February 15, 2022
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letter seeking correction of the sales and use tax assessment issued to ***** (the “Taxpayer”) as a result of an audit for the period from October 2011 through June 2013. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer, headquartered in ***** (State A) with a research facility located in Virginia, is engaged in pharmaceutical development, formulation, and production. The Department’s auditor assessed use tax on the Taxpayer’s purchases of the supplies and materials used to construct a clean room within the research facility, finding that the clean room became a part of the real property upon completion. At the time of the audit, the Taxpayer did not permit the Department’s auditor to physically view or inspect the clean room or any interior rooms of the research facility. The Taxpayer appealed the assessment on the grounds that the supplies and materials were not converted to real property and not subject to sales and use tax under the laboratorial or experimental research and development exemption for tangible personal property. In its appeal, the Taxpayer submitted additional documentation, such as its lease and its purchase invoices for the clean room materials.
DETERMINATION
Research and Development
Virginia Code § 58.1-609.3 5 provides an exception from the 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.” In order to qualify for the exception, the property must be tangible personal property, the tangible personal property must be exclusively and directly used for research and development, and the research and development must be experimental or laboratorial.
The classification of the Taxpayer’s pre-fabricated walls as tangible personal property permits the walls to be included as “other materials” under the description of tangible personal property items that may be exempt from sales and use tax under Title 23, VAC 10-210-3071 A and Virginia Code § 58.1-609.3 5. However, the Taxpayer’s use of the clean room must also qualify as a direct and exclusive use of tangible personal property for research and development purposes.
In the audit, the Department accepted the Taxpayer’s assertion that the clean room was used exclusively and directly for experimental research and development. The Taxpayer’s statements and the Department’s audit records indicate the Taxpayer’s activities and direct and exclusive use of the tangible personal property constitute research and development in accordance with Virginia Code § 58.1-609.3 5 and Title 23, VAC 10-210-3070 A, 3071 A.
Without being able to tour the Taxpayer’s facility, however, the auditor concluded some of the materials had become part of the realty and were no longer tangible personal property eligible for the exception. To address the Taxpayer’s appeal, the Department must analyze whether the Taxpayer’s materials and supplies remained tangible personal property or converted to real property upon installation.
Real Property
The clean room materials attached to the floor of the Taxpayer’s leased building must be analyzed under the three prong test for analyzing tangible personal property affixed to real property stated in Transcontinental Gas Pipe Line Corporation v. Prince William County, 210 Va. 550, 555 (1970), 172 S.E.2d 757, 761, 762 and Danville Holding Corp. v. Clement, 178 Va. 223, 232, 16 S.E.2d 345, 349 (1941). The three prong test used to determine if personal property has been affixed to realty so as to become part of the realty are (1) annexation of the property to the realty, (2), adaptation to the use or purpose to which that part of the realty with which the property is connected is appropriated, and (3) the intention of the parties, which is the primary factor to determine whether tangible personal property has been converted to real property (see Transcontinental Gas Pipe Line Corporation v. Prince William County and Danville Holding Corp).
In Public Document (P.D.) 14-83 (5/30/2014), the Department determined pre-fabricated movable interior walls that were attached using installed “tracks” to hang the walls constituted a conversion of tangible personal property to real property in accordance with the test stated in Transcontinental. In this appeal, the Taxpayer’s use of “c-channels” to attach the outer walls of the clean room to the interior floor is substantially similar to the taxpayer’s facts in P.D. 14-83. For the first prong in P.D. 14-83, the Department determined that the taxpayer’s use of installed tracks to hang the interior movable walls constituted an annexation to real property. For the second prong, the Department determined the movable wall partitions were installed for long term use and were intended to indefinitely remain, and thus the walls constituted an affixed and permanent adaptation to the real property. Additionally, the Tax Commissioner stated in P.D. 14-83 that movable partitions did not need to be integrated into the structural components of a building in order to be considered real property. For the third prong in P.D. 14-83, the Tax Commissioner lacked sufficient evidence to determine the original intention of the parties as to whether the walls were to be considered tangible personal property or real property. Under these circumstances, the Tax Commissioner determined the walls were real property under the first two prongs of Transcontinental.
In this matter, the Taxpayer used “c-channels” bolted to the concrete interior floor of the building to attach the pre-fabricated exterior walls of the clean room. Under the three prong test in Transcontinental, the Taxpayer’s use of the “c-channels,” as with the taxpayer’s use of tracks in P.D. 14-83, constitutes an annexation of tangible personal property to real property under the first prong and an adaptation to the real property that may be intended for long term and indefinite use under the second prong. Unlike the taxpayer in P.D. 14-83, however, the Taxpayer has provided its lease agreement that indicates the intention, requirement, and duty of the Taxpayer to return the real property to the landlord in the same condition as at the time of the Taxpayer’s possession. The property at the time the Taxpayer took possession did not include the clean room. Applying these facts to the third prong under Transcontinental, the parties have sufficiently shown they intended to classify the clean room exterior walls as a non-permanent addition of tangible personal property to real property.
CONCLUSION
Based on the information provided, the Taxpayer’s construction of a clean room and all its material components constitute a direct and exclusive use of tangible personal property for research and development purposes that qualifies for the sales and use tax exemption stated in Virginia Code § 58.1-609.3 5. As set out in this determination, the appropriate items will be removed from the audit and the audit adjusted accordingly. The Department’s records indicate that the Taxpayer paid the contested assessment in full. A refund of the overpayment, plus applicable interest, will be issued to the Taxpayer based on the revision of the audit liability.
Although I find in favor of the Taxpayer in this case, the fact that the Department’s auditor was not allowed access to the interior rooms of the research facility or provided with the lease agreement likely resulted in the conclusion that the clean room was real property was correct at the time of the audit. Had the Taxpayer provided the lease, indicating its requirement to remove all installed components of the clean room upon expiration of the lease and vacating the premises, during the audit, the resulting assessment may have been more accurate.
The Code of Virginia section, regulations, and public document cited are available online at www.tax.virginia.gov in the Laws, Rules, and Decisions section of the Department’s website. 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/1524.C