Tax Type
Retail Sales and Use Tax
Description
Virtual campus of on-line education and training coursework
Topic
Exemptions
Royalties
Date Issued
04-13-2006
April 13, 2006
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****************:
This is in response to your letter in which you seek correction of the retail sales and use tax assessment issued to ***** (the "Taxpayer") as a result of an audit for the period August 1998 through October 2001. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer provides a virtual campus of on-line education and training coursework to the general public. The courses are generally derived from third-party authors, and "almost all content requires significant adaptation and alteration in order to use the course as a part of the [Taxpayer's] electronic learning environment."
The Taxpayer contests the tax assessed on royalties charged in connection with certain software licensing agreements. The Taxpayer maintains that such royalties are not taxable on the basis that the software constitutes an exempt research and development expenditure, an exempt audiovisual work, and an exempt service pursuant to the doctrine of "load and leave" adopted by other states. The Taxpayer also contests the tax assessed on a tradeshow booth, claiming exemption on the basis that the booth was in Virginia only for storage and no actual use occurred in Virginia.
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- DETERMINATION
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Royalties
Research and development exemption. You state that the majority of the contracts held taxable in the audit expressly require adaptation and alteration of the coursework as a condition of the use of the work acquired. You also state that the Taxpayer is not permitted to make use of the coursework in its unaltered state or to redistribute that coursework in its unaltered state to others. You maintain that the modifications and alterations that the Taxpayer makes to the coursework clearly improve the coursework for on-line delivery and provide a new product. Accordingly, it is your conclusion that the Taxpayer has satisfied all of the criteria needed to qualify for the research and development exemption.
Virginia Code § 58.1-609.3 5 provides an exemption from the retail sales and use 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." This exemption is interpreted by several regulations set out in Title 23 of the Virginia Administrative Code (VAC) under 10-210-3070 through 10-210-3074, 10-210-762, and 10-210-765. Addressing computer software development, Title 23 VAC 10-210-765 provides the following:
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- Tangible personal property used directly and exclusively in computer software research and development activities is generally exempt from the tax. Exempt research and development activities are those that have as their ultimate goal the advancement of computer software technology, the development of new computer software products, the improvement of existing computer software products, or the development of new uses for existing computer software products. An example of exempt tangible personal property used in a research and development activity is computer hardware and software used in programming and other development activities with respect to new computer software products, including the testing of such new products.
Based on these criteria, and the facts presented, I find that the Taxpayer's coursework development activities do not rise to the level of true research and development as envisioned under the law and regulations. For instance:
Taxpayer's routine business is the development and publication of online products. Nevertheless, the routine development demonstrated in this case is not indicative of any ongoing innovations that establish an advancement in computer software technology.
· Although you claim that the Taxpayer is producing new computer software products, the users of the on-line courses are not receiving software per se. Rather, they are accessing and viewing educational content and graphics.
The conversion of printed materials or the adaptation of coursework to on-line use does not necessarily result in a better state, quality or value for the course. Accordingly, there are no grounds to establish that the Taxpayer's coursework development activities improve existing computer software products.
You claim that the determination in P.D. 02-11 (02/15/02) - exempting certain software under the research and development exemption - should apply to the Taxpayer's situation. On the contrary, the contested software at issue in P.D. 02-11 was used only to develop new software products in which significant programming changes and improvements were made to the vendor's source code. In the instant case, however, there is no mention in the contracts that the Taxpayer is given access to the source code or given rights to modify the source code of the licensed software. Rather, the Taxpayer engages in coursework development by converting printed materials into a digital format for on-line use or adapting coursework (in object code form) to an on-line use capability. Accordingly, there appears to be little or no alteration of the source code by the Taxpayer. Because P.D. 02-11 does not involve a similar factual situation, it is not relevant here.
Audiovisual works exemption. Virginia Code § 58.1-609.6 6 provides an exemption from the retail sales and use tax for:
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- a. (i) The lease, rental, license, sale, other transfer, or use of any audio or video tape, film or other audiovisual work where the transferee or user acquires or has acquired the work for the purpose of licensing, distributing, broadcasting, commercially exhibiting or reproducing the work or using or incorporating the work into another such work; (ii) the provision of production services or fabrication in connection with the production of any portion of such audiovisual work, including, but not limited to, scriptwriting, photography, sound, musical composition, special effects, animation, adaptation, dubbing, mixing, editing, cutting and provision of production facilities or equipment; or (iii) the transfer or use of tangible personal property, including, but not limited to, scripts, musical scores, storyboards, artwork, film, tapes and other media, incident to the performance of such services or fabrication; however, audiovisual works and incidental tangible personal property described in clauses (i) and (iii) of this subdivision shall be subject to tax as otherwise provided in this chapter to the extent of the value of their tangible components prior to their use in the production of any audiovisual work and prior to their enhancement by any production service; and
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- b. Equipment and parts and accessories thereto used or to be used in the production of such audiovisual works. [Emphasis added.]
You claim that there is no statutory basis for a restrictive reading of the words "audiovisual work" and the term is entitled to be read with its usual meaning without the additional interpretations that the Commissioner applies pursuant to P.D. 03-2 (01/18/03) and P.D. 00-33 (03/31/00). On the contrary, the conversion of books, other printed materials, or coursework or software into an on-line format is not contemplated by the exemption. Nor is it the intent of the Virginia General Assembly to extend the exemption to the sale or production of on-line products. This is evident from the information presented in the fiscal impact statement for Senate Bill 1292 (copy enclosed) considered by the 2001 session of the General Assembly. According to that fiscal impact statement, the stated purpose of Senate Bill 1292 is to expand the audiovisual works exemption to include (i) audiovisual works in electronic or digital format when leased, rented, sold to, or used by an Internet service business, and (ii) equipment used in the production, storage, hosting, processing and distribution of audiovisual works by an Internet service business. Senate Bill 1292 was never enacted into law.
The Tax Commissioner has been consistent in the interpretation of the audiovisual works exemption. In P.D. 03-2 (01/18/03), the Tax Commissioner states that, "the audiovisual works exemption exempts certain tangible personal property from the sales and use tax. Claiming that an Internet-based game is an 'other audiovisual work' ignores the basic principle of the Virginia Retail Sales and Use Tax Act that it is the tangible nature of property that subjects it to the sales and use tax."
The Department must adhere to the rule of strict construction of the exemptions from the retail sales and use tax as adopted by the courts. See Commonwealth v. Community Motor Bus, 214 Va. 155, 198 S.E.2d 619 (1973) and Title 23 VAC 10-210-540. To do otherwise would unjustly broaden the intended scope of the exemptions. See Title 23 VAC 10-210-540. Based on all of the foregoing, I must conclude that the audiovisual works exemption in Va. Code § 58.1-609.6 6 a has no application to the Taxpayer's virtual campus with its on-line courses.
Service exemption. In this case, the Taxpayer generally received the electronic content from which its virtual campus is derived on CD-ROM disks. In addition to copying the disks, you indicate that the only use of those disks was to load the software onto the Taxpayer's servers for alteration and adaptation into its virtual campus for deployment on-line. You also state that the Taxpayer has no interest in the physical media other than as an installation device to place the content on its servers and that the Taxpayer does not retain such tangible media. You contend that the true object of each contested transaction is the provision of an exempt service and that the tangible software media transferred to the Taxpayer was not critical to the transaction.
The Department has consistently taxed prewritten programs conveyed by tangible media and exempted prewritten programs delivered by electronic means only. As you point out, the Department has also adopted a type of "load and leave" policy in P.D. 96-143 (6/20/96) that exempts the uploading of software onto customer-owned hardware when no tangible personal property (such as the software media) is transferred. You also cite P.D. 01-61 (5/15/01), which exempts a transaction for uploading prewritten software without transferring possession of tangible software media but transferring a tangible software manual deemed incidental to the transaction. Clearly, the Department's long-standing policy is that the tangible software media used to convey prewritten programs is critical to the transaction. Accordingly, consistent with established policy, the contested transactions are subject to the tax.
Tradeshow booth
Based on the documents presented, the Taxpayer purchased a tradeshow booth from a Virginia vendor in August 2000. You indicate that this booth was assembled in Minnesota by the vendor and then shipped to a Colorado tradeshow for first use by the Taxpayer before shipping it to Virginia on September 24, 2000, for storage and other subsequent reuse by the Taxpayer. You indicate that while the booth is stored in Virginia when not in use at tradeshows and exhibits, at no time has the booth been used at any tradeshow or exhibit in Virginia. For this reason, you claim that no taxable use has occurred in Virginia.
You cite two statutory definitions from Va. Code § 58.1-602. First, you cite the definition of "use tax," which "refers to the tax imposed upon the use, consumption, distribution, and storage as herein defined." Second, you cite the first part of the definition of "storage" as follows:
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- "Storage" means any keeping or retention of tangible personal property for use, consumption or distribution in this Commonwealth or for any purpose other than sale at retail in the regular course of business. [Emphasis added.]
As so defined, taxable storage is keeping or retaining property for use in Virginia but also includes storage for any other purpose (except storage of resale inventory). Accordingly, the mere storage of tangible personal property in Virginia for actual use outside Virginia is sufficient to create a taxable event in Virginia. Commonwealth of Virginia, Department of Taxation v. Miller-Morton Co., 220 Va. 852, 263 S.E.2d 413 (1980). In addition, no temporary storage exemptions [e.g., see Va. Code §§ 58.1-609.3 1 and 58.1-609.6 4] are applicable in this matter. Nor has any evidence been presented that a sales or use tax was paid on the booth purchase to another state as to allow a tax credit in accordance with Va. Code § 58.1-611.
Moreover, pursuant to Va. Code § 58.1-604, "[t]angible personal property which has been acquired for use outside this Commonwealth and subsequently becomes subject to the tax imposed hereunder shall be taxed on the basis of its cost price if such property is brought within this Commonwealth for use within six months of its acquisition." In this case, the booth was brought into Virginia within two months of its acquisition.
You contend that P. D. 95-274 (10/26/95) also provides a basis for exempting the booth. In that case, no tax was due on the scripts and dubs at issue because "the value of the scripts [was] negligible since they already have been used in the production of a film." Because the scripts and dubs were typically brought into Virginia six months after acquisition, they could be subject to use tax on the basis of their fair market value when brought into Virginia. See Va. Code § 58.1-604 1. As the scripts had no fair market value when brought into Virginia, no tax was due. In contrast to the situation addressed in P.D. 95-274, the contested booth was brought into Virginia within two months of purchase and subject to taxation based on its cost price.
CONCLUSION
Based on this determination, the assessment is correct. A consolidated bill, with interest accrued to date, will be mailed shortly to the Taxpayer. The outstanding balance must be paid within 30 days from the date of the consolidated bill to avoid the accrual of additional interest. In addition, failure to submit full payment within this 30-day period may also result in the imposition of an additional 20% penalty on the tax due under the terms of the Virginia Tax Amnesty Program. See the enclosure entitled "Important Payment Information."
Payment should be remitted to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attn: *****. If you have any questions concerning 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 web site. If you have any questions about this determination, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.
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- Sincerely,
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- Kenneth W. Thorson
Tax Commissioner
- Kenneth W. Thorson
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AR/48268R
Rulings of the Tax Commissioner