Tax Type
Retail Sales and Use Tax
Description
Software packages sold to customer qualify for the manufacturing exemption
Topic
Appropriateness of Audit Methodology
Manufacturing Exemption
Date Issued
12-05-2007
December 5, 2007
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This will reply to your letter in which you seek correction of the retail sales and use tax assessment issued to ***** (the "Taxpayer") for the period October 2000 through July 2005. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer writes and sells computer software, primarily for the manufacturing industry. The Department audited the Taxpayer's records and assessed tax on the sale of four computer software packages to seven separate manufacturing entities. The Taxpayer contends that software packages sold to ***** (collectively referred to herein as "Customer One") are custom programs exempt from tax pursuant to Va. Code § 58.1-609.5 7. In addition, the Taxpayer contends that the software packages sold to (collectively referred to herein as "Customer Two") qualify for the manufacturing exemption under Va. Code § 58.1-609.3 2.
DETERMINATION
Custom Software vs. Prewritten Software
Virginia Code § 58.1-609.5 7 provides an exemption from the retail sales and use tax for custom programs as defined in Va. Code § 58.1-602. A custom program means:
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- a computer program which is specifically designed and developed only for one customer. The combining of two or more prewritten programs does not constitute a custom computer program. A prewritten program that is modified to any degree remains a prewritten program and does not become custom.
Virginia Code § 58.1-602 also defines a prewritten program as:
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- a computer program that is prepared, held or existing for general or repeated sale or lease, including a computer program developed for in-house use and subsequently sold or leased to unrelated third parties.
The first question to be determined in this case is whether the software sold to Customer One is a custom or prewritten program. The Master License Agreement in Section 2.1 states that the Taxpayer grants to the customer a nontransferable license to use the software. In addition, although the Taxpayer had hopes of marketing this software for general or repeated sale, the software was too customer specific to market. Furthermore, a review of the invoices, statements of work and internal documentation reveals that numerous hours of programming, code writing and other customized work were attributable to each of the software programs produced.
Based on the facts and documentation presented and in accordance with the above authorities, I find basis to treat the software packages sold to Customer One as custom software programs. Therefore, the sale of such software packages will be removed from the audit assessment.
Manufacturing Exemption
Virginia Code § 58.1-609.3 2 provides an exemption from the sales and use tax for "machinery or tools or repair parts therefor or replacements thereof, fuel, power, energy, or supplies, used directly in . . . manufacturing . . . products for sale or resale."
As provided above, in order to qualify for the manufacturing exemption, the machinery or equipment must be used directly in the production process. Title 23 of the Virginia Administrative Code (VAC) 10-210-920 B interprets the term "used directly" to mean that the machinery, equipment or activity must be indispensable to the actual production process and it must be used as an immediate part of the production process.
Title 23 VAC 10-210-920 C 2 identifies taxable and exempt production items and provides that computer hardware and software used to direct or control production line and/or quality control operations is exempt. This is contrasted to computer hardware and software used merely to monitor production operations, e.g., computers used to produce production reports, make production information available to plant personnel, monitor the efficiency of production machinery, etc. These are deemed to be taxable administrative items.
In this case, the Taxpayer sold software to Customer Two but did receive an exemption certificate at the time of the transaction in order to sell the software tax exempt. Furthermore, according to the Taxpayer's website the software sold to Customer Two is used to collect, aggregate, and analyze production data to detect waste in the business process. The software is used as an administrative tool to allow plant machinery and systems to reach optimal performance through data analysis. The Taxpayer has presented no evidence to support its contention that the software sold to Customer Two is used to direct or control production line and/or quality control operations.
The Department's policy on this issue is well established. See, for example, P.D. 88-50 (4/4/88). Based on the above facts and authorities, the software sold to Customer Two does not qualify for the manufacturing exemption.
Software Modifications
The Taxpayer maintains that it possesses detailed expense reports that will support exemption from the tax pursuant to Va. Code § 58.1-609.5 6 for separately stated charges for labor or services rendered in connection with the modification of prewritten software. The Taxpayer requests the opportunity to submit this documentation.
A member of the Department's audit staff will contact you to review the detailed expense reports. Audit staff will review the available supporting documentation and make the appropriate adjustments, if any, to the audit report and assessment.
CONCLUSION
Based on this determination, the audit will be returned to the audit staff to remove the custom software transactions from the assessment. In addition, the auditor j will review the documentation supporting an exemption under Va. Code § 58.1-609.5 6 and adjust the assessment accordingly. After the adjustments have been made the auditor will issue an updated bill, with interest accrued to date. No additional interest will accrue provided the assessment is paid within 30 days from the date of the unpaid bill
The Code of Virginia sections and regulations 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 determination, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.
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- Sincerely,
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- Janie E. Bowen
Tax Commissioner
- Janie E. Bowen
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AR/1-941466543i
Rulings of the Tax Commissioner