June 6, 2018
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This will reply to your letter in which you seek the correction of retail sales and use tax assessments issued to ***** (the “Taxpayer”) for the period August 2012 through July 2015. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer operates a division that sells, installs and rents audiovisual systems and equipment. The Department audited the Taxpayer and assessed the retail sales tax on untaxed charges billed for various services that were provided with the sale of audiovisual systems. The Taxpayer contests the tax assessment on the services, which it contends are exempt from the sales and use tax. The Taxpayer maintains that an untaxed rental charge for a sound system was assessed in error. The Taxpayer also disputes the sales sample methodology used in the audit on the basis that the sample results are not representative of the audit period.
DETERMINATION
The contested transactions in the Taxpayer's appeal will be addressed following a discussion of the applicable statutes, regulations and the Department's policy that form the basis of the Taxpayer's appeal and this determination.
True Object Test
The Taxpayer states that many of the contested services have a high degree of customization, uniqueness and specificity that meet the necessary criteria to be classified as exempt services pursuant to Title 23 of the Virginia Administrative Code (VAC) 10-210-4040. Title 23 VAC 10-210-4040 addresses the application of the tax to mixed transactions that include the sale of tangible personal property and services. A true object test is used to determine the taxability of these types of transactions. Title 23 VAC 10-210-4040 D states that:
In order to determine whether a particular transaction which involves both the rendering of a service and the provision of tangible personal property constitutes an exempt service or a taxable retail sale, the “true object” of the transaction must be examined. If the object of the transaction is to secure a service and the tangible personal property which is transferred to the customer is not critical to the transaction, then the transaction may constitute an exempt service. However, if the object of the transaction is to secure the property which it produces, then the entire charge, including the charge for any services provided, is taxable. [Emphasis added.]
Based on the information provided, I agree that certain of the Taxpayer's services do have a high degree of customization, uniqueness and specificity. However, in the instant case, the audiovisual systems and equipment are the true object of the contested sales transactions. The services provided by the Taxpayer are of no value to customers without a tangible audiovisual system. Generally, any charges for labor or services that are related to the sale of an audiovisual system become part of the taxable sales price of the system. These same services are exempt from the tax pursuant to the true object test when provided without the sale of an audiovisual system or other tangible personal property.
Sales Price
During the audit period, the Taxpayer charged the sales tax on the price of the tangible personal property, i.e., the audiovisual systems and equipment, sold to its customers. In addition, the Taxpayer billed customers separately stated charges for various services related to the sale of the systems and equipment. There was no sales tax billed on the charges for these services. The auditor assessed the retail sales tax on the untaxed charges because the services were provided in connection with taxable sales of tangible personal property.
Virginia Code § 58.1-603 imposes the Virginia retail sales tax upon “every person who engages in the business of selling at retail or distributing tangible personal property in this Commonwealth....” The tax is computed on the gross sales price of tangible personal property and services that are expressly stated as taxable under Virginia law. “Sales price” is defined in Virginia Code § 58.1-602 as “the total amount for which tangible personal property or services are sold, including any services that are a part of the sale, ... without any deduction therefrom on account of the cost of the property sold, the cost of materials used, labor or service costs, losses or any other expenses whatsoever.” [Emphasis added.]
Absent a statutory exemption in the Code of Virginia, labor or service charges are taxable when billed in connection with the sale of tangible personal property. A sales transaction that includes charges for tangible personal property and for related services is taxable on the full amount of the sale, even if the services are separately stated on the sales record. This treatment is consistent with the application of the true object test.
The Code of Virginia provides exemptions for specific types of services. The exemption statutes typically require that the charges for exempt services be separately stated on the record of the sale. The charges are then properly excluded from the taxable sales price of property sold in connection with the service. For example, Virginia Code § 58.1-609.5 2, which is cited in the Taxpayer's appeal, provides an exemption from the sales and use tax for “[a]n amount separately charged for labor or services rendered in installing, applying, remodeling or repairing property sold.” The Taxpayer also cites in its appeal Public Documents (P.D.) 09-117 (7/31/09) and 11-127 (7/6/11), both of which address the Department's policy with respect to exempt installation charges.
Strict Construction of Exemptions
The Virginia courts have consistently required the strict construction of sales and use tax exemptions. Based on this principle, if there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption. See Commonwealth v. Community Motor Bus, 214 Va. 155, 198 S.E.2d 619 (1973). In addition, Virginia Code § 58.1-205 1 states that “[a]ny assessment of a tax by the Department shall be deemed prima facie correct.” This means that the burden is on taxpayers to prove that an assessment issued by the Department is incorrect.
Keeping the cited authorities in mind, I will address the contested services as set out in the Taxpayer's appeal letter by reference to the exception numbers in the audit report.
Exception Numbers 2, 9 and 16
The Taxpayer states that these audit exceptions are programming charges for the creation of code that controls the systems and subsystems of an audiovisual system. The Taxpayer customizes each audiovisual system to account for room size, time zones, schedules, audio environment and other needs of the customer. The Taxpayer creates specific engineering documentation (addressed as “Exception #s 3 and 10”) for each system. The documentation is provided to a subcontractor that writes the program code that will control the audiovisual system.
Virginia Code § 58.1-609.5 7 provides an exemption from the tax for “[c]ustom programs as defined in § 58.1-602.” A “custom program” is defined in Virginia Code § 58.1-602 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.” The Taxpayer states that the programming services are specifically designed and developed based on the specific needs of each customer. If this is the case, the programming meets the criteria of a custom program and the exemption applies.
Before the contested programming charges can be removed from the audit, it is necessary to verify that the services at issue are custom programming. The Taxpayer must provide sufficient evidence that the charges are for programming that is customized for each customer. For this reason, the Taxpayer should provide documentation to the Department that establishes the customized nature of the programming. The documentation may include work or purchase orders, contracts, detailed billings or invoices from the subcontractor, a breakdown of the programming hours for each transaction or similar information. The audit will be adjusted as appropriate to remove the programming charges based on the Department's review of this information.
Exception Numbers 3 and 10
The Taxpayer describes these contested transactions as labor costs associated with developing the design for a custom audiovisual system. Engineering and signal flow diagrams are produced and provided to a subcontractor that uses the information to create program code that is specific to the audiovisual system to be sold. (See the previous discussion of exception #s 2, 9 and 16.) The Taxpayer maintains that exception #s 3 and 10 are exempt installation labor and cites Virginia Code § 58.1-609.5 2, P.D. 09-117 and P.D. 11-127 as support for the removal of these items from the audit.
P.D. 12-70 (5/3/12) discusses a sign business that disputed an audit assessment on charges for permits and site surveys that were billed to customers with the sale of signs. The sign business maintained the charges should be treated as exempt installation charges. The Tax Commissioner, citing the strict construction rule for exemptions set out in Commonwealth v. Community Motor Bus, determined that the permit and survey charges did not qualify as exempt installation services because the activities were preparatory to and occurred before the actual installation of the signs that were sold. The design and creation of the engineering and signal flow diagrams is also an activity that occurs prior to the actual installation of an audiovisual system.
In accordance with the rule of strict construction of exemptions, the labor costs for the engineering and signal flow diagrams are not exempt installation labor. There is no other statutory exemption for this type of service. While the engineering and signal flow diagrams may be customized and unique to the system sold to each customer, the charges for these activities are billed in connection with the sale of the audiovisual system. Pursuant to the definition of sales price in Virginia Code § 58.1-602, the contested charges become part of the taxable sales price of the audiovisual system. As such, exception #s 3 and 10 will remain in the audit.
I note the Taxpayer's appeal states that P.D. 11-127 provides that the design and building of audiovisual systems constitutes exempt installation labor. This conclusion is not correct. P.D. 11-127 merely states that certain contested invoice line items were installation labor and would be removed from the taxpayer's audit. The determination letter does not state that the design and building of audiovisual systems is exempt installation labor. The Department has issued numerous public documents that state charges for the design, building or assembly of tangible personal property are taxable when billed in connection with the sale of that tangible personal property. For example, see P.D. 98-26 (3/13/98) and P.D. 96-88 (5/14/96).
Exception Numbers 4 and 11
These contested charges are described on the Taxpayer's sales invoices as “Patch holes, fire caulking, hole cut in table, grommet install.” The Taxpayer maintains that the charges are labor costs related to the installation of audiovisual systems and are exempt pursuant to Virginia Code § 58.1-609.5 2 and Title 23 VAC 10-210-4040.
Based on information provided by the Taxpayer, some jobs that involve the removal or installation of an audiovisual system may cause minor damage to the building or structure. The patching of holes and the application of fire caulking are repairs to correct the damage. Some of the repairs appear be made with respect to real property, as well. Holes are cut or drilled in furniture, ceilings, floors and walls to install wiring and cabling for an audiovisual system. Grommets are placed in the holes for the wiring and cabling. The labor to drill or cut holes and the placement of grommets in the holes is an installation activity. As described by the Taxpayer, this category of charges consists of repair and installation labor and is exempt from the tax. The contested charges will be removed from the audit.
The Taxpayer states that this invoice item may consist of one or more of the services listed in the description. If there are other services not included in the description or the Taxpayer begins to bill additional services as part of this lump sum charge, the Taxpayer should evaluate whether the additional labor or service charges qualify for an exemption. The Department's longstanding policy is that a lump sum charge that includes some taxable and exempt services is taxable on the entire charge. This is supported by the statutory requirement in the Code of Virginia that charges for exempt labor or services must be separately stated. If the lump sum charge contains taxable charges, the entire charge could be deemed taxable if the services are performed in connection with the sale of tangible personal property.
Exception Numbers 5 and 12
The Taxpayer provides a technician to manage some of its projects. Customers are given the option to have a project management technician present for the job. According to the Taxpayer, exception numbers 5 and 12 are project management charges, which are described as the labor costs to have an on-site technician take a leadership role at the job site. Multiple technicians may report to the project management technician. The Taxpayer contends that the project management charges qualify as exempt installation labor pursuant to Virginia Code § 58.1-609.5 2 and as an exempt service under Title 23 VAC 10-210-4040.
The project management services described may involve the management of technicians that perform exempt installation services. However, under the rule of strict construction, the Department recognizes the exemption only for actual installation services performed. The management by a technician of an audiovisual project is not an installation service. Given that there is no statutory exemption for project management labor and the true object of the transactions is the taxable sale of an audiovisual system, the charges for this type of labor are taxable and were properly included in the audit.
Exception Numbers 6 and 13
The transactions at issue relate to integrating and placing the audiovisual system on the client's IT network. The charges are described as the labor costs for a technician to work with the client's IT team and assist with getting an audio visual system on the client's IT network. The Taxpayer maintains that the charges qualify as exempt installation labor. In addition, the Taxpayer cites Title 23 VAC 10-210-4040 in support of its claim that the charges are for an exempt service.
In P.D. 13-119 (7/1/13), the Tax Commissioner ruled that charges billed by a computer sales and service company for setup and configuration qualified as exempt installation services. P.D. 13-119 states that certain activities that occur after the physical placement of a computer can be considered part of the installation process. The Tax Commissioner agreed that adding client ordered off-the-shelf software, transferring files from an old computer to a new computer and adjusting network connections to accept the computer hardware were properly classified as installation activities.
Based on the policy set out in P.D. 13-119, the Taxpayer's charges for integrating and placing the client's audiovisual system on a client's IT network may qualify as exempt installation charges. However, it is not clear from the description provided for this type of charge if a technician actually performs the integration activities or merely directs and assists the client's IT staff. The Taxpayer should provide additional documentation regarding the integration activities for the Department's review. If warranted, exception #s 6 and 13 will be removed from the audit based on this review.
Exception Numbers 7 and 14
Line item numbers 7 and 14 are charges for labor associated with the use of a subcontractor to create a custom graphical user interface (“GUI”) for touch panel devices. The labor costs include meeting with the client to review artwork and graphics, development of a GUI and layout for a particular audiovisual solution and the client's needs. The subcontractor provides labor to commission, or install, the GUI onto the devices used in the audio visual system. The subcontractor also creates a custom audio file specific to the room's environment and installs the file onto the digital signal processor.
The charges at issue consist of various types of labor or services. Some of the labor costs, such as client meetings, the development of a GUI and layout are not exempt from the tax. It appears that the transactions include other charges that qualify for exemption. However, in the instant case, the charges are billed together as a lump sum amount. The Department's longstanding policy is that lump sum charges are taxable on the full amount if the lump sum amounts include a mixture of taxable and exempt charges. For example, P.D. 02-60 (4/19/02) states that shipping and handling charges are taxable when billed as a lump sum amount. Shipping charges are exempt from the tax when separately stated. Based on the Department's policy, there is no basis to remove these charges from the audit.
Exception Numbers 8 and 15
Items numbers 8 and 15 are charges for client training by a technician furnished by the Taxpayer. The Taxpayer contends that the training qualifies for the installation labor exemption set out in Virginia Code § 58.1-609.5 2 and as an exempt service pursuant to Title 23 VAC 10-210-4040.
The Department's longstanding policy is that training services are exempt from the tax only if the training services are not part of a transaction for the sale of tangible personal property. The Code of Virginia does not provide a statutory exemption for training services. Further, the true object of the transactions in which training services were provided is the sale of audiovisual systems. The training is a service in connection with the sale of the audiovisual systems and is deemed to become part of the taxable sales price of the property sold.
P.D. 03-31 (4/9/03) discusses a taxpayer that made software sales and provided training services as part of the sale. Although the charges for training were separately stated on the sales invoices, the training charges were deemed to be a taxable addition to the sales price of the software. The Taxpayer's charges for training were properly assessed in the audit.
Exception Number 17
This transaction is for the rental of a sound system. The invoice contains two charges. The first charge is for the sound system rental. The second charge is listed as “[d]elivery, set up and tear down.” An additional line item on the invoice states that a complimentary stand-by AV technician is provided at no charge. The Taxpayer contends that the transaction is an exempt service because an operator was provided with the rental of the sound system.
Virginia Code § 58.1-603 imposes the sales tax on the lease or rental of tangible personal property in the Commonwealth. The tax is computed on the gross proceeds charged for the lease or rental. However, the rental of equipment with an operator is treated as an exempt service in accordance with Title 23 VAC 10-210-840 A and Title 23 VAC 10-210-4040 D.
P.D. 04-194 (10/29/04) discusses a business that rented inflatable amusement games. The business was audited by the Department and assessed the sales tax on the untaxed rental charges. The business contested the assessment on the basis that the true object of the transactions was the services performed by the operators of the amusement games. The Tax Commissioner ruled that the operator was merely an attendant who monitored the operation of and use of the games. The transactions were deemed to be taxable rentals of the inflatable amusement games rather than the provision of exempt services because the operators did not actually operate the games.
The facts of this case are similar to those in P.D. 04-194. The invoice for the contested sale states that a technician was furnished on a stand-by basis with the rental of the equipment. Neither the sales invoice nor the purchase order for the rental transaction states that the technician was responsible for operating the sound system. The second line item on the invoice suggests that the technician may have been responsible for delivery, set up and tear down of the system. Based on the Department's longstanding policy, the provision of personnel with the rental of equipment is not sufficient to consider the transaction an exempt service. The personnel must also operate the equipment for the transaction to be considered an exempt service. The audit assessment is correct with respect to this issue.
Audit Sample
The Taxpayer maintains that the audit sample of sales is not representative of the entire audit period. The auditor conducted a three-month sample of sales to determine an error factor for untaxed sales. The resulting error factor was extrapolated against gross sales for the entire audit period to determine the taxable sales measure on which the sales tax was assessed. The Taxpayer has performed a detail audit of its sales for the audit period and states that the amount of the sales tax liability calculated is significantly less than the tax liability determined by the audit sample.
Sampling is an audit technique of significant value that is widely used in both the public and private sectors. The Department uses sampling in sales and use tax audits where a detailed audit would not prove beneficial to either the auditor or the taxpayer. When sampling techniques are properly applied, the final results should be within a narrow percentage range of the actual amounts that would be determined by a detailed audit.
The Taxpayer has provided documentation to support its contention that the sales liability produced by the Department's sample is overstated. Based on a review of this information, the audit will be referred to the audit staff to review and verify the Taxpayer's calculations. The audit will be revised accordingly.
CONCLUSION
The audit will be returned to the audit staff for revision. Exception numbers 4 and 11 will be removed from the audit. The Taxpayer should be prepared to provide documentation for review by the auditor that supports the removal from the audit of exception numbers 2, 6, 9, 13 and 16. In addition, the Taxpayer's sales documentation will be reviewed to determine if the Taxpayer's calculation of the tax liability based on a detailed review of sales is acceptable. Alternatively, the audit sample may be expanded to facilitate the review, if both parties agree to do so.
The Department's records indicate the Taxpayer has paid the audit assessments issued as Bill Number ***** and Bill Number ***** in full. After revision of the audit and the resulting liability is adjusted, refunds of the bill overpayments, with applicable interest, will be issued to the Taxpayer as soon as practicable.
The Code of Virginia sections, regulations and public documents cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions concerning this determination, please contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1092.S