Tax Type
Corporation Income Tax
Description
Sales Factor; Out-of-state services; Federal solicitation taxation prohibition
Topic
Allocation and Apportionment
Date Issued
10-07-1996
October 7, 1996
Re: Request for Ruling: Retail Sales and Use Tax/Corporation Income Tax
Dear*********************
This is in response to your letter in which you request a ruling on behalf of ***************(the "Taxpayer").
FACTS
The Taxpayer, located outside of Virginia, primarily provides electronic transmittal of medical insurance claims and related services. The Taxpayer describes three scenarios in which its services may be provided to Virginia customers, as follows:
1) In this case, the Taxpayer's customer is headquartered in Virginia but has branch offices in various states. All insurance claim forms are sent to the corporate office where they are scanned into a computer, edited, and then electronically transmitted to the Taxpayer. The Taxpayer processes the claims and electronically transmits them to a third party payor.
2) This case is similar to the first except the claim forms are electronically transmitted to the Taxpayer directly from the customer's branch offices and are not handled by the customer's corporate office. The Taxpayer processes the claims and electronically transmits them to a third party payor.
3) In this instance, the insurance claims are filed with the Taxpayer electronically through an existing local clearing house. The Taxpayer subsequently processes the claim and electronically transmits the claim to a third party payor.
The Taxpayer invoices for a number of items provided under these scenarios. These items include: (1) a claims conversion fee for creating an electronic image of the claim form; (2) a one-way transaction fee for transmitting the claim to the payor; (3) a clearinghouse fee for transmitting claims from the customer to the Taxpayer; and (4) an archival fee for converting the claim form from an electronic image to a CD which is sent to the customer.
In addition to providing the electronic receipt and transmittal of insurance claims, the Taxpayer provides computer software and may also lease computer hardware to its customers. You indicate that separate charges are not made for computer software and hardware. Instead, the charges for these items are included in the claims conversion fee, transaction fee, clearinghouse fee and archival fee.
The Taxpayer requests a ruling on the application of the sales and use tax and the corporation income tax to its transactions.
RULING
Sales and Use Tax
Code of Virginia § 58.1-609.5(1) provides that the sales and use tax does not apply to "professional, insurance, or personal service transactions which involve sales as inconsequential elements for which no separate charges are made...."
In addition, Virginia Regulation (VR) 630-10-97.1 sets forth the "true object" test to determine whether a particular transaction involves the taxable sale of tangible personal property or the provision of an exempt service. This regulation provides that:
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- If the object of the transaction is to secure a service and the tangible personal property which is transferred to the customer is not critical to the transaction, then the transaction may constitute an exempt service. However, if the object of the transaction is to secure the property which it produces, then the entire charge, including services provided, will be taxable.
Sales: A review of the Taxpayer's "Service Agreement" and the scenarios noted above indicates that the Taxpayer is providing a nontaxable service to its customers. Therefore, the tax would not apply to any of the invoiced items identified in your correspondence. In addition, while the conversion of data via a CD involves the transfer of tangible personal property (for which the Taxpayer charges an archival fee), such property is incidental in nature when furnished in connection with electronic transmittal services. If the Taxpayer, however, makes any sales of tangible personal property outside of its service agreements, including the sale of archival conversions, such sales are taxable.
Purchases: As a service provider, the Taxpayer is the user and consumer of all items used in Virginia for providing its services, including computer hardware and software. Accordingly, the Taxpayer is required to pay the tax to its suppliers at the time of making such purchases or remit the use tax directly to the department on a Consumer Use Tax Return, Form ST-7, when the property is placed in service in Virginia. The tax Is based on the cost price of the property.
Computer Hardware: I understand that a major concern is the taxation of computer hardware. The computer hardware is purchased exempt of the tax and stored at the Taxpayer's facility outside of Virginia. The Taxpayer questions the application of the tax to the hardware if the lease or rental charges are separately listed on the invoices to customers. Alternatively, the Taxpayer asks if it can pass the use tax along to the customer as a separately identified item.
Generally, the lease or rental of tangible personal property is deemed to be a taxable sale under Code of Virginia § 58.1-602. In this instance, however, where the Taxpayer leases or rents computer hardware to customers in connection with its electronic transmittal services, the tax does not apply to the charges for that equipment. The use tax remains applicable. See Public Documents (P.D.) 88-299 (10/31/88) and 91-190 (8/30/91), copies attached.
If the Taxpayer separately states the use tax on invoices to customers, the department will require that the collected tax be remitted to the department. In this instance, the tax will be deemed to be an erroneously collected sales tax subject to the provisions of VR 630-10-24(C). Further, separately stating the use tax on invoices will not relieve the Taxpayer of its responsibility to pay the use tax on the purchase of the hardware.
Based on the above, the Taxpayer may separately charge and collect a sales tax on the lease or rental of computer hardware if the hardware is provided to customers outside of any service agreement. For example, the Taxpayer may issue two separate contracts to customers, one for the provision of transmittal services and a second for the lease or rental of computer hardware. In this case, the lease or rental of equipment will be subject to the sales tax. In this instance, the tax must be separately stated on the invoice, collected from customers, and remitted to the department. This scenario would therefore require the Taxpayer to register with the department as a dealer and to remit monthly sales and use tax returns. Any hardware purchased for taxable lease or rental under this scenario may be purchased by the Taxpayer exempt of the tax under the resale exemption.
Income Tax
Scenario 1: The Taxpayer will lease computer hardware and software to a customer in Virginia, and derive fee income for its transmission services. The Taxpayer will retain ownership of computer hardware located in Virginia. In addition, the Taxpayer will send company employees to Virginia to install computer software and train customer employees in the use of the systems.
Every corporation having income from Virginia sources is subject to the corporate income tax. A taxpayer will have income from Virginia sources when sales are made to customers located in Virginia. Based on the facts presented, the Taxpayer has income from Virginia sources and is therefore subject to Virginia corporate tax.
However, Public Law (P.L.) 86-272, codified at 15 U.S.C.A. §§ 381-384, prohibits a state from imposing a net income tax where the only contacts with a state are a narrowly defined set of activities constituting solicitation of orders for sale of tangible personal property. In this scenario, the Taxpayer is primarily engaged in the sale of services, which are clearly outside the federal statutory protection of P.L. 86-272. However, the department applies P.L. 86-272 type standards to solicitation of sales of other than tangible personal property. See P.D. 93-75 (3/17/93), copy attached.
The department's historical policy is to extend the "solicitation test" of P.L. 86-272 to situations involving the sale of intangible personal property. Nevertheless, the department limits the scope of P.L. 86-272 to only those activities that constitute solicitation, are ancillary to solicitation, or are de minimis in nature.
The Taxpayer's actions following its sales, such as installation and the training of the employees of the customer are neither ancillary to the solicitation of sales nor de minimis in nature. Rather, such activities serve a business function apart from soliciting sales. See Wisconsin Department of Revenue v. William Wrigley. Jr.. Co., 112 . Ct. 2447 (1992). In addition, the Taxpayer will own tangible personal property (i.e. hardware) in Virginia.
Based upon the information you have provided, the activities of the Taxpayer, taken together, will exceed P.L. 86-272 protection. Consequently, the Taxpayer would be subject to the Virginia corporate income tax.
Sales Factor: The department has previously ruled that separately identified sales of prewritten, "canned" software are considered sales of tangible personal property. See P.D. 94-181, (6/13/94), copy attached. Sales of tangible personal property are apportioned based on destination in accordance with VR 630-3-415, copy attached.
Sales of service fees and other transactions not involving the sale of tangible personal property are apportioned based on "cost of performance" pursuant to VR 630-3-416, copy attached. In this case, the Taxpayer's costs of performance are likely to be greater outside than inside Virginia. Consequently, the Taxpayer is not likely to have a positive Virginia sales factor as a result of its service income.
Scenarios 2,and 3: According to the information you have provided about these scenarios, the Taxpayer's activities in Virginia will be far more limited than its activities in scenario 1. It appears the Taxpayer's activities in Virginia will be limited to executing a service agreement with the Virginia customer. The Taxpayer will not install any computer hardware or software at the customer's Virginia location, nor will it train any of the customer's Virginia employees. In these scenarios, if the Taxpayer performs these activities, it will only do so at the Virginia customer's branches located outside of Virginia.
Because the Taxpayer's activities described in scenarios 2 and 3 will be limited to executing a service contract with the Virginia customer, the department finds this activity does not exceed P.L. 86-272 protection. Accordingly, the Taxpayer would not be subject to the Virginia corporate income tax. Nonetheless, because the Taxpayer has income from Virginia sources, it must file a return even if it believes itself exempt pursuant to P.L. 86-272. See VR 630-3-441 A 4, copy attached.
I trust that this information will prove helpful. If you have any questions, please contact **************in my Office of Tax Policy at***********************
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/11109
Rulings of the Tax Commissioner