Tax Type
Retail Sales and Use Tax
Description
Equipment Eligible for Research Exemption
Topic
Property Subject to Tax
Date Issued
09-10-2001
September 10, 2001
Re: Reconsideration of § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****
This is in response to your letter of June 1, 2001, requesting reconsideration of the department's determination of April 16, 2001, in which the research and development exemption was denied for the assets used in the verification lab of ***** (the "Taxpayer"). Copies of cited sources are enclosed.
FACTS
You indicate that the Taxpayer's verification lab is used to perform the last stage of product testing during the development of a new product prior to releasing it for general sale. You claim that the documents presented show that verification testing is an integral part of the Taxpayer's design and development process and is used to confirm whether the Taxpayer's prototype products are capable of meeting the requirements of its intended use.
You indicate that off-the-shelf products (not prototypes) of other manufacturers are used in the verification lab to verify interoperability with the Taxpayer's products but only as part of the completion of the design and development of a new Taxpayer product. You also indicate that the verification lab is treated as part of the Taxpayer's research and development expense.
DETERMINATION
The Virginia courts have consistently required strict interpretation of sales and use tax exemptions. That is, where there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption. See Title 23 of the Virginia Administrative Code 10-210-540.
Code of Virginia § 58.1-609.3(5) provides an exemption from the retail sales and use tax 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.) Thus, property used directly but not exclusively in research activities does not qualify for the exemption, unless the taxable use is de minimis in nature. See Title 23 of the Virginia Administrative Code (VAC) 10-210-3071(B) & (C).
Pursuant to 23 VAC 10-210-3070(A), "exclusive use" refers to items which "are used solely in basic research or research and development activities." Subsection B of this regulation goes on to state that exempt research activities do not include activities, which test or inspect materials or products for quality control. Also, feasibility studies, environmental analysis, and other information gathering investigations are activities outside the scope of the research exemption.
In this case, I would note that the department's audit staff observed the verification lab being used to test other companies' modems for compatibility purposes. It is my understanding that this lab is also used to test approximately 13% of the Taxpayer's products pulled from the production line for environmental and quality control test purposes, e.g., compliance with safety standards and client specifications. Such taxable use is not de minimis in nature.
Although many of the Taxpayer's verification activities may be the last stage of a research and development process, I must recognize that the contested equipment is also used by the Taxpayer in activities, which are not part of the actual research process. In this regard, the contested equipment is not used exclusively in research and development activities as mandated in the exemption statute.
Based on the above and the application of the strict construction rules mandated by the courts, the verification lab equipment does not qualify for the research and development exemption. Accordingly, the sales and use tax assessment issued as a result of an audit for the period June 1996 through May 1999 is found to be correctly assessed.
If you have any questions regarding this letter, please contact ***** in the department's Appeals and Rulings Office at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
ARO/34941R
Rulings of the Tax Commissioner