Tax Type
Retail Sales and Use Tax
Description
Government contractor; Computer system
Topic
Property Subject to Tax
Date Issued
03-04-1993
March 4, 1993
Re: §58.1-1821 Application: Retail Sales & Use Tax
Dear***********
This will reply to your letter of February 28, 1991 in which you seek correction of a sales and use tax assessment to your client, ********** (the "Taxpayer") for the period May 1987 through April 1990.
FACTS
The Taxpayer, a government contractor primarily located in another state but which has facilities in Virginia, was audited and found to have failed to pay the tax on certain purchases of tangible personal property. The Taxpayer contests the application of the tax on: (1) purchases from ********* ("Equipment Company") in connection with the***********("Systems") federal government contract; (2) equipment, material and supplies which it maintains are used exclusively in performing qualified research and development; and (3) various miscellaneous purchases, tangible personal property purchased outside of Virginia and temporarily stored in Virginia pending distribution to various locations without Virginia.
DETERMINATION
I will address each of the three contested areas individually below:
Systems Contract: The Taxpayer maintains that the Systems contract was for the resale of equipment to the federal government. The auditor, on the other hand, held the equipment taxable as being used in the rendition of services to the government. My analysis of the Systems contract reveals that while it does involve the provision of various services by the Taxpayer, it is indeed a contract for the sale of tangible personal property - an integrated computer system. Although the Taxpayer is obligated to provide various services, such as the design of the overall system, development of computer software and training, and while the contract gives the federal government the option to require the Taxpayer to provide some on-site support, the goal of the contract is to provide the federal government with a tangible computer system consisting of hardware, software, and related equipment. Accordingly, the tangible personal property that ultimately passed to the federal government may have been purchased exempt from the tax under a resale exemption certificate and will be removed from the assessment.
In addition, the testing and approval of the computer and other equipment prior to its transfer to the federal government does not subject the Taxpayer to the tax. Equipment purchased for resale to the government, but used by the Taxpayer in the actual development of the computer system or the training of federal employees is exempt. Each of these activities is an integral part of the sale of the system to the federal government. (see Opinion of the Attorney General dated October 30, 1987, copy enclosed) Accordingly, the assessment will be revised to remove any tax assessed on any equipment used in the above manner, such as equipment used to test the System software at the Taxpayer's testing facility, the title to which passed to the federal government.
However, equipment used in the development of the System which does not qualify for exemption under the research and development exemption and the title to which does not pass to the federal government, as verified by an auditor, remain in the assessment. Furthermore, materials and supplies for use in the operation of the testing facility and other items used and consumed by the Taxpayer in designing the computer system or in the management of its systems development contract which were picked up by the auditor will remain in the assessment.
Research and Development: It is my understanding that the Taxpayer no longer contests the assessment of the tax on items B-7 and B-8.
For your review and reference, I have enclosed a public document, P.D. 88-61 (4/6/88), which explains the research and development exemption from the retail sales and use tax and the department's long-standing interpretation of such. As the letter indicates, most research into innovative technologies or fields will qualify for the research exemption. However, the production of management studies and similar projects do not constitute exemption research under Virginia Regulation (VR) 630-10-92 since such projects do not involve experimental or laboratory research.
Based on the supplemental information provided regarding the contested research and development issues (referred to herein and in the Taxpayer's correspondence as items B-1 through B-11), I will agree to remove from the assessment items B-1 and B-3. In addition, I will agree to remove B-2 provided additional information is supplied which illustrates that such equipment is used exclusively in research and development.
From the information provided, I am not convinced that items B-4 through B-6, and B-9 through B-11 are used exclusively in research and development. As explained in P.D. 88-61, the exemption is applicable only to the extent that tangible personal property is "used directly and exclusively in...research and development in the experimental or laboratory sense." (Emphasis added) Items used both in exempt and taxable activities are not used exclusively in research activities and thus are taxable. Thus, the exemption does not apply to items purchased for use by the Taxpayer in activities which occur either before or after the actual research process. An activity which occurs before the research process would include investigations of techniques and procedures to facilitate the design of various systems. Activities which occur after the research process would include the preparation of engineering drawings, functional descriptions, or instructional manuals.
Likewise, as noted above, the exemption is not applicable to the production of management studies and similar projects as they do not involve experimental or laboratory research. Accordingly, the tax assessed on items B-4 through B-6 and B-9 through B-11 will remain in the assessment.
Miscellaneous: With regard to the various miscellaneous purchases, you have indicated that the Taxpayer no longer contests items C-11, C-15, C-16, and C-22. Based upon a review of the audit findings and additional information supplied, I will agree to remove the following items from the assessment: C-1 through C-5, C-10, C-12 through C-14, C-17, and C-24. In addition, I will agree to reduce the measure for items C-6 through C-9. Further, if the Taxpayer can provide documentation to the effect that the equipment in C-19, the overshipment part of the invoice, was used in connection the Systems contract, I will agree to remove such from the assessment. Since the Taxpayer has provided documentation indicating that the tax was paid on C-5 and that from the information provided, I have concluded that the equipment was used directly and exclusively in research and development, the Taxpayer should seek a refund from the vendor for the sales tax paid on such. The remaining items will remain fully taxable.
With regard to the "goods in transit" issue, please note that Va. Code §58.1-604 imposes the use tax on "the use or consumption of tangible personal property in this State..." The term "use" is defined in Va. Code §58.1-602 as "the exercise of any right or power over tangible personal property incident to the ownership thereof..." Furthermore, VR 630-10-109(A) provides that "[t]he use tax applies to the use, consumption or storage of tangible personal property in Virginia when the Virginia sales or use tax is not paid at the time the property is purchased." (Emphasis added) The term "storage" is defined in Va. Code §58.1-602 as "any keeping or retention of tangible personal property for use, consumption or distribution in this State, or for any purpose other than sale at retail in the regular course of business."
Accordingly, even if the Taxpayer intended to deliver the tangible personal property to other locations outside the state, this does not preclude the imposition of the sales and use tax on such property, it is held in Virginia prior to such delivery outside the state. This position is supported by the opinion of the Virginia Supreme Court in Commonwealth v. Miller-Morton, 220 Va. 852, 263 S.E. 2d 413 (1980) which held taxable the storage of tangible personal property in Virginia even though the property would ultimately be shipped outside of the state. The tax liability is incurred by the Taxpayer at the moment the property is brought into Virginia and stored for use by the Taxpayer. Further, the Court held that "if a taxable event occurs in Virginia, subsequent delivery of outside this State does not immunize the taxable event."
Proration of the use tax is inapplicable in the instant case. As explained in P.D. 92-179 (9/10/92), copy enclosed, the proration of the tax based on actual usage in Virginia is allowed only under extremely limited circumstances, i.e., when tangible personal property has been acquired for use outside the state and subsequently becomes subject to the Virginia tax. In this instance, the property was not acquired for use outside the state as the exercised first use of the property within Virginia .
I do not agree with your interpretation of Coe v. Errol, 116 U.S. 517 (1886). In such case, the Supreme Court found that with goods in transit, if the property is "taxed, in the usual way that other similar property is taxed, and at the same rate and subject to like conditions and regulations, the tax is valid." Accordingly, the tax assessed on items temporarily stored in Virginia for further distribution will remain in the assessment. Further, as explained above, the issue has been addressed by the Virginia Supreme Court.
The assessment will be adjusted as set forth above and may be revised further to the extent that the Taxpayer is able to provide convincing documentation item B-2 qualifies for the research and development exemption and additional information on item C-19 to support its exempt use as part of the Systems contract. Furthermore, an auditor from the department's *********** District Office will be contacting the Taxpayer to schedule a visit to its training facility to make a determination on the taxability of the facility's equipment using the guidelines described herein.
The requested documentation should be provided to the department's Office of Compliance, Audit Review Unit, P. O. Box 615, Richmond, Virginia 23205-0615 within 45 days. If at the end of the 45 day period such documentation has not been received, a revised notice of assessment will be mailed to the Taxpayer.
Sincerely,
W. H. Forst
Tax Commissioner
OTP/5012H
Rulings of the Tax Commissioner