Tax Type
Retail Sales and Use Tax
Description
Taxpayer contends that purchases made in connection with government contracts
Topic
Appropriateness of Audit Methodology
Exemptions
Government Contractor
Sale for Resale
Date Issued
12-15-2010
December 15, 2010
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This will reply to your letter in which you seek correction of a retail sales and use tax assessment issued to ***** (the "Taxpayer") for the period March 2003 through March 2006. I apologize for the delay in this response.
FACTS
The Taxpayer is an information technology services business that performs contract work for the federal government. The Taxpayer was audited and assessed use tax on various purchases, some of which were made in connection with government contracts. The Taxpayer maintains that the audit erroneously includes use tax assessed on purchases that were made by related but separate entities. The Taxpayer contends that purchases made in connection with certain government contracts qualify for the resale exemption because the true object of the contracts was the sale of tangible personal property to the federal government. The Taxpayer also disputes the Department's authority to conduct audit samples and the inclusion of a large purchase transaction in the expense purchases sample.
DETERMINATION
Authority for Audit Sampling
The Taxpayer states that the Department has no authority to use sampling in audits if complete and accurate records are available. The Taxpayer contends that the Department cannot unilaterally estimate taxes due by projecting a liability outside the actual periods audited or reviewed by the auditor.
Virginia Code § 58.1-202 1 provides that the Tax Commissioner shall "[s]upervise the administration of the tax laws of the Commonwealth, insofar as they relate to taxable state subjects and assessments thereon, with a view to ascertaining the best methods of reaching such property, of effecting equitable assessments and of avoiding conflicts and duplication of taxation of the same property." This statute gives the Tax Commissioner wide latitude in the methods used to calculate an equitable assessment. Under this statute, the Department is authorized to use sample methodologies in audits. Sampling is frequently used by the Department, as it reduces the number of records reviewed and the amount of time required to complete audits.
In the Taxpayer's audit, every effort was made to objectively select sample periods that were representative of the entire audit period and to reach a consensus with the Taxpayer concerning the validity of the sample. The auditor selected average periods that were based on the Taxpayer's purchase and expenditure activities for the audit period. Based on the cited statute and the procedures followed by the auditor, the use of sampling in the Taxpayer's audit is valid. There is no basis to conduct a detailed audit or to adjust the audit liability by removing all tine periods other than the sample periods actually reviewed during the audit.
Audit Sample
The Taxpayer maintains that the audit sample contains an isolated, large dollar transaction that is nonrecurring and is not representative of its normal purchasing activity. The Taxpayer contends that this transaction distorts the audit sample and overstates the resulting tax liability because the transaction amount exceeds the normal purchase amounts for the business.
Sampling is an audit technique of significant value 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 properly applied, the final result should be within a narrow percentage range of the actual amount that would be determined by a detailed audit. Before requiring that a detailed audit be conducted or a sample period be adjusted or extended, the taxpayer must demonstrate that the sample is not representative of the audit period or that it is flawed in a manner that would invalidate the sample.
Public Document (P.D.) 99-66 (4/15/99) and P.D. 04-204 (11/23/04) address this issue and explain that a transaction cannot be removed from the audit sample unless the transaction is isolated in nature and not a normal part of the taxpayer's business operation, regardless that the item is a large dollar transaction or that it may constitute a large percentage of the taxable measure in the audit sample. In this case, the auditor selected a sample month from each calendar year in the audit period. Using the Taxpayer's general ledger account information, the three sample months were chosen based on the average purchasing activity for selected expense accounts. The auditor found recurring errors in the periods sampled including untaxed purchases of computer hardware. The disputed transaction is a purchase of computer hardware. Thus, it is not an isolated transaction but is consistent with the types of purchases made by information technology services businesses. The audit report indicates that the Taxpayer purchased computer hardware on a recurring basis and that such purchases were a normal part of its business operations.
Virginia Code § 58.1-205 provides that tax assessments issued by the Department are deemed prima facie correct. With regard to audit sampling, a taxpayer must demonstrate that a sample used in an audit is not representative of the audit period or that it is flawed in some other manner to invalidate the sample. The Taxpayer has not provided documentation demonstrating that the sample was invalid. Consistent with the law and the Department's policy, the Taxpayer has not met the burden of proving that the assessment is incorrect with regard to this issue.
Incorrect Entity Assessed
The Taxpayer has provided a schedule of entities and each entity's respective Federal Employer Identification Number The Taxpayer claims it is related to all the entities listed. Further, the Taxpayer states that the government contract purchases listed in the audit reference a number that is unique to each contract or project. The first two digits of the project number identify the entity that is the government contractor, which the Taxpayer contends is the entity that made the actual purchase. Thus, many of the project numbers for the purchases listed in the audit identify the entities that should have been assessed the tax and it is these purchases on which the Taxpayer was improperly assessed the tax.
Virginia Code § 58.1-633 A states:
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- Every dealer required to make a return and pay or collect any tax under this chapter shall keep arid preserve suitable records of the sales, leases, or purchases, as the case may be, taxable under this chapter, and such other books of account as may be necessary to determine the amount of tax due hereunder, and such other pertinent information as may be required by the Tax Commissioner.
While the information provided by the Taxpayer suggests that the purchases at issue may have been made by other entities, the evidence presented is not conclusive.
The Taxpayer's claims and the information provided to support these claims is not consistent with the accounting records reviewed by the auditor or with the representations made by the Taxpayer during the audit. The Taxpayer must provide additional documentation to the Department that clearly demonstrates the disputed purchases listed in the audit were made by entities other than the Taxpayer. Such documentation should include evidence that the purchases were paid from another entity's checking account and that the accounting entries for the purchases were recorded on the books of the entity that made the purchase. I will allow the Taxpayer 60 days to provide this information to the Department.
The Taxpayer notes that some of the entities listed on the schedule provided with its appeal may have been audited by the Department, resulting in assessments of tax on the same transactions. Research conducted by a member of my Appeals staff indicates there is no duplication of the tax assessed in the Taxpayer's audit by assessments issued to any of the entities listed in the schedule.
True Object of Government Contracts
The Taxpayer also asserts that many of the contested purchases are for government contracts in which the true object of the contracts was the sale of tangible personal property to the federal government. In determining the tax treatment of government contracts, the Department relies on Title 23 of the Virginia Administrative Code (VAC) 10-210-4040 D, which states:
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- In order to determine whether a particular transaction which involves both the rendering of a service and the provision of tangible personal property constitutes an exempt service or a taxable retail sale, the "true object" of the transaction must be examined. If the object of the transaction is to secure a service and the tangible personal property which is transferred to the customer is not critical to the transaction, then the transaction may constitute an exempt service. However, if the object of the transaction is to secure the property which it produces, then the entire charge, including the charge for any services provided, is taxable.
Title 23 VAC 10-210-693 addresses the application of the tax to government contractors and states the following:
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- The appropriate tax treatment of purchases of tangible personal property by persons who contract with the federal government, the state or its political subdivisions, 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 the sale of tangible personal property, a contractor may purchase such tangible personal property exempt from the tax using a resale exemption certificate, Form ST-10. The tangible personal property may be resold to the government exempt of the tax.
The Taxpayer's position is that certain purchases assessed in the audit qualify for the resale exemption because the true object of the contracts associated with those purchases is the sale of tangible personal property to the government. The Taxpayer concedes that the assessment its valid with respect to the purchase transactions listed in the exceptions list as line items 2, 4, 5, 22, and 29. The Taxpayer has provided copies of three work order proposals for contracts associated with some of the purchase exceptions listed in the: audit. The Department's policy is that when determining the true object of transactions between contractors and government entities, the overall contract must be examined to determine the true object of the contract. Individual work orders issued under a particular contract do not necessarily reflect the true object of the overall contract.
P.D. 00-111 (6/19/00) discusses this policy, which was in effect until July 1, 2006. In this case, a government contractor argued that it was improperly assessed use tax on purchases for a contract it considered to be a basic ordering agreement. Under the contract, the government placed individual delivery orders with the contractor. Each delivery order carried its own Statement of Work. Despite the fact tangible personal property was delivered and transferred to the government under the delivery orders, the true object of the underlying contract was for services. Thus, the contractor's purchase of the property at issue did riot qualify for the resale exemption.
P.D. 00-111 addresses a contract for a software solution that was sold to the government. Under this contract, upgraded computer equipment for operation with the software was provided to the government. The software and equipment were delivered as an integrated system and the contractor maintained the true object of the contract was the exempt sale of a tangible computer system to the government. The Tax Commissioner ruled that the underlying contract was for the provision to the government of engineering and technical services related to signal interception. Again, the contractor's purchase of the computer equipment did not qualify for the resale exemption.
Based on the Department's policy and the documentation provided by the Taxpayer, the true object of the government contracts in the audit cannot be determined. The auditor has indicated the government contracts were reviewed during the audit, and it was determined that the true object of those contracts was for the provision of services to the government. Thus, there is no basis to remove any of the disputed purchases from the audit with respect to this issue. However, I will agree to allow the Taxpayer 60 days to provide contracts to the Department for review.
If the Department determines that the true object of the contracts is the sale of tangible personal property to the government, the appropriate purchase exceptions will be adjusted or removed from the audit. Without this information, the assessment must be considered correct.
Alternatively, if the Taxpayer can show that other entities made the purchases associated with any of the contracts listed, the purchase exceptions will be removed from the audit. If this information cannot be provided, the assessment of use tax on these purchases will be considered correct.
CONCLUSION
Based on the information presented, the audit sample is valid. The Taxpayer will be allowed 60 days to provide documentation indicating that it was improperly assessed use tax on purchases made by related entities. Alternatively, the Taxpayer has 60 days to provide the Department copies of or access to government contracts that support the audit contains purchases that qualify for the resale exemption. A review of the contracts must demonstrate that the true object of the contracts is the sale of tangible personal property to the government. The assessment will be considered due and payable if the requested information is not provided within the allotted time.
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 concerning this determination, please contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
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- Sincerely,
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- Linda D. Foster
Deputy Tax Commissioner
- Linda D. Foster
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AR/1-2284543212.S
Rulings of the Tax Commissioner