Tax Type
Consumer Use Tax
Retail Sales and Use Tax
Description
Consumer use tax assessed on untaxed purchases of tangible personal property
Topic
Credits
Internet Sales
Records/Returns/Payments
Date Issued
05-09-2012
May 9, 2012
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 April 2007 through March 2010. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is a telephone company. As a result of an audit, consumer use tax was assessed on untaxed purchases of tangible personal property held as taxable.
The Taxpayer contests the tax assessed on purchases from ***** (the “Supplier"). The Taxpayer contends that such transactions are for repair services because equipment is shipped to the Supplier for repair and then returned to the Taxpayer. As such, the Taxpayer maintains that the charges are exempted by Va. Code § 58.1-609.5 1.
The Taxpayer also requests a credit against the audit liability for the payment of sales tax to vendors and use tax remitted by the Taxpayer on Internet service provider equipment claimed as exempt from the tax pursuant to Va. Code § 58.1-609.6 2.
DETERMINATION
Virginia Code § 58.1-205 1 provides that any tax assessment issued by the Department is deemed prima facie correct. This means that the burden of proving that the tax does not apply is upon the Taxpayer. For submissions to the court, Va. Code § 58.1-1825 D also places the burden of proof upon the Taxpayer to show that an assessment complained of is erroneous or otherwise improper.
Repair Services
Virginia Code § 58.1-609.5 1 provides an exemption from the retail sales and use tax for "services rendered by repairmen for which a separate charge is made." Virginia Code § 58.1-609.5 2 also provides an exemption from the retail sales and use tax for "an amount separately charged for labor or services rendered in . . . repairing property sold." In either instance, the implication is that the charge for the repair services must be separately stated from the tangible personal property sold for the exemption to apply.
I would also note that the above exemptions are incorporated in the Department's longstanding regulation on repair businesses. Subsection A of Title 23 Virginia Administrative Code (VAC) 10-210-3050 sets out the following:
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- Any person engaged in the business of repairing tangible personal property is required to register and to collect and pay the tax. If the dealer performing the repair work does not separately state, itemize or segregate at a fixed or retail price, the parts, materials and supplies sold, the tax will apply to the total charge including repair labor.
In this case, the documentation presented does not convincingly support the Taxpayer's contention that the contested transactions are for repair services only. None of the invoices and information presented provides conclusive evidence that all defective equipment was shipped to the Supplier for repair and then returned to the Taxpayer. On the contrary, all of the contested invoices charge for a product, i.e., tangible personal property. There is no indication on the invoices that the transactions included repair services (i.e., with the repair service labor charge separately stated on the invoice as required by the statute) or that the invoices were for repair services only.
Moreover, the Supplier does not indicate whether the defective equipment was returned to the Taxpayer immediately upon its repair or was retained by the Supplier as a spare for future use. While indicating that either negligible or no components were provided in connection with the contested invoices, the Supplier does not address whether its contractual obligation to provide advanced replacements of equipment was carried out with any of the transactions held in the audit. While the Supplier claims that repair services were provided with little or no replacement parts, the repair agreement between the Taxpayer and the Supplier allows for the Supplier's provision of replacement products in advance, the repair of defective parts, and the retention of such repaired parts by the Supplier until needed to fulfill another order from the Taxpayer. This advance replacement process seems especially likely regarding several transactions held in the audit, including, for example, the following:
- Page 35 of the training manual that is incorporated into the contract order indicates that materials with a monetary value of $100 or less are not eligible for the one-stop repair program and should not be sent in for repair. It further states that exceptions will be reviewed on a case by case basis, i.e., line cards. There are a number of transactions with card charges for less than $100, such as DMS-100 line cards, MX2800 mux card, channel cards and quad line cards. The documentation presented for these transactions does not indicate that the same serial numbered card was returned to the Supplier, repaired, and then returned to the Taxpayer for immediate use. Instead, the Taxpayer's records indicate that a charge for a product without any repair service charges. The Supplier also indicates that no component costs are associated with these cards. Because of their low cost, these cards may have been impractical to repair. Accordingly, it appears that the cards were replaced rather than repaired and returned for immediate use. Unless the Taxpayer has convincing evidence that the same serial numbered cards (that became defective) were returned to the Taxpayer for immediate use and no replacement card was obtained from the Supplier, line items 11, 68, 95, 105, 106, and 111 - 113 of the purchase exceptions list will remain in the audit.
- While none of the line cards, channel cards, quad cards or the mux card had any component cost associated with them, the same is mostly true with other charges for less than $100.00. Although there are some instances of component costs associated with charges for less than $100.00, it appears based on the contract order that a replacement product was provided.
- When an emergency advance replacement product is needed on the same day or overnight basis, Exhibit B of the contract order dated July 1, 2008 indicates that an emergency freight fee of $50.00 will apply. In these instances, the Taxpayer receives a replacement product instead of the same serial numbered repaired product. A sale of tangible personal property occurs in these instances because tangible personal property is transferred for a consideration. The $50.00 fees are associated with invoices for line items 5, 7 - 9, 17 - 19, 27, 40, 51, 52, 56, 70, 72 - 76, 89, 94, and 123 of the purchase exceptions list.
- Clause 3.5 of Exhibit A to the contract order pertains to items not economical to repair (NER). In such instances, the Supplier will charge the Taxpayer for replacement of NER equipment. In the audit, there are several instances in which the invoices indicate "replacement" in the description section of the invoice. See the invoices for line items 14, 22, 42, 59, 61, 82, and 92 of the purchase exceptions list.
- Several invoices have the comment "scrap" in the tracking number. As such, this comment would appear to imply that the defective product was scrapped and a replacement part was furnished. These invoices are associated with line items 53, 54, and 77 - 79 of the purchases exceptions list.
- One invoice has the comment "not repairable." Such comment would appear to imply that the defective product was scrapped and that a replacement part was furnished. See the invoice for line item 39 of the purchases exceptions list.
- The description area of one invoice indicates that it "replaces the NT6X3." See line item 87 of the purchases exceptions list.
In addition, the term "product" is defined in Exhibit A of the contract order to include "(i) equipment shipped from (the Taxpayer) to Supplier for repair and (ii) repaired or replacement equipment shipped to (the Taxpayer) by Supplier." [Insert and emphasis added.] Thus, although a defective product may be repaired, the Supplier will either return the repaired item or send a replacement product.
The Supplier also does not indicate whether or not any of the defective products were deemed habitually failing units as addressed in clause 3.4.1 of Exhibit A to the contract order. According to such contract clause, a habitually failing unit is replaced with a like product and the original product is retired from service. Such a transfer would represent a taxable sale when a charge is also made. The Supplier does not indicate whether any of the contested items qualified as this type of replacement.
In claiming that the contested transactions are primarily for repair services, I note that repair costs do not fluctuate in many instances. For example, standard charges appear to have been applied in the following instances:
- $30.00 for DMS-100 line cards,
- $31.85 for central office channel cards,
- $150.15 or $234.00 for equipment described as R-POTS,
- $86.45 for quad line cards, repeaters, or power supply/alarm equipment,
- $150.00 for R-PSU, ADSL 6 + 6 H, or DCU207B equipment,
- $386.75 for timing equipment,
- $77.35 for NIU-PM equipment,
- $113.75 for DCU 33, TRU1B, ADU, QCU6OD, or LM converter equipment,
- $28.67 for channel units,
- $29.12 for ISDN 2B1Q U-Interface CP equipment,
- $68.25 for DCU-20E SP MTS-R equipment,
- $75.00 for 16 PRT units, and
- $17.29 for line card remote terminals.
Generally, I would expect the cost of repairs to fluctuate depending upon the nature of the defect, the components replaced or repaired, and the extent of repair labor needed. However, none of the charges for the above items show any fluctuations in pricing from one repair job to the next. For this reason, it is questionable whether any repairs were performed on these items. That is, the pricing of the contested transactions do not appear to be indicative of transactions for repair services. Rather, these transactions appear more indicative of sales of tangible personal property (i.e., the provision of a replacement product) because of the standard or fixed pricing used.
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- Virginia Code § 58.1-602 defines the term "sale" as follows:
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- Sale means any transfer of title or possession, or both, exchange, barter, lease or rental, conditional or otherwise, in any manner or by any means whatsoever, of tangible personal property and any rendition of a taxable service for a consideration . . . .
None of the invoices and other information provided indicates the type of repairs provided or satisfactorily describes the Supplier's billing process. Rather, in the absence of convincing proof to the contrary and because the contested invoices are structured only as transfers of tangible personal property for a consideration at a discounted or list price, all indications are that sales of tangible personal property occurred as defined by Va. Code § 58.1-602. Because the Taxpayer has not established with convincing evidence that only the standard repair process (i.e., the defective article is repaired and returned immediately to the Taxpayer upon completion of the repair and no advanced replacement product is provided) was performed for all of the contested items, I must conclude that replacement products were advanced to the Taxpayer and that such replacement products were used instead of the same serial-numbered item that became defective. Accordingly, the contested transactions will remain in the audit.
I will reconsider this issue only if the Taxpayer has additional documentary evidence that convincingly establishes that no replacement products (e.g., like-for-like exchanges, emergency advanced replacements, advanced replacements, or other instances in which defective products are replaced with new, used or refurbished products) were provided by the Supplier for some or all of the contested purchases.
Credit/Refund Claim for Internet Service Equipment
Pursuant to Va. Code § 58.1-609.6 2, telephone common carriers who use an open video system are exempt from the retail sales and use tax on broadcasting equipment, parts and accessories thereto, and towers. The exemption also extends to amplification, transmission and distribution equipment used or to be used by open video systems provided by telephone common carriers. Virginia Code § 58.1-602 defines amplification, transmission and distribution equipment as "production, distribution, and other equipment used to provide Internet-access services, such as computer and communications equipment and software used for storing, processing and retrieving end-user subscribers' requests." Virginia Code § 58.1-602 also defines other terms that are pertinent to this exemption. For instance, the phrase "open video system" is defined to include "Internet service regardless of whether the provider of such service is also a telephone common carrier." The phrase "Internet service" is defined as "a service that enables users to access proprietary and other content, information electronic mail, and the Internet as part of a package of services sold to end-user subscribers." Thus, to qualify for the Internet service exemption, a telephone common carrier providing an open video system must provide the three specific Internet services noted in the statutory definition, i.e., it must provide access to proprietary and other content, information electronic mail, and the Internet to end-user subscribers. According to the auditor, the Taxpayer is a provider of such Internet services.
Issue 1
The Taxpayer notes that the audit lacks credits for the erroneous payment of sales or use tax on purchases of exempt Internet equipment. The Taxpayer presents a spreadsheet claiming that certain equipment qualifies for the Internet service exemption and that sales or use tax erroneously paid on such equipment should be credited against the assessment. The information provided, however, is inadequate to allow an exemption for the specific items listed. Furthermore, no documentation has been provided in support of the Taxpayer's refund/credit claim.
The Taxpayer's 24-page spreadsheet is organized in columns listing the vendor names, voucher ID's, invoice dates, merchandise amounts, freight amounts, use tax amounts, sales tax amounts, monetary amounts, descriptions, a taxable or exempt designation, refund percentages, and total amounts. In the description's column, equipment part numbers are shown (some with the manufacturer's name). In many instances, only a number is indicated. The Taxpayer does not explain the exact reason for why the Internet service exemption should apply for each item of equipment at issue.
For instance, the description on the first line of the Taxpayer's spreadsheet is given as "Pedestal CPLM 6IN Magnum Non-M." At the top of the second page of the spreadsheet, a piece of equipment is described as "09-116-02." At the bottom of page three of the spreadsheet, equipment is described as "Cisco 7609S Chassis, 9-slot, Red." These do not explain the type or kind of equipment, how the equipment is used, or whether used for exempt purposes. On page seven of the refund request, an item is described as "48 V PVC battery system." While batteries could be used in exempt applications, the Taxpayer has not described how this particular battery is used or how it may qualify for exemption. There are other arbitrary entries described as "resource and arbitration process" but no explanation is offered on how equipment used in such process would qualify for the exemption. The descriptions "AMP administration and maintenance," "Contract," "Deferred Sales Tax," "Eng or Engineering," "Hardware Management Discount," "Factory Shipping," "LABI," "Installation," "TX Charlottesville VA," other Virginia locations, and entries with only an individual's name are also ambiguous descriptions and very possibly have no relation to the Internet service exemption.
I would also note that the first two pages of the Taxpayer's spreadsheet claims that the taxable usage is 50% but the Taxpayer fails to provide any explanation on how it derived such a percentage or any documentary evidence to support its claim.
Issue 2
In several instances, the Taxpayer contends that the requested credits are for the same equipment the auditor reviewed and found eligible for the exemption. The only reason to include such equipment in the audit would be if it was used in a taxable activity and no or insufficient sales or use tax had been paid. It is my understanding that these items were included in the audit because it was not possible for the auditor to verify the specific usage of these untaxed items. When the Taxpayer's engineer explained that these specific items were used in the provision of Internet services, the auditor removed them from the audit.
Such removal action does not automatically extend to other similar items because the Taxpayer's business involves multiple operations in which equipment may be used in either taxable activities (telecommunications) or exempt activities (Internet services) or in both. For instance, it is my understanding that the Taxpayer uses DSL equipment that can be used simultaneously in the provision of Internet and telecommunications services, could be used solely for one service or the other, or could be used for other purposes. For these reasons, a claim that similar equipment that has been taxed but used in exempt activities must be verified by the auditor.
The Department is obligated to follow the rule of strict construction set out by the courts for exemptions from the sales or use tax. In this regard, the courts have held that the tax is the rule, and exemption is the exception. Thus, where there is any doubt, the doubt is resolved against the one claiming the exemption. Golden Skillet Corp. v. Commonwealth, 214 Va. 276, 199 S.E.2d 511 (1973). Because the equipment usage and tax payment information is lacking in this case, it is not possible to determine whether any of the equipment at issue was used in the provision of Internet services or whether all of the tax was paid as claimed. Because these circumstances raise a serious doubt as to whether the exemption applies to the specific equipment at issue, I must resolve the doubt against the Taxpayer. For these reasons and the fact that the Taxpayer has not met its burden of proof, your request for credit or refund is denied.
Additional Documentation Required
I will give the Taxpayer an opportunity to provide additional documentation to support (a) its contention that it has erroneously remitted tax on the equipment at issue and (b) the exact usage made by the Taxpayer of such equipment. It is not enough to claim that equipment is used in Internet services. Rather, the Taxpayer must establish through documentary evidence and testimony of its engineers how the equipment enables end-user subscribers to access the Internet services defined in Va. Code § 58.1-602 and how such equipment is used to store, process and retrieve end-user subscribers' requests. Furthermore, the tax on equipment used in both taxable and exempt activities must be prorated based on the amount of time used in exempt activities. The Taxpayer must identify such dual-use equipment and indicate how it computed the percentage of exempt usage.
Examples of additional documentation and information required include:
- Non-technical descriptions for each piece of equipment.
- Layman's explanations of the usage made of each piece of equipment and how each piece of equipment at issue is used in Internet service activities.
- Documentary evidence that Virginia sales tax was actually paid to vendors in which the sales invoice charges a Virginia sales tax.
- Documentary evidence that Virginia use tax was remitted to the Department for claimed exempt items that were not taxed by the vendors or were taxed by the vendors but the Taxpayer failed to pay the sales tax to the vendors.
- Copies of invoices (and related purchase orders) for items claimed as part of this refund.
- Internal accounting records indicating where each item was used.
- Any other necessary evidence and information required by the auditor.
Additional documentation provided by the Taxpayer will be reviewed by the Department's auditor. If it is determined that the Taxpayer erroneously paid tax on the equipment at issue and has adequately supported its claim for exemption, the Taxpayer will be given a credit against the audit assessment, provided the sales tax has not already been refunded and further provided that the Taxpayer certifies in writing to the auditor that it has not and will not seek a tax refund from its vendors in regard to the specific items in question. I would note that a credit for the sales tax paid to vendors must be reduced by the dealer's discount taken. See Title 23 VAC 10-210-3040.
A tour of the Taxpayer's facility would aid in the auditor's verification of equipment usage. I understand that such a tour was previously requested by the auditor but was denied. If there is a federal security clearance issue, the Department does have a classified contract agent, i.e., an auditor with federal security clearance. If such agent is needed to conduct such a tour, the Department can arrange for such agent to tour the Taxpayer's facility and assist the current auditor in the resolution of this matter. The auditor will be contacting you to make such arrangements, or if not needed, to determine whether the Taxpayer will now permit the auditor to tour its facility.
CONCLUSION
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- Based on this determination, the assessment is correct. An updated bill, with
Please note that failure to remit full payment within the 30-day period may result in the imposition of an additional 20% penalty on the tax due under the terms of Virginia's Amnesty Program. See the enclosure entitled "Important Payment Information."
Notwithstanding the above, the auditor will contact you within the 30-day period to determine whether additional documentation will be submitted for the purchase and credit issues. lf forthcoming, the auditor will arrange for the review of such documentation and will also arrange for the continued suspension of the assessment from collection actions. Such documentation should be made available or submitted to the auditor within 120 days of the date of this letter. If the documentation review warrants an adjustment to the assessment, a revised bill with interest accrued to date and a revised audit report will be mailed to the Taxpayer following the adjustment. For questions about the documentation requirements or audit revision, you may contact the auditor, ***** at *****.
The Code of Virginia sections and regulations 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 *****.
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- Sincerely,
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- Craig M. Burns
Tax Commissioner
- Craig M. Burns
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AR/1-4713843770.R
Rulings of the Tax Commissioner