03-64 | Virginia Tax

Tax Type

Retail Sales and Use Tax

Description

Software license

Topic

Appropriateness of Audit Methodology

Exemptions

Property Subject to Tax

Date Issued

08-18-2003

August 18, 2003

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

Dear *****:

This is in response to your letter requesting correction of the retail sales and use
tax assessment issued to ***** (the "Taxpayer") as a result of an audit. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer provides engineering services to the federal government. An audit for the period April 1998 through August 2000 resulted in the assessment of tax on various purchases of tangible personal property used in the Taxpayer's operations.

You take exception to the tax assessed on the purchase of a ***** License Agreement (hereinafter, the "software license" or "software"). You claim that the Taxpayer specifically and exclusively uses this software for "deploying defined software processes for the development of software." You indicate that the software is installed on a computer server for use by a software development organization, establishes requirements for effective software processes to develop and maintain high-quality consistent and predictable software, defines step-by-step procedures - with associated templates and methods - for software requirements analysis, software design, and software testing, and is used across the organization by software engineers, programmers, testers, and their managers. For these reasons, you maintain that this software qualifies for the research and development exemption set out by Va. Code § 58.1-609.3(5).

DETERMINATION

Virginia Code § 58.1-609.3(5) provides an exemption from the retail sales and use 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."

Title 23 of the Virginia Administrative Code (VAC) 10-210-3070 defines the terms "direct use" and "exclusive use" as follows:

- ‘Direct use’ means those activities which are an integral part of basic research or research and development activities, including all steps of these activities, but not including secondary activities such as administration, general maintenance, product marketing, and other activities collateral to the actual research process.

- 'Exclusive use' means items used solely in basic research or research and development activities.

When research property is used in a taxable manner, 23 VAC 10-210-3071(C) provides that the property will continue to be exempt from the tax if the taxable use is de minimis in nature. This regulation further provides that taxable use of the property is considered "de minimis" in nature if the taxable usage of the property:

· Does not involve a continuous or ongoing operation,
· Does not follow a consistent pattern, i.e., weekly, monthly, quarterly, etc.,
· Is occasional in nature occurring no more than three times, and
· In total, accounts for no more than three days.

The research and development exemption is also set out in 23 VAC 10-210-765. This regulation addresses computer software development and provides an example for applying the research and development exemption to "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." You must bear in mind, however, that the "direct use" and "exclusive use" criteria discussed above as well as the "experimental or laboratory sense" criteria must also be satisfied.

In this case, the contested software license provides to the Taxpayer "a perpetual, nontransferable, nonexclusive, and nonassignable license (i) to install the Licensed Product onto Licensee's Equipment, (ii) to use the Licensed Product to manage Licensee's software development projects, (iii) to customize and tailor the Licensed Product to accommodate the specific needs of Licensee's organization and projects, and (iv) to use the Licensed Product to create and deliver to Licensee's customers reports relating to software development projects being performed by Licensee for its customers." This software license defines "Licensed Product" to mean a "software development management product" and "Licensee's Equipment" to mean "certain computer equipment and communications network operated by Licensee for the purpose of performing software development and maintenance." In addition, the software license defines "user" to mean "each of License's employees ... who have access to the Licensed Equipment and who are engaged in software development or maintenance or in the management, administration, or support thereof." [Emphasis added.]

The language of the software license sets forth that the contested software is to be used not only in the development of software products, but also to manage software development activities and for other administrative activities. These managerial and administrative activities are collateral to the actual research process and thus violate the "exclusivity" mandate of the research and development exemption. Further, this administrative use of the software is consistent and continuous. Accordingly, the administrative functions of the contested software are not de minimis.

Based on this determination, the assessment is correct. A consolidated bill, with interest accrued to date, will be mailed shortly to the Taxpayer. No further interest will accrue provided the outstanding assessment is paid within 30 days from the date of this letter.

The Code of Virginia sections and the regulations cited are available on-line 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/40348R

Rulings of the Tax Commissioner