Tax Type
Retail Sales and Use Tax
Description
Modeling software
Topic
Exemptions
Date Issued
05-22-2002
May 22, 2002
Re: Request for Ruling: Retail Sales and Use Tax
Dear *****:
This is in response to your letter concerning the application of the retail sales and use tax to software used by ***** (the "Taxpayer"). I apologize for the delay in the department's response.
FACTS
The Taxpayer is an industrial manufacturer of air handling units. At issue in this case is modeling software used by the Taxpayer to design and develop air handling units that meet exact customer specifications. In this regard, the modeling software is used to design and develop air handling units that provide optimum air flow efficiency together with the physical dimensions that correspond to the customer's space limitations.
You suggest that the modeling software qualifies for the innovative high technology exemptions and the exemption for industrial manufacturers set out in Title 23 of the Virginia Administrative Code (VAC) 10-210-920.
DETERMINATION
Research and Development
Title 23 of the Virginia Administrative Code (VAC) 10-210-765(D) indicates that persons engaged in research and development in the field of computer aided engineering may be entitled to the research and development exemption. This exemption is authorized by Code of Virginia § 58.1-609.3(5), which exempts from the tax "tangible 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 23 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.
By way of contrast, the regulations provide that exempt 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." Nor does the exemption apply to secondary activities such as administration, general maintenance, and other activities collateral to the actual research. Further, in order to qualify for the exemption, tangible personal property must be used directly and exclusively in an actual research process.
The Tax Commissioner has previously determined in Public Documents 88-95 (5/10/88) and 99-8 (1/8/99) that computer systems used to create manufacturing designs are taxable. Further, in Public Document 96-32, the Tax Commissioner determined that a computer-aided design system used for commercial design activities was not used in an exempt research and development activity.
Based on these prior determinations, and the language of the regulation concerning product modifications, the software used to design products to meet customers' specifications and requirements is not used in an exempt research and development activity.
Industrial Manufacturing
Code of Virginia § 58.1-609.3(2) addresses the exemptions available to industrial manufacturers and extends the exemption to tangible personal property "used directly" in industrial manufacturing. Pursuant to 23 VAC 10-210-920(B)(2), the exemption includes the production line of a plant but does not extend to items that are not an immediate part of actual production.
Public Documents 88-95 and 96-119 (6/4/96) address product design activities. The Tax Commissioner determined that such activities are not an immediate part of the "actual production" process. Rather, product design is a pre-production activity and items used in that activity are taxable.
As set out in 23 VAC 10-210-540, exemptions from the sales and use tax are strictly construed. This regulation specifies that "when exemption language is susceptible of two constructions, one granting the exemption and the other not granting it, the construction denying the exemption will be followed." Based on the information before me, and the doctrine of strict construction, I cannot determine that the Taxpayer's design activities are exempt under either the research and development exemption or the industrial manufacturing exemptions.
Copies of the Code of Virginia, regulations, and public documents are cited for reference purposes. These and other reference documents are available online in the Tax Policy Library 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 sent to you.
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/37840i
Rulings of the Tax Commissioner