Tax Type
Retail Sales and Use Tax
Description
Government Transactions
Topic
Taxability of Persons and Transactions
Date Issued
04-16-1999
April 16, 1999
Re: Request for Ruling: Retail Sales and Use Tax
Dear***
This is in response to your letter of March 1, 1999, concerning the application of the sales and use tax to purchases by ***** (the "Taxpayer') pursuant to a contract with the federal government.
FACTS
The Taxpayer was awarded a contract by a branch of the United States Department of Defense. The general purpose of the contract is to explore new technologies related to research and development of night vision, electro-optical systems, electronic sensors, and survivability systems. In response to this purpose, the Taxpayer will provide highly technical scientific, engineering, and other specialized skills. At the same time, many of the Taxpayer's responsibilities will be set out in delivery orders which will vary in scope and duration depending on the level of services required.
The Taxpayer suggests that the contract is for basic research as defined in Title 23 of the Virginia Administrative Code (VAC) 10-210-3070 (formerly VR 630-10-92). The Taxpayer requests a determination that purchases made under specific delivery orders are an integral part of the contract's basic research and that those purchases may be made exempt of the retail sales and use tax.
In addition, the Taxpayer has provided an internal document titled Memorandum for the Record. The Taxpayer requests a ruling that this document may be deemed an affidavit to support tax exempt purchases pursuant to the contract.
RULING
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 23 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 in an actual research process, but excluding activities which are collateral to the actual research.
In the instant case, I agree that the scope of the work in the contract is for basic research and for research and development as defined above. Tangible personal property used directly and exclusively in research activities may be purchased exempt of the tax. I do have some concerns, as follows:
Administrative items: As noted in the regulations, administrative items are taxable.
Collateral activities: The contract sets out tasks which are collateral to the actual research. For example, Section 3.3.7 requires the Taxpayer to provide a review and evaluation of current and proposed manufacturing processes. Tangible personal property used in such collateral activities is not used directly in actual research and is therefore taxable.
Delivery orders: I have not reviewed any of the specific delivery orders associated with the contract. Accordingly, I cannot concede that purchases made under specific delivery orders are, as you maintain, an integral part of the basic research. It may be that specific delivery orders will describe tasks which are exempt basic research or exempt research and development. If so, tangible personal property used directly and exclusively in those exempt research activities may be purchased exempt of the tax. Conversely, in the event that specific delivery orders describe tasks which are collateral to actual research, the exemption will not apply.
Also, 23 VAC 10-210-540 provides for a strict interpretation of sales and use tax exemptions. That is, "when exemption language is susceptible of two constructions, one granting the exemption and the other not granting it, the construction denying the exemption will be followed.' I am concerned that you may be interpreting the research and development exemption more broadly than is justified. I understand that the contract's scope is for research and development. I also understand that the federal government might classify the contract as a research and development contract. Still, the sales and use tax exemption is limited to tangible personal property used directly and exclusively in an actual research activity.
Memorandum for the Record
The Taxpayer has created a document (hereinafter, the "Memorandum') to use for each contract purchase. As I understand it, the Memorandum will be used as an internal document to assist the Taxpayer in identifying exempt and taxable purchases. The Memorandum includes: (1) a section for identifying information (e.g., purchase order number, cost, equipment description, and delivery location); (2) potential exempt research and development uses of the purchase (including prototype development, and incorporation into simulation systems); and (3) a section to be checked if the purchase is for a taxable administrative use. The Memorandum will be signed by the purchaser and approved by a project manager.
You suggest that the Memorandum will assist the Taxpayer and the department's examination of direct charges to the contract. You ask that I approve this Memorandum as an "affidavit' to support purchases made pursuant to this (and potentially other) research and development contracts.
I appreciate the Taxpayer's attempt to simplify its documentation process. However, Code of Virginia § 58.1-103 directs the Tax Commissioner to inspect all records and documents associated with Virginia tax laws and regulations. I agree that the Memorandum may prove useful in identifying taxable and exempt purchases. At the same time, I cannot agree that the Memorandum, by itself, be accepted as proof that a specific purchase is exempt.
In addition to the regulations noted above, I have enclosed Public Document 96-90 (5/16/96) which was previously issued to the Taxpayer on another research and development government contract. I have also enclosed Public Document 98-121 (7/24/98) which addresses a government contractor issue.
I trust that this information is helpful. Please contact ***** in the department's Office of Tax Policy at ***** if you have any questions regarding this letter.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/21616I
Rulings of the Tax Commissioner