Tax Type
Retail Sales and Use Tax
Description
Taxed on combined freight /handling and combined shipping/handling charges
Topic
Appropriateness of Audit Methodology
Basis of Tax
Computation of Tax
Date Issued
08-30-2004
August 30, 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 retail sales and use tax audit assessment issued to ***** (the "Taxpayer") for the period January 1998 through August 2001. I apologize for the delay in the Department's response.
FACTS
The Taxpayer is a commercial real property contractor. The Taxpayer disagrees with the Department's audit assessment, asserting that its representative, the Controller, was not authorized to bind the corporation in regard to financial decisions relating to the audit results. The Taxpayer contends that the Controller was unfamiliar with construction accounting and because of inexperience allowed a form of sales tax audit that is not representative of the Taxpayer's purchases.
The Taxpayer maintains the sample used by the auditor is not valid because purchases varied greatly from one year to the next depending on the percentage of subcontractors used by the Taxpayer. The purchase of materials was not linear; therefore, it is not possible to apply an average for the periods audited and apply one error factor for the entire audit period.
The Taxpayer also seeks waiver of the assessed penalty. The Taxpayer states that the purchases used in the sample extrapolation were related to construction projects for churches or governmental entities. At the time of purchase, the Taxpayer believed items used for such projects were exempt from the tax. While the Taxpayer now understands that tax should have been paid on these items, it seeks waiver of the assessed penalty based on its understanding of the law at the time of purchase.
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DETERMINATION
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Sample
Sampling is an audit technique that is widely used in both the public and private sectors for all types of audits where a detailed audit would not prove beneficial either to the auditor or the client. When sampling techniques are understood and properly applied, the final result should be within a narrow percentage range of the actual amount that would be determined by a detailed audit. The purpose of the audit sample is to determine a factor for errors within a representative selected period. Once the error factor is determined, the factor is extrapolated over the entire audit period. The purpose of the projection is to account for likely similar transactions on which Virginia tax has not been paid. Every effort is made to objectively select the sample periods that are representative of the period being audited and to reach a consensus with the taxpayer concerning the validity of the sample.
After reviewing the information provided in your letter and the manner in which the sample was conducted, I find no basis to invalidate the sample and the error factor extrapolated over the audit period. The courts have held that a tax assessment issued by the proper taxing authorities is prima facie correct and the burden is on the taxpayer to prove otherwise. It is my determination that the Taxpayer has not met this burden. Both the auditor and the Controller agreed to sample the calendar year 2000. The exceptions were extrapolated based on the cost of materials. It is my understanding that the Controller provided information on cost of materials for each year under review after consulting with the corporation's Chief Executive Officer. The sample and extrapolation factor were applied in accordance with established audit procedures. Accordingly, there is no basis to revise the assessment.
Penalty
The Virginia sales and use tax law treats every contractor as the user or consumer of all tangible personal property furnished to or by the contractor in connection with real property construction, reconstruction, installation, repair, and similar contracts. See Va. Code § 58.1-610 and Title 23 of the Virginia Administrative Code (VAC) 10-210-410. Any sale to such a contractor is deemed a sale for the ultimate consumer (i.e., the contractor). No sale to a contractor is exempt from the tax on the grounds that the other party to the contract is a federal or state government agency, a federally chartered credit union, a public service corporation, a nonprofit school, college, or other institution of learning, a nonprofit hospital, or a nonprofit church. A contractor is considered the final user of such tangible personal property and must pay tax on its purchases.
Based on the law and regulation cited above, the Taxpayer is responsible for payment of the tax on purchases of tangible personal property purchased in connection with real property contracts for churches and governmental entities. The auditor properly included such untaxed purchases in the sample used to compute the Taxpayer's tax liability. The Taxpayer's misunderstanding of the law during the periods audited does not excuse payment of the tax.
Virginia Code § 58.1-635 mandates the application of penalty to tax deficiencies. Title 23 VAC 10-210-2032 provides that the application of penalty is to be determined based on whether a satisfactory level of tax compliance has been achieved. For second audits of use tax compliance, penalty will apply unless a taxpayer's compliance ratio meets or exceeds 60%. As the Taxpayer's compliance ratio for the audit at issue is 0%, the penalty has been properly applied.
Title 23 VAC 10-210-2032 states that the application of penalty to audit deficiencies will not be waived for other than exceptional mitigating circumstances. Based on the information presented, there are no exceptional mitigating circumstances in this case. The fact that the Taxpayer believed its purchases for construction projects with churches and governmental entities should be exempt is not a mitigating circumstance. The Department's policy with regard to this issue is long-standing.
Additional Issues
I note that since submitting its original protest the Taxpayer furnished additional documentation listing areas of dispute with regard to specific vendors. Based on the auditor's review of the documentation, I offer the following:
Tax included in contract price: In several contracts with vendors for the purchase of tangible personal property, the contract indicates the tax is included in the purchase price. Virginia Code § 58.1-625 requires dealers to separately state the amount of sales tax and add the tax to the sales price or charge. Title 23 VAC 10-210-340 further provides that the "[i]dentification of the tax by a separate writing or symbol is not required provided that the amount of the tax is shown as a separate item on the record of the transaction." Virginia Code § 58.1-625 also provides that payment of the sales and use tax is a legal obligation of the purchaser. Although dealers are required to collect and remit Virginia sales taxes, the purchaser is ultimately liable for payment of the tax.
In this case, the Taxpayer contends that all taxes were included in the written proposal or purchase contract. The auditor assessed the tax on the purchases because the Taxpayer could not provide documentation showing that the sales tax was a separately stated item on the invoice. The additional information provided by the Taxpayer does not prove that tax was shown as a separate item on the record of the transaction. Further, there is no evidence that tax was paid on the contested purchases. Consequently, there is no basis for adjustment.
Sales tax paid to another taxing authority: In these instances, the invoices revealed a shipping address to Virginia. Because the property at issue was received in Virginia, the sales tax on the transaction was properly due to Virginia. See Va. Code § 58.1-602, definition of "sale." The Taxpayer paid sales tax to another state in error. Accordingly, the assessment is correct. Any taxes erroneously paid to another state must be recovered from that state.
Shipment of tangible personal property: The auditor assessed tax on invoices for which no sales taxes were paid and which did not indicate where the property was delivered. In such instances and until proof is submitted that the property was not received in Virginia, there is no basis to remove from the audit the sales tax assessed on these items.
Freight, shipping and handling: The Taxpayer disputes the assessment of tax on combined freight and handling and combined shipping and handling charges. Title 23 VAC 10-210-6000 provides that the tax does not apply to transportation or delivery charges provided that such charges are separately stated on the invoice to the customer. If such charges are not separately stated, the charges become a part of the sales price subject to the tax. This same section defines transportation charges while specifically excluding handling charges from such definition. As stated in Public Document 91-223 (09/23/1991), when a seller does not segregate nontaxable transportation charges from taxable handling charges, but instead combines the two into a single charge, the combined "shipping and handling" charge is taxable, even if separately stated.
In this case, the auditor properly assessed tax on the combined freight and handling and combined shipping and handling charges. Accordingly, there is no basis to revise the audit.
Photography services: This invoice is for labor, photography time and other such charges in connection with the sale of photographs. Title 23 VAC 10-210-2050 states that the tax is applicable "to the total charge to the customer for a photograph, slide, etc., including but not limited to, charges for labor, photocomposition, setting design, photography time, and any other components of the charge regardless of whether such components are separately stated." (Emphasis added). Accordingly, the auditor properly included this invoice in the audit assessment.
Computer software support: The invoice represents the purchase of software support services including updates. The Department has published a number of public documents addressing software maintenance agreements and stating that charges for such agreements are taxable when tangible software updates are included in the agreements. Public Document 96-49 (04/17/1996) discusses a case in which a taxpayer entered into a contract for telephone support services that also included the provision of tangible software updates. Although a separate charge was billed for the updates, the support agreement was considered taxable because the contract specifically stated that tangible updates would be provided.
A review of the audit information reveals that the invoice at issue is for software support with updates provided in tangible form. As provided in Public Document 96-49, such support agreements are subject to tax. The auditor properly assessed tax on one-half the total price of the invoice, in accordance with Va. Code § 58.1-609.5(9).
Conclusion
Based on the foregoing, there is no basis to revise the Department's audit. The assessment is correct as issued and remains due and payable. A revised bill, with interest accrued to date, will shortly be sent to the Taxpayer. No additional interest will accrue provided the outstanding balance is paid within 30 days from the date of the revised bill.
The Taxpayer should remit its payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attention: *****. If you have any questions concerning payment of the assessment, you may contact ***** at *****. Please be advised that a failure to submit the full payment within 30 days from the date of the revised bill may result in the imposition of a 20% penalty on the balance of the taxes due under the terms of Virginia's recent Amnesty. Please see the enclosure entitled "Important Payment Information."
The Code of Virginia sections, regulations and public documents cited, along with other reference documents, are available on-line in the Tax Policy Library section of the Department's web site, located at www.tax.state.va.us. If you have any questions regarding this determination, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at @tax.state.va.us or at *****.
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- Sincerely,
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- Kenneth W. Thorson
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- Tax Commissioner
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- Kenneth W. Thorson
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AR/43301Q
Rulings of the Tax Commissioner