Tax Type
Retail Sales and Use Tax
Description
Manufacturing, processing, assembling, or refining; Research and development
Topic
Taxability of Persons and Transactions
Date Issued
11-03-1994
November 3, 1994
Re: §58.1-1821 Application: Sales and Use Tax
Dear***********
It is my understanding that the department's Northern Virginia District Office has recently completed the second revision of the telecommunication portion of the sales and use tax audit of ***** (the "Taxpayer") for the period of August 1, 1987 through June 30, 1990. As provided to a member of my staff on October 19, 1994, the Taxpayer is currently reviewing these revisions and such review should be completed by November 1, 1994. I would like to take this opportunity to address the research and development portion of the audit of which the Taxpayer is taking issue. I apologize for not responding to this issue sooner.
FACTS
The Taxpayer operates a ****** Laboratory Facility (the "Facility") which the Taxpayer feels qualifies for the research and development exemption provided in Code of Virginia §58.1-609.3(5). In the alternative, the Taxpayer takes the position that should the department rule that the Facility does not qualify for the research and development exemption, it would qualify for the public utility exemption as set forth in Code of Virginia §58.1-609.3(3).
The Taxpayer is also taking exception to the penalty assessed on this, the third generation audit of the Taxpayer. The Taxpayer feels they have made a reasonable effort to determine the sales and use tax application to its technologically advanced equipment, therefore the audit penalty should be waived.
DETERMINATION
In order to qualify for the research and development exemption, research and development should have as it's ultimate goal: i) the development of new products; ii) improvement of existing products; or, iii) the development of new uses for existing products. Basic research and development does not include testing (see VR 630-10-92, enclosed).
Unfortunately, the Facility is no longer in operation. In addition, I have been advised that a tour of the Facility was not afforded to the auditor or the audit supervisor during the course of the audit, despite requests by the auditor. This leaves the department with no other alternative other than to rely on information available from the previous audit and information furnished in a meeting with my staff on May 4, 1994.
As provided in the previous audit and confirmed in the May 4 meeting with my staff, the Taxpayer routinely incorporates new hardware/software for use in its long-distance services. It was specifically stated that the Facility was not engaged "in the hardware development business." Rather, the primary function of the Facility was to write specifications for the hardware/software to set forth the functions and capabilities needed to operate the Taxpayer telecommunications systems. The Taxpayer would then contract with outside vendors to develop a working prototype and submit it to the*****************. Facility for testing in a simulated operating environment. As understood by this office, the prototypes were never put on-line for direct use in the Taxpayer's long distance service. Based on the facts available to the department, the Facility does not qualify for the research and development nor the public utility exemptions set out under the sales tax statute.
With regard to the audit penalty, VR 630-10-80(C)(1) provides for the mandatory application of penalty to second and subsequent audits. Assessment of penalty on audits is determined by the level of compliance exhibited by the taxpayer. At the time this audit was conducted, the department mandated that use tax compliance on third generation audits must be 75%. The use tax compliance ratios on this, the third generation audit of the Taxpayer, are 33% and 54%. In addition, no exceptional mitigating circumstances have been demonstrated, particularly as use tax accrual problems were specifically identified in the two previous audits. Therefore, I find that the audit penalty was properly applied.
In order to avoid the accrual of additional interest on the research and development portion of the audit, payment in the amount of*************should be made by December 1, 1994. This payment represents*****************in tax**************in penalty, and********in interest.
Upon completion of your review of the current revisions to the "telecommunications" issues, I will address any concerns the Taxpayer may have. Absent additional information, however, by December 1, 1994, the department will consider that you concur with the findings set out in this portion of the audit.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/6869K
Rulings of the Tax Commissioner