Tax Type
Retail Sales and Use Tax
Description
Computer aided design (CAD) system; Manufacturing; R&D
Topic
Property Subject to Tax
Date Issued
01-08-1999
January 8, 1999
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 1994 through September 1997. I apologize for the delay in responding to your appeal. I note that the tax and interest on uncontested issues have been paid.
FACTS
The Taxpayer operates an engineering and fabrication facility in Virginia. This facility offers design, analysis, testing and inspection of high-technology products primarily to the aerospace and marine industries. This facility also accommodates the fabrication and manufacture of models, prototypes, and one-of-a-kind aerospace and marine products, as well as the limited production of such products.
At issue in this case is the application of the tax to a Unigraphics Computer Aided Design ("CAD") system, associated computer software, and related computer hardware. The Taxpayer uses the contested items to provide a number of services to its aerospace and marine technology customers. For example, the equipment is used to develop, design, and test new products for a customer's specific need. The equipment is also used to perform engineering analyses for mechanical and thermal stresses, structural dynamics, and aeroelasticity.
Specifically, the Taxpayer may use the CAD system to create and develop a 3-D computer model of a customer's job request. Using the associated software, the computer model is analyzed through a series of simulated tests to insure the model meets the required specifications. The design is continually modified through these tests until a final design is established.
In other instances, the Taxpayer will use a customer-supplied CAD file to generate an analysis model. The Taxpayer will then analyze, modify, and improve the design until a new working model is achieved.
I also understand that the Taxpayer uses the CAD system to translate intricate designs to magnetic tape or floppy disks that are subsequently used by the Taxpayer to manufacture or fabricate the product.
You maintain that the contested computer hardware and software are integrally related to the Taxpayer's research and development activities. You therefore conclude the CAD system, the associated computer software and the related computer hardware are exempt from the sales and use tax under the research and development exemption.
DETERMINATION
Code of Virginia § 58.1-609.3(5) provides an exemption from the tax 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 addresses this exemption in Title 23 of the Virginia Administrative Code (VAC) 10-201-3070 and defines "research and development" to mean:
A systematic study or search directed toward 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. Research and development must have as its ultimate goal: (i) the development of new products; (ii) the improvement of existing products; or (iii) the development of new uses for existing products. Research and development does not include the modification of a product merely to meet customer specifications unless the modification is carried out under experimental or laboratory conditions in order to improve the product generally or develop a new use for the product.
That same regulation defines "direct use" to mean:
Those activities which are an integral part of basic research or research and development activities, including all steps of these activities, but not including secondary activities such as administration, general maintenance, product marketing, and other activities collateral to the actual research process. (Emphasis added)
The Tax Commissioner has previously determined that CAD/CAM systems used in engineering design activities were used in a taxable manner. For example, in Public Document 88-95 (5/10/88), the Tax Commissioner found that the tax applied to computer systems used to create manufacturing designs of power transformers. This activity is analogous to the Taxpayer's use of its CAD system to translate designs to magnetic tape or floppy disks that are subsequently used in the manufacture or fabrication of products. In Public Document 96-32 (4/2/96), the Tax Commissioner indicated that a CAD system used for commercial design purposes was not used in an exempt research and development activity. Also, l note that the Taxpayer uses the contested items to test and modify customers' existing designs. As discussed in Public Document 96-61 (4/24/96), these testing and product modification activities do not qualify for the research and development exemption.
Further, Public Document 96-335 (11/18/96) on which you rely is not determinative. In that case, the Tax Commissioner determined that certain research activities (such as testing and analysis in connection with aerodynamic technology) constitute "basic research" as defined in the department's regulations. There was no determination made in that case that specific items of tangible personal property were used "directly and exclusively" in the basic research activity. Similarly, Public Document 96-90 (5/16/96) determines that activities advancing knowledge in the field of simulation technology are basic research. Again, no determination was made in that case regarding direct and exclusive use of tangible personal property.
Nor am I am convinced that 23 VAC 10-210-765(D) to which you refer is applicable in your case. This regulation addresses research and development "in the field" of computer aided engineering. This is a wholly different activity from the Taxpayer's use of computer aided engineering for its aerospace and marine customers.
The Virginia courts have consistently required strict interpretation of sales and use tax exemptions. That is, where there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption. See, for example, Commonwealth v. Community Motor Bus. 214 Va.155,198 S.E.2d 619 (1973). In the instant case, l agree that many of the Taxpayer's activities (like those in Public Documents 96-335 and 96-90) are related to a technologically advanced field. Nevertheless, the contested equipment is also used by the Taxpayer in activities which are collateral to the actual research. In this regard, the contested equipment is not used exclusively as mandated in the statute.
Based on the above, the audit assessment is found to be correctly assessed. A revised bill, with interest accrued to the date of the Taxpayer's letter of protest, will be sent to the Taxpayer. No additional interest will accrue provided the bill is paid within 30 days from the date of this letter.
If you have any questions regarding this letter, please call ***** in the department's Office of Tax Policy at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/13457I
Rulings of the Tax Commissioner