Tax Type
Retail Sales and Use Tax
Description
Penalties and Interest; Waiver of penalties
Topic
Collection of Delinquent Tax
Date Issued
12-20-1995
December 20, 1995
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear****************:
This is in response to your letter of April 17, 1995 and prior correspondence in which you seek correction of a sales and use tax assessment issued to**************(the "Taxpayer") for the period January 1991 through September 1993. I understand that the tax and interest on the uncontested issues have been paid.
FACTS
The Taxpayer operates principally as a government contractor. The Taxpayer contests certain government contract purchases and maintains that these items were purchased for resale to the federal government.
The Taxpayer also contests the assessment on: (i) purchases of photos and display items; (ii) recycled laser cartridges; and (iii) computer purchases which you maintain were made by and for employees. In addition, you question the sampling procedure used to calculate the audit deficiency and also the assessment of penalty charges.
DETERMINATION
Government Contracts: The department has previously ruled that in considering the tax treatment of federal government contracts, it must be determined whether the contract is for the sale of tangible personal property or for the provision of services. In making such a determination, the department considers the entire contract, including any addenda or task orders, as one transaction which is either taxable or exempt. The amount of tangible personal property transferred relative to the overall value of the contract has no bearing on the tax status of the contract. Instead, the "true object" of the transaction as described in Virginia Regulation (VR) 630-10-97.1 is used to determine whether the contract is for the sale of tangible personal property or for the provision of some service.
As explained in Public Document 94-155 (5/23/94), if a contract is for the provision of services, the contractor is deemed to be the taxable user or consumer of all tangible personal property used in performing its services, even though title to some or all of the property may pass to the government. Conversely, if a contract is for the sale of tangible personal property to the government, the contractor may purchase such property exempt from the tax under a resale exemption certificate. The subsequent resale of that property to the government is exempt from the tax under Code of Virginia § 58.1-609.1(4) which provides an exemption for sales of tangible personal property to the Commonwealth and the federal government.
Two government contracts are at issue in this case, the first of which is with a financial agency of the federal government. From the information provided, it appears, that the true object of this contract is for the provision of services to the federal government. Pursuant to this contract, the Taxpayer is required to design and develop an operational environment including the provision of computer hardware, software and network configurations. In addition, the Taxpayer is required not only to perform hardware and software maintenance, but is further required to completely operate the computer systems and networks.
The Taxpayer's operational responsibility distinguishes this contract from those cases cited in your correspondence. In Public Documents 88-159 and 92-4, the contractors were required to provide a wide range of services in connection with the provision of computerized systems. In those cases, however, there was no requirement that the contractors operate the systems on an on-going basis for the government as there is in the instant case.
The second of the contested federal government contracts calls for the Taxpayer to develop and implement procedures to cope with mandatory foreign inspections of American weapons' facilities. You indicate that under the terms of the contract the Taxpayer is required to deliver a final product, and you therefore maintain that the contract represents the sale of tangible property to the government.
I agree that the contract specifies that the Taxpayer is engaged in the development of a finished product, but the language of the contract appears to emphasize the development of procedures.
Indeed, the contract also specifies that the Taxpayer is not expected to purchase equipment for the government during the course of the contract. Accordingly, it appears that the true object of the contract is for the Taxpayer's services in the development, assessment and implementation of compliance inspection plans.
Photos and other display items: These charges relate to purchases from one specific vendor which frequently operates as an advertising agency and who you describe as a service provider. The invoices submitted with your correspondence indicate that this vendor apparently paid or accrued taxes when making its purchases. In billing to the Taxpayer, the vendor passed on the tax along with other charges. You maintain that these other charges are for the vendor's nontaxable services in selecting the appropriate supplier of the tangible personal property which was ultimately sold to the Taxpayer. Further, because the invoices show that the vendor paid or accrued the tax on its purchases, you maintain that no additional tax should be assessed to the Taxpayer.
It is clear that the charges made for these transactions are for such items as picture framing, art work, gifts and other items of tangible personal property. In this regard, Code of Virginia § 58.1-602 provides, under the definition of "sales price," that the tax applies to the "total amount for which tangible personal property or services are sold, including any services that are a part of the sale...." Accordingly, the department has no option but to hold the total invoice charges from the vendor as taxable.
Furthermore, advertising agencies are deemed to be providing nontaxable services when they provide media advertising. However, the exemption for media advertising does not extend to retail sales of tangible personal property by advertising businesses or to the sale of non-media promotions. Please see the attached Public Document 94-316 (10/19/94) which further addresses this issue.
Recycled laser cartridges: The application of the tax to these items has been previously addressed by the department in Public Document 91-186 (8/30/91). As noted therein, the tax applies to separately stated repair parts. Repair labor charges made by the vendor are not taxable provided such labor charges are separately stated.
You maintain that when parts were invoiced, sales tax was charged by the vendor. I understand, however, that the invoices seen by the auditor were not properly taxed. Therefore, I can currently find no grounds to remove these items from the assessment. If you have invoices which contradict the auditor's findings, the department will certainly review them and make adjustments to the assessment as warranted.
Employee computer purchases: The Taxpayer sponsors an employee benefit whereby employees may borrow interest-free funds from the Taxpayer to purchase qualifying computer equipment. In some instances, it was found that a joint check (from the Taxpayer and the employee) was issued to the vendors, and these purchases were assessed in the audit. Upon further review, however, it was also found that invoices were issued from the vendors to the employees and not to the Taxpayer. Accordingly, these transactions will be removed from the assessment.
Extrapolation of tax assessment: In at least one prior audit, the department assessed untaxed purchases by calculating an average monthly exception from the sample period and then multiplying that average by the number of months in the audit period. The assessment for untaxed purchases in the current audit was calculated based on a percentage of error that was found in a nine-month sample. This percentage was then applied to the total purchases made throughout the audit period. You request that the current method be reviewed.
I understand that in the prior audit the total purchases were not readily available, so an average monthly deficiency was calculated. Conversely, improved records for the current audit period allowed the auditor and Taxpayer to easily determine yearly gross purchases and so a percentage of error could be applied to those purchases.
Upon review, I am satisfied with the methodology used in the current audit. I note, for example, that the sample period of nine months is extensive enough to be representative of the entire audit period. I also note that had the auditor used a monthly average, the assessment would have been somewhat greater than it is.
Penalty charges: The application of penalty charges to audits is addressed in VR 630-10-80 and indicates that penalty will be applied to third and subsequent audits unless the compliance ratio for purchases meets or exceeds 85%. The current audit, which represents the Taxpayer's fourth, showed a compliance ratio very close to the 85% threshold. Based on the Taxpayer's relatively high compliance, coupled with the circumstances outlined in your correspondence, I find grounds to waive all penalty charges.
The assessment will be revised to remove employee computer purchases and penalty charges. A revised assessment will be issued with interest accrued through the date of your latest correspondence, and no additional interest will accrue provided the revised assessment is paid within 30 days.
Please contact **************in my Office of Tax Policy at ********if you have any questions about this letter.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/90731
Rulings of the Tax Commissioner