You may have seen the recent announcement of the settlement of a New
York tax whistleblower suit brought by the New York Attorney
General against Fanatics Inc., the sports merchandise and
memorabilia retailer. The suit was brought after a
whistleblower-initiated investigation found that Fanatics
undercollected sales and use tax on online sales between 2014 and
2017.
In 2012, Fanatics engaged a third-party tax software provider to
have it calculate state and local sales tax rates and exemptions
for its sales in New York. Fanatics also used a backup system to
calculate the tax if the third-party software failed. The
backup system's rates were initially set at 4%, but in July
2013 the default rate was set to zero and remained unchanged until
November 2015, when it went back to 4%. When the primary system
went down, the backup system charged taxes that did not always
reflect the applicable local rate or the state rate when exemptions
were not applicable. As a result, Fanatics failed to collect
approximately $1.4 million in sales tax that it should have.
According to the settlement, Fanatics was aware of the issues
with its backup system, but did not fully correct them until
December 2017.
While, according to the settlement, Fanatics did not admit
liability and agreed to settle the action to "avoid the time,
expense, uncertainty, and distraction of litigation," the case
is a reminder of the importance of maintaining systems for the
collection of sales tax that comply with applicable state and local
rules. The case also is a reminder that detection of any such
systemic failure is not necessarily the result of a governmental
audit or examination. In the Fanatics case, New York's
investigation was triggered by a qui tam complaint filed by
whistleblowers under New York's False Claims Act.
Interestingly, the whistleblowers, who are attorneys, will
collect $464,371 as part of the settlement. The same
attorneys brought a whistleblower action related to Fanatics'
sales tax practices in Illinois earlier this year, but an Illinois
appellate court held that they were not entitled to a portion of
Fanatics' $2.1 million settlement payment because the Illinois
Department of Revenue had already audited Fanatics' tax
liability and sent it a notice of proposed liability by the time
the attorneys filed their qui tam complaint.
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