Tax Type
Retail Sales and Use Tax
Description
Leases and rentals; Partial refund of lease payment
Topic
Taxability of Persons and Transactions
Date Issued
07-31-1995
July 31, 1995
Re: §58.1-1821 Application: Retail Sales and Use Tax
Dear*********************
This will reply to your letter of February 15, 1994 in which you seek correction of the sales and use tax audit assessment of your client,**************(the "Taxpayer"), for the period of March, 1990 through August, 1 993.
FACTS
The Taxpayer is in the business of manufacturing and wholesaling transmissions and clutches. A recent audit resulted in an assessment of sales and use taxes on the lease of computer hardware and software and the lease of forklift trucks used in both the Taxpayer's manufacturing process and its distribution process. The Taxpayer is taking exception to the taxing of these items along with the application of penalty to this fifth generation audit.
The Taxpayer leased a computer system from a large international computer company (hereinafter "Company A"). In negotiating the financing lease of the computer system with Company A, the Taxpayer agreed to finance an amount substantially higher than the lease of the computer system in order to lease the software necessary to meet the Taxpayer's needs. The software was to be leased from a company other than Company A (hereinafter referred to as "Company B"). Company B installed its software on the Taxpayer's computer system and after an extended period of time, it was determined that Company B was unable to convert its software program to a workable product capable of meeting the Taxpayer's needs. At this point, Company B removed its software which was never used by the Taxpayer and never put into operation. Company B refused to refund any monies to the Taxpayer and the Taxpayer initiated legal action against Company B. The Taxpayer ultimately prevailed in the lawsuit and was refunded all monies paid to Company B through Company A.
In conducting the audit, the auditor held the entire payment to Company A as a taxable lease. It is the Taxpayer's contention that while the portion of their monthly payment to Company A represented the lease of the computer system from Company A, the remainder of the payment represented the financing of the software from Company B. It is also the Taxpayer's contention that provided the department ruled that the entire monthly payment to Company A was a taxable lease payment, the Taxpayer never owned the software or utilized the software in its operation as Company B was unable to enhance the software to make it compatible to the Taxpayer's operation. The Taxpayer believes this position is supported by the court's award of a full refund of all monies paid to Company B.
The Taxpayer is also taking exception to the taxing of the lease of 7 forklift trucks used in various aspects of their operation. The Taxpayer states that all 7 forklifts are used interchangeably throughout their operation. At any given time, the forklift may be used as follows; Receiving Department (1 truck), Shipping Department (1 truck), Transmission Housing (1 truck), Production Line (3 trucks), Loading/Unloading (1 truck). Based on the preponderance of use test set forth in Virginia Regulation (VR) 630-10-63(D), the Taxpayer takes the position that all forklift leases should be exempt.
Finally, the Taxpayer is requesting waiver of audit penalty. It is the Taxpayer's contention that the computer hardware and software lease are new items which are unique to this fifth generation audit and therefore should be treated as first generation audit issues for purposes of the audit penalty. The Taxpayer's argument is based on VR 630-10-80(2)(A)(6).
DETERMINATION
In regard to the lease of the computer software from Company B, VR 630-10-57 sets forth the department's policy with respect to leases and provides that any person in the business of leasing tangible personal property is required to register as a dealer and collect and remit the sales and use tax on the gross proceeds. "Gross proceeds" is defined in this regulation to include finance or interest charges, insurance charges, charges for property tax on the property being leased, and other similar charges. Based on this regulation, the total charge paid to Company A for both the computer hardware and software, can be classified as "gross proceeds" with respect to the lease of tangible personal property. However, based on the fact that the software in question was never used by the Taxpayer in its operation, and the fact the Taxpayer was ultimately refunded all monies associated with the software from Company B, I find basis for removing the amount of the refund *******from the total lease measure held taxable in the audit*****************.
Code of Virginia §58.1-609.3.2 provides that "machinery, tools and equipment, or repair parts therefor or replacements thereof, shall be exempt if the preponderance of their use is directly in processing, manufacturing, refining, mining or converting products for sale or resale". According to your letter, the 7 forklifts leased by the Taxpayer are all used interchangeably in both taxable and exempt activities, with the preponderance of use in an exempt manner. Upon verification of their use to the auditor, I will agree to remove the forklifts from the audit. Provided the Taxpayer cannot provide documentation as to the forklift usage, l regret that the department has no alternative but hold the lease of the forklifts taxable.
VR 630-10-80.2.B (copy enclosed) provides that on second and subsequent audits, the use tax compliance ratio must meet or exceed 85%. The use tax compliance ratio on this fifth generation audit of the Taxpayer is 0%, therefore penalty was properly applied. However, this regulation also states that penalty will not be applied to audit deficiencies occurring in new areas not covered in prior audits. Due to the fact that the lease of the computer hardware is a new area not covered in the previous audits, l will agree to remove the audit penalty associated with this one issue. The balance of the penalty will remain due, however.
An auditor from the Peninsula District Office will contact the Taxpayer as soon as practical to verify the documentation necessary for the revisions set forth above. Upon revision of the audit, a revised assessment will be issued to the Taxpayer. If you should have any further questions, please feel free to contact*********** Office of Tax Policy, at****************.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/8252K
Rulings of the Tax Commissioner