Tax Type
Retail Sales and Use Tax
Description
Government contracts, Exemption documentation required
Topic
Taxability of Persons and Transactions
Date Issued
05-28-1996
May 28, 1996
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear*****************
This is in reply to your letter seeking correction of a sales and use tax assessment issued to your client, ******* (the "Taxpayer"), for the period December 1989 through December 1992.
FACTS
The Taxpayer is a technical services corporation that does software and hardware engineering primarily for the federal government. The Taxpayer was audited and contests the assessment primarily with respect to inventory parts purchased for resale and items purchased in connection with government contracts. You maintain that all of the government contracts were for the procurement of tangible personal property. In the alternative, you assert that the contracts entail a substantial amount of research and development, and the tangible personal property purchased in connection with the contracts qualifies for the research and development exemption. The auditor determined that the contracts were for the provision of services and held the Taxpayer as the taxable user and consumer of all tangible personal property purchased in connection with the contracts.
DETERMINATION
I will address each of the issued raised in your letter individually.
Inventory parts purchased for resale
You suggest that inventory parts were purchased solely for resale. At the time of purchase, however, the Taxpayer did not present the seller with a resale exemption certificate. You suggest that proof was provided to the auditor that the items were charged to the Taxpayer's inventory account and have been resold. In the alternative, you suggest that the department look to the seller for payment of the tax.
While you point out that the items were for resale, absent documentation illustrating the resale nature of the items, the department has no choice but to hold them taxable. The charging of such items to an inventory account alone does not necessarily indicate that the items were purchased for resale. Furthermore, with regard to your suggestion that the department look to the seller for payment of the tax, it is well established in Virginia that the legal incidence of the tax is on the purchaser. Although the seller is legally obligated to collect the tax from the purchaser, the tax is the legal debt of the purchaser. U.S. v. Forst, 442 F.Supp. 920 (W.D. Va. 1977), affd 569 F.2d 811 (4th Cir. 1978). Thus, the auditor was correct in holding the items taxable. Upon provision of the proper documentation regarding the resale nature of the items, l will agree to abate the portion of the assessment relating to the inventory parts.
Contract A230
You suggest that Contract A230 required the Taxpayer to develop software, procure necessary hardware systems and components to manufacture a prototype, and perform system engineering tasks to design and manufacture "conventional and expert" systems for the federal government. You point out that the items held taxable by the auditor, such as computer hardware and software, user licenses and warranty upgrades, were purchased in the last two months of the contract and shipped directly to a federal government location outside Virginia. You suggest that no use of the items was made in Virginia. Furthermore, you suggest that the items qualify for the research and development exemption.
A review of the contract indicates that, notwithstanding the substantial services required of the contractor, the contract was for the sale of tangible personal property. Because the items at issue could have been purchased exempt of the tax and resold to the federal government exempt of the tax, I will agree to remove the items from the audit, provided title to the property passed to the federal government. For your information, I have enclosed P.D. 88-159 (6/22/88), which explains the department's policy on government contracts.
Contract Number A17A
You maintain that Contract A17A is a contract for the sale of tangible personal property and not a contract for services, as determined by the auditor.
Based upon a review of the information provided, I find that the contract is for the sale of tangible personal property. Although the Taxpayer is obligated to provide various services, such as the design of the overall system, the goal of the contract is to provide the federal government with a tangible product. 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.
Equipment used in the development of the system which does not qualify for the research and development exemption and title to which does not pass to the federal government, as verified by the auditor, will remain in the assessment.
For your review, I have enclosed P.D. 88-61 (4/6/88), which explains the research and development exemption and the department's longstanding interpretation. As the letter indicates, most research into innovative technologies or fields will qualify for the research exemption. The production of management studies and similar projects do not constitute exempt research under Virginia Regulation (VR) 630-10-92.
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. Items used both in exempt and taxable activities are not used exclusively in research activities and are taxable.
Classified Contracts
It is my understanding that the auditor held taxable purchases in connection with several highly classified contracts, as he was not permitted to review the terms of the contracts. Repeated attempts have been made by my staff to confirm the tax status of the contracts through a contracting officer or through other means, but all have been fruitless. Accordingly, absent proof that the contracts were, in fact, for the procurement of tangible personal property or that the purchases made in connection with the contracts qualify for the research and development exemption, the department has no choice but to uphold this portion of the assessment.
I will agree, however, to give the Taxpayer 45 days to work out an arrangement with governmental authorities to allow department personnel with security clearance to review the contract or to provide documentation regarding the resale nature of the contracts. If we are not provided any additional information supporting your position during this time period, we will have no alternative but to require payment of the assessment with respect to these contracts.
Interest and Penalties
You suggest that due to the circumstances surrounding the audit, waiver of some, if not all, interest and penalty would be appropriate.
The application of interest to all audit deficiencies is mandatory and cannot be waived. Accordingly, the interest assessed cannot be waived.
Virginia Regulation (VR) 630-10-80 provides that penalty will not be waived on second or subsequent audits for other than exceptional mitigating circumstances. Because this is the second audit of the Taxpayer and no exceptional mitigating circumstances have been demonstrated, there is no basis for waiver of the penalty assessed. Upon revision of the audit assessment, the application of the penalty will be reviewed. If it is found that the Taxpayer meets the appropriate compliance ratios, the penalty will be abated.
Revision of the audit assessment will be postponed pending the 45 day period. If additional information is received, it will be given due consideration in the revision of the audit assessment. If no additional information has been provided supporting the procurement or research and development nature of the contracts at issue, the assessment will be revised as provided in this letter.
If you have any questions regarding this matter, you may call************* at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/8063I
Rulings of the Tax Commissioner