Tax Type
Retail Sales and Use Tax
Description
Deficiency assessments, government contractor providing specific technical and engineering services to the federal government
Topic
Collection of Delinquent Tax
Date Issued
07-24-1998
July 24, 1998
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *********
This is in response to your letter in which you seek correction of a sales and use tax assessment issued to ********* (the "Taxpayer') for the period August 1992 through July 1995. I regret that your correspondence was not answered more promptly.
FACTS
The Taxpayer, a government contractor providing specific technical and engineering services to the federal government, was audited and held liable for the tax on various purchases made in connection with government contracts. I understand that the contested property was ultimately delivered to a federal facility outside Virginia, but was first delivered to the Taxpayer's location in Virginia.
Most of the contested purchases are associated with one particular contract and are identified as "Account # 9310.' This contract was issued by the ************** ("NRL'). The NRL conducts research in astronomy, astrophysics and atmospheric science through satellites, rockets and ground-based facilities. The introduction to the Statement of Work for this contract states that "research and development is needed for satellite design, computer modeling, experiment design, data analysis, instrument packing and payload testing.'
You note that the contract is categorized by the government as a research and development contract. You further note that solicitation for this contract was limited to contractors, such as the Taxpayer, classified in the Standard Industrial Classification Manual as research and development businesses. For these reasons, you conclude that no tax applies to the tangible personal property purchased by the Taxpayer under Account # 9310.
In addition to Account # 9310, you maintain that other contested purchases are made in connection with other contracts under which the Taxpayer is assisting the NRL in research and development.
Finally, I note that your protest of fixed assets has been resolved in that the contested fixed assets have been removed from the assessment.
DETERMINATION
Government Contracts -- Generally
The department has traditionally held 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. The "true object' test described in Title 23 of the Virginia Administrative Code (VAC) 10-210-4040 is used to determine whether the contract is for the sale of tangible personal property or for the provision of some service.
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 contractual 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, the contractor may purchase such property exempt from the tax for resale. The subsequent sale of the property to the government is exempt under Code of Virginia § 58.1-609.1(4).
Research and Development
Notwithstanding the true object of a government contract, Code of Virginia § 58.1-609.3(5) provides a sales and use tax exemption for "[t]angible personal property purchased for use or consumption directly and exclusively in basic research or research and development in the experimental or laboratory sense.' (Emphasis added.) The department interprets this statute in 23 VAC 10-210-3070 through 3074. These regulations define "research and development' as "a systematic study or search directed toward a new knowledge or new understanding of a particular scientific or technical subject and the gradual transformation of this new knowledge or new understanding into a usable product or process.' The term "basic research' is defined as "a systematic study or search in a scientific or technical field or endeavor with the ultimate goal of advancing knowledge or technology in that field.'
By way of contrast, the regulations provide that exempt research does not include testing or inspection of materials or products for quality control, environmental analysis, testing of samples, operations research or management studies. Further, in order to qualify for the exemption, tangible personal property must be used directly and exclusively in an actual research process and must be purchased by the organization that actually performs the exempt research activities.
Account # 9310
Applying the government contractor and research and development guidelines to the contract in the instant case leads to the following conclusions:
First, it appears that the true object of the contract is for the provision of services. I note that the Taxpayer is responsible for some tangible deliverables; however, the preponderance of tasks set out in the Statement of Work call for the Taxpayer to use its technical and engineering expertise to provide services for the NRL.
The application of the research and development exemption in this case is less clear. I agree that some of the specified tasks may represent exempt research and development activities. Pursuant to §§ 5.0 and 5.1 of the Statement of Work, the Taxpayer is required to: (1) design and develop ground experiment test equipment, and (2) design and develop space shuttle payload electronic printed circuit boards. These two design and development activities, made in connection with NRL's astronomic, astrophysics and atmospheric research activities, qualify as exempt research and development as envisioned in the statutory exemption. Accordingly, tangible personal property used directly and exclusively in these activities is exempt. To the extent that such property has been assessed, it will be removed from the assessment.
Conversely, other specific tasks set out in the Statement of Work would not qualify for the research and development exemption. These other activities include, for example: (1) the procurement, screening, selection, evaluation and inspection of parts provided by third-party vendors; (2) the development of procedures for clean room operations; and (3) the development of quality assurance procedures and processes.
While these activities are related to and essential to NRL's overall research objectives, they do not by themselves constitute "an actual research process' as set out in the regulations. For example, electronic parts used in atmospheric tests would likely be exempt as such items are directly used in the research process. However, items used to facilitate the purchase of those parts -- or used to test those parts -- are not used directly in the research process. Accordingly, purchases of such items are taxable.
Other Accounts
In your correspondence, you indicate that other contested purchases are also for research and development contracts. You further indicate that these contracts are vehicles by which the Taxpayer assists in the development of the NRL's next generation of instrumentation. As addressed above and in the regulations, the exemption applies only to items used directly and exclusively in exempt research activities. Without a clearer understanding of the Taxpayer's specific activities in regard to these other contracts, it is impossible to make a determination.
Summary
Based on this determination, the audit will be returned to the audit staff. In cooperation with the Taxpayer, the audit staff will identify tangible personal property items used directly and exclusively in exempt research and development activities under Account # 9310. At the same time, the audit staff will review the other accounts to see if the Taxpayer's specific contractual activities qualify for the exemption.
The department will continue to suspend collection activity on the outstanding assessment pending this review process. In the meantime, please call ***** in the department's Office of Tax Policy at ***** if you have any questions on this matter.
Sincerely,
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *********
This is in response to your letter in which you seek correction of a sales and use tax assessment issued to ********* (the "Taxpayer') for the period August 1992 through July 1995. I regret that your correspondence was not answered more promptly.
FACTS
The Taxpayer, a government contractor providing specific technical and engineering services to the federal government, was audited and held liable for the tax on various purchases made in connection with government contracts. I understand that the contested property was ultimately delivered to a federal facility outside Virginia, but was first delivered to the Taxpayer's location in Virginia.
Most of the contested purchases are associated with one particular contract and are identified as "Account # 9310.' This contract was issued by the ************** ("NRL'). The NRL conducts research in astronomy, astrophysics and atmospheric science through satellites, rockets and ground-based facilities. The introduction to the Statement of Work for this contract states that "research and development is needed for satellite design, computer modeling, experiment design, data analysis, instrument packing and payload testing.'
You note that the contract is categorized by the government as a research and development contract. You further note that solicitation for this contract was limited to contractors, such as the Taxpayer, classified in the Standard Industrial Classification Manual as research and development businesses. For these reasons, you conclude that no tax applies to the tangible personal property purchased by the Taxpayer under Account # 9310.
In addition to Account # 9310, you maintain that other contested purchases are made in connection with other contracts under which the Taxpayer is assisting the NRL in research and development.
Finally, I note that your protest of fixed assets has been resolved in that the contested fixed assets have been removed from the assessment.
DETERMINATION
Government Contracts -- Generally
The department has traditionally held 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. The "true object' test described in Title 23 of the Virginia Administrative Code (VAC) 10-210-4040 is used to determine whether the contract is for the sale of tangible personal property or for the provision of some service.
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 contractual 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, the contractor may purchase such property exempt from the tax for resale. The subsequent sale of the property to the government is exempt under Code of Virginia § 58.1-609.1(4).
Research and Development
Notwithstanding the true object of a government contract, Code of Virginia § 58.1-609.3(5) provides a sales and use tax exemption for "[t]angible personal property purchased for use or consumption directly and exclusively in basic research or research and development in the experimental or laboratory sense.' (Emphasis added.) The department interprets this statute in 23 VAC 10-210-3070 through 3074. These regulations define "research and development' as "a systematic study or search directed toward a new knowledge or new understanding of a particular scientific or technical subject and the gradual transformation of this new knowledge or new understanding into a usable product or process.' The term "basic research' is defined as "a systematic study or search in a scientific or technical field or endeavor with the ultimate goal of advancing knowledge or technology in that field.'
By way of contrast, the regulations provide that exempt research does not include testing or inspection of materials or products for quality control, environmental analysis, testing of samples, operations research or management studies. Further, in order to qualify for the exemption, tangible personal property must be used directly and exclusively in an actual research process and must be purchased by the organization that actually performs the exempt research activities.
Account # 9310
Applying the government contractor and research and development guidelines to the contract in the instant case leads to the following conclusions:
First, it appears that the true object of the contract is for the provision of services. I note that the Taxpayer is responsible for some tangible deliverables; however, the preponderance of tasks set out in the Statement of Work call for the Taxpayer to use its technical and engineering expertise to provide services for the NRL.
The application of the research and development exemption in this case is less clear. I agree that some of the specified tasks may represent exempt research and development activities. Pursuant to §§ 5.0 and 5.1 of the Statement of Work, the Taxpayer is required to: (1) design and develop ground experiment test equipment, and (2) design and develop space shuttle payload electronic printed circuit boards. These two design and development activities, made in connection with NRL's astronomic, astrophysics and atmospheric research activities, qualify as exempt research and development as envisioned in the statutory exemption. Accordingly, tangible personal property used directly and exclusively in these activities is exempt. To the extent that such property has been assessed, it will be removed from the assessment.
Conversely, other specific tasks set out in the Statement of Work would not qualify for the research and development exemption. These other activities include, for example: (1) the procurement, screening, selection, evaluation and inspection of parts provided by third-party vendors; (2) the development of procedures for clean room operations; and (3) the development of quality assurance procedures and processes.
While these activities are related to and essential to NRL's overall research objectives, they do not by themselves constitute "an actual research process' as set out in the regulations. For example, electronic parts used in atmospheric tests would likely be exempt as such items are directly used in the research process. However, items used to facilitate the purchase of those parts -- or used to test those parts -- are not used directly in the research process. Accordingly, purchases of such items are taxable.
Other Accounts
In your correspondence, you indicate that other contested purchases are also for research and development contracts. You further indicate that these contracts are vehicles by which the Taxpayer assists in the development of the NRL's next generation of instrumentation. As addressed above and in the regulations, the exemption applies only to items used directly and exclusively in exempt research activities. Without a clearer understanding of the Taxpayer's specific activities in regard to these other contracts, it is impossible to make a determination.
Summary
Based on this determination, the audit will be returned to the audit staff. In cooperation with the Taxpayer, the audit staff will identify tangible personal property items used directly and exclusively in exempt research and development activities under Account # 9310. At the same time, the audit staff will review the other accounts to see if the Taxpayer's specific contractual activities qualify for the exemption.
The department will continue to suspend collection activity on the outstanding assessment pending this review process. In the meantime, please call ***** in the department's Office of Tax Policy at ***** if you have any questions on this matter.
Sincerely,
Rulings of the Tax Commissioner