Document Number
02-161
Tax Type
Retail Sales and Use Tax
Description
Government contractor, Consumer Use
Topic
Allocation and Apportionment
Basis of Tax
Date Issued
12-18-2002

December 18, 2002


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


Dear *****:

This is in response to your letter in which you seek correction of the consumer use tax assessment issued to ***** (the "Taxpayer") as a result of an audit. I apologize for the delay in the department's response.
FACTS

The Taxpayer is a subsidiary company operating primarily as a government contractor. An audit for the period October 1996 through December 2000 resulted in the assessment of use tax on untaxed purchases of tangible personal property (e.g., hardware, cabling, installation supplies, etc.) in connection with government contracts.

The Taxpayer contests the tax assessed on communications hardware purchased in connection with a particular government contract. The contested contract consists of a series of revisions and updates that lead ultimately to changes in the scope of the contract. The Taxpayer maintains that the true object of the contested contract is for upgrade and modernization of tangible communications systems and that the contested transactions constitute exempt purchases of tangible personal property for resale to the federal government.
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 described in Title 23 of the Virginia Administrative Code (VAC) 10-210-4040 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). However, the contractor is liable for the tax on any property that it purchases for its use or consumption in the performance of the contract.

Applying these guidelines to the contract at issue leads to the following conclusions:

Operations and Maintenance of the Network Information Systems ("OMNIS" contract

The initial 1993 Statement of Work ("SOW") identifies goals and objectives of the OMNIS contract at issue. The basic scope of this SOW involves the operation of the data and voice networks (i.e., computer and telephone systems), the maintenance and repair of telephone and computer network equipment, and tasking for planning, design, installation, and technical support.

Section 3 of the SOW requires that the Taxpayer perform the above general tasks and the specific tasks defined in paragraph 4 of the SOW. The specific outline of tasks under the contract is divided into two categories: Mode I and Mode II tasks. Mode I tasks are the minimum tasking requirements expected of the Taxpayer under the contract. In regard to the operational Mode I scope of the contract, the Taxpayer is required to perform the following support tasks:
  • Customer service (receiving and logging customer trouble calls, diagnosing problems and recommending approaches for solution, etc.);
  • Operation of the telecommunications network by manning positions, monitoring the status of the network, reporting on and verifying network performance, diagnosing problems and recommending solutions, logging problems, carrying out quality control requirements, acceptance testing, reconfiguring the existing network service if necessary, and installing and maintaining crypto keys;
  • Switch operations (operating switches, updating and auditing equipment and configuration databases, monitoring equipment operations and performance, carrying out certification and quality control standards, acceptance testing and activating switches, reconfiguring switches, documenting all actions, and line assignment and testing);
  • Telephone services, such as:
  • Telephone assistance (directory assistance and skylink services);
  • Publishing telephone directories;
  • Services related to telephone billing; and
  • Providing equipment and services for facsimile installations and pagers.

Clearly, these Mode I service tasks go beyond the provision and maintenance of tangible personal property. In reviewing the subsequent contract amendments, the operational scope was modified to exclude customer services and telephone services in 1999. However, the remaining Mode I operational tasks still appear in later contracts and clearly require that the Taxpayer take on an operational role.

In addition, the Taxpayer was tasked to use its expertise to provide several technical support tasks, such as:
  • Inventory management of equipment and spares;
  • Configuration management requiring the maintenance and administration of a database of information;
  • Database administration to support management functions; and
  • ADP support to develop support software for application changes and new applications and to provide software maintenance.

The software development function was eliminated in 1999 but reintroduced in 2000. However, the database administration requirement was removed in 2000. In any event, these technical support functions further demonstrate the service role requirement under the contract.

In regard to the Mode II tasking, the Taxpayer is given even greater responsibility under the contract. An examination of the contract reveals a distinction between Mode I and Mode II tasking. Under Mode I tasking, the Taxpayer's responsibilities are limited to supporting the government in operating the network. However, under Mode II, the Taxpayer is required to perform the entire Mode I tasks, plus fully "manage and operate" the network.

The Taxpayer maintains that the contract never transitioned to a Mode II expectation. Accordingly, the management tasks of Mode II were never implemented. Notwithstanding the lack of Mode II implementation, the Taxpayer still has considerable operational tasking to fulfill under the Mode I portion of the contract. Furthermore, the revised contracts continued to include the specific Mode II operations elements. In effect, if the government intended to delete such operations, it certainly could have done so before the third revision on May 26, 1999.

In regard to the numerous public documents cited in your letter, I must point out that the department relied upon the language of each contract in reaching a correct determination. For example, on page 15 of your appeal, you reference Public Document 95-323 (12/20/95) as a determination that "best articulates the Department's position with respect to contracts involving an active operational element in addition to the procurement of network hardware" (in other words, a services contract). You then quote a substantial segment of that public document. That public document, like others you reference, clearly indicates that the determination is made pursuant to the contract.

The department recognizes that government contracts are legally binding and set out what the government wants and what it requires its contractors to provide. In this regard, the department looks to the contract language to determine the true object of the contract for the proper application of the sales and use tax to the contract. The department will apply the same standard to the OMNIS contract that it applies to all other government contracts, i.e., the true object is found in the language of the contract.

Based on all of the foregoing, I cannot agree that the true object of the contract is for the sale of tangible personal property. On the contrary, the contract terms reveal an overall emphasis upon operational, technical and support service roles. It appears that the provision of these services to the government is the true object of the contract. Clearly, the minimum expectations of the contract are for the Taxpayer to provide Mode I service tasking. Even without the Mode II service tasking, the contract is still deemed a services contract.

Conclusion

Based on the foregoing, the assessment is correct. A consolidated bill, with interest accrued to date, will shortly be mailed to the Taxpayer. No additional interest will accrue provided the outstanding assessment is paid within 45 days from the date of this letter. If you have any questions about remitting payment, you may contact ***** in the department's Collections Section at *****.

Code of Virginia sections, regulations and public documents 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 any questions about this determination, you may contact ***** in the department's Office of Policy and Administration, Appeals and Rulings, at *****.

                • Sincerely,

                • Kenneth W. Thorson
                  Tax Commissioner


AR/39582R


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46