Document Number
06-148
Tax Type
Retail Sales and Use Tax
Description
Real property construction contractor fabricator of materials for its own use
Topic
Assessment
Manufacturing
Date Issued
12-08-2006


December 8, 2006





Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear ********:


This will reply to your letters in which you seek the correction of a retail sales and use tax assessment issued to your client, ***** (the "Taxpayer") for the period June 2001 through July 2004. I apologize for the delay in responding to your appeal.

FACTS


The Taxpayer is a steel fabricator and real property contractor. The Taxpayer makes some retail sales of tangible personal property. During the audit period, the Taxpayer's annual gross receipts derived from real property construction activities exceeded 50% of its total annual gross receipts.

The Taxpayer was audited by the Department and assessed use tax on purchases of various items used or consumed in Virginia. The Taxpayer claims that a number of the items in the audit were assessed erroneously. The issues upon which the Taxpayer bases its claim are addressed in detail below.

DETERMINATION


In accordance with Title 23 of the Virginia Administrative Code (VAC) 10-210-410 E, a contractor that operates in a dual role of fabricating tangible personal property for sale or resale and fabricating tangible personal property for use or consumption in real property construction must use a primary purpose rule to determine the tax treatment of fabricated materials and other purchases made for use or consumption in real property construction jobs. Applying this rule to the period audited, the Taxpayer was primarily a real property contractor that fabricated for its own use and consumption.

Out-of-State Purchases

The Taxpayer maintains that the audit includes out-of-state purchase transactions that were invoiced to, delivered to and used in other states. These transactions include materials that were never physically in Virginia and were shipped directly to job sites in other states. You represent that the Taxpayer also paid sales taxes on these transactions to other states.

Virginia Code § 58.1-604 states that Virginia use tax applies to the use, consumption or storage of tangible personal property in Virginia. I will have the auditor review these transactions to determine if no use of the property occurred in Virginia, or if the property was used in Virginia, that sales or use tax was properly paid to another state prior to the property's use in Virginia. The audit will be adjusted accordingly.

Purchases for Resale

The Taxpayer claims that some of the purchases in the audit qualify for the resale exemption. Virginia Code § 58.1-602 defines "use" to mean "the exercise of any right or power over tangible personal property incident to the ownership thereof, except that it does not include the sale at retail of that property in the regular course of business." Under this definition, a taxpayer is generally not liable for use tax on property purchased for resale if the taxpayer makes retail sales as part of its normal business operations.

Title 23 of the Virginia Administrative Code (VAC) 10-210-410 E interprets the application of the resale exemption to contractors that primarily fabricate for their own use or consumption. The regulation states that contractors may only use the resale exemption to purchase items that can be identified at the time of purchase as a purchase for resale. Contractors must pay the applicable sales or use tax on purchases of tangible personal property that cannot be identified as a purchase for resale at the time of purchase. If the contractor pays sales tax on purchases that are later sold at retail, the tax must be collected on the retail sales price. The seller is not entitled to a credit for sales or use tax paid on the original purchase because the purchase and subsequent retail sale are considered separate and distinct transactions.

I will have the auditor review these transactions to determine if the purchases in question qualify for the resale exemption. The Taxpayer should provide documentation that identifies those purchases that were originally made for resale and were subsequently resold to the Taxpayer's customers. The audit will be adjusted accordingly.

Custom Software

The Taxpayer states that a computer software purchase held taxable in the audit is custom software and qualifies for exemption from sales and use tax. The audit also included charges for a maintenance contract related to the same software. The Taxpayer maintains that the software was specifically designed for the Taxpayer. The Taxpayer contends that the maintenance contract is for labor support only, and because it was purchased to support the custom software, the charges are exempt from the sales and use tax.

Virginia Code § 58.1-609.5 7 provides an exemption from sales and use tax for custom computer programs. Virginia Code § 58.1-602 defines "custom program" as:
    • A computer program which is specifically designed and developed only for one customer. The combining of two or more prewritten programs does not constitute a custom computer program. A prewritten program that is modified to any degree remains a prewritten program and does not become custom.

If the Taxpayer can provide detailed information showing that the software was customized for the Taxpayer, the software purchase will be removed from the audit. Likewise, the maintenance contract charges will be exempt if the Taxpayer establishes that the software is a custom program. This would be consistent with the Department's policy discussed in Public Document (P.D.) 05-44 (4/4/05), which states that the application of sales tax to maintenance contracts follows the application of the tax to the property for which the maintenance contract applies.

If the Taxpayer cannot demonstrate to the Department that the software is custom, the Taxpayer must provide documentation that shows the maintenance contract is for labor only. If this is the case, the maintenance contract charges will be removed from the audit.

Service Awards

The Taxpayer contends that the audit includes exempt third party gift transactions in which the Taxpayer purchased gifts that were transferred by the seller to a third party recipient. The 1995 Virginia General Assembly amended Va. Code § 58.1­602 by adding the following language to the definition of "use":

    • The term [use] does not include the exercise of any right or power, including use, distribution, or storage, over any tangible personal property sold to a nonresident donor for delivery outside of the Commonwealth to a nonresident recipient pursuant to an order placed by the donor from outside the Commonwealth via mail or telephone.

This definition exempts from the sales and use tax the purchase of gifts by persons from an out-of-state location if the gift is delivered to a nonresident recipient outside Virginia. Gifts delivered to Virginia residents at the direction of out-of-state purchasers and gifts purchased by Virginia residents for delivery to out-of-state recipients remain taxable. The Taxpayer must provide evidence that the service awards were ordered from and delivered to out-of-state locations. The audit will be adjusted, if warranted, based on documentation of these transactions provided by the Taxpayer.

Manufacturing Exemption

The Taxpayer asserts that the audit includes purchases of equipment, machinery and related parts and supplies that qualify for the manufacturing exemption. Using the primary purpose rule in Title 23 VAC 10-210-410 E, we have established that the Taxpayer was principally fabricating tangible personal property for its own use and consumption as a real property contractor. Any person who is principally fabricating tangible personal property for his own use or consumption in real property construction contracts shall apply the tax according to Title 23 VAC 10-210-410 D, which states that the tax must be paid on the cost price of the raw materials that make up the fabricated property used or consumed in real property contracts.

Title 23 VAC 10-201-410 F discusses the manufacturing exemption as it applies to contractors and states that the manufacturing exemption is not available to a fabricator who principally fabricates for his own use or consumption. The manufacturing exemption requires that manufacturing be done for sale or resale. Based on the fact that the Taxpayer is primarily a using and consuming contractor, the manufacturing exemption is not applicable to the Taxpayer's purchases. These items were properly assessed in the audit.

Purchases on Which Virginia Tax Paid

The Taxpayer states that Virginia sales tax was paid on certain purchases included in the audit. I will have the auditor review the Taxpayer's documentation to determine if tax was paid on these transactions. The audit will be adjusted accordingly.

Fabrication Labor Exclusion for Contractors

The Taxpayer maintains that the Department incorrectly included in the audit fabrication labor performed on materials for its use in construction contracts. In accordance with Title 23 VAC 10-210-4.10 D, the Taxpayer would be liable for use tax on the cost price of raw materials, not the fabricated cost price of the materials, used in the construction projects. The galvanization of steel is the primary type of fabrication labor at issue in the audit. Both the Taxpayer and the Department agree that galvanization is a type of fabrication.

The Taxpayer has provided the Department with a spreadsheet that lists the disputed fabrication transactions. With one exception, the fabrication labor charges listed on the spreadsheet are charges billed by third parties. The audit work papers confirm this observation. The Taxpayer is correct that the provisions of Title 23 VAC 10-210-410 D would apply to fabrication labor that it performs on materials for use in construction projects. However, the regulation does not apply to fabrication services purchased by contractors from third parties. Third parties include entities that are related to the Taxpayer but organized as separate legal entities. Consistent with P.D. 87-137 (5/7/87), a fabricator's purchase of fabrication services from a third party for the fabricator's use or consumption is subject to the tax. I will have the auditor review the fabrication labor transactions. If the Taxpayer has been assessed use tax on charges for fabrication labor that it performed on tangible personal property for use in real property construction work, the charges will be removed from the audit.

Prior Guidance from the Department

The Taxpayer was assessed Virginia use tax on materials used for out-of-state jobs. The materials were physically in Virginia prior to their shipment or transport to the out-of-state job locations. The Department assessed the tax based on the Taxpayer's "first use" of the job materials in Virginia. The Taxpayer maintains that it paid use tax on the job materials to the states in which the materials were installed or used. The Taxpayer suggests that it paid the tax based on the results of prior audits and written guidance received from the Department. For this reason, the Taxpayer requests that the Department abate the assessment of use tax on materials used for out-of-state jobs.

Virginia Code § 58.1-1835 provides that the Tax Commissioner will abate any tax, interest and penalty that is attributable to written erroneous advice provided to a taxpayer by an employee of the Department acting in his official capacity, if the following conditions are met:
    • The written advice was reasonably relied upon by the taxpayer and was in response to a specific written request by the taxpayer;
    • The portion of the penalty or tax did not result from a failure by the taxpayer to provide adequate or accurate information; and
    • The facts of the case described in the written advice and the request therefor are the same, and the taxpayer's business or personal operations have not changed since the advice was rendered.

Based on a review of the two previous audit reports, I can find no evidence that the Taxpayer requested the Department's opinion or determination on the taxation of out-of-state job materials, either in writing or verbally. There is no mention of this issue in the audit reports. The Department has also responded to two ruling requests made by the Taxpayer. In letters issued to the Taxpayer as Public Documents 89-117 (4/10/89) and 93-91 (3/29/93), the Department addressed the application of the primary purpose rule to the Taxpayer's business activities. However, the Taxpayer did not request a ruling on the taxability of out-of-state job materials. Thus, this issue was never addressed in the Department's ruling letters.

To support its contention, the Taxpayer has provided a copy of an auditor's letter that was written at the conclusion of the Department's previous audit. The letter addressed the Taxpayer's dual role as a fabricator acting as a retailer and contractor. Again, there is no discussion in the letter of the Taxpayer's use in Virginia of materials that are subsequently used in out-of-state jobs. Based on the above, I can find no basis to abate the use tax assessed on out-of-state job materials due to erroneous advice provided by the Department.

Credit for Taxes Paid to Other States

The Taxpayer states that the taxation of out-of-state job materials is contrary to Virginia's statutory credit for sales and use taxes paid to other states. In its second letter, the Taxpayer requests the Department address its contention that the Department's regulation, Title 23 VAC 10-210-450, has no statutory basis. The Taxpayer maintains that the regulation is too narrow and limits Virginia's statutory credit for sales or use taxes paid to other states. Virginia Code § 58.1-611 states, in part, that:
    • A credit shall be granted against the taxes imposed by this chapter with respect to a person's use in this Commonwealth of tangible personal property purchased by him in another state.

Title 23 VAC 10-210-450 A states, in part, that:
    • Any person who purchases tangible personal property in another state and who has paid a sales or use tax to such state or its political subdivision or both on the property, is granted a credit against the use tax imposed by Virginia on its use within this state for the amount of tax paid in the state of purchase.

I do not agree with the Taxpayer's contention that the regulation is not consistent with the statute. The statute states that the credit is allowed for tangible personal property purchased in another state and subsequently used in Virginia. Clearly, the purchase of tangible personal property must occur in another state before the property can be used in Virginia. The statute contemplates situations in which an out-of-state purchase is taxed in the state of purchase prior to the use of the purchased property in Virginia. The allowance of a Virginia credit prevents Virginia from taxing the same transaction that was previously taxed in the other state or jurisdiction. The statute does not apply to situations in which untaxed property is first used in Virginia and then transported to another state for use there. This position is supported by the opinion of the Virginia Supreme Court in Commonwealth v. Miller-Morton, 220 Va. 852, 263 S.E.2d 413 (1980), which held that "if a taxable event occurs in Virginia subsequent delivery of property outside this State does not immunize the taxable event."

In P.D. 99-40 (3/31/99), the taxpayer argued that it was entitled to a credit for sales and use tax paid to other states on elevators stored in Virginia and subsequently installed in the other states. The Department ruled that the act of storing the elevators in Virginia constituted first use of the property in Virginia and that the tax was properly assessed on the elevators. I also note that, contrary to the Taxpayer's arguments, Virginia would allow an out-of-state contractor credit for sales or use tax paid on tangible personal property purchased in another state and then transported into Virginia for use in real property construction here. This is exactly the type of transaction contemplated by both the statute and the regulation. Based on the above, the assessment is correct with respect to the Taxpayer's first use in Virginia of tangible personal property that was later used for real property construction jobs in other states.

Temporary Storage Exclusion

The Taxpayer maintains that some of the job materials used in out-of-state jobs qualify for exemption under Va. Code § 58.1-609.3 1. This exemption applies to:
    • Personal property purchased by a contractor which is used solely in another state or in a foreign country, which could be purchased by such contractor for such use free from sales tax in such other state or foreign country, and which is stored temporarily in Virginia pending shipment to such state or country.

The Taxpayer states that the bulk of the Taxpayer's jobs occurred in a state where a number of possible exemptions would have applied to the Taxpayer's use of construction materials for those jobs.

P.D. 93-225 (11/16/93) addresses Virginia's temporary storage exemption and states that contractors are eligible for this exemption only if they can purchase property free of sales tax in another state. In states that provide for refunds of sales taxes paid, the exemption does not apply. The contractor must be entitled to an exemption from the state's sales tax on the purchase of the property at the time of purchase. The state noted in the Taxpayer's letter issues refunds of sales taxes paid by contractors on qualifying real property construction projects to the entity for which the job is performed. Based on the Department's longstanding policy, the Taxpayer would not qualify for exemption on the temporary storage of job materials in this state for use in other states that provide for a refund of sales and use taxes paid on the cost of materials used in real property construction jobs.

I find the Taxpayer's other argument that construction materials temporarily stored in Virginia would qualify for exemption based on another state's temporary storage exemption to be unpersuasive. Virginia's temporary storage exemption is intended to exempt from use tax a contractor's first use of construction materials in Virginia because the construction project or the entity for which the construction project is performed qualifies for sales tax exemption in another state. Virginia's temporary storage exemption cannot apply based on another state's temporary storage exemption because first use of the property can occur in only one state.

I also cannot agree that the Department's regulation on Virginia's temporary storage exemption is inconsistent with the statute. The Taxpayer states in its second letter that the regulation could be construed to require taxpayers to receive permission to use Virginia's temporary storage exemption. This language exists to assist Virginia dealers in obtaining valid exemption certificates from purchasers when making exempt sales of tangible personal property. Real property contractors are generally taxable on all purchases made for their own use or consumption. Vendors are required by law to charge sales tax on all sales made to real property contractors unless the vendor is presented a valid exemption certificate.

The audit assessment is considered correct with respect to the Taxpayer's storage in Virginia of out-of-state job materials unless it can provide documentation showing that there are items in the audit that were used in exempt construction projects in other states in accordance with Va. Code § 58.1-609.3 1, Title 23 VAC 10-210-410 I and the Department's established policy.

CONCLUSION


A member of the Department's audit staff will contact the Taxpayer to set up a mutually agreeable time to review the documentation requested from the Taxpayer in this determination. The audit assessment will be adjusted based on the Department's review of the documentation and the Taxpayer will receive an updated bill that will include accrued interest on the revised assessment amount. No additional interest will accrue provided the Taxpayer makes payment within 30 days of the date on the bill. The Taxpayer should remit its payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attn: *****. If you have any questions regarding payment of the assessment, you may contact ***** at *****.

The Code of Virginia sections, regulations and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have any questions about this determination, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
                • Sincerely,


                  Janie E. Bowen
                  Tax Commissioner



AR/56416S


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46