That sales tax you pay on your meal? Some restaurants keep it, using illegal ‘zappers’ | McClatchy Washington Bureau

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

The cross-border fraud is depriving U.S. states of money they could be using for education, law enforcement and other services. But to date, there’s been little coordinated attempt to root out the offshore operators that assist rogue retailers in under-reporting 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 the full figure is difficult to track.

“Manipulation of American business records offshore is happening on a wide scale,” said Ainsworth. “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. Some 26 other states have passed similar laws.

Over the last six months, restaurant owners in Minnesota, Michigan and Connecticut have been charged with using illegal sales tax suppression software. In some cases, restauranteurs 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 all income they receive to tax agencies, keep records on those sales and remit all tax 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.

In the digital age, such businesses have turned to more high-tech tricks. One common method is to install “zapper” software into their computerized cash registers — commonly known as “Point of Sale” or POS 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, according to Ainsworth.

These 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 — states that all rely heavily on sales tax revenue.

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, said Klomp, state tax authorities are lagging behind some of their Canadian counterparts in combating this form of fraud, as he noted in testimony to New York lawmakers last year.

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 diva Celine Dion. The investigation found that the restaurants, part of the Nickels chain, were all using zappers. While Dion wasn’t personally implicated, the probe 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 perfectly 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 a Hong Kong native named Pius Chan, Profitek was originally called InfoSpec Systems Inc. It started out specializing in providing Chinese-language POS systems to Canada’s Chinese restaurants and other businesses. Although its website hasn’t been updated for years, the firm continues to boast that it is “a leading software development company” that has “three offices in Canada, two offices in China and a growing dealership network across North America.”

From 2000 onward, Canadian authorities investigated Chan and his company for marketing zappers along with its POS 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 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 tax. 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 software 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 initially 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 to the tune 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 stated 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 interview Pius Chan, or locate his whereabouts, were unsuccessful. Photographs posted on the website of the Chinese Federation of Commerce Canada show he has remained active this year with the British Columbia-based group, but his relationship with Profitek is unclear.

When McClatchy contacted Profitek offices in Canada, a receptionist answered and directed the call to Chan’s voice mail. The call was not returned, but a few days later, someone claiming to be a company official emailed McClatchy a pair of statements. One claimed Chan had not been a director with the company for two years, despite his voice mail still being active.

Another statement asserted that Profitek it has been unfairly targeted due to the “open architecture database design” of its software.

“Profitek’s reputation has suffered in the past few years from accusations of complicity in the installation or use of sales suppression software; however, our position has remained the same: Profitek does not distribute, promote, support, or condone the use of sales suppression software or any illegitimate use of Profitek’s products.”

Compared to U.S. states, Quebec has moved aggressively to increase the security of computerized cash registers. To combat fraud, 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 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 there are simpler and less costly approaches than the Quebec solution. Yet just getting a law passed in New York has proven to be 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 if 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.”