Document Number
12-80
Tax Type
Retail Sales and Use Tax
Description
Transactions for repair services: Exempted by Va. Code § 58.1-609.5 1.
Topic
Exemptions
Records/Returns/Payments
Tangible Personal Property
Date Issued
05-09-2012


May 9, 2012




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 ***** (the "Taxpayer") as a result of an audit for the period April 2007 through March 2010. I apologize for the delay in responding to your letter.

FACTS


The Taxpayer is a telephone company. As a result of an audit, consumer use tax was assessed on untaxed purchases of tangible personal property held as taxable.

The Taxpayer contests the tax assessed on purchases from ***** (the "Supplier"). The Taxpayer contends that such transactions are for repair services because equipment is shipped to the Supplier for repair and then returned to the Taxpayer. As such, the Taxpayer maintains that the charges are exempted by Va. Code § 58.1-609.5 1.

The Taxpayer also requests a credit against the audit liability for the payment of sales tax to vendors and use tax remitted by the Taxpayer on Internet service provider equipment claimed as exempt from the tax pursuant to Va. Code § 58.1-609.6 2.

DETERMINATION


Virginia Code § 58.1-205 1 provides that any tax assessment issued by the Department is deemed prima facie correct. This means that the burden of proving that the tax does not apply is upon the Taxpayer. For submissions to the court, Va. Code § 58.1­1825 D also places the burden of proof upon the Taxpayer to show that an assessment is erroneous or otherwise improper.

Repair Services

Virginia Code § 58.1-609.5 1 provides an exemption from the retail sales and use tax for "services rendered by repairmen for which a separate charge is made." Virginia Code § 58.1-609.5 2 also provides an exemption from the retail sales and use tax for "an amount separately charged for labor or services rendered in . . . repairing property sold." In either instance, the implication is that the charge for the repair services must be separately stated from the tangible personal property sold for the exemption to apply.

I would also note that the above exemptions are incorporated into the Department's longstanding regulation on repair businesses. Subsection A of Title 23 Virginia Administrative Code (VAC) 10-210-3050 sets out the following:
    • Any person engaged in the business of repairing tangible personal property is required to register and to collect and pay the tax. If the dealer performing the repair work does not separately state, itemize or segregate at a fixed or retail price, the parts, materials and supplies sold, the tax will apply to the total charge including repair labor.

In this case, the documentation presented does not convincingly support the Taxpayer's contention that the contested transactions are for repair services only. None of the invoices and information presented provides conclusive evidence that all defective equipment was shipped to the Supplier for repair and then returned to the Taxpayer. On the contrary, all of the contested invoices charge for a product, i.e., tangible personal property. There is no indication on any of these invoices that the transaction included repair services (i.e., with a repair service labor charge separately stated on the invoice as required by the statute) or that the invoices were for repair services only.

Moreover, the Supplier does not indicate whether the defective equipment was returned to the Taxpayer immediately upon its repair or was retained by the Supplier as a spare for future use. While indicating that either negligible or no components were provided in connection with the contested invoices, the Supplier does not address whether its contractual obligation to provide advanced replacements of equipment was carried out with any of the transactions held in the audit. While the Supplier claims that repair services were provided with little or no replacement parts, the repair agreement between the Taxpayer and the Supplier allows for the Supplier's provision of replacement products in advance, the repair of' defective parts, and the retention of such repaired parts by the Supplier until needed to fulfill another order from the Taxpayer. This advance replacement process seems especially likely regarding several transactions held in the audit, including, for example, the following:
    • Page 35 of the training manual that is incorporated into the contract order indicates that materials with a monetary value of $100 or less are not eligible for the one-stop repair program and should not be sent in for repair. It further states that exceptions will be reviewed on a case by case basis, i.e., line cards. There are a number of transactions with card charges for less than $100, such as the DMS-100 line cards. The Supplier charged $30.00 for each DMS-100 line card. The documentation presented for these transactions does not indicate that the same serial numbered line card was returned to the Supplier, repaired, and then returned to the Taxpayer for immediate use. Rather, the documentation indicates that a charge was made for a product, not repair services. Furthermore, the Taxpayer's records indicate no component costs for these line cards. Because of their low cost, these line cards may have been impractical to repair. Accordingly, it appears that the cards were replaced rather than repaired and returned for immediate use. Unless the Taxpayer has convincing evidence that the same serial-numbered cards (that became defective) were returned to the Taxpayer for immediate use and no replacement card was obtained from the Supplier, line items 7, 9, 19 - 23, 32 - 35, 47, 52 - 60, and 72 - 78 of the purchase exceptions list will remain in the audit.
    • There are also other items with charges for less than $100, which are shown on line items 5, 6, 10 - 18, 26, 41 - 46, 48 - 50, 61, 71, 79, 81, and 89 of the purchase exceptions list. Although some of these items have component costs associated with them, it appears from the contract order that a replacement product was furnished.
    • When an emergency advance replacement product is needed on the same day or overnight basis, Exhibit B of the contract order dated July 1, 2008 indicates that an emergency freight fee of $50.00 will apply. In these instances, the Taxpayer receives a replacement product instead of the same serial numbered repaired product. A sale of tangible personal property occurs in these instances because tangible personal property is transferred for a consideration. The $50.00 fees are associated with the invoices for line items 3, 25, 29, 67, 68, 83, 85, and 91 of the purchase exceptions list.
    • Clause 3.5 of Exhibit A to the contract order pertains to items not economical to repair (NER). In such instances, the Supplier will charge the Taxpayer for replacement of NER equipment. In the audit, there are two instances in which the invoices indicate "replacement" in the description section of the invoice. See the invoices for line items 27 and 70 of the purchase exceptions list.
    • Contested invoice #20014846 charges $17.29 for a remote terminal line card. The invoice indicates that it was broken when received. I would note that contested invoices #20014841 and #20014842 also charge $17.29 for the same item. As such, it appears that replacement line cards were furnished in these instances.
    • For repeated repairs, clause 3.4.1 of the contract order states that a returned product that fails three times will be replaced with a like product. This would represent a taxable sale when a charge is also made. The Supplier has not indicated whether any of the contested items qualified for this type of replacement.

Furthermore, while component costs were associated with some of the contested equipment, most of the equipment had no component costs. Thus, when a defective product is returned to the Supplier and no repairs are made, it would appear that most of the equipment was replaced with like-kind equipment rather than repaired. Even for equipment with associated component costs, there is no indication on the invoice that the same serial numbered item was repaired and returned to the Taxpayer.

In addition, the term "product" is defined in Exhibit A of the contract order to include "(i) equipment shipped from (the Taxpayer) to Supplier for repair and (ii) repaired or replacement equipment shipped to (the Taxpayer) by Supplier." [Insert and emphasis added.] Thus, although the defective product may be repaired, the Supplier will either return the repaired item or send a replacement product.

The Supplier does not indicate whether or not any of the defective products were deemed habitually failing units as addressed in clause 3.4.1 of Exhibit A to the contract order. According to the contract, a habitually failing unit is replaced with a like product and the original product is retired from service. Such a transfer would represent a taxable sale when a charge is also made. The Supplier does not indicate whether any of the contested items qualified as this type of replacement.

In claiming that the contested transactions are primarily for repair services, I note that repair costs do not fluctuate in many instances. For example, standard charges appear to have been applied in the following instances:
    • $30.00 for DMS-100 line cards,
    • $104.65 for two charges described as R-POTS and five charges described as R­PSU,
    • $90.00 for two charges described as power converters,
    • $50.05 for four charges described as transmitter logic,
    • $17.29 for three charges described as line card remote terminals,
    • $70.00 for three charges described as 2 wire dial pulse terminating,
    • $113.75 for three charges described as Rpots cards,
    • $105.56 for two charges described as message protocol,
    • $54.60 for two charges described as line interface, and
    • $108.29 for two charges described as deluxe test sets.

Generally, I would expect the cost of repairs to fluctuate depending upon the nature of the defect, the components replaced or repaired, and the extent of repair labor needed. However, none of the above charges show any fluctuations in pricing from one repair job to the next. For this reason, it is questionable whether any repairs were performed on these items. As such, I cannot conclude that the pricing of the contested transactions is indicative of transactions for repair services. Rather, these transactions appear more indicative of sales of tangible personal property because of the standard or fixed pricing used.

Virginia Code § 58.1-602 defines the term "sale" as follows:
    • Sale means any transfer of title or possession, or both, exchange, barter, lease or rental, conditional or otherwise, in any manner or by any means whatsoever, of tangible personal property and any rendition of a taxable service for a consideration. . .

None of the invoices and other information provided indicates the type of repairs provided or satisfactorily describes the Supplier's billing process. Rather, in the absence of convincing proof to the contrary and because the contested invoices are structured only as transfers of tangible personal property for a consideration at a discounted or list price, all indications are that sales of tangible personal property occurred in accordance with Va. Code § 58.1-602. Because the Taxpayer has not established with convincing evidence that only the standard repair process (i.e., the defective article is repaired and returned immediately to the Taxpayer upon completion of the repair and no advanced replacement product is provided) was performed for all of the contested items, I must conclude that replacement products were advanced to the Taxpayer and that such replacement products were used instead of the same serial-numbered item that became defective. Accordingly, the contested transactions will remain in the audit.

I will reconsider this issue only if the Taxpayer has additional documentary evidence that convincingly establishes that no replacement products (e.g., like-for-like exchanges, emergency advanced replacements, advanced replacements, or other instances in which defective products are replaced with new, used or refurbished products) were provided by the Supplier for some or all of the contested purchases.

Credit/Refund Claim for Internet Service Equipment

Pursuant to Va. Code § 58.1-609.6 2, telephone common carriers who use an open video system are exempt from the retail sales and use tax on broadcasting equipment, parts and accessories thereto, and towers. An exemption also extends to amplification, transmission and distribution equipment used or to be used by open video systems provided by telephone common carriers. Virginia Code § 58.1-602 defines amplification, transmission and distribution equipment as "production, distribution, and other equipment used to provide Internet-access services, such as computer and communications equipment and software used for storing, processing and retrieving end-user subscribers' requests."

Virginia Code § 58.1-602 also defines other terms that are pertinent to this exemption. For instance, the phrase "open video system" is defined to include "Internet service regardless of whether the provider of such service is also a telephone common carrier." The phrase "Internet service" is defined to mean "a service that enables users to access proprietary and other content, information electronic mail, and the Internet as part of a package of services sold to end-user subscribers." Thus, to qualify for the Internet service exemption, a telephone common carrier providing an open video system must provide the three specific Internet services noted in the statutory definition, i.e., it must provide access to proprietary and other content, information electronic mail, and the Internet to end-user subscribers. According to the auditor, the Taxpayer is a provider of such Internet services.

Issue 1

The Taxpayer notes that the audit lacks any credits for the erroneous payment of sales or use tax on purchases of exempt Internet equipment. The Taxpayer presents a spreadsheet claiming that certain equipment qualifies for the Internet service exemption and that sales or use tax erroneously paid on such equipment should be credited against the assessment. The information provided, however, is inadequate to allow an exemption for the specific items listed. Furthermore, no documentation has been provided in support of the Taxpayer's refund/credit claim.

The Taxpayer's 24-page spreadsheet is organized in columns listing the vendor names, voucher ID's, invoice dates, merchandise amounts, freight amounts, use tax amounts, sales tax amounts, monetary amounts, descriptions, a taxable or exempt designation, refund percentages, and total amounts. In the descriptions column, equipment part numbers are shown (some with the manufacturer's name). In many instances, only a number is indicated. The Taxpayer does not explain the exact reason for why the Internet service exemption should apply for each item of equipment at issue.

For instance, the description on the first line of the Taxpayer's refund request is given as “T200 Mechanics H4TUR Remote UN." On the second page of the refund request, a piece of equipment is described as “0000006544." These descriptions do not explain the type or kind of equipment it is, how it is used, or whether it is used for exempt purposes. On page three of the credit request, equipment is described as "0807 coaxial cable 735A 12 con," but there is no explanation indicating how this specific cable is used or how it is claimed to qualify for exemption. There is no explanation as to how this particular cable differs from coaxial cable used in taxable activities. On another page is the description "batteries, 12 volt vrla 170 ah." While batteries could be used in exempt applications, the Taxpayer has not described how this particular battery is used or how it may qualify for exemption. Another entry is described as "deferred sales tax" but no explanation is provided. Another description is for "engineering." Property used in engineering activities does not automatically qualify for exemption. Furthermore, an engineering description does not indicate the type of equipment, how it is used, or explain how the equipment may qualify for exemption. The descriptions "EDLC Quote," "Installation," "Materials," "Relocation of Equipment," "Resource and Arbitration Process," "Site Preparation," and locations are also ambiguous descriptions and may very possibly have no relation to the Internet service exemption.

The Taxpayer's refund/credit claim includes property that is shown as used 50% of the time in exempt activities. The Taxpayer, however, has not furnished any explanation or evidence indicating how it derived such percentage.

Issue 2

In several instances, the Taxpayer contends that the requested credits are for the same equipment the auditor reviewed and found eligible for the exemption. The only reason to include such equipment in the audit would be if it was used in a taxable activity and no or insufficient sales or use tax had been paid. It is my understanding that these items were included in the audit because it was not possible for the auditor to verify the specific usage of these untaxed items. When the Taxpayer's engineer explained that these specific items were used in the provision of Internet services, the auditor removed them from the audit.

Such removal action does not automatically extend to other similar items because the Taxpayer's business involves multiple operations in which equipment may be used in either taxable activities (telecommunications) or exempt activities (Internet services) or in both. For instance, it is my understanding that the Taxpayer uses DSL equipment that can be used simultaneously in the provision of Internet and telecommunications services, could be used solely for one service or the other, or could be used for other purposes. Thus, a claim that similar equipment that has been taxed but claimed as used in exempt operations must be verified by the auditor.

The Department is obligated to follow the rule of strict construction set out by the courts for exemptions from the sales or use tax. In this regard, the courts have held that the tax is the rule, and exemption is the exception. Thus, where there is any doubt, the doubt is resolved against the one claiming the exemption. Golden Skillet Corp. v. Commonwealth, 214 Va. 276, 199 S.E.2d 511 (1973). Because the equipment usage and tax payment information is lacking in this case, it is not possible to determine whether any of the equipment at issue was used in the provision of Internet services or whether all of the tax was paid as claimed. Because these circumstances raise a serious doubt as to whether the exemption applies to the specific equipment at issue, I must resolve the doubt against the Taxpayer. For these reasons and the fact that the Taxpayer has not met its burden of proof, your request for credit or refund is denied.

Additional Documentation Required

I will give the Taxpayer an opportunity to provide additional documentation to support (a) its contention that it has erroneously remitted tax on the equipment at issue and (b) the exact usage made by the Taxpayer of such equipment. It is not enough to claim that equipment is used in Internet services. Rather, the Taxpayer must establish through documentary evidence and testimony of its engineers how the equipment enables end-user subscribers to access the Internet services defined in Va. Code § 58.1-602 and how such equipment is used to store, process and retrieve end-user subscribers' requests. Furthermore, the tax on equipment used in both taxable and exempt activities must be prorated based on the amount of time used in exempt activities. The Taxpayer must identify such dual-use equipment and indicate how it computed the percentage of exempt usage.

Examples of additional documentation and information required include:
    • Non-technical descriptions for each piece of equipment.
    • Layman's explanations of the usage made of each piece of equipment and how each piece of equipment at issue is used in Internet service activities.
    • Documentary evidence that Virginia sales tax was paid to vendors in which the sales invoice charges a Virginia sales tax.
    • Documentary evidence that Virginia use tax was remitted to the Department for claimed exempt items that were not taxed by the vendors or were taxed by the vendors but the Taxpayer did not pay the sales tax to the vendors.
    • Copies of invoices (and related purchase orders) for items claimed as part of this refund.
    • Internal accounting records clearing indicating where each item was used.
    • Any other necessary evidence required by the auditor.

Additional documentation furnished by the Taxpayer will be reviewed by the Department's auditor. If it is determined that the Taxpayer erroneously paid tax on the equipment at issue and has adequately supported its claim for exemption, the Taxpayer will be given a credit against the audit assessment, provided the sales tax has not already been refunded and further provided that the Taxpayer certifies in writing to the auditor that it has not and will not seek a tax refund from its vendors in regard to the specific items in question. I would note that the credit for sales tax paid to vendors must be reduced by the dealer's discount taken. See Title 23 VAC 10-210-3040.

A tour of the Taxpayer's facility would aid in the auditor's verification of equipment usage. I understand that such a tour was previously requested by the auditor but was denied. If there is a federal security clearance issue, the Department does have a classified contract agent, i.e., an auditor with federal security clearance. If such agent is needed to conduct such a tour, the Department can arrange for such agent to tour the Taxpayer's facility and assist the current auditor in the resolution of this matter. The auditor will be contacting you to make such arrangements, or if not needed, to determine whether the Taxpayer will now permit the auditor to tour its facility.

CONCLUSION


Based on this determination, the assessment is correct. An updated bill, with interest accrued to date, will be sent to the Taxpayer. No further interest will accrue provided the outstanding assessment is paid within 30 days from the date of the bill. The Taxpayer should remit its payment to: Virginia Department of Taxation, 600 East Main Street, 23rd Floor, Richmond, Virginia 23219, Attn: *****. If you have any questions concerning payment of the assessment, you may contact ***** at *****.

Please note that failure to remit full payment within the 30-day period may result in the imposition of an additional 20% penalty on the tax due under the terms of Virginia's Amnesty Program. See the enclosure entitled "Important Payment Information."

Notwithstanding the above, the auditor will contact you within the 30-day period to determine whether additional documentation will be submitted for the purchase and credit issues. If forthcoming, the auditor will arrange for the receipt or review of such documentation and will also arrange for the continued suspension of the assessment from collection actions. Such documentation should be made available or submitted to the auditor within 120 days of the date of this letter. If the documentation review warrants an adjustment to the assessment, a revised bill with interest accrued to date and a revised audit report will be mailed to the Taxpayer following the adjustment. For questions about the documentation requirements or audit revision, you may contact the auditor, ***** at *****.

The Code of Virginia sections and regulations 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,


                • Craig M. Burns
                  Tax Commissioner





AR/1-4713843800.R

Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46