Tax Type
Retail Sales and Use Tax
Description
Does this Qualify for Research and Development Exemption
Topic
Property Subject to Tax
Taxability of Persons and Transactions
Date Issued
09-19-2001
September 19, 2001
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****
This is in response to your letter in which you seek correction of a sales and use tax assessment issued to ***** (the "Taxpayer") for the period February 1997 through January 2000. I apologize for the delay in responding to your protest.
FACTS
The Taxpayer is engaged in electronics engineering and research. The only contested issue in this case is the lease of intrusion detection equipment (the "Detection System"). The Detection System was leased by the Taxpayer from one of its subsidiaries and subsequently used by the Taxpayer pursuant to a subcontract with a federal government prime contractor.
According to the Technical Proposal prepared by the prime contractor, the Taxpayer will initially use the Detection System in the field to collect acoustic data and other measurements relating to the detection of jet aircraft takeoffs. Using that data at its Virginia facility, the Taxpayer will then develop algorithms for the Detection System that are best suited for detecting jet aircraft takeoffs. After additional field tests and modifications, the Taxpayer will provide training to the prime contractor. This training will permit the prime contractor to set up and operate the Detection System for a field demonstration.
The Taxpayer suggests it uses the Detection System in exempt research and development and that its lease of the Detection System from the supplier is exempt of the tax.
DETERMINATION
Government Contracts - Generally
The department has traditionally held that in considering the tax treatment of federal government contracts, it must be determined whether the contract is for the sale of tangible personal property or for the provision of services. The "true object" test is used to determine whether the contract is for the sale of tangible personal property or for the provision of some service.
If a contract is for the provision of services, the contractor is deemed to be the taxable user or consumer of all tangible personal property used in performing its contractual services, even though title to some or all of the property may pass to the government. Conversely, if a contract is for the sale of tangible personal property, the contractor may purchase such property exempt from the tax for resale. The subsequent sale of the property to the government is exempt under Code of Virginia § 58.1-609.1(4).
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 Title 23 of the Virginia Administrative Code 10-210-3070 through 3074. These regulations define "research and development" as "a systematic study or search directed toward a new knowledge or new understanding of a particular scientific or technical subject and the gradual transformation of this new knowledge or new understanding into a usable product or process," including the development of new uses for existing products. The term "basic research" is defined as "a systematic study or search in a scientific or technical field or endeavor with the ultimate goal of advancing knowledge or technology in that field."
Applying the government contractor and research and development guidelines to the contract in the instant case leads to the following conclusions:
First, it appears that the true object of the contract between the Taxpayer and the prime contractor is for the provision of services. I note that the Taxpayer is responsible for some tangible deliverables; however, the true object set out in the prime contractor's Technical Proposal calls for the Taxpayer to use its technical and engineering expertise to support demonstrations to detect jet aircraft takeoffs. This support function represents the provision of a service to the prime contractor.
At the same time, I find that the scope of the work set out in the Technical Proposal is for research and development as defined above. The Taxpayer, via field tests and laboratory experimentation, is developing new uses for the Detection System. This work also advances the technology associated with the technical field of intrusion detection.
Based on the Technical Proposal, the Detection System is used directly and exclusively in an exempt research and development activity and will be removed from the assessment. I note that all of the uncontested issues in the audit assessment have been paid. Removing the Detection System thereby reduces the outstanding balance of the assessment to zero.
If you have any questions regarding this letter, please contact ***** in the department's Appeals and Rulings Office at ****@tax.state.va.us or at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
ARO/28865I
Rulings of the Tax Commissioner