examine prior audit if any
4.   Research statute and rules
5.   Review information supplied on and with the Audit Questionnaire
6.   Search the World Wide Web to see if the Hotel has a website. If so, examine site for amenities provided, locations, services available to the clients, policy regarding charges for guaranteed rooms and no-shows, etc.
7.   If the hotel is owned by a public company the financials may be available on the World Wide Web
B.   Verify that the Taxpayer's Information Letter and the Audit Questionnaire were sent to the taxpayer - copies should be included in the audit folder
C.   Examine the Audit Questionnaire completed by the taxpayer to determine:
1.   Contact and location of the records
2.   The individual (owner, partner, corporate officer) that has the authority to sign the Agreement to Extend Period of Limitation
3.   Description of the business activity
4.   Availability of computer records
5.   The individual (owner, partner, corporate officer) that should receive the "Notification of Sampling Procedures" and/or "Notification of Estimation Procedures"
6.   Special instructions
D.   Review Reported Information on the History:
1.   Title information
a.   Compare information with Agency Work Manager
b.   Date of history (should be current)
2.   Outlet Information
a.   Trade name
b.   Status
c.   Status date
d.   First sale date
e.   Capacity
f.   Last report filed
3.   Data File
a.   Were all outlets reported that were in business?
b.   Compare the taxpayer receipts reported for each period and note significant variance.
c.   Compare each outlet's occupancy capacity to taxable receipts reported to determine if reasonable taxable receipts are reported.
4.   Open Collection Records
5.   Prior Audit Information
E.   Run terminal inquiries
1.   MTSUMM.taxpayer #.(Master inquiry and summary status for all applicable taxes)
2.   MTBALS.taxpayer #. (Multi-tax balance)
3.   XICOLL.taxpayer #.75. (Open collection record)
F.   Examine Prior Audits, if any, for:
1.   Periods audited
2.   Method of accounting
3.   Audit procedure
4.   Errors noted in the previous audit
5.   Prior contact person and location of records
G.   Examine other documents for additional information including:
1.   Correspondence with taxpayer or with others in reference to the taxpayer
2.   Any other sources such as newspaper articles, magazine stories, etc.
3.   Hotel Occupancy Tax Accounts, Mixed Beverage Accounts and any other taxes and fees the hotel may be responsible for
H.   Review Hotel Law, Rules, Manual Procedures and Microfiche
I.   Set an appointment via telephone
1.   Inform taxpayer of audit period
2.   Inform taxpayer of other taxes to be audited
3.   Determine the location of the records needed to conduct the audit.
4.   Determine whether records are computerized or manual and the method of filing the exemption certificates, daily records, purchase invoices and revenue reports.

II.   ENTRANCE CONFERENCE
A.   List taxpayer's representatives who attend the entrance conference in the audit plan
B.   Discuss the taxpayer's understanding of the Hotel Occupancy Tax Law and Rules
C.   Discuss the taxpayer's business operations
1.   Type of hotel (transient, residential or semi-residential)
2.   Whether the hotel(s) has banquet/meeting rooms
3.   Whether the hotel(s) caters to exempt customers
D.   Discuss the taxpayer's accounting systems and reporting procedures
1.   Are records kept per the cash or accrual method?
2.   What types of records are available and how are they filed?
3.   Who are the personnel who prepare the report and have there been changes?
4.   What are the step-by-step procedures used by the taxpayer to prepare hotel returns? (Ask for the preparer to walk through this process for you)
5.   What internal control checks are used to insure that all taxable receipts are reported?
E.   Discuss audit procedures
1.   Audit period
2.   Sampling and projection procedures
3.   Possibility of using C.A.M.S. (Computer Audit Menu System)
4.   Possibility of obtaining statute extension agreement
F.   Discuss historical data from the history or the system with the taxpayer
1.   Changes in ownership
2.   If the hotel is operated as a sole proprietor, partnership or corporation
3.   If taxpayer is permitted for all applicable taxes
4.   Information on related firms

III.   TOTAL ROOM RECEIPTS
A.   Visual inspection of premises - items to look for:
1.   Location of meeting and banquet rooms. Observe if banquet/meeting room(s) are located in the same building with the sleeping accommodations, because only then are the receipts subject to Hotel Occupancy Tax.
2.   The number of rooms in the hotel as compared to the capacity shown on the history
3.   New construction repair to real property (taxable purchases)
4.   Restaurants and gift shops (sales tax)
5.   Vending machines (sales tax)
B.   Analyze taxpayer's records (e.g., general ledger and/or Income Tax Return) to determine if all receipts are being reported or if taxpayer claims exempt room rental receipts. Some examples of receipts which are subject to Hotel Occupancy Tax which may not be included as taxable room rental receipts are as follows:
1.   Charges that are connected with the actual occupancy of the room, such as television rental and the furnishing of additional beds or cots
2.   A room charged to a customer who did not show is subject to Hotel Occupancy Tax - a deposit that is not directly related to the room charge would not be subject to Hotel Occupancy Tax
3.   Cancellation fees for reservations canceled within 30 days of the scheduled check-in date. If the cancellation fee is the same price as the room rate, the entire charge is taxable.
4.   Banquet/meeting room charges when they are located in the same building with the sleeping accommodations.
C.   Reconcile tax collected to tax reported by comparing the amounts to the general ledger, monthly summaries and daily summaries. Remember: the city portion of the Hotel Occupancy Tax may be included in the same account. The City Hotel Occupancy Tax is not audited by the Comptroller's agency.
D.   Reconcile daily reports to folios. The folio shows the itemized charges accrued by the guest by date and by department. (This step is only necessary when the taxpayer's internal control is nonexistent or ineffective)
E.   Randomly choose a preliminary test period which will determine the following:
1.   Types of records used by the taxpayer
2.   How the taxpayer is calculated the reported amounts for Hotel Occupancy Tax
3.   Scrutinize the test period to determine types of errors, if any, the taxpayer may have made
4.   That the preliminary test period is representative of the entire audit period

IV.   BAD DEBTS/TAX-EXEMPT ROOM RECEIPTS
A.   Review taxpayer's records for bad debts claimed in error or bad debts not claimed.
1.   Review general ledger to determine if there is a bad debt account.
2.   Review taxpayer's Federal Income Tax Returns to determine if bad debts were written off. Bad debts are allowed only if they are written off or if past history indicates that the bad debts recorded in the general ledger will be written off the Federal Income Tax Returns.
3.   Determine if the bad debt account relates only to hotel receipts and determine which debts relate to customers that were charged Hotel Occupancy Tax.
4.   The general ledger and/or Income Tax Returns should be examined for recoveries of bad debts that have previously been written off. These recoveries should be reported as taxable receipts if tax was originally due on the transactions.
5.   Bad debts should be scheduled on an exam separate from other tax adjustments and a footnote added that credit interest will not accrue on bad debts.
B.   Review taxpayer's records to determine if exemptions were claimed and if so for what types of reasons. (If for example Permanent Resident exemptions were claimed).
1.   A permanent resident is an occupant who has the right to occupancy of any room for at least 30 consecutive days. The moving of a customer from one room to another has no effect on the permanent resident status. Intention to occupy the premises in excess of 30 days must be presented to the hotel at check-in or prior to qualify as permanent resident status. If documentation is not presented - after the first consecutive 30 days have passed - the 31st day will be considered exempt.
2.   A Company such as an airline or a railroad may contract for lump rentals of hotel rooms without having the same employees occupy the same rooms during the 30-days; in this case, the company would qualify as a permanent resident.
3.   Review the following available records for a residential or semi-residential hotel
a.   Revenue cards by room
b.   Monthly summary report
c.   Deposit agreements
d.   Accounts receivable for frequency of payment
4.   Review the following available records for a transient hotel.
a.   Room revenue sheets
b.   Registration cards
c.   Folios
C.   Review taxpayer's records to determine if tax-exempt room rental receipts (deductions) were properly claimed for exempt organizations.
1.   Determine if the exempt organization paid for the accommodations by reviewing the city ledger (billing).
2.   Determine if exemptions are being claimed for governmental persons - U.S. Government and State of Texas personnel only.
3.   Determine if the taxpayer is claiming exemption for municipal or county governments (they are not exempt from Hotel Occupancy Tax).
4.   Review the Texas Hotel Occupancy Tax Exemption Certificates the taxpayer has on file and the exempt organization list on CICS.
D.   Other records which can be reviewed when taxpayer's records are unavailable or inadequate are:
1.   Bank statements
2.   City hotel returns
3.   Federal Income Tax returns

V.   EXIT CONFERENCE
A.   Explain to the taxpayer the audit procedures performed. This would include a discussion of the following:
1.   All records examined
2.   A detail description of audit procedures utilized, audit adjustments and flow of audit package
3.   Minor errors for which no adjustments were made
4.   Applicable law, rulings and proper reporting procedures
5.   Additional information the taxpayer may obtain to reduce the liability
6.   Taxpayer's disagreements with the audit - these should be clearly understood by the auditor and documented
7.   The reconciliation conference should be offered if the taxpayer disagrees.
8.   The "What If I disagree with my audit results" brochure should be given to the taxpayer.
B.   Other procedures which should be discussed with the taxpayer include:
1.   The billing process (whether penalty waiver will be recommended and policies and procedures pertaining to penalty and interest). The "What If I disagree with my Audit" brochure should be given to the taxpayer.
2.   Payment should be requested.
3.   Redetermination procedures explained.

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