Audit Report

Marijuana Taxation – Finance Department, Treasury Division

The objective of our audit was to assess the effectiveness and efficiency of
the Treasury Division’s audit unit in conducting marijuana tax audits. Our assessment of effectiveness looked at how well the audit unit is achieving its objectives and meeting its goals, while our assessment of efficiency looked at the extent of resources required by the audit unit to produce marijuana tax audits.

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The city’s Treasury Division within the Department of Finance is responsible for collecting, recording, and depositing all City and County of Denver taxes and other city revenues. Further, Treasury also ensures compliance with all applicable tax laws.

The audit unit is the largest unit within Treasury and performs audits for Denver’s six excise taxes — the sales tax, use tax, occupational privilege tax, lodger’s tax, facilities development admissions tax, and telecommunications business tax — as well as the business personal property tax.

The Treasury Division’s Audit Unit Is Not Effective or Efficient at Ensuring All Marijuana Taxes Are Reported and Paid

  • Treasury’s audit unit does not use quality information to select marijuana businesses, which impacts how effective it is in identifying businesses with the highest risk of underreporting.
  • Treasury’s audit unit does not use — or retain — all relevant information when conducting audits of marijuana businesses.
  • Treasury’s audit unit does not adequately measure how efficiently it deploys city resources.
  • Treasury’s audit unit has an ineffective process to identify unlicensed marijuana businesses.
  • The audit unit’s lack of verification of state shareback payments may lead to a loss of revenue for the city or a liability to the state.

1.1 Develop Data-Driven Approach to Audit Selection – The Treasury Division’s director of tax compliance should develop a data-driven approach to monitor and identify marijuana businesses with a high risk of underreporting. The data-driven approach should include:

  • Reviewing tax audit results each year to identify risk factors;
  • Quantifying the effect each risk factor has on tax audit assessment of the current year’s tax audits;
  • Identifying the most powerful model to account for tax audit assessment and selecting cases based on this model; and
  • Analyzing tax audit results regularly to determine how effective the risk indicators used to select audits were and to determine whether changes are needed.

Agency Response: Agree, Implementation Date – Aug. 31, 2020

1.2 Formalize and Follow Policy to Validate Data – The Treasury Division’s director of tax compliance should develop and use a formal policy that requires data be validated before it is relied upon to select businesses for audit. Further, the director of tax compliance should develop a corresponding procedure that spells out how the data are to be validated, who is to be responsible for the validation, and the frequency of the validation.

Agency Response: Agree, Implementation Date – Aug. 31, 2020

1.3 Communicate with the Colorado Department of Revenue – The Treasury Division’s director of tax compliance should coordinate with the Colorado Department of Revenue’s Division of Taxation to obtain state tax audit information through an information exchange agreement. This information should be used to:

  • Inform the city’s audit selection process; and

  • Verify sales information reported to the state matches the sales information reported to the city.

Agency Response: Agree, Implementation Date – Aug. 31, 2020

1.4 Better Define Policy and Create Detailed Procedures – The Treasury Division’s director of tax compliance should expound on, and formalize, the agency’s current policy, defining exactly what constitutes an “abnormal” and “erratic” payment trend. Further, Treasury’s director of tax compliance should establish written procedures that correspond to the policy, including defining the individual tasks the specialist is to perform, how communication of risks is to be delivered to the audit unit, and the person responsible for receiving the communication from the specialist.

Agency Response: Agree, Implementation Date – Aug. 31, 2020

1.5 Adopt Audit Standards – The Treasury Division’s director of tax compliance should adopt professional audit standards to inform how the audit unit performs its marijuana tax audits. Standards such as those set by the American Institute of Certified Public Accountants, the U.S. Government Accountability Office, and The Institute of Internal Auditors would ensure quality information and relevant information, such as Metrc waste reports, are used to support audit assessments. Compliance with standards would also ensure there is evidence audit work was properly reviewed.

Agency Response: Agree, Implementation Date – Aug. 31, 2020

1.6 Retain Supporting Documentation for Tax Audits – The Treasury Division’s director of tax compliance should update Treasury’s policy for tax audits to require tax auditors to retain supporting documentation in the tax audit files that would provide a clear explanation of any tax adjustments and conclusions made as a result of the audit. This information should be obtained and retained in the audit file as supporting workpapers and could include items such as sales journals, invoices, and other pertinent information. This supporting documentation should be kept for a period of six years after the completion of the audit.

Agency Response: Disagree
Auditor’s Addendum: See page 38 under Recommendation 1.6

1.7 Develop Safeguards to Ensure Procedures Are Followed – The Treasury Division’s director of tax compliance should develop safeguards to ensure the audit unit’s marijuana tax audit procedures are consistently followed.

Agency Response: Agree, Implementation Date – Aug. 31, 2020

1.8 Develop and Monitor a Comprehensive Set of Performance Measures – The Treasury Division’s director of tax compliance should develop a comprehensive set of performance measures that address each of the audit unit’s goals and objectives and the different aspects of the services being provided. Further, the performance measures should be monitored closely on a recurring basis to assess the adequacy of results using the following criteria:

  • Expected resource use or efficiency level;

  • Past performance (trending); and

  • Performance measurement rates of other units doing similar work.

    Lastly, management should interpret the results of performance measurement and take appropriate action where needed.

Agency Response: Agree, Implementation Date – Aug. 31, 2020

1.9 Identify Unlicensed Marijuana Delivery Businesses – The Treasury Division’s director of tax compliance should develop policies and procedures for identifying unlicensed marijuana delivery businesses that are not reporting and remitting sales tax. Such procedures could include:

  • Setting Google alerts for terms relevant to the marijuana industry and marijuana delivery;

  • Checking marijuana businesses advertised on digital platforms such as Weedmaps, Leafly, and WeedAdvisor, and cross-reference those businesses with the city license database; and

  • Identifying potential unlicensed businesses through the city’s business license complaint system and the Denver 311 program.

Agency Response: Agree, Implementation Date – Aug. 31, 2020

1.10 Coordinate with the Department of Excise and Licenses – The Treasury Division’s director of tax compliance should coordinate with the Department of Excise and Licenses to obtain relevant reports the division could use to streamline its monthly reconciliation process. The reports should contain the marijuana license reports received from the state, as well as Accela data documenting status updates with city marijuana licenses.

Agency Response: Agree, Implementation Date – Aug. 31, 2020

1.11 Design and Implement Verification Safeguards over Shareback Payments – The Treasury Division’s director of tax compliance and the Controller’s Office should work together to ensure that either the division or the office design and implement safeguards to make sure the monthly state shareback payment is accurate. Such safeguards should include:

  • Reconciling amounts reported by the state for sales in Denver to recreational marijuana sales pulled from the city’s GenTax system;

  • Recalculating the amount of the shareback payment using amounts reported from the state; and

  • Comparing the state’s shareback payment received to the amount reported by the state as being owed.

Agency Response: Agree, Implementation Date – April 30, 2020

The objective of our audit of the City and County of Denver’s marijuana taxation was to assess the effectiveness and efficiency of the Treasury Division’s audit unit in conducting marijuana tax audits. Our assessment of effectiveness looked at how well the audit unit is achieving its objectives and meeting its goals, while our assessment of efficiency looked at the amount of resources required by the audit unit to produce marijuana tax audits. I am pleased to present the results of this audit.

The audit revealed Treasury’s operations over its audit unit have led to an ineffective and inefficient use of city resources. The audit found gaps in agency-level practices that include: relying on faulty assumptions and inaccurate data when selecting which marijuana businesses to audit, not using relevant and sufficient information when performing its marijuana sales tax audits, not communicating with the state to obtain relevant information when performing tax audits, and a lack of structure related to how the audit unit uses its marijuana industry-dedicated tax technician specialist. Such risks could lead to a loss in marijuana tax revenue for the city, which then could mean less funding for services to Denver residents.

Through a stronger set of internal controls and a more systematic approach to evaluating marijuana businesses, the audit unit could more effectively identify and select marijuana tax audits, conduct more impactful marijuana tax audits while efficiently using resources, and generate more marijuana tax revenue. Our report lists several related recommendations.

This performance audit is authorized pursuant to the City and County of Denver Charter, Article V, Part 2, Section 1, “General Powers and Duties of Auditor,” and was conducted in accordance with generally accepted government auditing standards. Those standards require we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

We extend our appreciation to personnel within the Treasury Division who assisted and cooperated with us during the audit. For any questions, please feel free to contact me at 720-913-5000.

Follow-up report

A follow-up report is forthcoming. 

Audit Team: Katja E.V. Freeman, Patrick Schafer, Ryan Dougherty, Todd Green, Chris Wilson, Sam Musler

Methodological Support: Samuel Gallaher