April 2, 2025
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 assessment issued for the period November 2020 through October 2023.
FACTS
An audit was conducted on the books and records of the Taxpayer, a dealer and renter of construction equipment, for the period at issue. Among the exceptions listed, the auditor found that the Taxpayer had failed to collect the sales tax from ***** (the “Customer”) for the sale of several pieces of equipment. As a result of the audit, assessments were issued. The Taxpayer paid the assessments and filed an application for correction contending that it accepted the Customer’s exemption certificate in good faith.
ANALYSIS
Exemption Certificates
Virginia Code § 58.1-623 A sets out that all transactions involving the sale or lease of tangible personal property are subject to the tax until the contrary is established. Under this statute, “the burden of proving that a sale, distribution, lease, or storage of tangible personal property is not taxable is upon the dealer unless he takes from the taxpayer a certificate to the effect that the property is exempt under this chapter.” Title 23 of the Virginia Administrative Code (VAC) 10-210-280 A further explains, in part, that “a certificate that is incomplete, invalid, infirm or inconsistent on its face is never acceptable, either before or after notice.”
Good Faith Acceptance
The Customer provided the Taxpayer with a Form ST-11 which is used by manufacturing, processing, or mining businesses to make exempt purchases of certain tangible personal property used directly in the manufacturing process. This exemption certificate was not accepted by the auditor because the customer was purchasing equipment, not materials, and the box for industrial materials was checked rather than the box for machinery and tools.
Title 23 VAC 10-210-280 B then states that “[r]easonable care and judgment must be exercised by all concerned to prevent the giving or receiving of false, fraudulent or bad faith exemption certificates. An exemption certificate cannot be used to make a tax-free purchase of any item of tangible personal property not covered by the exact wording of the certificate.”
The reasonable care and judgement standard is addressed in International Paper Company v. Virginia Department of Taxation, CL-2009-360, Circuit Court of Fairfax County, July 29, 2010, issued as Public Document (P.D.) 10-258 (10/25/2010). The Court held that a dealer could satisfy the good faith and reasonable care and judgment standards in taking a certificate to the effect that the acceptance is exempt if:
Upon a facial examination of the certificate, a dealer could reasonably conclude that the items purchased could potentially be used for any of the exempt purposes claimed on the certificate of exemption; or
Based upon the dealer’s actual knowledge of the business of its purchaser, the dealer could reasonably determine in good faith that the specific purchaser intended to use the items purchased for one or more of the exempt purposes claimed on the certificate of exemption.
The Taxpayer contends that it has met the requirements of International Paper Company because the equipment at issue is intended for use in the manufacturing process for resale and, based on its actual knowledge of the Customer, it believed in good faith that the equipment was to be used for the exempt purpose stated on the certificate.
The standard addressed in International Paper Company is applicable only when a valid certificate is received and retained at the time of sale and can be produced by the taxpayer at the time of an audit. In P.D. 04-75 (8/25/2004), the Department cited longstanding policy as set out in P.D. 98-29 (2/20/1998) that the absence of a valid exemption certificate at the time of a sales transaction indicates that the certificate was never accepted in good faith.
In addition, International Paper Company stated that a dealer must be able to reasonably conclude that the items purchased could potentially be used for any of the exempt purposes claimed on the certificate of exemption. The only purpose claimed on the exemption certificate was for the exempt purpose of industrial materials. In this case, the Taxpayer sells or rents construction and other heavy equipment and the Customer purchased equipment, not materials. The Department finds it doubtful that the equipment would ever be purchased as materials unless the equipment is being scrapped. Because the Customer did not engage in the metal recycling business and the original exemption certificate provided to the Taxpayer claimed the wrong exemption, it was not valid.
Greater Scrutiny Test
The Taxpayer asserts that the auditor imposed a greater scrutiny standard for its first-generation audit that is unreasonable when examining the exemption certificate. Contrary to what is asserted by the Taxpayer, when a valid certificate is not received at the time of sale, the “good faith acceptance” privilege is invalidated, and the dealer becomes subject to the tax that was not applied to the transaction. See P.D. 98-29 and P.D. 23-99 (8/17/2023). While the dealer has the responsibility to prove the transaction is exempt, the Department also applies “greater scrutiny” to determine whether the transaction is exempt in order to avoid collecting tax when it is not due. See P.D. 98-29, P.D. 04-75, P.D. 10-201 (8/31/2010), P.D. 17-114 (6/29/2017), and P.D. 22-69 (4/13/2022). As such, greater scrutiny can be applied even in first generation audits. See P.D. 23-99.
During the course of the audit, the Taxpayer provided a Form ST-11 from the Customer that marked the box for “machinery and tools” and was dated after the transactions at issue. Under the greater scrutiny test, exemption certificates are acceptable only if the Department is able to confirm that a purchaser’s use of the certificate is valid and proper for the specific transaction. See P.D. 98-29 and P.D. 06-87 (9/19/2006). As such, the auditor using the greater scrutiny standard as stated above examined the exemption certificate that the Taxpayer obtained from the customer that is dated after the sale of the equipment.
When applying greater scrutiny, the Department may perform a search of its records to determine if a purchaser has a registration number, as well as a sales and use tax return filing history. Once this search is performed, the Department can reasonably conclude whether the purchase made by a customer would qualify for an exemption. The Department takes these additional steps because dealers do not have access to the registration and filing histories of their customers and, therefore, cannot reasonably be expected to provide such scrutiny regarding the acceptance of exemption certificates.
The auditor researched the Customer and found that it was not registered for sales or consumer use tax. The Customer was in the business of processing construction materials such as asphalt and concrete. It also sold topsoil, dirt, and sand. As such, it could not be determined whether the equipment sold to the Customer would be used directly in manufacturing, processing, refining, mining, or converting products for resale.
The Taxpayer contends that the auditor informed it that the second exemption certificate provided by the Customer was acceptable. Nothing in the auditor’s documentation states that the second exemption certificate was acceptable for the transactions at issue.
Form Instructions
The Taxpayer also contends that the Form ST-11 lacks adequate instructions as to which boxes are to be checked in order to claim the proper manufacturing exemption. The Form ST-11 has eleven different boxes representing 11 different categories of exemptions. When a dealer is provided with a Form ST-11, the buyer is certifying that all tangible personal property purchased or leased from the dealer on and after the certificate date will be purchased or leased for the purpose or purposes indicated.
For Form ST-11, which provides for multiple exemptions, a buyer is charged with the care and responsibility of indicating the appropriate category in order to claim the proper manufacturing exemption.
DETERMINATION
The evidence shows that the Taxpayer received an exemption certificate from the Customer that did not indicate the correct exemption and was, therefore, invalid. As such, the Taxpayer does not enjoy the good faith protection afforded to dealers that obtain valid exemption certificates at the time of sale.
In addition, the Taxpayer obtained an exemption certificate during the audit that was dated after the transactions at issue. Under the greater scrutiny test, the certificate failed to support the tax-exempt sales to the Customer because the Department was unable to conclude that the equipment was purchased for an exempt purpose. Therefore, the exceptions at issue will not be removed from the audit and the assessment is upheld. The Department’s records indicate that the Taxpayer has paid the audit assessments in full and no further action is required.
The Code of Virginia sections and regulation cited are available online at law.lis.virginia.gov. The public documents cited are available at tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy and Legal Affairs, Adjudications and Resolution Division, at ***** or *****.
Sincerely,
James J. Alex
Tax Commissioner
Commonwealth of Virginia
AR/5002.B