06-83 | Virginia Tax

Tax Type

Retail Sales and Use Tax

Description

Tangible personal property, Federal government contracts

Topic

Amnesty

Exemptions

Property Subject to Tax

Tangible Personal Property

Date Issued

08-25-2006

August 25, 2006

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

Dear ******************:

This is in response to your letter in which you seek correction of the retail sales and use tax assessment issued to ***** (the "Taxpayer") for the period August 2000 through July 2003. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer is a web application development and network infrastructure engineering company that serves clients in the government and public sectors. As a result of the Department's audit, the Taxpayer was assessed tax on its purchases of tangible personal property made pursuant to three contracts entered into with a federal government agency ("Agency"). The Taxpayer contests the tax and raises a number of issues to support its position that the tax does not apply in this instance.

The Taxpayer describes one contract as an Indefinite Delivery/Indefinite Quantity (ID/IQ) Contract ("Contract #1"), which was entered into by the Agency to obtain the Taxpayer's assistance with the implementation, operation and maintenance of a portion of the Agency's computer system. The Taxpayer maintains that each contested purchase under this contract was made pursuant to task orders that addressed only the purchase and sale of tangible personal property. The Taxpayer maintains that the contract is a master contract under which the Agency has no obligation to purchase more than a guaranteed minimum until it and the Taxpayer enter into separate written task/delivery orders.

The ***** ("Contract #2") was modified several times by the parties. The Taxpayer represents that the contract was a "task order" under a large ID/IQ contract with another federal agency. The contract required the Taxpayer to research, develop and install "next generation" electronic commerce system applications. The contract established five tasks, each of which contains one or more subtasks. Some of the tasks and subtasks are related to contract administration and the provision of services related to research and development. Most of the tasks and subtasks are related to developing and installing new electronic commerce architecture, including both hardware and software. In its efforts to develop new products and to adapt commercially available application for government use, the Taxpayer maintains that it had to research and develop original computer code.

The Taxpayer represents that it is required by the ***** ("Contract #3") to develop and install a web-enabled computer system.

DETERMINATION

Issue 1

The Taxpayer maintains that the contested purchases made in connection with Contracts #1 and #2 are exempt under the resale exemption. The Taxpayer further contends that every contested transaction under these contracts involved the purchase of tangible personal property by the Taxpayer for immediate sale to the Agency.

In order to determine what, if any exemptions apply to the purchases made under these contracts, each contract must be carefully analyzed to determine the underlying purpose of the contracts. A blanket resale exemption cannot be applied to these purchases.

Issue 2

The Taxpayer maintains that the true object test should be applied to each individual task order issued under Contract #1. Relying on Public Document (P.D.) 01-6 (1/4/01) and P.D. 04-53 (8/18/04), the Taxpayer contends that each individual task order under Contract #1 must be separately analyzed to determine whether the sales tax applies.

The application of tax to purchases of tangible personal property made pursuant to government contracts is set out in Title 23 of the Virginia Administrative Code (VAC) 10-210-693, and is based upon whether the contract is for the sale of tangible personal property or for the provision of an exempt service. If a contract is for both the provision of a service and the transfer of tangible personal property, the Department applies the true object test found in Title 23 VAC 10-210-4040 to the overall contract to determine whether the contract constitutes a sale of tangible personal property or the provision of an exempt service.

An exception to this general policy is found in P.D. 01-6 and P.D. 04-53. In both instances, the contracts executed were ID/IQ contracts. Individual delivery orders or task orders were used by the government agency to request the tangible personal property or services required. The overall contracts were worded too broadly to determine the government's true object. Accordingly, the Tax Commissioner applied the true object test to the individual delivery orders or task orders to determine the correct application of the retail sales and use tax. If the true object of the delivery order issued pursuant to the underlying contract was for the provision of services, the taxpayer would be deemed the taxable user and consumer of all tangible personal property used in performing its services. If, however, the true object of the delivery order was for the sale of property to the government, the taxpayer would be able to purchase the property exempt of the tax for resale.

In this instance, Contract #1 entered into by the Taxpayer and the Agency required that individual task orders be issued in order for specific tasks to be completed by the Taxpayer. The underlying ID/IQ Contract and the Statement of Work are broadly worded in that neither states specifically what is required under the contract. The contract does imply that the Taxpayer may have to provide services and tangible personal property under the contract when requested through individual task orders. The contract, however, does not list with specificity the types of services or tangible personal property that will be required to be delivered by the Taxpayer.

In light of these facts, the exception to the general policy regarding the application of the true object test as noted in P.D. 01-6 and P.D. 04-53 will be applied to this Contract #1. The application of the sales and use tax with regard to this contract will be based on individual task orders and not on the underlying ID/IQ contract. If the true object of the task order issued pursuant to the contract is for the sale of property to the Agency, the resale exemption will apply to those purchases. If the true object of the task order issued pursuant to the contract is for the provision of services, the Taxpayer will be deemed to be the taxable user or consumer of all property used in performing the services, and will be liable for the tax on the purchase of such property.

It is my understanding that the Taxpayer provided the individual task orders at issue with its appeal. These task orders will be forwarded to the audit staff for further review. Upon review of the task orders and application of the true object test in accordance with P.D. 01-6 and P.D. 04-53, the audit staff will make the necessary adjustments to the audit.

The Taxpayer contends that the true object test was not properly applied to Contracts #2 and #3. The Taxpayer maintains that the true object of Contract #2 was the provision of the computer architecture, consisting primarily of computer software that would facilitate the Agency's electronic commerce programs. The Taxpayer maintains that the true object of Contract #3 was a completed computer system. The Taxpayer contends that the main deliverables under these contracts were tangible personal property, and that the property purchased and transferred to the Agency was exempt of the tax under the resale exemption.

As previously stated, the Tax Commissioner has ruled that in considering the tax treatment of contracts with the government, it must be determined whether the contract is for the sale of tangible personal property or for the provision of services to the government. In P.D. 95-293 (11/20/95), the taxpayer entered into a contract with the U.S. Department of Commerce to replace its Trade Policy Information System. Under the terms of the contract, the taxpayer was required to provide total systems integration and was responsible for procuring system equipment, hardware, software, and other necessary components. In addition, the taxpayer was required to perform engineering, applications development, implementation, testing, pilot operation, installation and other services. Upon a review of the contract at issue, the Tax Commissioner determined that the true object of the contract was the provision of tangible personal property. Even though the contract required the Taxpayer to perform various services, the goal of the contract was the provision of tangible personal property, i.e., a complete, integrated automated system. Accordingly, the Taxpayer was able to purchase the tangible personal property that ultimately passed to the Agency exempt of the retail sales and use tax. In light of P.D. 95-293, I will address the contracts in more detail.

Contract #2

The Taxpayer represents that Contract #2 is part of a larger ID/IQ contract. A review of the documentation provided confirms this. Contract #2 states that the Taxpayer "is to provide comprehensive electronic commerce systems and security engineering support for the Electronic Commerce systems, specifically implementation of the Next Generation Electronic Commerce Infrastructure." The Taxpayer contracted to provide total systems integration and to be responsible for procuring system equipment, hardware, software and other necessary components. Additionally, under the terms of the contract, the Taxpayer agreed to provide analysis, integration, applications development, implementation and engineering services.

A review of the contract reveals that the true object is the provision of tangible personal property, i.e., the Next Generation Electronic Commerce Infrastructure. Even though the Taxpayer is required to perform various services under the contract, the goal of the contract is provide the Agency with a fully integrated tangible system. Accordingly, tangible personal property purchased under the terms of this contract and transferred to the Agency was correctly purchased exempt of the tax by the Taxpayer. These items will be removed from the exceptions list in the audit. Please note that the tax will apply to any items of tangible personal property used by the Taxpayer in the performance of the contract.

Contract #3

Contract #3 is for the development of a web enabled system. The contract also requires the Taxpayer to develop the system architecture. A review of the contract reveals that the true object is the provision of tangible personal property, i.e., the tangible system. Even though the Taxpayer is required to perform various services under the contract, the goal of the contract is to provide the Agency with a fully integrated web system. Accordingly, tangible personal property purchased under the terms of this contract, and transferred to the Agency was correctly purchased exempt of the tax by the Taxpayer. These items will be removed from the exceptions list in the audit. Please note that the tax will apply to any items of tangible personal property used by the Taxpayer in the performance of the contract.

Issue 4

The Taxpayer contends that the tangible personal property purchased under Contract #2 is exempt under the research and development exemption. The Taxpayer maintains that the contested tangible personal property was used directly and exclusively in the research and development of computer software. The Taxpayer further maintains that its activities fall within the meaning of Title 23 VAC 10-210-765 because it developed a set of new computer software products.

Virginia Code § 58.1-609.3 5 provides that the retail sales and use tax does not apply to "[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 VAC 10-210-765 A provides additional guidance and states that:

- Tangible personal property used directly and exclusively in computer software research and development activities is generally exempt from the tax. Exempt research and development activities are those that have as their ultimate goal the advancement of computer software technology, the development of new computer software products, the improvement of existing computer software products, or the development of new uses for existing computer software products.

Contract #2 requires the Taxpayer to design and build the next generation Electronic Commerce Infrastructure for the Agency. The Taxpayer is tasked with developing the new infrastructure from two existing electronic commerce infrastructures currently being used. Additionally, the Taxpayer is required to update the current infrastructures by integrating them with new tools. Based on a review of the contract, the tangible personal property at issue is used directly and exclusively in computer software research and development activities because the Taxpayer's development of a new infrastructure constitutes the development of new computer software products. Accordingly, the tangible personal property at issue and used in such development activities is exempt of the tax pursuant to Va. Code § 58.1-609.3 5.

Issue 5

The Taxpayer contends that it was erroneously assessed the amnesty penalty in the audit. The Taxpayer maintains that it should not have been assessed the amnesty penalty because it was not eligible to participate in the amnesty program. The Taxpayer contends that the fact that the purchases subject to the penalty assessment occurred during the amnesty window is irrelevant. The Taxpayer maintains that under the statute, the time of the assessment, not the time of the contested transaction, determines whether a taxpayer could participate in the Amnesty Program. The Taxpayer also contends that it would be unfair to be assessed the amnesty penalty when it relied on the rulings of the Tax Commissioner and Department regulations in determining how it should apply the tax to the contested transactions at issue.

Virginia Code § 58.1-1840.1 F 1 provides that:

- If any taxpayer eligible for amnesty under this section and under the rules and guidelines established by the Tax Commissioner retains any outstanding balance after the close of the Virginia Tax Amnesty Program because of the nonpayment, underpayment, nonreporting or underreporting of any tax liability eligible for relief under the Virginia Tax Amnesty Program, then such balance shall be subject to a 20 percent penalty on the unpaid tax. This penalty is in addition to all other penalties that may apply to the taxpayer.

The Virginia Tax Amnesty Guidelines state under Section (C)(4)(j) that the 20% Amnesty penalty would not be applied to:

- Any assessment generated from a field audit of a business for an Amnestyeligible period in cases where the audit is a second or subsequent audit of the taxpayer, provided that the Compliance Ratio is greater than 85 percent for sales tax and greater than 60 percent for use tax, no penalty has been applied to the tax deficiency, any uncontested liability is paid within 30 days from the date of assessment, and payment for any contested liability remaining upon resolution of an appeal under Va. Code § 58.1-1821 is paid within 30 days from the date of the Tax Commissioner's final determination.

The statute clearly intends to include not only late filers and nonfilers, but also taxpayers that underpaid or underreported their liabilities during the period covered by the Amnesty Program. In this instance, the audit was the Taxpayer's second audit and the Taxpayer's compliance ratio for use tax was 3%. Further, the audit covered Amnesty-eligible periods (taxable periods ending on or before April 30, 2003).

Accordingly, the amnesty penalty was properly applied in the audit. However, the application of the amnesty penalty will be readdressed once the audit revisions are complete. Should the Taxpayer meet the required compliance ratio for a second generation audit, the amnesty penalty will not be applicable.

Issue 6

The Taxpayer contends that it was assessed interest in the audit in excess of the rate authorized by Va. Code § 58.1-15. The Taxpayer maintains that it was incorrectly assessed interest based on the federal "large corporate underpayments" rate. The Taxpayer cites the ruling in General Motors Corp. v. Virginia Dept. of Taxation, 62 Va. Cir. 4 (2003) to support its position.

I agree that the large corporate underpayment rate should not have been used to assess interest in the Taxpayer's audit. Accordingly, the interest will be recomputed using the correct interest rate.

CONCLUSION

Based on this determination, the audit will be returned to the audit staff to make the necessary revisions. This determination is based on the specific facts of this case as those facts apply to the contracts and task orders at issue. This determination has no application to any other government contracts.

The Code of Virginia sections, regulations and public documents cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions about this response, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.

- - - - Sincerely,

- - - - Janie E. Bowen
        Tax Commissioner

AR/55376P

Rulings of the Tax Commissioner