Some restaurants keep sales tax, using illegal 'zappers'December 6, 2017 8:01am

Dec. 05-- WASHINGTON-States nationwide are losing billions of dollars in sales tax revenue to restaurants and other businesses that deploy technological methods to evade tax collectors, including cloud-based computing systems originating in Canada, China and other foreign countries.

But there has been little coordinated action to root out the offshore operators that help rogue retailers under-report their sales, especially those handled in cash.

Richard Ainsworth, a Boston University professor who has written extensively about sales tax fraud, estimates that states are losing roughly $20 billion in taxes yearly due to various "sales suppression" methods. But he acknowledges that the real amount is difficult to determine.

"Manipulation of American business records offshore is happening on a wide scale," Ainsworth said. "The fraud is moving much faster than the tax agencies can catch it."

With the help of federal prosecutors, Washington this year became the first state to successfully prosecute a U.S. distributor of illegal software used to commit sales tax fraud. That prosecution was helped by a 2014 state law criminalizing use of "zappers" and other ways of altering cash register records. Twenty-six other states have passed similar laws.

Over the past six months, restaurant owners in Minnesota, Michigan and Connecticut have been charged with using illegal sales-tax suppression software. In some cases, restaurateurs have allegedly taken the diverted tax money to pay employees in cash, thereby skirting requirements to pay for workers' compensation, overtime and other benefits.

But states lack jurisdiction to go after bigger fish –– the offshore syndicates that market tax-zapping software. Moreover, retailers are increasingly managing their sales records with cloud-based computing, posing other challenges.

"More and more, this is going to the cloud," said Warren Klomp, a district administrator for the California Department of Tax and Fee Administration. "The owner uses the data to see what is selling well, the best hour for sales, and so on. But if it is all sitting in the cloud, there is an opportunity to log into the cloud and manipulate the data."

Under state and federal law, retailers are required to report to tax agencies all income they receive, keep records on those sales and remit all taxes they collect from customers. Yet from the advent of the sales tax, unscrupulous businesses have managed to get around the law simply by keeping two sets of books.

Now such businesses have turned to more technological tricks. One common method is to install "zapper" software into their computerized cash registers –– commonly known as "point-of-sale" systems –– either with a thumb drive or a disk. With use of a zapper, business owners can delete entire transactions from a day's receipts, allowing them to under-report the sales tax collected from customers and owed to the state.

In 2009, the Canadian province of Quebec conducted extensive audits of restaurants and found that they were under-reporting roughly 5 percent of all revenue received. If the U.S. restaurant industry is under-reporting a similar percentage, it would mean that states collectively could be losing more than $20 billion a year in sales tax proceeds, Ainsworth said.

The projected losses include $2.8 billion in California, $1.7 billion in New York, $1.6 billion in Texas and more than $1 billion in Florida.


Some state tax officials say those loss estimates are too high. Klomp, the district administrator for California's tax agency, estimates that as of 2014, the state was losing $218 million annually to sales tax fraud. Still, Klomp said, state tax authorities are lagging behind some of their Canadian counterparts in fighting this form of fraud.

In Quebec, tax-zapping software first gained notoriety in 1999, when the province's tax inspectors raided a chain of 32 restaurants founded by a group that included pop singer Celine Dion. The investigation found that the restaurants, part of the Nickels chain, were all using zappers. While Dion wasn't implicated, the investigation revealed a network of rogue software distributors that were providing Nickels and other restaurant groups with the zappers.


Sales tax fraud is made easier by the fact that multiple companies market legal point-of-sale systems that allow retailers to tally and record transactions, often using off-the-shelf database software. The systems can be modified to suit a retailer's language or other needs, but that flexibility also makes it easier for retailers to take advantage of zappers to manipulate sales records.

Profitek, a company based in Richmond, British Columbia, a suburb of Vancouver, is one company implicated in several investigations of illegal zappers.

Founded in 1985 by Hong Kong native Pius Chan, Profitek was originally called InfoSpec Systems Inc. It started out specializing in providing Chinese-language point-of-sale systems to Canada's Chinese restaurants and other businesses.

From 2000 on, Canadian authorities investigated Chan and his company for marketing zappers with its point-of-sale system. In 2012, a British Columbia court convicted InfoSpec of fraud and fined it $100,000. But Canada at that time did not have a law specifically prohibiting such software, and later that year, an appeals court overturned the conviction. Canada the next year passed a law criminalizing zappers and other sales-suppression techniques.

Soon after that law was passed, Washington state tax auditors started noticing that some of the state's Chinese restaurants were reporting unusually low cash sales. They set up a sting operation, comparing receipts received during meal purchases to the records kept by the restaurants.

In 2016, Washington's attorney general charged Yu-Ling Wong, owner of Facing East restaurant in Bellevue, with using Profitek software to pocket nearly $400,000 in sales taxes. Seven other restaurants were also cited for keeping roughly $3 million more in state and federal taxes.

Wong's arrest led U.S. prosecutors to indict John Yin, a resident of Everett, Washington who worked with Chan to distribute Profitek software and zappers to the restaurants. Yin pleaded guilty to wire fraud and conspiracy in late 2016, after investigators established that he, two years earlier, had directed a customer to email a Profitek supplier in China to obtain the sales-suppression software.

According to Yin's lawyer, Kirk C. Davis, Yin offered to help the government make a case against Pius Chan and his wife, Cindy Chan. But prosecutors rejected that offer after Yin balked in arranging a meeting between the Chans and an undercover agent. In April, he was sentenced to 18 months in prison and shares responsibility with the eight restaurants to make restitution of $3.4 million.

Davis, Yin's lawyer in Seattle, said he is incredulous that U.S. prosecutors didn't seek his client's help in investigating the Chans.

"Why squander the opportunity?" said Davis. "Why are they not using the opportunity to get at the most guilty party in the case? They could have had him (Yin) wear a wire. They didn't have to rely on him except for an introduction or a meeting across the border."

Emilie Langlie, a spokeswoman for U.S. Attorney Annette Hayes, declined to comment on her office's handling of the case and whether it may be pursuing other leads. But records filed in the Yin case suggest that further prosecutions could be difficult. After 2014, Profitek "moved the zapper software production out of Canada and relocated it to China," prosecutors said in one filing. "A Chinese email account is nearly untouchable by law enforcement and its records are unobtainable by the United States or Canada."

Numerous attempts by McClatchy to find Pius Chan were unsuccessful. Photographs posted on the website of the Chinese Federation of Commerce Canada show that he has remained active this year with the British Columbia-based group, but his relationship with Profitek is unclear.

Compared with U.S. states, Quebec has moved aggressively to increase the security of computerized cash registers. The province has been phasing in installation of "secure recording modules" at thousands of restaurants and retail businesses. The modules can't be tampered with, and the government subsidizes their installation. Revenue Quebec, the province's tax authority, estimates that the program will have recovered more than $2 billion in taxes by 2019 that otherwise would have been lost.

In New York state, Democratic State Sen. Liz Krueger has held hearings on sales tax fraud, and has concluded that there are simpler and less costly approaches than the Quebec solution. Yet just getting a law passed in New York is difficult, she said. Credit card companies have raised red flags about installing systems to ensure better tracking of sales transactions, and Gov. Andrew Cuomo has questioned whether a new law is necessary.

Kruger said she is frustrated. "The bottom line is people go to stores, pay the sales tax and think it is being transferred to the government," she said. "But that is not always happening."


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