Tax Type
Retail Sales and Use Tax
Description
Research and Development Inquiry
Topic
Property Subject to Tax
Date Issued
12-06-2001
December 6, 2001
Re: Request for Ruling: Retail Sales and Use Tax
Dear *****
This will reply to your letter in which you seek a ruling on behalf of your client, ***** (the "Taxpayer"), regarding the application of the retail sales and use tax exemption for research and development to certain purchases made by your client. I apologize for the department's delay in responding to your request.
FACTS
The Taxpayer is an Internet information technology company that develops electronic commerce marketing analysis processes. The Taxpayer uses these processes to provide clients with information about the behavior of their customers on the Internet. This information includes the purchasing and on-line buying habits of over one million customers who have agreed to participate in a network of individuals that allow the Taxpayer access to their activities on the Internet.
The Taxpayer uses computer equipment and software to develop and improve the technologies that it employs to provide its services to clients. This equipment is used to improve technologies related to servers, data compression and optimization, data identification, data storage and data manipulation. The equipment used by the Taxpayer includes servers, routers, computers, and software.
The Taxpayer seeks a ruling from the department that the hardware and software purchased to develop and improve the systems and technology used to provide its services are exempt from retail sales and use tax under the research and development exemption in Code of Virginia § 58.1-609.3(5).
RULING
Code of Virginia § 58.1-609.3(5) provides an exemption from the 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.) The department addresses this exemption in Title 23 of the Virginia Administrative Code (VAC) 10-210-3070 and defines "research and development" to mean:
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- A systematic study or search directed toward 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. Research and development must have as its ultimate goal: (i) the development of new products; (ii) the improvement of existing products; or (iii) the development of new uses for existing products. Research and development does not include the modification of a product merely to meet customer specifications unless the modification is carried out under experimental or laboratory conditions in order to improve the product generally or develop a new use for the product.
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- Title 23 VAC 10-210-765 provides that:
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- Exempt research and development activities are those that have as their ultimate goal the advancement of computer software technology, 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.
Title 23 VAC 10-210-3070 defines "direct use" as activities that are an integral part of basic research or research and development activities, including all steps of these activities. Direct use does not include secondary activities such as administration, general maintenance, product marketing, and other activities collateral to the actual research process. 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. 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. The Taxpayer's primary activity, Internet market research, is not an exempt research and development activity.
Based on the information provided in your correspondence, I agree that some of the activities engaged in by the Taxpayer may qualify as exempt research and development. Only those activities to develop or improve the technologies and processes described in the Taxpayer's letter would qualify as research and development. In addition, the Code of Virginia mandates that exempt property must be used "directly and exclusively." Property purchased to perform secondary or collateral activities is taxable. Further, if a single item is used both in taxable and exempt activities, such property is taxable since it is not used exclusively in research and development. The only exception to this is if the taxable usage is de minimis as addressed in Title 23 of the VAC 10-210-3071(C).
I am concerned that some of the activities engaged in by the Taxpayer may not qualify as research and development for purposes of the retail sales and use tax exemption. For example, equipment used by the Taxpayer to gather, monitor, store, or manipulate Internet behavior data would not be used exclusively in an exempt research and development activity. If the Taxpayer makes improvements to one of its processes to meet certain customer specifications, this activity may not be research and development, although this activity may improve existing technology or processes. Moreover, if some of the Taxpayer's equipment is used to store Internet surfing and buying data and is used in research and development activities, the exemption would not apply because the equipment is not used exclusively in research and development.
The Taxpayer may wish to have a representative from the department review its operations and equipment usage to insure that certain activities qualify as research and development and that the equipment used in these activities meets the direct and exclusive criteria set out in the exemption. If the Taxpayer has any questions concerning this ruling, or wishes to have a representative from the department review its operations, please contact ***** in the department's Office of Policy and Administration, Policy Development, at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
PD/31203S
Rulings of the Tax Commissioner