Document Number
11-10
Tax Type
Consumer Use Tax
Retail Sales and Use Tax
Description
Untaxed purchases of tangible personal property; Subcontracts and third party subcontractor.
Topic
Exemptions
Government Contractor
Sale for Resale
Date Issued
01-21-2011


January 21, 2011



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

Dear *****:

This is in response to your letter requesting correction of the retail sales and use tax assessment issued to ***** (the Taxpayer) as a result of an audit for the period February 2007 through January 2010. I apologize for the delay, in responding to your letter.

FACTS


The Taxpayer is a government contractor with a location in Virginia specializing in congressional analysis support, strategic planning, and program management services. It was assessed consumer use tax on untaxed purchases of tangible personal property on the basis that such property was used or consumed by the Taxpayer in Virginia.

The Taxpayer raises two issues. First, the Taxpayer contends that hosting and maintenance charges assessed in the audit are not taxable. The Taxpayer contends that these charges relate to exempt custom computer programs or exempt charges for the modification of prewritten software. Second, the Taxpayer contends that the exhibits furnished to the ***** (a federal agency) are not taxable pursuant to the Form ST-12 exemption certificate presented by such federal agency. The auditor assessed these items because the Taxpayer is registered for the reporting of consumer use tax and is thus not entitled to purchase items exempt of the tax for resale purposes.

DETERMINATION


Section C of Title 23 of the Virginia Administrative Code (VAC) 10-210-693 provides the following:
    • In order to determine whether a particular transaction that involves both the rendering of a service and the provision of tangible personal property constitutes a sale of a service or of tangible personal property, the true object of the transaction must be examined. The appropriate tax treatment of purchases of tangible personal property by persons who contract with the government or its political subdivisions is based upon whether the transaction is for the sale of tangible personal property (e.g., a computerized data retrieval system) or for the provision of an exempt service (e.g., real property facilities management). If a transaction is for the sale of tangible personal property, a contractor may purchase the tangible personal property exempt of the tax using a resale exemption certificate, Form ST-10. The tangible personal property may be resold to the government exempt of the tax.
    • However, if a transaction is for the provision of services, the 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.

Hosting and Maintenance

Pursuant to the statement of work for task orders 67 and 72 with the federal government, the Taxpayer is tasked with providing a web-enabled Congressional knowledge management system (a relational database website) for use by the government. This system will allow the government to retrieve information for timely analysis, disseminate information to those who need it, and develop a central repository of information. The application must have already been customized for use in agencies doing legislative liaison work. A number of features are required, including but not limited to, calendar and search functionality, links, printing capability, interfaces, custom creation of reports by users, charts, user access control, applications allowing access to other applications, training and hosting. In regard to hosting, the Taxpayer must host the application in a controlled access web-site for the government and be responsible for ensuring the site is available and operational continuously during the contract period.

Based on these contractual obligations, I must conclude that the true object of the task orders is for the provision of exempt services to the federal government. As a service provider, the Taxpayer is generally liable for the retail sales and use tax on its purchases of tangible personal property used or consumed in the performance of such services.

In this case, however, the Taxpayer subcontracts these tasks to a third party subcontractor. The subcontract indicates that the subcontractor developed the baseline website and a series of requested modifications. The subcontractor was tasked to provide further support and modifications to the baseline website application, such as hosting and maintaining the website application, redeveloping and installing modules and components, testing modifications, and performance of script development for new functionality.

Based on the subcontract, I must conclude that the subcontractor provided a nontaxable service to the Taxpayer. The Taxpayer performed certain modifications to the software applications that were separately charged and exempted from the tax pursuant to Va. Code § 58.1-609.5 6. The Taxpayer also charged for lump-sum hosting and maintenance charges. A hosting charge, by itself, is generally not taxable when such charges do not involve the provision of tangible personal property. On the other hand, maintenance charges in connection with prewritten software applications are either taxable or exempt depending upon whether any tangible upgrades or updates are to be furnished. See Title 23 VAC 10-210-910. In this case, it appears that the subcontractor provided no tangible personal property to the Taxpayer because the software application is hosted and maintained by the subcontractor on its server.1 Because there is no provision of tangible personal property to the Taxpayer, the charges for hosting and maintenance are not taxable. Line items 24 - 26 of the non-contested purchases exception list will be removed from the audit.

Exhibits

In this case, tax was assessed on exhibits furnished to a federal agency. The Taxpayer subcontracted the work to a second company who acquired the materials and sold it to the Taxpayer. I understand that a third company provided storage, set-up, staging and other services to the second company.

The Taxpayer entered into a contract order that was effective on July 1, 2002 with one base year and 4 option years which were exercised. As such, it was due to expire on July 1, 2007 if not extended. The order was extended (i.e., the option years were exercised) pursuant to the provisions of the original order, which states that the contract is renewable in four increments of twelve months each at the unilateral option of the government. The order also states that the option must be exercised by issuance of a unilateral modification for the subsequent option requirements within 60 days before the end of the current period.

The order originally had four contract line item numbers (CLINs) and was amended on March 2, 2004 to add another CLIN (CLIN #5) requiring the Taxpayer to produce and maintain exhibits for use at government conferences, as well as to provide shipping, set up and on-site support. CLIN #5 also had a base year and option years (that were exercised) to extend the period of performance to June 30, 2007. After June 30, 2007, the order was subsequently amended on several occasions to extend the period of performance for several (but not all) CLINS of the original order, including the 5th CLIN.

Section F of Title 23 VAC 10-210-693 states, "The true object test shall be applied to all orders issued under all mixed government contracts if executed on and after July 1, 2006, regardless of the date on which the original contract, add-on, or order was executed." Section A of such regulation defines the term "add-on" to mean "additional obligations subsequent to the execution of the original contract or order, including modifications to contracts or orders." Section A of such regulation also defines the term "order" to mean "a specific task assigned to a contractor pursuant to a contract with a government entity" and includes "contract line item numbers (CLINs)" and "add-ons to existing contracts."

The order as originally proposed and amended includes the option year effective from July 1, 2006 through June 30, 2007. Such option year was exercised. Subsequent amendments to the order extended the period of performance into the periods in which the contested purchases were made. Accordingly, because the option year July 2006 through June 2007 was put into effect on and after July 1, 2006, the true object test must be applied to CLIN #5 to determine the application of the tax. Based on my review of the contract documents, I find that the true object of CLIN #5 is for the provision of tangible personal property to the government. Although CLIN #5 requires some incidental services, those services are required for the provision of the property and thus do not transform such order into a service order. Thus, the Taxpayer is not the consumer of the exhibits purchased in connection with such CLIN. Rather, the exhibits may be purchased exempt of the tax pursuant to the resale exemption. The sale of such property to the government is also exempt pursuant to the government's exemption at Va. Code § 58.1-609.1 4. Based on the foregoing, line items 52 - 65 will be removed from the non-contested purchases exception list.

Future Compliance

The Taxpayer is currently registered for consumer use tax purposes. Consumer use tax registrations are generally for consuming contractors, service providers and others who sell no tangible personal property at retail. Sales and use tax registrations are required for dealers who engage in making retail or wholesale sales of tangible personal property. To avoid a similar assessment in the future, the Taxpayer is requested to obtain a sales and use tax registration. Such registration will lawfully allow the Taxpayer to use the Department's resale exemption certificate, Form ST-10, when making purchases for resale.

CONCLUSION


The assessment will be revised in accordance with this determination. Because the assessment has been paid, the overpaid tax, penalty and interest amounts will be refunded with interest in accordance with Va. Code § 58.1-1833.

The Code of Virginia and regulation sections cited 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 Tax Policy, Appeals and Rulings, at *****.
                • Sincerely,


                • Linda D. Foster
                  Deputy Tax Commissioner



AR/1-4460505507.R
1. As a service provider, the subcontractor is liable for the tax on its purchases of tangible personal property used or consumed in the performance of its services under the subcontract

Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46