Document Number
08-120
Tax Type
Retail Sales and Use Tax
Description
Taxpayer furnish and installs residential heating, ventilation and air conditioning equipment.
Topic
Appropriateness of Audit Methodology
Collection of Tax
Credits
Statute of Limitations
Taxpayers' Remedies
Date Issued
06-26-2008


June 26, 2008



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

Dear *****:

This is in response to your letter requesting correction of the retail sales and use tax assessment issued to ***** (the "Taxpayer") as a result of an audit for the period December 2002 through October 2005. I apologize for the delay in responding to
your letter.

FACTS


The Taxpayer is engaged in furnishing and installing residential heating, ventilation and air conditioning (HVAC) equipment. An audit resulted in the assessment of use tax on untaxed purchases of tangible personal property, and sales tax on certain sales of installed equipment for which sales tax was separately charged and collected but not remitted to the Department.

The Taxpayer raises several issues with respect to the assessment. First, the Taxpayer contends that the audit is assessed outside of the statute of limitations. Second, the Taxpayer requests the application of the resale exemption to its HVAC purchases and a tax credit against the sales tax assessed. Third, the Taxpayer contends that the sales sample is flawed. Fourth, the Taxpayer maintains that independent contractors (the "installers") should be held liable for any sales tax collected but not remitted. Fifth, the Taxpayer requests an adjustment to the audit for any sales tax erroneously collected if it can prove that it refunded such tax to its customers. Sixth, the Taxpayer seeks waiver of all penalties assessed in the audit. Lastly, the Taxpayer requests that the auditor provide certain documentation, explain the audit methodology used, and participate in a post audit conference.

I will address each issue separately as follows.

DETERMINATION


Statute of Limitations

The Taxpayer contends that part of the period covered by the assessment is barred by the three-year statute of limitations. The provisions of Va. Code § 58.1-220 apply in this case and provide the following:
    • Where before the expiration of the time prescribed for the assessment of an omitted or additional state tax, both the Tax Commissioner and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.

In this case, the Taxpayer and the Department's audit representative entered into four such agreements to extend the assessment date for the period covered by the audit. Such agreements are entitled "Waivers of Time Limitation on Assessment of Taxes." These waivers were timely signed by both parties, and the subsequent assessment was issued within the agreed upon time frame. Accordingly, the audit period covered by the assessment is within the statute of limitations and is valid.

Double Taxation, Credit and Refund Claims

The Taxpayer asserts that the resale exemption should apply to its purchases of HVAC equipment so that it is not placed at a competitive disadvantage and treated differently than large retailers that sell and install similar products but buy their product inventories exempt of the tax pursuant to the resale exemption. The Taxpayer contends that it is being subjected to double taxation and, therefore, requests a credit for the sales tax paid on its HVAC purchases for application against the sales tax assessed in the audit.

Because the HVAC equipment installed by the Taxpayer is permanently affixed to realty, the Taxpayer is considered a consuming contractor of the equipment and liable for the sales and use tax on all such purchases of tangible personal property pursuant to Va. Code § 58.1-610. Pursuant to the contractor regulation in Title 23 of the Virginia Administrative Code ("VAC") 10-210-410, the Taxpayer should not separately charge and collect a sales tax from its customers on permanently installed items. That is, it should not pass the sales or use tax on to anyone else as a tax in those instances. Rather, it should take the amount of tax liability into consideration, like other expenses, when bidding for jobs.

At the conclusion of the prior audit, the Department advised the Taxpayer by letter dated February 10, 2003 (copy enclosed) of the following:
    • We have enclosed "Table A, Areas of Tax Liability" to help explain the major areas of tax liability identified during the audit. The table includes a list of categories where we identified audit issues and the corresponding Virginia Sales Tax Regulation or Code of Virginia section that relates to the particular category. The table also provides an explanation to help you with future compliance in these areas. If you have any questions or need assistance in any of these areas, please call [the auditor].

Of relevant importance, Table A noted above references the real property contractor regulation at Title 23 VAC 10-210-410 and the contractor statute at Va. Code § 58.1-610. The table specifically explains that a contractor respecting real estate is the final consumer of tangible personal property that loses its identity as tangible personal property and becomes real property.

As a result, the Taxpayer was advised to correct its tax treatment of real property service transactions. The first corrective step was to begin paying sales tax charged by its vendors on equipment to be affixed to realty (or remit and report consumer use tax to the Department on such items when not taxed by the vendor). The second corrective step was to cease charging and collecting the sales tax from its customers when equipment was affixed to realty.

Although the Taxpayer took the first corrective step, I understand that it failed to take the second corrective step. That is, the Taxpayer continued in the current audit period to separately charge and collect sales tax with respect to certain installed HVAC equipment. I also understand that the Taxpayer failed to report and remit the erroneously collected sales tax to the Department.

In the prior audit, the Taxpayer was given prospective compliance to allow the Taxpayer to correct its compliance for the future. For this reason and because it was a first audit situation, the Department applied a credit for erroneous sales tax collected and remitted against the consumer use tax liability owed. To provide the Taxpayer a credit as requested in this audit is clearly not warranted because the Taxpayer failed to abide by the verbal and written instructions provided as a result of the prior audit, and did not comply with the applicable statute and regulation for the current audit period.

The only remedy for the Taxpayer's situation is found in Va. Code § 58.1-625, which sets out the following:
    • Any dealer collecting the sales or use tax on transactions exempt or not taxable under this chapter shall transmit to the Tax Commissioner such erroneously or illegally collected tax unless or until he can affirmatively show that the tax has since been refunded to the purchaser or credited to his account.

Accordingly, the Taxpayer must pay the assessed sales tax or issue a refund to each of its affected customers for the audit period within a reasonable time frame. If any of the affected customers cannot be located or are out of business, then the Taxpayer has no choice but to pay the assessed sales tax to the Department. Any Taxpayer issued refund under these circumstances must be verified by the Department's auditor. Such refunds of erroneously collected sales tax occurring during the period of audit will lower the assessment dollar for dollar but may only apply to the sales tax portion of the assessment. Any resulting sales tax adjustment to the audit shall not exceed the sales tax assessment amount. Furthermore, any such customer refund is not refundable by the Department nor can it be used to otherwise offset any other sales, use or other tax liability.

The Taxpayer's complaint that it is placed at a competitive disadvantage to large retailers is without merit. The tax treatment set forth in Va. Code § 58.1-610 and Title 23 VAC 10-210-410 is proper and applies to all contractor/sellers regardless of the size of business. The Taxpayer is not allowed to charge and collect sales tax from its customers whenever it transacts to perform real property installation services for HVAC or other equipment. If the Taxpayer does not abide by this direction, then it will be held fully liable for any erroneously collected sales tax that is not remitted.

Dual Role Operator and Future Compliance

For the prior and current audit periods, the Taxpayer was registered for the collection of the retail sales tax. Because the Taxpayer made retail sales during the prior audit, the sales tax collection registration was justified and continued into the current period in case additional retail sales of tangible personal property were made.

Based on these facts and the potential for the Taxpayer to operate as a real property service contractor and seller, the provisions of Title 23 VAC 10-210-410 B would apply. Those provisions are set out as follows:
    • A person who is a using or consuming contractor, as explained in subsection A (of Title 23 VAC 10-210-410), may also be engaged in the business of selling tangible personal property to customers, including contractors, for use or consumption by them. If so, the person is a dealer with respect to such sales, and is required to obtain a Certificate of Registration.
    • After obtaining a Certificate of Registration as a dealer because he is engaged in the business of selling tangible personal property to customers for use or consumption by them, a contractor may purchase the tangible personal property under a resale exemption certificate. He may not purchase under a resale exemption certificate any tangible personal property which he knows at the time of purchase will be furnished by him in connection with any specific contract. If such a person, as a using or consuming contractor, removes from his sales inventory for use in the performance of any contract any tangible personal property purchased under a resale certificate, he must include the cost to him of such tangible personal property on his dealer's return and pay the tax. [Insert and emphasis added.]

The general intent of this regulation is to allow the resale exemption to contractor/sellers when they make bulk purchases of tangible personal property and do not know at the time of purchase whether the property will be sold at retail or used by them. The regulation also prohibits the resale exemption when a contractor/seller buys tangible personal property to furnish to a specific customer for the purpose of affixing it to the realty. In such instances, the contractor/seller knows at the time of purchase that it will be the ultimate taxable consumer of the equipment.

For the future, the Taxpayer is expected to continue paying the tax on its purchases when buying on a job-to-job basis. In contrast, it may use the resale exemption when it buys HVAC equipment on a bulk basis and remains registered with the Department for the collection and remittance of the retail sales tax. When resale inventory is withdrawn for use in real property installations, the Taxpayer must report and remit the consumer use tax on HVAC equipment and any other tangible personal property.

Sample

A one month sample of invoices was reviewed to determine whether the Taxpayer erroneously charged and collected sales tax on transactions for real property services. Based on a review of that month's invoices, the auditor found several instances in which sales tax was erroneously stated on invoices or work orders given to customers for real property service transactions. Having employed multiple independent installers, the Taxpayer contends that the sample is flawed because it contains invoices from only one installer and is not valid under any statistical sampling rules.

A review of the contested sales exceptions list for the audit report shows that the sales sample consists of transactions completed by two independent installers and the Taxpayer's owner. These three parties were the only ones issuing invoices during the sample month based on the auditor's review of the invoices occurring in the sample month. Pursuant to Va. Code § 58.1-205 1, the Taxpayer has the burden of proving that the sample is flawed. Absent evidence that the sample is flawed, I find no basis in the Taxpayer's claim.

Tax Liability of Independent Contractor

The Taxpayer contends that any sales tax collected by the independent installers cannot be assessed to the Taxpayer but should be collected from the installer that collected it. According to the auditor, the following occurred:
    • Customers placed their order with the Taxpayer;
      Installers used vehicles with the Taxpayer's emblems;
      Installers presented the Taxpayer's invoice to the customers;
      Customer payments were made to the Taxpayer;
      The payment revenue was deposited into the Taxpayer's bank account; and
      The Taxpayer reported this revenue on its federal tax returns.

These actions demonstrate that the installers represented the Taxpayer and were not independently hired by the customers to perform the work. Furthermore, the Taxpayer purchased the HVAC equipment that was installed. According to the work orders presented, the Taxpayer retains title to all equipment and materials furnished until final payment has been made. The order further states that the Taxpayer will remove the equipment if the payment is not made as agreed. Further, based on the descriptions set out in the order, it is the Taxpayer that contracts with the customer for the installation of the equipment. Because the transaction is a contract between the Taxpayer and its customer, the Taxpayer is the general contractor in these transactions and is ultimately liable for the tax on the installed equipment. As such, I find no basis for holding the independent installers liable for any of the tax at issue.

Fraud Penalty

Virginia Code § 58.1-635 provides for two compliance penalties: (1) 50% fraud penalty and (2) 30% non-fraud penalty. In regard to fraud penalty, Va. Code § 58.1-635 B states, "It shall be prima facie evidence of intent to defraud the Commonwealth of any tax due under this chapter when any dealer reports his gross sales, gross proceeds or cost price, as the case may be, at fifty percent or less of the actual amount." The non-fraud penalty is generally applied when the Taxpayer does not meet the minimum prescribed compliance ratios. See Title 23 VAC 10-210-2032 A 2.

Based on the gross sales shown on the Tax Return Summary of the audit report and the sales tax compliance ratio of 76% computed in the audit, the sales reported to the Department per these documents exceed fifty percent of the actual amount of gross sales. According to the auditor, the compliance ratio is based on the gross sales reported on the Taxpayer's federal corporate income tax returns because the Taxpayer had not reported any gross sales. As a result, the computed compliance ratio is greatly inflated and does not provide the prima facie evidence necessary under Va. Code § 58.1-635. Accordingly; I will reduce the penalty from a 50% fraud penalty to a 30% non-fraud penalty because the Taxpayer's sales tax compliance is well below the acceptable level of compliance for a second audit.

Amnesty Penalty

The Taxpayer contends that no amnesty penalty is justified without fraud penalty or any penalty. Virginia Code § 58.1-1840.1 F 1 provides that "[i]f any taxpayer eligible for amnesty under this section and under the rules and guidelines established by the Tax Commissioner retains any outstanding balance after the close of the Virginia Tax Amnesty Program because of the nonpayment, underpayment, nonreporting or underreporting of any tax liability eligible for relief under the Virginia Tax Amnesty Program, then such balance shall be subject to a 20 percent penalty on the unpaid tax. This penalty is in addition to all other penalties that may apply to the taxpayer." Because the 30% non-fraud compliance penalty applies, the 20% amnesty penalty applies to the first five periods of the audit as originally assessed.

Request for Audit Information

You request copies of all audit work papers and all supporting documents, including all memos, exhibits, and witness interviews. You also request an explanation of the auditing method and to participate in a post-audit conference. Shortly after receiving your appeal, I understand that the Department's auditor sent you the requested documentation. I also understand that the auditor discussed the audit methodology with you and that both of you agreed that a meeting was not necessary. As such, I do not find it necessary to address this issue further.

CONCLUSION


The assessment will be revised in accordance with this determination. A revised bill, with interest accrued to date, will be sent to the Taxpayer. The outstanding balance should be paid within 30 days of the bill date to avoid additional interest charges. 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 concerning payment of the assessment, you may contact ***** at *****.

The auditor will contact you soon concerning whether the Taxpayer will refund its customers any of the erroneously collected sales tax. If so, collection action will be suspended for a period not to exceed 120 days from the date of this determination. At or before the end of that period, the audit will be revised, if warranted, and a revised bill will be issued to the Taxpayer.

The Code of Virginia and regulation sections 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 Tax Policy, Appeals and Rulings, at *****.
                • Sincerely,

                • Janie E. Bowen
                  Tax Commissioner




AR/1-1381264179.R

Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46