February 16, 2021
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letter submitted on behalf of ***** (the “Taxpayer”), in which you seek correction of the retail sales and use tax assessments issued for the period July 2008 through June 2014. I note that the Taxpayer has paid the assessments in full. I apologize for the delay in responding to your request.
FACTS
The Taxpayer is a full service testing laboratory conducting tests on components, systems, and products for customers in Virginia. The Taxpayer’s testing services include stress screening, environmental testing, aging, and various military operational tests. As a result of an audit conducted by the Department, the Taxpayer was assessed consumer use tax on expense and asset purchases. The Taxpayer argues the testing of customers’ products is part of the research and development process and qualifies for the exemption set out in Virginia Code § 58.1-609.3 5. The Taxpayer requests a refund for the tax paid on the contested items.
DETERMINATION
Research and Development
Virginia Code § 58.1-609.3 5 provides an exemption from the retail sales and use tax for “[t]angible personal property purchased for use or consumption directly and exclusively in basic research or research and development in the experimental or laboratory sense.” Title 23 of the Virginia Administrative Code (VAC) 10-210-3070 interprets the exemption statute with subsection A defining “basic research” as:
A systematic study or search in a scientific or technical field of endeavor with the ultimate goal of advancing knowledge or technology in that field. The development of a tangible product or process need not occur in basic research activities. Examples of basic research activities include medical, chemical, or biological experiments conducted in a laboratory environment.
Subsection A also defines “research and development” as:
A systematic study or search directed toward new knowledge or new understanding of a particular scientific or technical subject and the gradual transformation of this new knowledge or new understanding into a usable product or process. Research and development must have as its ultimate goal: (i) the development of new products; (ii) the improvement of existing products; or (iii) the development of new uses for existing products. Research and development does not include the modification of a product merely to meet customer specifications unless the modification is carried out under experimental or laboratory conditions in order to improve the product generally or develop a new use for the product.
Title 23 VAC 10-210-3071 A discusses the direct and exclusive use requirements of the exemption and provides:
The exemption is limited in scope to tangible personal property used directly and exclusively in an actual research process, starting with the handling and storage of raw materials and supplies at the research facility and ending after the last step of the research process when the products of the research process are stored at the research facility. Items of tangible personal property used directly and exclusively in research include chemicals, drugs and other materials, equipment, machinery, tools, supplies, energy, fuel, and power used in these processes. An item is not considered used directly and exclusively merely because it is essential to research activities or because its use is required by law.
The phrase “direct use” is defined in the regulation as:
Those activities that are an integral part of basic research or research and development activities, including all steps of these activities, but not including secondary activities such as administration, general maintenance, product marketing, and other activities collateral to the actual research process.
Title 23 VAC 10-210-3071 B addresses items that are used in both taxable and exempt research activities and provides:
When a single item is used both in exempt and nonexempt activities, it is not used exclusively in research activities and is taxable. Therefore, a prorated research exemption of the single item based upon percentages of exempt and nonexempt usage or an exemption based upon the preponderance of an item's use in exempt activities is not permitted.
While an item may be used directly and exclusively in research activities, it must also be used in an experimental or laboratory sense to qualify for the exemption. The phrase “experimental sense” is defined as work conducted through tests, trials, tentative procedures, or polices adopted under controlled conditions to discover, conform, or disprove something doubtful. “Laboratory sense” is defined as work conducted in a place equipped for experimental study in a science and providing an opportunity for experimentation, observation, or practice in a field of basic scientific or traditional physical science research.
Instances in which the research and development exemption will not apply are stated in Title 23 VAC 10-210-3070 B, which explains:
Research does not include environmental analysis, testing of samples for chemical or other content, operations research, feasibility studies, efficiency surveys, management studies, consumer surveys, economic surveys, research in the social sciences, metaphysical studies, advertising, promotions, or research in connection with literary, historical, or similar projects.
It is longstanding and established policy that statutes granting tax exemptions are construed strictly against the taxpayer. Commonwealth v. Community Motor Bus Co., Inc., 214 Va. 155, 198 S.E.2d 610 (1973). Exemption from taxation is the exception, and where there is any doubt, the doubt is resolved against the one claiming exemption. Golden Skillet Corp. v. Commonwealth, 214 Va. 276, 199 S.E.2d 511 (1972). Based on these authorities, I will address the Taxpayer’s contested issues.
The Taxpayer characterizes its operations as follows. A customer will engage the Taxpayer to test a new component or device to see how it reacts to different conditions or circumstances. The Taxpayer will then conduct tests, record data, and provide the test results to the customer. The customer will then either modify the component and submit it for additional testing or begin production.
The Taxpayer states the auditor met with the Taxpayer’s representatives and reviewed documentation that outlines the research operations and believes the auditor’s position is incorrect because a tour the facility to view the manner in which the Taxpayer operates was not permitted.
The auditor and senior auditor repeatedly requested a tour of the Taxpayer’s facility, but access was denied due to the classified nature of the Taxpayer’s work. Also, upon appeal, the Department requested the Taxpayer provide contracts and statements of work for each contested item included in the appeal letter. These documents were requested in order to aid in the Department’s review of the nature of the Taxpayer’s operations regarding the contested exceptions. The Taxpayer, instead, provided testing reports and written explanations of the tests related to the contested exceptions. These explanations and documentation outlined instances of environmental and feasibility testing, whereby the Taxpayer was given a product or component by a customer and placed it through the necessary tests to determine if the item could withstand certain environments or feasibly work under various specified conditions.
In its appeal letter, the Taxpayer argues it qualifies for the research and development exemption in accordance with Public Documents (P.D.) 95-99 (9/4/1995) and 95-91 (4/28/1995). In these public documents, the taxpayers provided contracts and statements of work for the Department’s review that detailed the purpose and nature of the work and allowed the Department to determine how the research and development exemption applied. In the instant case, the Taxpayer has provided no such contracts or statements of work for review and, accordingly, no such treatment can be extended to the Taxpayer based on the facts of those public documents.
The Taxpayer also cites the decisions in P.D. 84-46 (4/11/1984) and P.D.15-82 (4/22/2015) to support its position in claiming the research and development exemption. The Taxpayer argues that in P.D. 84-46, the taxpayer was not using test results to develop new products or capabilities and, instead, performed feasibility testing, whereas the instant Taxpayer’s testing involved new products, capabilities, and applications. The Taxpayer also argues the distinction in P.D.15-82 between the two types of work does not support the denial of the exemption because the Taxpayer does not conduct non-exempt testing. This, however, is contradictory to the work explained in the testing reports provided to the Department. Without contracts and statements of work, these are the only documents upon which the Department can rely. These documents outline the environmental and feasibility testing conducted by the Taxpayer.
Moreover, as explained in P.D. 96-61 (4/24/1996), while changes to a prototype may be made as a result of test results, Title 23 VAC 10-210-3070 B provides that testing and product modification do not qualify as exempt research and development. P.D. 09-52 (5/1/2009) further explains instances in which the research and development exemption does not apply, namely “testing systems for operational compliance, planning, installation, integration, and training.”
Based on a review of testing reports and invoices provided by the Taxpayer, as well as information about the Taxpayer’s activities provided in the appeal letter and stated on the Taxpayer’s website, it appears the Taxpayer is engaged in taxable testing activities. The documentation provided shows the Taxpayer is engaged in environmental and feasibility testing and not basic research or research and development as delineated in Virginia Code §58.1-609.3 5. Thus, based on the foregoing determination, the assessments are deemed correct as issued. As the Taxpayer has paid the assessments, no further action is required.
The Code of Virginia and regulation sections and 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 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/677L