Tax Type
Retail Sales and Use Tax
Description
Research and development exemption
Topic
Exemptions
Date Issued
05-21-2002
May 21, 2002
Re: Request for Ruling: Retail Sales and Use Tax
Dear *****:
This is in response to your letters of January 8 and April 11, 2002, submitted on behalf of an unidentified client (the "Taxpayer"), concerning the retail sales and use tax. Specifically, you request a ruling on the availability of the research and development exemption set out in Code of Virginia § 58.1-609.3(5) to the Taxpayer's activities.
FACTS
The Taxpayer researches, develops and manufactures new technology to be used in the facilitation of learning and teaching in school systems throughout the country. To this end, the Taxpayer aims to provide portable computing and Internet access to teachers and students through wireless networking, handheld computers, software, and support. Potential applications will allow students to enter, store, transfer, and retrieve data on the handheld computers and to access the Internet for educational purposes. Teachers will be able to monitor individual student responses in real-time and to perform administrative tasks electronically.
Prior to developing the technology, the Taxpayer determined that the learning process would be enhanced through the use of the Taxpayer's technology. For example, the Taxpayer initially relied on third-party studies and reports demonstrating that technology can have a positive impact on learning. The Taxpayer also engaged focus groups of teachers, students, parents and administrators to determine if the Taxpayer's concepts were feasible as related to the learning process. These activities allowed the Taxpayer to proceed with the development of its concept and led to the subsequent development and testing of prototypes.
Initial prototypes were developed using handheld devices modified to work with the network designed by the Taxpayer. Based on feedback of the initial prototype, new prototypes were created to include certain modifications and technological improvements. The new prototypes were then field tested in classrooms. This testing phase resulted in a wide range of modifications and additions to the hardware, software, storage capabilities, and network control. Additional testing and refinements in the final development process resulted in what the Taxpayer believes is a saleable product ready for manufacture.
You propose that tangible personal property used in the development and testing of the Taxpayer's educational technology is exempt from the tax under the research and development exemption set out in Code of Virginia § 58.1-609.3(5).
RULING
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."
The department interprets this statute in Title 23 of the Virginia Administrative Code (VAC) 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." The ultimate goal of exempt research and development must be the development of new products, the improvement of existing products, or the development of new uses for existing products. Further, 23 VAC 10-210-765 illustrates certain specific innovative high technology industries and indicates that the exemption generally applies to activities with the ultimate goal of advancing information technology "or developing new products, technology or processes or improving or finding new uses for existing products, technology or processes . . . ."
Based on the information you provide, I agree that the development of the Taxpayer's product qualifies for the research and development exemption. The exemption will also apply to the testing of the prototypes as described above. Such testing, performed to determine the technological capabilities of the Taxpayer's proposed products, is an exempt research and development activity.
In order to qualify for the exemption, tangible personal property must be used directly and exclusively in an actual research process. As such, the exemption does not extend to secondary activities such as administration, general maintenance, and other activities collateral to the actual research. Nor does the exemption apply to feasibility studies, research in the social sciences, or economic surveys. Therefore, activities such as the Taxpayer's focus group research are not deemed to be exempt research and development activities (because such activities are not part of an actual exempt research process). Further, any testing to determine the feasibility of using the Taxpayer's products (such as tests to determine if the Taxpayer's products would enhance learning) would not be exempt research and development. Tangible personal property, including product prototypes, used in such a taxable activity remains taxable. This is because property used in such taxable testing would violate the exclusive use mandate set out in the statute.
Finally, the ruling set out in this determination is consistent with established tax policy and is applicable to the facts as addressed above. Because sales and use tax exemptions are strictly construed pursuant to 23 VAC 10-210-540, even minor changes in the fact pattern may result in a different determination.
The cited Code of Virginia sections and regulations are available online in the Tax Policy section of the Department of Taxation's web site, located at www.tax.state.va.us. Please contact the department if you need hard copies of these documents.
If you have any questions regarding this letter, please contact ***** in the Office of Policy and Administration, Appeals and Rulings, via e-mail at *****@tax.state.va.us or at *****.
Sincerely,
Kenneth W. Thorson
Tax Commissioner
AR/38397i
Rulings of the Tax Commissioner