Rulings of the Tax Commissioner

June 20, 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 September 2017 through April 2021. 

FACTS

An audit was conducted on the books and records of the Taxpayer, a restaurant and entertainment establishment, for the period at issue. For the three-month sample period, the Department’s auditor found that a number of the Taxpayer’s fixed asset and general expense purchases had not been taxed. The Taxpayer filed an application for correction contesting three exceptions from the audit. The Taxpayer contends that (1) certain electronic services and software with update subscriptions purchased in conjunction with a Point of Sale (POS) system package are tax exempt, (2) its contractor paid tax on a sunscreen system, and (3) documentation was provided supporting the payment of tax on purchases from various vendors.

ANALYSIS

Strict Construction of Exemptions 

The Department has the authority to interpret and enforce the laws of the Commonwealth governing taxes in accordance with Virginia Code § 58.1-203. With regard to such interpretations, settled case law requires strict construction of sales and use tax exemptions. Where there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption. See Commonwealth v. Community MotorBus, 214 Va. 155 (1973); Commonwealth v. Research Analysis Corporation, 214 Va. 161 (1973); and Golden Skillet Corp. v. Commonwealth, 214 Va. 276 (1973).

Point of Sale System

The Taxpayer contends that the services and software connected to the purchase of a POS system are exempt from sales and use tax. The submitted invoice for the POS system included tangible personal property, software, and services. The vendor charged tax on tangible property (i.e., terminals, printers, access points, switches, and routers), but not on the services and software. The Taxpayer asserts the untaxed items are exempt from the tax. The auditor listed the untaxed line-item amounts because they were provided in connection with the sale of tangible personal property.

Services Connected to Sale of Tangible Personal Property

Service-related items provided with the POS system installation included shipping and handling, menu configuration, location setup charges, project cost, onsite training, and live support. Virginia Code § 58.1-603 imposes retail sales tax on “every person who engages in the business of selling at retail or distributing tangible personal property in this Commonwealth…” A retail sale is defined, in part, in Virginia Code § 58.1-602 as “a sale to any person for any purpose other than for resale in the form of tangible personal property or services under this chapter…” Conversely, charges for transactions resulting solely from the provision of services are generally exempt from the retail sales and use tax. Services provided in connection with sales of tangible personal property are included in the sales price and are, therefore, taxable unless specifically exempt by statute. See Virginia Code § 58.1-602, Virginia Code § 58.1-609.5, and Title 23 of the Virginia Administrative Code (VAC) 10-210-4040.

In some transactions involving both the sale of tangible personal property and the provision of services, the Department has recognized that the full amount charged may be exempt regardless of whether the charges for the service and property components are separately stated. As explained in Title 23 VAC 10-210-4040 D, the “true object” test is used to determine the taxability of these transactions.

Under the true object test, transactions involving both the sale of tangible personal property and the provision of services generally are either taxable or exempt on the full amount charged, regardless of whether the charges for the service and property components are separately stated. If the object of the transaction is to secure a service and the tangible personal property transferred to the customer is not critical to the transaction, then the transaction may constitute an exempt service. However, if the object of the transaction is to secure the property that it produces, then the entire charge, including the charge for any services provided, is taxable.

In the instant case, the tangible POS system is the true object of the contested transaction because it is used to record the daily operation of the business. The services provided by the vendor are clearly meant to support the tangible personal property obtained by the Taxpayer in the transaction, pursuant to the discussion below. 

Software Programs and Update Subscriptions

The POS system package included monthly subscriptions for updates to the systems program software, inventory database, gift card program, display screen application, loyalty program application, and tablet software. Virginia Code § 58.1-609.5 1 exempts, among other things, services that provide access to or use of the internet and any other related electronic communication service, including software, data, content and other information services delivered electronically. In Public Document (P.D.) 96-192 (8/6/1996), the Department determined that the medium on which the computer software is transferred is critical to the taxable status of the transaction. Thus, when software is provided in tangible form, the sale and all charges in connection with the transaction are deemed to be a taxable sale of tangible personal property. Conversely, if the software is transmitted via electronic means, the transaction is deemed to be a nontaxable service, and any additional charges included in the electronic transfer take on the same nontaxable status.

However, when electronically downloaded software is provided in connection with the sale or lease of tangible personal property such as computer hardware (e.g., desktops, laptops, tablets, cellular/mobile phones, and other tangible devices or equipment), the transactions are taxable regardless of whether the charges for the electronically downloaded software are stated on the same invoice as the computer hardware and other equipment or whether it is separately billed or invoiced. See also P.D. 05-44 (4/4/2005) and P.D. 14-178 (10/23/2014). This policy is derived from Virginia Code § 58.1-603, which imposes the retail sales tax on the gross proceeds derived from the sale, lease or rental of tangible personal property. Gross proceeds include all of the charges made or voluntary contributions received for the sale, lease, or rental of tangible personal property, net of any deductions permitted under the definition of the term “sales price” under Virginia Code § 58.1-602. As defined under this section, sales price includes “the total amount for which tangible personal property or services are sold ... without any deduction therefrom on account of the cost of the property sold, the cost of materials used, labor or service costs, losses or any other expenses whatsoever.” Accordingly, the term “gross proceeds” is inclusive of all charges included in a transaction for tangible personal property, unless specifically excluded from the definition by statute or regulation.

When computer equipment is sold with the software and software updates installed, the software and software updates are encapsulated into the cost of the tangible personal property sold and the entire price of the software and hardware is taxable. Likewise, when such software is updated in order to maintain or upgrade the functionality of the computer or equipment hardware, any additional charge would be subject to Virginia sales and use tax.

Motorized Retractable Screen Systems

According to the Taxpayer, a motorized retractable screen system was installed, and taxes were paid by their contractor. The auditor listed a fixed asset purchase for a retractable screen system. An invoice, dated June 6, 2017, identifies the Taxpayer as the customer, and shows no separately stated sales tax on the invoice. An invoice dated May 1, 2017, included in the Taxpayer’s application for correction, lists the contractor as the customer but fails to separately state any amount of sales tax charged. The amounts charged on the two invoices are also different. The invoice to the contractor indicated a partial payment was made and the amount paid by the Taxpayer is exactly equal to 25% of the total billed to the contractor. 

Under Virginia Code § 58.1-625, dealers are required to separately state the amount of the tax when adding it to the sales price or charge. While it is possible that the Taxpayer made a partial payment for the screen system, insufficient evidence has been provided to confirm whether either the contractor or the Taxpayer paid tax to the vendor.

General Expense Purchases

The auditor included purchase amounts for which the Taxpayer did not provide documentation verifying the payment of Virginia tax. The Taxpayer contends that it provided documentation verifying the payment of tax on some of the purchases, but could not produce all purchase invoices requested by the auditor. The Taxpayer maintains the select invoices from the various vendors showing the payment of tax should be enough substantiation to conclude that tax had been paid on all purchases to these various vendors.

Virginia Code § 58.1-633 A states that every dealer required to file a retail sales and use tax return and to pay or collect such tax must keep and preserve suitable records of the sales, leases, or purchases subject to the retail sales and use tax. The dealer must also maintain such other books of account as may be necessary to determine the amount of tax due and other pertinent information as may be required by the Department. This recordkeeping requirement is further explained in Title 23 VAC 10-210-470, which promulgates:

Every person who is liable for collection of sales tax or remittance of use tax or both is required to keep and preserve for three years adequate and complete records necessary to determine the amount of tax liability. Such records must include:

a) A daily record of all cash and credit sales, including sales under any type of financing or installment plan in use;
b) A record of the amount of all merchandise purchased, including a bill of lading, invoice, purchase order, or other evidence to substantiate each purchase;
c) A record of all deductions and exemptions claimed in filing sales or use tax returns, including exemption and resale certificates, returned or repossessed goods, and bad debts;
d) A record of all tangible property used or consumed in the conduct of the business;
e) A true and complete inventory of the stock on hand and its value, taken at least once each year.

The Department reviews transactions based on the documentation presented for each transaction. This is consistent with longstanding policy that the retail sales and use tax is a transactional tax, and the determination as to the taxation of a specific transaction is based on the underlying documents that support the transaction. Thus, documentation must be provided to prove the tax was paid to a vendor on each transaction. See P.D. 00-100 (5/25/2000) and P.D. 25-30 (2/27/2025). Because the Taxpayer did not submit transaction-specific documentation for the contested purchases, the auditor was justified in assessing tax on them.

DETERMINATION

In accordance with the evidence provided and applicable authorities cited, the Department has made the following determination.

Because the true object of the transaction involving the POS system package was the acquisition of tangible personal property, the shipping and handling, menu configuration, location setup charges, project cost, onsite training, and live support provided in conjunction with the sale are subject to Virginia sales and use tax. The amount of these service charges will remain in the audit.

Likewise, software applications, databases, and programs, including subscription updates, installed on the POS system are part of the sales price of the tangible personal property subject to the retail sales and use tax. The amount of these charges for the software and updates will remain in the audit.

Lastly, the documents provided fail to support the contention that tax was paid on the motorized retractable sunscreen system and the expense purchases listed as exceptions. These transactions will remain in the computation of the assessment.

Based on this determination, the assessment is upheld. An updated bill, with accrued interest to date, will be mailed shortly to the Taxpayer. No further interest will accrue provided the outstanding assessment is paid within 30 days of the date of this letter.

The Taxpayer indicates that paying the full amount of the assessment will cause a financial burden. As such, the Taxpayer may wish to request an offer in compromise based on doubtful collectibility. The Taxpayer must present evidence of doubtful collectibility to support a claim of financial hardship. If the Taxpayer wishes to pursue a settlement based on doubtful collectibility, please complete and return the enclosed OIC – Fee and OIC B – 3 forms to: Tax Commissioner, Virginia Department of Taxation, P.O. Box 2475, Richmond, Virginia 23218-2475. These forms will allow the Department to review and analyze the Taxpayer’s financial situation. Upon completion of the Department’s review, we will respond based upon the information provided.

The Code of Virginia sections and regulations 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, Tax Adjudication and Resolution Division, at ***** or *****@tax.virginia.gov.

Sincerely,

James J. Alex
Tax Commissioner
Commonwealth of Virginia

AR/3735.Z