Tax Type
Retail Sales and Use Tax
Description
Penalties and Interest; First and third time audit issues
Topic
Collection of Delinquent Tax
Date Issued
02-10-1997
February 10, 1997
Re: § 58.1-1821 Application: Retail Sales & Use Tax
Dear***********************
This is in reply to your letter in which you seek correction of the department's sales and use tax audit assessments issued to ************* formerly ********************** (the "Taxpayer"), for varying periods beginning January 1991 through December 1993. I apologize for the delay in our response.
FACTS
The Taxpayer was awarded a contract by the United States Government to provide switching equipment at numerous sites to ultimately service switched main and private lines. The department's audit imposed the tax on the projected sample of the Taxpayer's purchases related to the government contract. The Taxpayer protests the tax assessed on its purchases, on the basis that it is a public service corporation providing a public service to all parties inclusive of businesses, government, and residences. In addition to an adjustment of these purchases, the Taxpayer states that it self assessed and paid the tax on three particular invoices also relating to the government contract. The Taxpayer maintains that the purchases related to the government contract are not taxable, and it erroneously applied the tax to the specific purchases.
The Taxpayer also requests that a credit be allowed for transactions on which taxes were erroneously paid to the vendor, or were erroneously accrued and paid to the department during the audit period. Additionally, the Taxpayer requests a waiver of penalty.
DETERMINATION
Public Service Exemption
Code of Virginia § 58.1-609.3(3) provides an exemption for tangible personal property sold or leased to:
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- (I) a public service corporation subject to a state franchise or license tax upon gross receipts, (ii) a telecommunications company as defined in § 58.1-400.1 or (iii) a telephone company chartered in the Commonwealth which is exclusively a local mutual association ... for use or consumption ... directly in the rendition of its public service ....
Virginia Regulation (VR) 630-10-87, which interprets this exemption, provides that the term "public service":
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- is used ... in its broadest and most inclusive sense and includes any product or commodity furnished by any public utility ... devoted to the purposes in which such public utility is engaged and to the use and accommodation of the public. Accordingly, the public service of a utility is to keep its production, generation, initiation, transmission or distribution facilities in operation and to keep open the lines of distribution through which ... phone ... service is provided to the public. Generally, property is not deemed to be used directly in the rendition of public service unless it is used in activities the cost of which is recoverable by a utility through the rate making process. When tangible personal property is to be used in activities the cost of which is not recoverable through rates, such property is deemed to be subject to the tax when purchased or used by a utility. (Emphasis added).
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- This same section defines "direct usage" as:
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- those activities that are an integral part of the rendition of a public utility service, including all steps of a utility's production, generation or initiation process as well as a utility's transmission or distribution process, but not including incidental public utility functions such as administration and management.
Code of Virginia § 13.1-620 (formerly § 13.1-50) provides that a public service corporation may, under some circumstances, perform nonpublic service business. The relevant portion of this section reads as follows:
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- No corporation organized under this chapter to conduct the business of a public service company shall have general business powers in this Commonwealth. Corporations organized under this chapter to conduct the business of a public service company may, however, conduct in this Commonwealth other public service business or nonpublic service business so far as may be related to or incidental to its stated business as a public service company ....
In this case, the Taxpayer entered into a contract with the federal government to provide a custom digital network over a ten-year period. While tangible personal property may be used directly in providing telephone services in accordance with public service requirements, the regulations specifically require that the property must also be used directly in the rendition of service for the use and accommodation of the public. This is analogous to a Virginia Supreme Court decision in which the Court upheld a State Corporation Commission ruling that the provision of outdoor lighting services were not a part of a public utility's service. See Virginia Electric and Power Co. v. State Corporation Commission, 219 Va. 894 (1979).
Based on the information provided, the development and operation of a custom digital network for the Federal government does not satisfy the requirement that the property be used directly in the rendition of service for the use and accommodation of the public. Accordingly, the exemption provided by Code of Virginia § 58.1-609.3(3) is not applicable to the transactions related to the Taxpayer's performance under the government contract.
Government Contract Purchases
With regard to the Taxpayer's status as a government contractor, the department has previously ruled that in considering the tax treatment of government contracts, it must be determined whether the contract is for the sale of tangible personal property or for the provision of services. The department considers the entire contract in making its determination. In its consideration of the contract, the "true object" of the transaction, described in VR 630-10-97.1, is used to determine if the contract is for the sale of tangible personal property or for the provision of services.
If a contract is for the provision of services, the contractor is deemed to be the taxable user and consumer of all tangible personal property used in performing its services. A review of the contract at issue reveals that the Taxpayer is to assume total system performance responsibility and related services, including, but not limited to, the design, engineering, furnishing, installation, testing, and cut over of all initial requirements, as well as post cut over requirements throughout the contract life. Accordingly, l find that the true object of the contract is for the provision of services. I also find the auditor's inclusion of the purchases by the Taxpayer, in fulfillment of the government contract to be correct.
Additionally, the Taxpayer's self assessment of tax on the three separate purchases was correctly applied as well.
Credit
Certain function codes, which relate to Part 32, Uniform System of Accounts, identify purchases normally used in the rendition of a public utility service. The auditor notes that the purchases referenced by the Taxpayer are related to those accounts, and used in providing a public service. The Taxpayer states that it erroneously accrued taxes on the subject purchases, and requests an adjustment to the department's audit.
Based on the information before me, l find sufficient cause to allow for an adjustment to the department's audit.
Penalty
The auditor assessed the penalty in accordance with revised compliance ratios effective July 28, 1993. As this was a third generation audit, the Taxpayer was required to meet an 85% ratio for sales tax as well as the use tax. The Taxpayer met and exceeded the sales ratio requirement at 100%, but failed to meet the use tax requirement with a ratio of 64%.
The Taxpayer states that it made a good faith effort to pay all required taxes, and accordingly, requests waiver of the penalty. In the alternative, the Taxpayer requests that consideration be given to assess the penalty based on 25% rather than the 30% imposed. The Taxpayer cites the change in the compliance ratio levels from 75% to 85%, and assumes that the change in maximum penalty to 30% coincided with the compliance ratio revision effective July 28, 1993. Additionally, the Taxpayer states that the purchases related to the government contract are deficiencies occurring in a new area not covered by a prior audit. Accordingly, the exclusion of the government purchases would reflect a compliance ratio in excess of the penalty threshold (75%) prior to the change in the regulation, thereby warranting waiver of the penalty. A review of the compliance calculations, however, reveals that even if the government contract purchases were excluded, the compliance ratio would not exceed 70%. Accordingly, l do not find sufficient cause to allow waiver of the penalty. I will, however, allow for waiver of penalty related to the government contract purchases, as they are first time audit issues.
I have enclosed a copy of a section of the 1991 Legislative Summary, which explains that the Code of Virginia was amended, effective July 1, 1991, to increase the penalty on a monthly basis from 5% to 6%, and increase the maximum allowable penalty from 25% to 30%. The Summary states that the amendment applies to all assessments outstanding as of July 1, 1991. It further provides that, for any assessment issued on or after July 1, 1991 for periods prior to that date, the increased penalty rate would apply. As the current assessments were issued October 31, 1995, the penalty, at the rate of 30%, was properly applied. It should be noted that on future audits, the Taxpayer will be expected to conform to compliance requirements established in the department's revision of VR 630-10-80, copy enclosed.
Based on the foregoing, the audit's sample calculation has been revised, and to exclude penalty on the government contract purchases. Please return your payment for the revised balance of tax, penalty and interest totaling******** to the department's Office of Tax Policy, Post Office Box 1880, Richmond, Virginia 23218-1880, within 45 days. If payment is not received within that time, interest will accrue on the balance due from the original date of assessment. If you should have any additional questions regarding this matter, please contact ***********of the department's Office of Tax Policy at***********
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/10896Q
Rulings of the Tax Commissioner