May 17, 2016
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This will reply to your letter in which you seek the correction of an assessment issued to ***** (the “Taxpayer”) for the period January 2013 through September 2014. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is a holding company for subsidiary companies (the “Subsidiaries”) that perform electrical and telecommunications contract work. The Taxpayer purchases equipment that is used by the Subsidiaries to perform the contract work. The Subsidiaries use the equipment interchangeably. The Taxpayer pays the applicable sales or use tax on the equipment at the time of purchase. The costs for the use of the equipment are accounted for on the books of the Taxpayer by allocating the costs to the Subsidiaries and to each job. The cost allocations are recorded in the Taxpayer's accounting records as journal entries. There is no markup of the cost allocations recorded in the Taxpayer's accounting records, and the Taxpayer claims depreciation deductions for the equipment.
The Department audited the Taxpayer and treated the allocated cost amounts as rental charges billed to the Subsidiaries. Retail sales tax was assessed on the amounts of the cost allocations recorded as journal entries in the Taxpayer's books. The Taxpayer was given credit in the audit for the sales and use taxes paid on the equipment purchases. The Taxpayer asserts that the retail sales tax was erroneously assessed on the amounts allocated as equipment costs to the Subsidiaries and treated as rental charges.
DETERMINATION
The Taxpayer maintains that it is not in the business of leasing or renting tangible personal property to others. The Taxpayer states that, as the parent company, various services are provided to the Subsidiaries. These services include human resources management, safety and risk management, information technology support, fleet services and various accounting services. The costs for the provision of these services are allocated to properly account for the operating costs for each of the Subsidiaries. Likewise, the shared use of the equipment by the Subsidiaries must be charged to each job and to each of the Subsidiaries to properly account for the equipment costs. The practice of allocating costs from the Taxpayer to the Subsidiaries is not intended to generate a profit.
There are certain benefits to establishing separate but related corporate entities and having each entity engage in specified activities. For example, having the Taxpayer as the owner and the Subsidiaries as the users of the subject equipment protects the entities and the equipment from possible liability and loss issues. The financial reporting for the related entities can produce more appealing results for shareholders, potential investors and commercial lenders. This accounting arrangement provides certain benefits, direct and indirect, to the Taxpayer and the Subsidiaries. Otherwise, there would be no reason to have such an arrangement.
Intercompany Accounting
“Sale” is defined in Va. Code § 58.1-602 as “any transfer of title or possession, or both, exchange, barter, lease or rental, ... in any manner or by any means whatsoever, of tangible personal property ... for a consideration ....” The Department has previously ruled in several public documents that intercompany accounting entries to record transactions between related but separate entities constitute a consideration for sales and use tax purposes. For example, Public Document (P.D.) 04-134 (9/16/04) discusses a corporate reorganization in which assets were transferred between separately incorporated subsidiaries with a common parent. The transfers were recorded as an adjustment of intercompany balances on the subsidiaries’ books. There were no direct payments of cash, exchanges of stock or lines of credit issued between the subsidiaries. The Tax Commissioner ruled that, based on the definition of “sale,” the paper or accounting entries that recorded the transfers were a consideration and the asset transfers qualified as sales that were subject to retail sales and use tax.
Leases and Rentals
The Taxpayer contends that it is not in the business of leasing or renting tangible personal property. Virginia Code § 58.1-603 2 imposes the retail sales tax on leases or rentals of tangible personal property if the lease or rental of the property is part of an established business or is germane to the business. The intent of the law is to tax leases made by one in the business of making leases. “Business” is defined in Va. Code § 58.1-602 as “any activity engaged in by any person, or caused to be engaged in by him, with the object of gain, benefit or advantage, either directly or indirectly.”
Virginia Code § 58.1-602 defines “Lease or rental” as “the leasing or renting of tangible personal property and the possession or use thereof by the lessee or renter for a consideration, without transfer of the title to such property.” Based on the facts presented, the Taxpayer purchases, takes title to and depreciates the equipment at issue. The equipment is purchased by the Taxpayer for the sole purpose of providing it to the Subsidiaries. Possession of the equipment is transferred to the Subsidiaries for use in the provision of contract services. The Subsidiaries take possession of and use the equipment without taking title to it and the equipment is used interchangeably among the Subsidiaries.
As previously explained, the use of intercompany transactions to account for the costs associated with the purchase, lease or the use of tangible personal property constitutes a consideration. The provision of equipment by the Taxpayer to the Subsidiaries and the corresponding accounting entries to record the costs for the equipment constitute rental transactions that, absent an applicable exemption, are subject to Virginia sales and use tax. The fact that the Taxpayer and the Subsidiaries file on a consolidated basis for income tax purposes has no bearing on the application of the sales and use tax to leases and rentals. This has been the Department's consistent position. See P.D. 07-35 (4/20/07) and P.D. 11-207 (12/29/11).
Resale Exemption
“Retail sale” is defined as “a sale to any person for any purpose other than for resale....” Title 23 of the Virginia Administrative Code (VAC) 10-210-840 C provides that “[t]angible personal property for future use by a person for taxable lease or rental as an established business may be purchased tax exempt under a certificate of exemption.” Based on the definition of retail sale, the resale exemption applies to purchases or leases of tangible personal property for future lease or rental. The Taxpayer's purchase or lease of equipment and repair parts for subsequent lease to the Subsidiaries qualifies for the resale exemption.
In accordance with Title 23 VAC 10-210-280, the Taxpayer should issue its vendors properly executed resale exemption certificates (Form ST-10) when it purchases or leases equipment that will be leased or rented to the Subsidiaries. Any taxable use of the equipment by the Taxpayer prior to its transfer to any of the Subsidiaries is subject to use tax. As a lessor, the Taxpayer should report and remit to the Department the appropriate Virginia retail sales taxes based on the intercompany accounting entries recorded each month to allocate costs for the equipment used in Virginia by the Subsidiaries.
I note that the auditor properly allowed credits in the audit for sales taxes paid by the Taxpayer on purchases of the equipment at issue. In P.D. 96-270 (10/7/96), a taxpayer maintained that it was not a lessor under Virginia sales and use tax law but was in the business of financing equipment purchases for customers. The taxpayer paid sales and use tax at the time of purchase on equipment that the Tax Commissioner determined was being leased and was subject to retail sales tax on the lease charges. The Tax Commissioner agreed to allow a credit in the audit for the sales taxes paid, contingent on the verification of purchase invoices showing that the tax was paid. The Department's policy on this issue is based on the fact that the resale exemption applies to purchases made for future lease or rental. Thus, the allowance of the credits in the audit resulted in the proper sales tax liability being assessed on the Taxpayer's equipment cost allocations to the Subsidiaries.
CONCLUSION
The Taxpayer was properly treated as a lessor in the audit and should begin remitting sales taxes on the rental or lease charges allocated to the Subsidiaries. The Department's records indicate that the Taxpayer has paid contested bill ***** in full. Therefore, no further action is necessary with respect to payment of the audit liability.
The Code of Virginia sections, regulations and the public documents cited, along with other reference documents, are available on line at www.tax.virginia.gov in the Laws, Rules and Decisions 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 *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-6040425951.S