Minnesota Touts First Tax Zapper Fraud Prosecution

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By Michael J. Bologna

Minnesota racked up its first-ever criminal conviction in a fraud case involving tax “zappers”—sales suppression software—announcing guilty pleas from the owners of a Japanese restaurant and nearly $300,000 in restitution.

The Minnesota Department of Revenue and prosecutors in St. Louis County announced May 2 guilty pleas had been reached with the owners of Osaka Duluth Inc., operating as the Osaka Sushi Hibachi Steakhouse. The charging complaint alleged the defendants engaged in a 35-month scheme that used zapper technology to under-report more than $1 million in sales, triggering sales tax losses of $110,000 for the state and $24,000 for the city of Duluth.

Revenue Commissioner Cynthia Bauerly said the criminal convictions marked the first time the state has successfully prosecuted a group of defendants for a fraud scheme involving tax zapping software.

“These are first-of-their-kind convictions in Minnesota and highlight our investigators’ efforts to combat the growing use of sales suppression software,” Bauerly said in a statement. “These convictions demonstrate our determination to level the playing field so that businesses who report and pay their fair share of tax don’t have to compete with those who break the law.”

$21 Billion Fraud

Zappers are designed to enter a business’s point of sale database and delete selected sales, generally cash transactions. The systems then recalculate individual receipts and the taxes due. In addition, zappers can reorder sales slips and adjust the business’s internal ledger.

Richard Ainsworth, a professor of tax law at the Boston University School of Law, recently estimated that zappers rob the states of up to $21 billion in sales taxes annually.

Chris Pinkert, assistant St. Louis County attorney, said the state scored guilty pleas from Osaka Duluth owners Dan Xu on one felony count of aiding in the filing of false tax returns, and Zhong Wei Lin on one felony count of failing to pay sales tax. Both men avoided prison sentences by consenting to a year of probation and immediate payment of $292,760 in restitution.

A third restaurant employee, Su Ling Cao, acknowledged aiding in the fraud, but the case was stayed in lieu of a year of probation.

In addition, Pinkert said Osaka Duluth pleaded guilty to two felony counts for aiding in the filing of false tax returns, and 15 counts of failing to pay sales tax. The company is also subject to the order for restitution.

Under the plea terms, the defendants acknowledged using a sales suppression system called “Happy World,” stored on a thumb drive, to zap sales from the restaurant’s point of sales systems. The Happy World software essentially permitted Osaka Duluth and its owners to create a second set of books that hid cash transactions and shielded such transactions from taxes owed to the state and the city of Duluth.

New Criminal Statute

Moving forward, prosecutions of Minnesota businesses using tax zapping technology might become easier.

Pinkert pointed to a new law, Minnesota criminal statute 289A.63 subdivision 12, that became effective in 2017. The new law imposes criminal penalties on any person “who sells, purchases, installs, transfers, develops, manufactures, or uses an automated sales suppression device, zapper, phantom-ware, or similar device knowing that the device or phantom-ware is capable of being used to commit tax fraud or suppress sales.” In addition, zappers are considered contraband subject to forfeiture.

The new law specifies that such crimes are felonies, subject to a five-year prison term and fines up to $10,000.

“At the time the crimes in this case occurred, that statute was not in effect so it was not used to charge these folks. However, as part of their plea they admitted possessing and using it to reduce sales taxes owed,” Pinkert told Bloomberg Tax in an email.

The case is State v. Osaka Duluth, Inc., Minn. Dist. Ct., No. 69DU-cr-17-3331, convictions announced 5/2/18 .

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bloomberglaw.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bloombergtax.com

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