05-16 | Virginia Tax

Tax Type

Retail Sales and Use Tax

Description

Untaxed purchases of tangible assets; government contracts

Topic

Appropriateness of Audit Methodology

Exemptions

Date Issued

02-09-2005

February 9, 2005

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 your client, ***** (the "Taxpayer"), as a result of an audit for the period October 1997 through February 2002. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a government contractor that operates and maintains vessels owned by trusts or the United States government. An audit revealed untaxed purchases of tangible assets, administrative and operating supplies, and other tangible personal property used in connection with Taxpayer services provided aboard these vessels.

I understand that the contested items generally consist of consumable supplies and loose equipment not permanently affixed to the vessels but received at the Taxpayer's Virginia warehouse. You maintain that the retail sales and use tax should be determined based on application of the true object test to individual delivery orders of the contested government contracts. You also maintain that the Taxpayer its an agent of the United States, and its purchases under its contracts should be exempt based on the government exemption under Va. Code § 58.1-609.1 4. You further maintain that the contested purchases are eligible for the ship supply exemption granted by Va. Code § 58.1-609.3 4.

DETERMINATION

Indefinite Delivery/Indefinite Quantity (ID/IQ) contracts

The Taxpayer claims that the contested contracts should be evaluated using the same analysis as applied in Public Document ("P.D.") 01-6 (01/04/01). The Taxpayer states that "[e]ach of these contracts is separated into two parts: (1) a firm, fixed-price per diem paid by the government for the operation of vessels; and (2) a reimbursables-at-cost contract for the procurement of tangible personal property." The Taxpayer requests the removal from the audit of all tangible personal property purchased pursuant to the reimbursable-at-cost provisions of the contested contracts.

The general policy for determining the application of the retail sales and use tax to government contracts is to apply the true object test to the overall contract, rather than to individual task or delivery orders issued under those contracts. See Title 23 of the Virginia Administrative Code ("VAC") 10-210-693.

An exception to this general policy is found in P.D. 01-6 and P.D. 04-53 (8/18/04). In both of those instances, it was not possible to determine the true object of the underlying ID/IQ contract because there was little or no evidence of the government's true object. The government was under no obligation to purchase any goods or services from the contractor until a delivery order was executed. Thus, only when the government issued an individual task or delivery order to the contractor did the contractor learn of the government's expectations. Under these circumstances, the true object is appropriately applied to the task or delivery order rather than to the underlying contract. Those circumstances, however, differ from the circumstances in the Taxpayer's case.

In the instant case, the Taxpayer has contracted with the government specifically to operate and maintain certain public vessels. From a review of the Statement of Work ("SOW") for the underlying contract, there is no doubt as to what is expected of the Taxpayer. The Taxpayer has been given a broad mandate to perform operational, managerial and maintenance tasks for the vessels. Unlike the ID/IQ contracts addressed in the public documents cited above, the true object of the Taxpayer's work can be readily determined from the language of the underlying contracts at issue.

For instance, the SOW of the T-AGOS contract requires the Taxpayer "to provide personnel, operational and technical support (ashore and afloat), equipment, tools, provisions, and supplies to operate and maintain . . . public vessels of the United States Government under administrative control of the [United States]." See Clause C-1.1 of the SOW. The contract clearly designates that the Taxpayer will provide the crew and the Master for each vessel. (Clause C-5.7) As Master of each vessel, the Taxpayer retains the ultimate authority to control the movements of each vessel and the responsibility to navigate the vessels safely in support of government operations at all times. (Clauses C-1.6.3.2.2 and C-5.1.3.6) In addition, the Taxpayer "shall maintain and repair each ship and all of its installed equipment and systems and accomplish all alterations to the vessels." (Clause 5.3) The Taxpayer is further expected to provide managerial control in overhauling the ships. (Clauses C-5.7.1, C-5.7.1.1, arid C1.6.2.4.1.2.)

Although the Taxpayer must acquire and furnish tangible personal property under the contract, the SOW sufficiently demonstrates the government's desire to obtain the Taxpayer's commercial expertise in ship operations, management, and maintenance. Accordingly, I find that the true object of the T-AGOS contract is for the Taxpayer to provide ship operations and management services. Under these circumstances, the Taxpayer is liable for the sales and use tax on all its purchases of tangible personal property (unless a statutory exemption is available), regardless of the contract method of compensation, i.e., by the firm, fixed-price method or the reimbursement-at-cost method.

Likewise, I find that the true object of the other contracts at issue [the LMRS contract and the MPS contracts] is for services.

Agent relationship

The Taxpayer claims to be an agent of the United States and contends that purchases made in the performance of its service contracts should qualify for the government exemption set out under Va. Code § 58.1-609.1 4.

For Virginia retail sales and use tax purposes, a government service contractor is deemed "to be the taxable user and consumer of all tangible personal property used in performing its services, even though title to the property provided may pass to the government or the contractor may be fully and directly reimbursed by the government, or both." See Title 23 VAC 10-210-693.

Moreover, "[o]nly in instances where the credit of a governmental entity is bound directly and the contractor has been officially designated as the purchasing agent for such government entity will such purchases be deemed exempt from the tax." [Emphasis added.] See Title 23 VAC 10-210-410(J). This policy was established in large part based upon United States v. Forst, 442 F. Supp. 920 (W.D. Va. 1977), aff'd, 569 F.2d 811 (4th Cir. 1978). In that case, the court ruled "the sales and use tax was constitutionally assessed to a contractor of the federal government as purchaser of tangible personal property even though the United States held title after delivery, bore the risk before delivery and exercised substantial control over procurement under the contract, since only the credit of the contractor was pledged in the purchasing agreement."

In United States v. New Mexico, 455 U.S. 720 (1982), the United States Supreme Court rejected the government's argument that the purchases by the contractors were made in their capacity as "procurement agents" because the contractors made all such purchases in their own names and the vendors were not informed that the government was the only party with an independent interest in the purchases. The identity of interests between the government and the contractors was far from complete.

You cite several opinions from United States district courts and United States courts of appeals attempting to establish that the Taxpayer should be deemed an agent of the United States. In one representative case that you cite, Buck Kreihs Company, Inc. v. International Marine Carriers, Inc., 741 F.Supp. 1249 (E.D. La 1990), the court ruled that a "[c]ontract operator of a naval vessel is generally an agent of the United States for purposes of the exclusive remedy provision of the Suits in Admiralty Act, § 5, 46 U.S.C.A. App. § 745." That exclusive remedy provision bars suits or claims against contract operators of public vessels whose actions give rise to a claim. Based on Buck Kreihs, when the contract between the contract operator and the government provides the contract operator with "the authority to operate the [government vessel] on behalf of the government according to the government's regulations and directions," the contract operator is deemed an agent of the United States government for purposes of 46 U.S.C.A. App. § 745. Unlike the Forst and New Mexico opinions discussed above, all of the court opinions you cite are silent on whether the contract vessel operators are "purchasing agents" of the United States able to bind the credit of the United States to their purchases under the contracts. Thus, these cases are inapposite.

Although the Taxpayer may be designated as an agent of the United States within the meaning of the Suits in Admiralty Act, the contracts do not officially designate the Taxpayer as a purchasing agent of the United States with the authority to bind the credit of the United States to its purchases. Rather, it is my understanding that vendor invoices are billed to the Taxpayer who has the responsibility for payment. In fact, the invoices presented with the Taxpayer's appeal reveal that the Taxpayer is the one being billed by the vendor. There is no indication on the purchase orders presented that the government is the only party directly liable for payment. Rather, those orders show only the Taxpayer as the entity for vendor billing purposes.

Because the credit of the Taxpayer is bound to the purchases and not the government's credit, the legal incidence of the Virginia retail sales and use tax clearly falls upon the Taxpayer and not the government. In fact, the identity of interests between the government and the Taxpayer is far from complete and sufficiently distinct. Therefore, absent any purchasing agent designation in the contracts presented and evidence that the credit of the United States is directly bound to the purchase, I find that the Taxpayer is deemed to have purchased the tangible personal property in its own capacity as a private commercial entity. Accordingly, its purchases are not entitled to the government exemption under Va. Code § 58.1-609.1 4.

Ships and vessel exemption

Virginia Code § 58.1-609.3 4 provides an exemption from the retail sales and use tax for:

- Ships or vessels, or repairs and alterations thereof, used or to be used exclusively or principally in interstate or foreign commerce; fuel and supplies for use or consumption aboard ships or vessels plying the high seas, either in intercoastal trade between ports in the Commonwealth and ports in other states of the United States or its territories or possessions, or in foreign commerce between ports in the Commonwealth and ports in foreign countries, when delivered directly to such ships or vessels; or tangible personal property used directly in the building, conversion or repair of the ships or vessels covered by this subdivision.

In P.D. 01-7 (01/04/01), the Department determined that the above exemption applies to parts for ship repairs of installed equipment that is affixed to a public vessel of the United States government when the vessel is used primarily in a maritime business venture. That determination also held that the exemption for ship supplies was not available because there was no indication that the ships used Virginia ports to engage in the specified intercoastal trade or foreign trade between Virginia ports and ports outside Virginia. Furthermore, the contested supplies were not delivered directly to the vessels. Rather, they were delivered by vendors to the contractor's Virginia warehouse for subsequent shipment to foreign ports.

In this case, the Taxpayer operates and maintains public ships that ply the high seas and are controlled and used by the Taxpayer in a maritime business venture (i.e., operating naval vessels for a profit). I also understand that some of these ships operate between Virginia ports and foreign ports. Although these ships engage in foreign commerce, the remaining concern is whether or not the supplies are delivered directly to those vessels that use Virginia ports and ply the high seas in foreign commerce [or in intercoastal trade] as specified in the above-cited exemption.

Direct delivery generally implies no intermediate stops to the delivery process (e.g., delivery without intermediate warehousing). I recognize that delivery directly to the vessel by a vendor may, at times, be impractical. For example, the late arrival of the vessel to the port caused by weather conditions, national security concerns, or mechanical problems may prevent the vendor from making direct delivery to the vessel. These circumstances are problematic especially for vendors not located within the port area and who have already shipped their goods to the vessel. In such instances, it may be necessary to warehouse or store the goods until the arrival of the ship. This rationale provides reasonable basis for the ship supply exemption to embrace the delivery of supplies to the owner of the vessel, or the owner's authorized agent (e.g., the master of the vessel), when such supplies are earmarked for delivery to a specific vessel as noted on the vendor's invoice and the bill of lading and are in fact ultimately delivered to the vessel at a Virginia port.

The audit will be revised to remove those purchases that can be identified as marked for delivery to a qualifying vessel but received and held briefly at the Taxpayer's Virginia warehouse, pending the arrival of the qualifying vessel, provided it is shown that the supplies were subsequently delivered by the Taxpayer to the qualifying vessel at a Virginia port.

Other Adjustments

The Taxpayer also claims that the audit report included some purchases of tangible personal property that were not delivered or used in Virginia or were delivered directly from the vendor to the vessel and were not warehoused. In addition, the Taxpayer asserts that the audit report included purchases of tangible personal property used directly in the repair of vessels. Based on the additional documentation presented, all of these purchases will be removed from the audit.

CONCLUSION

The assessment will be revised in accordance with this determination. When the revision is completed, a consolidated bill, with interest accrued to date, will be mailed to the Taxpayer. The outstanding balance must be paid within 30 days from the date of the consolidated bill to avoid the accrual of additional interest. In addition, failure to submit full payment within the 30-day period may also result in the imposition of an additional 20% penalty on the tax due under the terms of Virginia's recent Amnesty. See the enclosure entitled "Important Payment Information."

The Taxpayer should remit its payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attn: *****. If you have any questions concerning payment of the assessment, you may contact ***** at *****.

The Code of Virginia sections, regulations and public documents cited are available on-line in the Tax Policy Library section of the Department's web site, located at www.policylibrary.tax.virginia.gov. 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/45895R

Rulings of the Tax Commissioner