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Welcome to part 5 of our series on combating sales suppression. In our prior posts, we have discussed the magnitude and simplicity of perpetrating fraud via sales suppression, introduced some procedural changes you may want to consider implementing, and why you may want to avoid pursuing criminal prosecution. Let’s shift our focus to scaling productivity.

Can you imagine achieving $5,000 per hour of audit productivity? Many states are tracking their hourly audit productivity in the $100 to $200 range while other states are achieving up to $500 per hour. Due to the magnitude and history of sales suppression, focused audit selection and highly advanced tools for detecting fraud easily enable achieving the goal of $5,000 per hour audit productivity. To achieve this level of productivity, you are going to need to make changes and additions within your business process.

Believe it or not, the key changes do not include changing your current staff or hiring additional staff. Critical changes do include the following:

1. Strong leadership that embraces implementing new processes and methods
2. Advanced analytics to support laser focus on audit selection
3. A specialized partner that can ensure results
4. Senior audit leaders that can ensure audits remain fair and equitable
5. A streamlined business process that minimizes work in the field
6. An iterative approach that supports implementing continuous learning

The first big secret to driving a successful sales suppression intervention program is strong leadership. Your leaders are going to need to craft and communicate a strong vision. While it is important to listen to dissenting opinions sympathetically, your leaders need to remain steadfast on making the changes that facilitate high productivity. By understanding opposing views, they can adapt the program to boost your department’s success. They will also need to demonstrate a sincere and on-going involvement in the program execution.

The next two big secrets to achieving this level of hyper-productivity are 1) the use of advanced analytics to identify the least compliant taxpayers and 2) a specialized partner with the expertise and the tools to isolate sales suppression. If your team attempts to resolve this on their own, you will not have the benefit of nationwide learning and a team of experts adapting to the latest fraud techniques. After a huge variety of cases are resolved at high-volume and high-velocity, fraudsters will constantly shift to new methods. A strong partner will help you keep pace with their evolving methods.

You will also need to ensure your audit selection team has a vigilant focus on remaining fair and equitable. This will require on-going review of audit results with a focus on widely distributed geographies, industries (i.e., NAICS code), and company sizes. It is possible that more audits will focus on specific industries that are more susceptible to perpetrating fraud. With adequate analysis and reporting, you can demonstrate that you are focusing on the least compliant tax payers with a very fair and equitable approach.

An additional element to boosting your hourly productivity is minimizing your work in the field. By limiting fieldwork to audit initiation and records collection, you will see a drastic increase in production when leveraging your partner and finalizing the audit as a desk audit. If you collaborate with a partner like XDS, you will see rapid a turnover in audits and increase revenue and overall compliance for the audit period and future filings with minimal effort.

The final element to delivering hyper-productivity is a focus on continuous learning through iterative execution. If you are just starting a sale suppression intervention program, you are not likely to achieve perfection immediately. Delaying while waiting to achieve perfection prevents your taxpayers from receiving all of their benefits. You will achieve better results by starting small iterations of 10 audits per week, review the results every other week, adjust your processes, and initiate another batch. By working in increments that have scheduled learning sessions, you will have an opportunity to fine-tune your processes while boosting productivity.

XDS is not here to make vague recommendations. We are here to be your partner in an efficient, quick, and productive process along with guiding you through the critical changes.

Welcome to part 4 of our series on combating sales suppression. In our prior posts, we have discussed the magnitude and simplicity of perpetrating fraudulent sales suppression. We have also introduced changes you should consider to keep pace with these illegal practices. Let’s shift our focus to the pursuit of these cases.

Many states have done a great job of passing legislation to outlaw the sale or possession of a zapper. While it is difficult to effectively describe or ban the use of phantom-ware that is pervasive in most POS systems, many states are closing that gap. But is it optimal to chase every case as a criminal proceeding? While it sends a very effective message, XDS recommends a different approach to recover revenue rapidly and boost long-term compliance.

Pursuing sales suppression as a criminal offense requires a significant amount of procedural and staff burdens. Unlike a traditional audit, investigators and prosecutors are involved very early in the process to execute search warrants and potentially subpoenas. As the evidence is gathered and analyzed, those same people continue to expend energy on the case. As the case proceeds, prosecutors will be involved in proving every step of the case. This approach could result in your jurisdiction using some of their most constrained and expensive resources and people to pursue hundreds of cases every year.

The procedural overhead of proving a criminal case is significant. While we can hope the perpetrators admit guilt or accept a plea bargain, our over-burdened court system will be further taxed. Some states have a backlog of individual fraud cases worth $250,000 waiting for prosecutors to pursue them. Do you really want to place further burdens on the same system that should be removing drug dealers and murderers from your streets? What if we could find a balance that allows us to collect past due taxes and apply them where they belong: family assistance, education, public welfare, and transportation?

XDS recommends a balanced approach to criminal proceedings. Rather than adding to an overburdened judicial system, consider working within the bounds of a traditional audit framework. By increasing the volume and velocity of audits focusing on the scientifically identified least compliant taxpayers, you will be sending a strong message to offenders, increasing overall compliance, and more productively recouping past due taxes. This becomes especially relevant when trust taxes have already been collected from consumers yet retained by fraudsters. As you level the playing field, you may be able to reduce gross tax rates and achieve the same revenue objectives.

 

Pop quiz discussion:

Answer (a) will help you send a strong message. You do not need to wait to pass legislation banning zappers since fraud is already a felony. You will also benefit by including a press release and possibly coverage on the local news. Unfortunately, your state is going to lose money on this case due to the extended use of auditors, criminal investigators, prosecutors, judges, bailiffs, court reporters, and a jury.

Answer (b) will help you recoup past due tax dollars rapidly and productively as well as increase future compliance. It also assumes you have the processes and a strong partner to execute an aggressive program.

Answer (c) will help spread the word throughout the business community that “the game” may be over for them. It will automatically increase compliance. Since the techniques have spread word-of-mouth throughout the business owners and vendors, that same process will help eliminate the fraudulent practices over time.

Answer (d) will connect you with the only vendor that has the tools and techniques to provide you with specific details on fraudulently modified transactions. XDS can help you execute a high-velocity, high-volume program productively.

Answer (e) is the best answer. An effective program requires a balance of all of these elements.

To process sales suppression audits in greater volume and increased velocity, you will need to embrace new approaches. XDS isn’t here to state the obvious. We are here to be your partner in a faster, more efficient process. To understand some key changes associated with the optimized process, please see the next blog post in the series: focus on scaling productively.

Welcome to part 3 of our series on combating sales suppression.

In our prior posts, we discussed the magnitude and simplicity of perpetrating fraudulent sales suppression. Unfortunately, many revenue agencies have accepted sales suppression as unidentifiable and untraceable without extraordinary manual efforts. Is that assumption accurate? Let’s challenge that belief by examining the current audit methods.

For most revenue agencies, an audit is initiated based on a tip or suspicion that a retail business is maintaining a second set of falsified sales records. Some revenue agencies are using trend analysis to detect reported cash sale anomalies. The standard practice for tracing sale suppression includes the following steps:

• Have auditors complete multiple incognito visits to the establishment and purchase items with cash.
• Have the auditors formally initiate the audit 1-4 weeks later and request the sales journals.
• Examine the sales journal and compare it to the receipts from the auditor’s controlled cash purchases.
• Manually identify receipts or line items that are missing or have been modified.
• Manually identify any missing receipts beyond the auditor’s controlled cash transactions.
• Estimate the tax liability based on a projection.

While this represents most jurisdictions’ current practice, it is not very thorough. It can be thwarted if the business correctly guesses the presence of auditors or receives a tip about the pending audit. The audit results may also be inaccurate if the transaction samples are not representative of the standard business volume or processes.

In a nutshell, the techniques from past decades are not keeping pace as technology advances. The fraudsters have advanced their use of POS systems and general technology while auditors continue to rely on outdated methods.

The reality is that the technologies that support business productivity and fraudulent practices can actually be used to end those fraudulent practices. While that may sound grand, ambitious, and bold, it is absolutely true! Do not confuse this with easy-to-do or simple. These tools and techniques are highly advanced, situationally and environmentally dependent, and require substantial time and effort to master. If you want to take advantage of those techniques, reduce fraud, and collect extremely past due revenue, you need to change some practices and approaches to identify and resolve the problem.

The first practice to change is how fraudulent businesses are identified. Many jurisdictions are hesitant to initiate a program based on the fear that it may be challenged as biased. Rather than be paralyzed by concern, XDS offers information-based solutions that immediately identify businesses that are most likely committing fraud. The same advanced analytics that help businesses optimize their sales and segment their customers can be used to optimize audit selection and segment the least compliant population. Our data-driven approach, supported by scientific method and statistics, makes it possible to be fair and equitable. With our analytic models, you will be applying scientific method to pursue the least compliant businesses and targeting those is easily defensible. Keep in mind that fairness applies to taxpayers who abide by the laws and rules, especially those who are in compliance and follow those rules.

XDS’ solution goes beyond accurate identification of businesses that are suppressing sales. We offer tools and services to help you collect sales transaction data. The biggest challenge your peers face is the analysis of that data. XDS will remove that burden from your staff. Our service goes far beyond trend and anomaly detection. We will apply advanced analytics, machine learning, and deep data mining to identify specific details on fraudulent transactions. With our solutions, your department will be able to move quickly from data collection to closing an audit with strong evidence and confidence. This will allow you to collect overdue revenue and increase future compliance. Your department can benefit from the latest techniques and technologies with minimal training. XDS is your partner to close the gap between your department and the constant evolution of fraud practices.

XDS isn’t here simply to preach about technology advances. We are here to help you review your processes and legal approach. We want to be your partner to have an all-inclusive solution. To understand some key constraints associated with the standard process, return for our next post in the series: Why you may want to avoid treating the audit results as criminal activity.

Welcome to part 2 of our series on combating sales suppression.

In the prior blog post, we discussed the magnitude of the sales suppression issue. It is a global problem due to the variety of techniques and readily available point-of-sale (POS) system features. Sales suppression has also been perceived as unidentifiable and untraceable without extraordinary manual efforts. Before we accept those assertions, let’s discuss the methods used to perpetrate this type of fraud.

Sales suppression is the practice of illegally removing cash from business activity to avoid paying taxes or other volume-based fees such as franchise fees, space utilization, and equipment rental. There are three techniques to perpetrating this fraud through the POS system:

1. Zapping – The use of a physical device plugged into the POS system to activate software that can modify the closed transactions.
2. Phantom-ware – Special program features built into the POS that allow transactions to be manipulated.
3. Sales Suppression as a Service – “Consulting” or “support” services that remotely access the POS system to alter closed transactions. This is frequently perpetrated from across state lines to make it more difficult for states to audit.

These techniques sound extremely difficult and “high tech.” Are they really that complex? To assess the difficulty, XDS gave one of our developers a very special task. We provided them with a new copy of a commercially available POS system in a lab environment and simple directions: “go suppress some cash sales.” They did not receive any special training or documentation.

In one working day, the system was installed, configured, initial cash closing reports generated, sales transactions processed, customer receipts printed, system records altered, falsified receipts printed, and bogus daily reports generated. The reports included the falsified cash reconciliation, X and Z reports, and sales summary. All reports were balanced based on the falsified transactions. To emphasize the potential impact on your jurisdiction: this happened in a single working day. With 20 lines of code, they removed more than 50% of the daily cash sales and the associated sales tax. While inventory reports were not addressed, you can make your own assumptions on the difficulty of modifying them as well.

With individuals seeking technical assistance on the dark web and a technical adoption rate of one working day, do you really think it’s possible your jurisdiction is avoiding this type of fraud? Thanks to the remote connectivity tools currently available, the cottage industry of “consultants” can move freely and quickly to avoid discovery. This is further complicated by the fact that nearly all POS system vendors include the capability in their systems. How can you possibly keep pace with that growth potential?

As mentioned in the first blog in this series, many states have passed legislation making it illegal to sell or possess a zapper. However, with Phantom-ware embedded in nearly every POS system and rapid advances in remote system access, those laws will provide little protection from or opposition to rapid expansion of this fraudulent practice. The Internal Revenue Service estimates 30% of retail businesses are already perpetrating this type of fraud. You’re already facing an epidemic where constraining the supply of suppression techniques will not be fully effective. Pursuing the suppliers will become the classic game of “whack a mole.” When you remove one supplier, there are plenty of other suppliers, system vendors, and unethical “consultants” prepared to close the gap.

To more effectively combat sales suppression, you need solutions that keep pace with the fraudulent technology and process expansion. You also need to address the retail businesses that are compromised.

XDS isn’t here simply to illustrate the growth of the problem. We are your partner to help resolve it with much more than an analytical selection process. To find out key steps to ending these fraudulent practices, return for our next post in the series: Sales suppression fraud is resolvable.

Stealing cash from retail businesses has been a problem since their inception with roots of this type of fraud far preceding our current concepts of e-commerce and advanced point-of-sale (POS) systems. It’s possible your jurisdiction is exempt from this problem. Or is it? In this blog series, we’ll examine the current state of sales suppression, how it can be resolved, and how you can recoup the fraud perpetrated against your revenue agency and constituents.

Let’s not get ahead of ourselves. Is this really a problem for your jurisdiction? We can find an answer by reviewing current research and cases. Professor Richard Ainsworth is an esteemed academic at Boston University who has studied this problem for over a decade. He’s been instrumental in estimating the size of the problem, identifying key perpetration methods, and guiding legislation for many states.¹ Ainsworth estimates that the United States is losing over $20 billion of tax revenue every year. Some states are estimating over $1 billion in annual loses in just one retail sector. In the “SALT effect,” ² Brian Strahle has provided additional insight and the background on how one Canadian province encountered this issue and responded with an extensive, yet costly solution.

The state of New York conducted a sting operation in 2009 to understand in greater detail how sale suppression is accomplished.³ They were researching the embedded sales suppression features in POS systems known as Phantom-ware. Shockingly, 100% of the 23 POS system vendors explained how they include the capability and would provide the retailers training on how to do it. At this point, those vendors must include the capabilities to remain competitive.

Professor Ainsworth estimates that 30% of retail businesses are perpetrating sale suppression fraud. According to XDS research, 24 states have passed legislation against the possession or use of a Zapper, one of many techniques used to perpetrate sale suppression; additional states have legislation in committee. In the past 12 months, other states have completed successful investigations, including Washington, Connecticut, and Illinois.

This is also a problem of international proportions. Over the past ten years, many countries have attempted to address sales suppression, including Canada, Rwanda, Sweden, South Africa, Norway, and Germany. In 2013, the Organization for Economic Cooperation and Development (OECD) commissioned a study on how to address sales suppression in their 34 member countries.

 

So let’s summarize the magnitude of this problem:

• Nearly half the states in the US have passed legislation banning the use or possession of a Zapper;
• Several states have prosecuted sales suppression cases;
• Experts estimate that 30% of retail businesses suppress sales;
• An international study involving 34 countries has studied the problem;
• 100% of POS software vendors involved in a sting operation admitted to providing the ability and offered training on how to suppress sales.

How can you be sure you don’t have this issue in your jurisdiction? Given the magnitude of the issue and estimated losses, let’s ask that question differently: How can your jurisdiction not be impacted? Is it worth the risk to turn a blind eye on this fraudulent practice?

XDS isn’t here simply to point to the problem. We are your partner to help resolve it. In our next blog post, we’ll cover the full extent of suppression methods and how you can respond.

For more information, please contact us at info@xds.us.com

 

¹ Richard Ainsworth’s scholarly overview on the international dimension: http://www.bu.edu/law/faculty-scholarship/working-paper-series/

² Brian Strahle’s SALT effect report on zappers: http://www.leveragestateandlocaltax.com/2013/11/ignorance-may-not-be-bliss-when-it.html

³ Richard Ainsworth’s scholarly overview on Sales Suppression as a Service: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2445991