Tax Type
Retail Sales and Use Tax
Description
Government contractor - "True object" test; Research; Maintenance contracts
Topic
Taxability of Persons and Transactions
Date Issued
05-16-2000
May 16, 2000
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****
This is in response to your correspondence requesting correction of the use tax audit assessment issued to the ***** (the "Taxpayer"). I apologize for the delay in responding to your letter. Copies of cited resources are enclosed.
FACTS
The Taxpayer is engaged in the development of computer systems and providing software maintenance and support services. An audit for the period August 1992 through July 1995 resulted in the assessment of use tax on untaxed purchases of tangible personal property and parts and labor maintenance contracts.
The Taxpayer takes exception to the use tax assessed in connection with one contract with NASA at the Langley Research Center (LRC) and the contract's classification as a service contract. The Taxpayer maintains that the department failed to take into account the following factors:
The maintenance costs and services are attributable to consulting, professional services, and help desk support.
The services provided under this contract are used exclusively in basic research or research and development activities in the experimental or laboratory sense.
Equipment purchases are essentially provided under a separate provision of this contract and thus can be bifurcated from other parts of the contract.
DETERMINATION
Government Contracts - True Object Test
Pursuant to Title 23 of the Virginia Administrative Code (VAC) 10-210-693, a true object test is applied to government contracts which involve both the rendering of services and the provision of tangible personal property to determine whether the contract constitutes an exempt service or the sale of tangible personal property.
The statement of work for the contract at issue establishes that the "object of this contract is for ( ) to obtain support services to operate and maintain most of the (communications, information, and general application systems) and all...voice, data, and video communications networks; and to provide system administration support to specified...systems." In the stated scope of the contract, the Taxpayer is required to "furnish all qualified personnel, material, and equipment (other than that provided by the Government) required to provide the services in the general task areas: ...operations, ...systems maintenance, ...communications systems support, and system administration...." (Inserts added.)
It is clear from the language of the contract and the scope of the work thereunder that the primary objective of the contract is for the Taxpayer to provide various support services to ****. Equipment or spare parts delivered by the Taxpayer to maintain and expand existing networks are in furtherance of the services provided and are not the primary objective of the contract.
The authority to procure goods to support a service contract does not transform a service contract into a contract for the sale of tangible personal property. Rather, purchases of tangible personal property made pursuant to a service contract are inseparable elements of a service contract and therefore do not qualify for the resale exemption. Therefore, as set out in 23 VAC 10-210-693, the Taxpayer is deemed the user or consumer of all items purchased for the performance of the contract and generally must either pay the tax to its suppliers at the time of purchase or remit the use tax directly to the department based on the cost of such items.
This position is consistent with prior Public Documents (P.D.) 96-155 (6/27/96), 93-196 (9/23/93), 93-186 (8/19/93) and 89-154 (4/28/89). This position is also consistent with the ruling in United States v. Forst, 442 F. Supp. 920 (W.D. Va. 1977), affd 569 F.2nd 881 (4th Cir., 1978), in which the court held that the resale exemption was inapplicable to a government contractor, which was the final consumer of the items. Even though the contractor never had legal title to such items and was reimbursed by the United States for the cost thereof, they were not "resold" to the United States.
Research and Development
Notwithstanding the true object of a government contract, Code of Virginia § 58.1-609.3(5) provides a sales and use tax exemption for "[t]angible personal property purchased for use or consumption directly and exclusively in basic research or research and development in the experimental or laboratory sense." (Emphasis added.) The department interprets this statute in 23 VAC 10-210-3070 through 3074. These regulations provide that the research exemption applies to "[c]omputer hardware and software when used exclusively to store, retrieve, and process research data."
This statute is also interpreted by 23 VAC 10-210-765, which provides that:
[e]xempt research and development activities are those that have as their ultimate goal . . . the development of new computer software products, the improvement of existing computer software products, or the development of new uses for existing computer software products. An example of exempt tangible personal property used in a research and development activity is computer hardware and software used in programming and other development activities with respect to new computer software products, including the testing of such new products.
By way of contrast, the regulations provide that exempt research does not include testing or inspection of materials or products for quality control, environmental analysis, testing of samples, operations research or management studies. Exempt research also does not include secondary activities such as administration, general maintenance, product marketing, or other activities collateral to the actual research process. In order to qualify for the exemption, tangible personal property must be used directly and exclusively in an actual research process and must be purchased by the organization that actually performs the research activities.
Maintenance Contracts
All of the items at issue are parts and labor maintenance contracts purchased by the Taxpayer to provide warranty coverage for computer hardware and software purchased by the government to conduct its research or research and development efforts. Pursuant to 23 VAC 10-210-910(D), such contracts represent the sale of tangible personal property to the Taxpayer and are subject to taxation on their total charge. (Effective January 1, 1996, the law was changed to exempt from the sales and use tax one-half of the total charge for parts and labor maintenance contracts. This law change has no bearing on the audit period at issue).
Although the Taxpayer has contracted to provide administrative, maintenance and management services, the contract also requires the Taxpayer to "provide data reduction support for various research facilities" of the government and includes the following tasks:
Develop scientific computer programs for data acquisition and data reduction in support of wind tunnel, environmental, and flight research experiments. Develop real-time software subsystems to allow control of laboratory tests.
To the extent that the Taxpayer performs the above development tasks in connection with LRC's aerospace and environmental research activities, the research exemption applies to the Taxpayer's purchases of tangible personal property used in the performance of such tasks. Based on additional information furnished the department, it is my understanding that the maintenance contracts at issue are for computer and interface equipment used directly and exclusively for data reduction, analysis, and storage of research and development data at LRC. It is also my understanding that the Taxpayer uses such equipment in the performance of the program development tasks mentioned above. As parts and labor maintenance contracts constitute tangible personal property for sales and use tax purposes, l find basis for the research and development exemption to apply to all of the maintenance contracts assessed in the department's audit. This determination is consistent with P.D. 98-121 (7/24/98) issued on a similar matter.
Accordingly, the assessment will be revised to abate the tax and interest assessed on all of the maintenance contracts at issue. This revision will also result in waiver of the entire audit penalty, as the revised compliance ratio is sufficient to be considered an acceptable level of compliance. These adjustments are shown on the enclosed Revision Statement.
The Taxpayer should submit payment for the uncontested balance of tax and interest totaling within 30 days from the date of this letter. Payment should be sent to the attention of **** Office of Tax Policy, P. O. Box 1880, Richmond, Virginia, 23218-1880. If payment is not received within the allotted time, additional interest charges will accrue. If you have any questions about this response, please contact ***** of my Tax Policy staff at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/24696R
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****
This is in response to your correspondence requesting correction of the use tax audit assessment issued to the ***** (the "Taxpayer"). I apologize for the delay in responding to your letter. Copies of cited resources are enclosed.
FACTS
The Taxpayer is engaged in the development of computer systems and providing software maintenance and support services. An audit for the period August 1992 through July 1995 resulted in the assessment of use tax on untaxed purchases of tangible personal property and parts and labor maintenance contracts.
The Taxpayer takes exception to the use tax assessed in connection with one contract with NASA at the Langley Research Center (LRC) and the contract's classification as a service contract. The Taxpayer maintains that the department failed to take into account the following factors:
The maintenance costs and services are attributable to consulting, professional services, and help desk support.
The services provided under this contract are used exclusively in basic research or research and development activities in the experimental or laboratory sense.
Equipment purchases are essentially provided under a separate provision of this contract and thus can be bifurcated from other parts of the contract.
DETERMINATION
Government Contracts - True Object Test
Pursuant to Title 23 of the Virginia Administrative Code (VAC) 10-210-693, a true object test is applied to government contracts which involve both the rendering of services and the provision of tangible personal property to determine whether the contract constitutes an exempt service or the sale of tangible personal property.
The statement of work for the contract at issue establishes that the "object of this contract is for ( ) to obtain support services to operate and maintain most of the (communications, information, and general application systems) and all...voice, data, and video communications networks; and to provide system administration support to specified...systems." In the stated scope of the contract, the Taxpayer is required to "furnish all qualified personnel, material, and equipment (other than that provided by the Government) required to provide the services in the general task areas: ...operations, ...systems maintenance, ...communications systems support, and system administration...." (Inserts added.)
It is clear from the language of the contract and the scope of the work thereunder that the primary objective of the contract is for the Taxpayer to provide various support services to ****. Equipment or spare parts delivered by the Taxpayer to maintain and expand existing networks are in furtherance of the services provided and are not the primary objective of the contract.
The authority to procure goods to support a service contract does not transform a service contract into a contract for the sale of tangible personal property. Rather, purchases of tangible personal property made pursuant to a service contract are inseparable elements of a service contract and therefore do not qualify for the resale exemption. Therefore, as set out in 23 VAC 10-210-693, the Taxpayer is deemed the user or consumer of all items purchased for the performance of the contract and generally must either pay the tax to its suppliers at the time of purchase or remit the use tax directly to the department based on the cost of such items.
This position is consistent with prior Public Documents (P.D.) 96-155 (6/27/96), 93-196 (9/23/93), 93-186 (8/19/93) and 89-154 (4/28/89). This position is also consistent with the ruling in United States v. Forst, 442 F. Supp. 920 (W.D. Va. 1977), affd 569 F.2nd 881 (4th Cir., 1978), in which the court held that the resale exemption was inapplicable to a government contractor, which was the final consumer of the items. Even though the contractor never had legal title to such items and was reimbursed by the United States for the cost thereof, they were not "resold" to the United States.
Research and Development
Notwithstanding the true object of a government contract, Code of Virginia § 58.1-609.3(5) provides a sales and use tax exemption for "[t]angible personal property purchased for use or consumption directly and exclusively in basic research or research and development in the experimental or laboratory sense." (Emphasis added.) The department interprets this statute in 23 VAC 10-210-3070 through 3074. These regulations provide that the research exemption applies to "[c]omputer hardware and software when used exclusively to store, retrieve, and process research data."
This statute is also interpreted by 23 VAC 10-210-765, which provides that:
[e]xempt research and development activities are those that have as their ultimate goal . . . the development of new computer software products, the improvement of existing computer software products, or the development of new uses for existing computer software products. An example of exempt tangible personal property used in a research and development activity is computer hardware and software used in programming and other development activities with respect to new computer software products, including the testing of such new products.
By way of contrast, the regulations provide that exempt research does not include testing or inspection of materials or products for quality control, environmental analysis, testing of samples, operations research or management studies. Exempt research also does not include secondary activities such as administration, general maintenance, product marketing, or other activities collateral to the actual research process. In order to qualify for the exemption, tangible personal property must be used directly and exclusively in an actual research process and must be purchased by the organization that actually performs the research activities.
Maintenance Contracts
All of the items at issue are parts and labor maintenance contracts purchased by the Taxpayer to provide warranty coverage for computer hardware and software purchased by the government to conduct its research or research and development efforts. Pursuant to 23 VAC 10-210-910(D), such contracts represent the sale of tangible personal property to the Taxpayer and are subject to taxation on their total charge. (Effective January 1, 1996, the law was changed to exempt from the sales and use tax one-half of the total charge for parts and labor maintenance contracts. This law change has no bearing on the audit period at issue).
Although the Taxpayer has contracted to provide administrative, maintenance and management services, the contract also requires the Taxpayer to "provide data reduction support for various research facilities" of the government and includes the following tasks:
Develop scientific computer programs for data acquisition and data reduction in support of wind tunnel, environmental, and flight research experiments. Develop real-time software subsystems to allow control of laboratory tests.
To the extent that the Taxpayer performs the above development tasks in connection with LRC's aerospace and environmental research activities, the research exemption applies to the Taxpayer's purchases of tangible personal property used in the performance of such tasks. Based on additional information furnished the department, it is my understanding that the maintenance contracts at issue are for computer and interface equipment used directly and exclusively for data reduction, analysis, and storage of research and development data at LRC. It is also my understanding that the Taxpayer uses such equipment in the performance of the program development tasks mentioned above. As parts and labor maintenance contracts constitute tangible personal property for sales and use tax purposes, l find basis for the research and development exemption to apply to all of the maintenance contracts assessed in the department's audit. This determination is consistent with P.D. 98-121 (7/24/98) issued on a similar matter.
Accordingly, the assessment will be revised to abate the tax and interest assessed on all of the maintenance contracts at issue. This revision will also result in waiver of the entire audit penalty, as the revised compliance ratio is sufficient to be considered an acceptable level of compliance. These adjustments are shown on the enclosed Revision Statement.
The Taxpayer should submit payment for the uncontested balance of tax and interest totaling within 30 days from the date of this letter. Payment should be sent to the attention of **** Office of Tax Policy, P. O. Box 1880, Richmond, Virginia, 23218-1880. If payment is not received within the allotted time, additional interest charges will accrue. If you have any questions about this response, please contact ***** of my Tax Policy staff at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/24696R
Rulings of the Tax Commissioner