Tax Type
Retail Sales and Use Tax
Description
Withdrawal of computer units from resale inventory for use in product demonstration
Topic
Exemptions
Property Subject to Tax
Date Issued
10-01-2004
October 1, 2004
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ***********:
This is in reply to your letter in which you seek correction of the sales and use tax assessments issued to ******** (the "Taxpayer"), for the period June 1998 through May 2001. I apologize for the Department's delay in responding to your letter.
FACTS
The Taxpayer is engaged in the research, development and commercialization of computer technology, hardware and related software for wearable computers. The Taxpayer withdraws computer units from its resale inventory for use in product demonstration. The units are carried on the Taxpayer's books in a separate demonstration unit inventory account and were depreciated as assets for federal income tax purposes.
As a result of the Department's audit, the auditor concluded that the Taxpayer makes a taxable use of the units when it removes them from its resale inventory and depreciates them as assets. The Taxpayer disputes the tax and contends that it intends to sell the units to customers when it removes them from its resale inventory for demonstration purposes. Further, the Taxpayer contends that it inadvertently depreciated the units as assets and has filed amended federal income tax returns reclassifying the units as inventory. To support its position, the Taxpayer cites a number of prior rulings of the Tax Commissioner. In addition, the Taxpayer requests waiver of the penalty.
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- DETERMINATION
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Demonstration Units
Virginia Code § 58.1-623(C) provides that if a taxpayer who gives a certificate (of exemption) makes any use of the property other than an exempt use or retention, demonstration, or display while holding the property for resale in the regular course of business, such use shall be deemed a taxable sale by the taxpayer.
Citing the above statute, the Tax Commissioner has issued a number of rulings regarding property withdrawn from inventory and used for demonstration purposes. In Public Document (P.D.) 88-70 (5/2/88), a manufacturer consigned products from its resale inventory to its sales personnel for demonstration to prospective customers. The sales personnel were required to purchase or return the products to the manufacturer within a six-month period. The Tax Commissioner determined that the products were intended for resale at the time they were withdrawn from inventory and the tax did not apply.
Further, in P.D. 96-260 (9/27/96), a manufacturer sold vital sign monitors and provided demonstration monitors to its sales personnel for a period of one year. At the expiration of one year, the sales personnel were issued new replacement monitors and the prior monitors were refurbished and sold to price-sensitive customers. The monitors were considered exempt resale inventory because they were not transferred to a fixed asset account for depreciation purposes, but continued to be held in an inventory account while in the possession of the sales personnel.
The above determinations differ from that in P.D. 94-45 (3/9/94). In that instance, a manufacturer of pressure sensing equipment treated demonstration units as depreciable assets for federal income tax purposes. The Tax Commissioner concluded that the manufacturer's treatment of the demonstration units as depreciable assets constituted removal of such units from a resale inventory, and, therefore, the units lost their exempt status.
In this instance, the Taxpayer withdraws computer units from its resale inventory and maintains them in a demo pool for use in product demonstration. These demo units are issued to the Taxpayer's sales personnel or to its customers. The units issued to the sales personnel are returned after a two-year period and a new computer is issued. The units issued to the Taxpayer's customers are provided on a trial basis. At the end of the trial period, the customer may opt to purchase the unit, purchase a new unit or make no purchase at all. The units returned by the sales personnel and the customers are returned to the demo pool and are refurbished and sold to price-sensitive customers or sold to customers who wish to purchase the used units.
There is no mention in the auditor's comments that would suggest the Taxpayer sold the units returned to its demo pool to customers. It is my understanding from your conversations with a member of my staff that the Taxpayer can provide sales documentation to prove that the units were sold to customers. This supporting documentation, along with the fact that the units are reclassified as inventory, would support a finding that the units do not lose their exempt status as resale inventory while in the possession of the Taxpayer's sales personnel and its customers. On the other hand, if the Taxpayer is unable to provide convincing documentation that the units were sold to customers, the Taxpayer is deemed to make a taxable use of the units, regardless of the fact that the Taxpayer has filed amended returns reclassifying the units as inventory.
Penalty
The Taxpayer contends that the units were not an issue in its prior (first) audit, and, therefore, the penalty should be waived based on Title 23 of the Virginia Administrative Code (VAC) 10-210-2032 (A)(6). This regulation states, "[p]enalty generally will not be applied to audit deficiencies occurring in new areas not covered by prior audit(s), provided the application of the tax is not clearly established . . . ." In addition, the Taxpayer requests the waiver of penalty due to substantial turnover in the Taxpayer's financial team since the prior audit.
If the tax is removed from the units as discussed, then the associated penalty will be removed as well. If the assessment of the tax stands, then the penalty is justified because the units were assessed as untaxed fixed assets in the prior audit. The units are clearly stated as an exception in the prior audit work papers provided to the Taxpayer by the auditor. Further, Title 23 VAC 10-210-2032(A)(6) provides that "[t]he application of penalty to audit deficiencies will not be waived on second and subsequent audits for other than exceptional mitigating circumstances." Turnover in personnel is a normal consequence of business operations and is not considered an exceptional mitigating circumstance for purposes of penalty waiver.
Conclusion
The auditor will revisit the Taxpayer to review the sales documentation. This information should clearly show the tracking of the units from the point of withdrawal from the resale inventory to the demo pool and then as the subject of a sale to a customer. Any questions regarding the review of this documentation should be directed to *****, Audit Supervisor in the ***** at *****. Questions regarding the policy set out in this letter should be directed to ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *********
The Code of Virginia sections, regulation and the public documents 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.
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- Sincerely,
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- Kenneth W. Thorson
Tax Commissioner
- Kenneth W. Thorson
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AR/41101J
Rulings of the Tax Commissioner