Document Number
02-147
Tax Type
Retail Sales and Use Tax
Description
Subcontract to furnish and install a security system
Topic
Appropriateness of Audit Methodology
Date Issued
12-02-2002

December 2, 2002


Re: § 58.1-1821 Application: Retail Sales and Use Tax


Dear**************

This is in reply to your letter and the letter from ***** seeking correction of the sales and use tax assessment issued to ***** (the "Taxpayer"), for the period December 1998 through August 1999. I apologize for the delay in the department's response.
FACTS

The Taxpayer is a contractor that operates in a dual role capacity and fabricates products for sale at retail and for its use and consumption in real property construction contracts. The Taxpayer entered into a subcontract to furnish and install a security system in the construction of a jail facility owned by a Virginia regional jail authority ("Authority"). The subcontract is between the Taxpayer and -the construction manager ("Manager") for the prison construction. The security system consists of specialized doors, electronic locking devices, and other components that become real property upon installation. The Taxpayer, along with a number of other vendors, supplied the construction materials necessary for the Taxpayer to perform the contract. In bidding the contract, the Taxpayer included the total amount for completing the job, including all materials costs, labor, and the applicable sales and use tax charges.

Notwithstanding the Taxpayer's obligation to furnish and install the necessary materials, the subcontract contained a provision allowing the Authority to purchase the materials. The Authority exercised this option and purchased the materials from the Taxpayer and the other vendors exempt of the tax. After the purchase, the Authority furnished the materials to the Taxpayer for use in building and installing the security system. Upon completion of the contract work, the Manager issued deductive change orders to the Taxpayer removing the materials costs (that the Authority paid) and the applicable sales tax charges from the total amount of the subcontract.

Upon audit, the auditor deemed the Taxpayer a using and consuming contractor with respect to the subcontract and denied the Taxpayer's exempt sale of the materials to the Authority. Because the data was not available regarding the Taxpayer's raw materials purchases, the auditor assessed the tax on the Taxpayer's sale of the materials to the Authority.

You dispute the tax and contend that the sale of the materials to the Authority qualifies as an exempt sale to the government. To support this, you cite an opinion of the Attorney General, 1997 Op. Va. Atty. Gen. 157, issued to the Authority. Further, you contend that no tax is due from the Taxpayer on the materials because the Authority furnished the materials to the Taxpayer for installation only, consistent with Virginia Tax Bulletin 92-2 (4/1/92).

In regard to a separate issue, you contest the tax applied to a sale of property by the Taxpayer that was shipped to the purchaser outside Virginia. You provide documentation to support the out-of-state delivery.
DETERMINATION

There are three transactions at issue in this case: (1) the Taxpayer's purchase of raw materials for use in fabricating the materials sold to the Authority, (2) the Taxpayer's sale of the materials to the Authority, and (3) the provision of the materials to the Taxpayer by the Authority. I will address each transaction individually.

Raw Materials Purchases: It is established that the Taxpayer fabricates property primarily for its own use and consumption in the performance of real property construction contracts. In accordance with the contractor regulation in Title 23 of the Virginia Administrative Code (VAC) 10-210-410(D), the Taxpayer is considered a using and consuming contractor and must pay the tax on the cost price of the raw materials which make up such fabricated property. Notwithstanding the above, Section E of the regulation states:
    • In addition, persons who sell tangible personal property to consumers must register, collect, and pay the tax on the retail selling price of the tangible personal property. Such person is entitled to purchase exempt from the tax only that tangible personal property which can be identified at the time of purchase as purchases for resale.

In regard to the subcontract, it is my understanding that the Taxpayer purchased the raw materials with the express intent of using the materials to fabricate the materials sold to the Authority. The Taxpayer, at the time of purchase, could identify the raw materials that would be resold to the Authority. Therefore, the Taxpayer's raw materials purchases qualify as exempt purchases for resale.

Sale to the Government: The Taxpayer's subcontract contains a "Special Requirement" that gives the Authority the option to purchase the materials from the suppliers. The summary of the "Special Requirement" states:
    • In connection with this subcontract, [the Authority] reserves the option to enter into an agreement with the Subcontractor to purchase all, or a portion of the tangible personal property necessary for the performance of the Contract, and thereby to save the amount of the sales tax thereon by virtue of the Authority's status as a Tax Exempt institution.

Code of Virginia § 58.1-609.1(4) provides an exemption from the sales and use tax for tangible personal property for use or consumption by the Commonwealth, any political subdivision of the Commonwealth, or the United States. The government regulation in 23 VAC 10-210-690 interprets the exemption and provides that governments are exempt when their purchases are made pursuant to required official purchase orders to be paid out of public funds.

The Authority exercised the above option and issued direct materials purchase orders to the Taxpayer as well as to the other vendors, and the Authority's credit was bound in connection with these purchases. Based on the regulation and the subcontract "Special Requirement," the Taxpayer's sale of the materials to the Authority qualifies as an exempt sale to the government.

Materials Furnished to the Taxpayer: Code of Virginia § 58.1-610(B) provides an exception to the general rule that contractors are subject to the tax. Section J of 23 VAC 10-210-410 addresses the exception and states that "[c]ontractors are not subject to the use tax when provided with tangible personal property purchased by a governmental entity for use in real property construction contracts." After purchasing the materials from the Taxpayer and the other vendors, the Authority furnished them to the Taxpayer for use in completing the subcontract. Based on the cited authorities, the Taxpayer is not taxable on the materials furnished to it by the Authority. This is true in regard to the materials purchased from the Taxpayer and those purchased from the other vendors.

Attorney General Opinion

The determinations in this case are consistent with the position taken in the Attorney General Opinion issued to the Authority. The Opinion affirms that the Authority's purchase of materials is exempt in accordance with Code of Virginia § 58.1-609.1(4). In addition, the Opinion indicates that the Authority may provide the materials to its subcontractors without the subcontractors incurring the tax in accordance with the exception in Code of Virginia § 58.1-610(B).

Virginia Tax Bulletin 92-2

The determinations are also consistent with Virginia Tax Bulletin 92-2. The bulletin addresses the sale and installation of public school equipment and applies the exception to the general contractor rule as follows:
    • Code of Virginia § 58.1-610(B) permits a public school system to purchase materials itself and then turn the materials over to a contractor for installation only, without subjecting the contractor to the tax on the materials.

The Taxpayer's subcontract is legally structured to satisfy this exception. The subcontract (1) provides the Authority the option to purchase the materials itself, and (2) provides a mechanism to change the amount due the Taxpayer in the event the Authority exercised the option.

Sale Outside Virginia

Based on the documentation provided, the sale to a purchaser outside Virginia will be removed from the audit.

Conclusion
    • In accordance with this determination, the assessment will be abated. The Code of Virginia sections, regulations, and Virginia Tax Bulletin cited are available online in the Tax Policy Library section of the Department of Taxation's web site, located at www.tax.state.va.us. If you have additional questions regarding this matter, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.

                • Sincerely,


                • Kenneth W. Thorson
                  Tax Commissioner


AR/29110J


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46