Rulings of the Tax Commissioner

April 8, 2019

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

Dear *****:

This will reply to your letter in which you seek a ruling regarding the application of the retail sales and use tax to software support transactions. This ruling request is a result of the Department’s denial of a refund request for consumer use taxes paid by ***** (the “Taxpayer”) for reporting periods from January 2011 through December 2013. Pursuant to Virginia Code § 58.1-1823, the denial of a refund is deemed to be an assessment for the purpose of allowing taxpayers to seek an administrative remedy. As such, the Taxpayer’s request has been treated as an administrative appeal pursuant to Virginia Code 58.1-1821. The Taxpayer has also submitted additional refund claims for reporting periods from January 2014 through July 2015. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a Virginia subsidiary of a parent corporation (the “Parent”) that is headquartered outside the state of Virginia. The Parent purchased software from an out-of-state vendor and took delivery of the software outside the state of Virginia. The Parent also purchased from the same vendor a support and maintenance agreement for the software. The use of the software and the support and maintenance for the software is shared by the Parent, the Taxpayer and other subsidiaries. The software vendor bills the Parent on a quarterly basis for the software support and maintenance. The Parent bills each subsidiary a prorated share of the cost for the software support and maintenance. The Taxpayer has accrued and paid Virginia use tax on its share of the quarterly charges billed by and paid to the Parent for the software support and maintenance. 

Based on a review of its use tax filing records, the Taxpayer determined that consumer use taxes were paid in error on various purchases that occurred during the period of January 2011 through December 2013. As a result, the Taxpayer filed a refund request with the Department to recover the taxes paid in error. The consumer use taxes accrued and paid to the Department on the quarterly software support amounts billed by and paid to the Parent were included in the refund request.

The Department’s audit staff reviewed the refund request and issued the Taxpayer a refund of the overpaid use taxes. The audit staff concluded, however, that there was insufficient information to determine that the software support charges paid to the Parent were exempt from the tax, and that the use tax paid on the charges should be refunded to the Taxpayer. 

As a result, the Taxpayer requests a ruling from the Department regarding the taxability of the software maintenance and support agreement charges billed by the Parent to the Taxpayer. The Taxpayer states that the software support transactions at issue are solely with the Parent. The Taxpayer did not contract with or otherwise engage in transactions with the software company that provides the software maintenance and support. The Parent is responsible for paying the software support charges billed by the software vendor. The Taxpayer further states that the software support charges are for an exempt service because the software support is received electronically. Further, the Taxpayer notes that the quarterly payments include its prorated share of a value added tax (“VAT”) that the software vendor bills to the Parent.  

DETERMINATION

Intercompany Transactions

Virginia Code § 58.1-602 defines “sale” as “any transfer of title or possession, or both, exchange, barter, lease or rental, … in any manner or by any means whatsoever, of tangible personal property … for a consideration ….” The Department has previously ruled in several public documents that intercompany accounting entries to record transactions between related but separate entities constitute a consideration for sales and use tax purposes. As such, an exchange of tangible personal property for a consideration between two related entities is a sale. 

Public Document (P.D.) 04-134 (9/16/04) discusses a corporate reorganization in which assets were transferred between separately incorporated subsidiaries with a common parent. The transfers were recorded as an adjustment of intercompany balances on the subsidiaries’ books. There were no direct payments of cash, exchanges of stock or lines of credit issued between the subsidiaries. The Tax Commissioner ruled that, based on the definition of “sale,” the paper or accounting entries that recorded the transfers were a consideration and the asset transfers qualified as sales that were subject to retail sales and use tax.

Based on the policy set out in P.D. 04-134 and other public documents such as P.D. 12-159 (10/12/12) and P.D. 16-84 (5/17/16), there is no exemption from the sales and use tax for intercompany transactions based solely on the fact the transactions are between related entities. A transaction must meet the statutory definition of a retail sale to trigger a sales or use tax liability. A “retail sale” is defined in Virginia Code § 58.1-602 as “a sale to any person for any purpose other than for resale in the form of tangible personal property or services taxable under this chapter ….” However, an intercompany transaction that is a retail sale may qualify for a statutory exemption in the Code of Virginia.

Electronic Delivery of Software

The Taxpayer maintains that all software support updates are delivered electronically. The Department’s longstanding policy is that the sale of software that is delivered electronically to customers is not a sale of tangible personal property and is generally not subject to taxation. This policy only applies in cases where there is no disc, tape or other tangible medium provided to the customer before or after the electronic download of the software. The Department’s policy applies to software updates provided electronically to customers when the original software is delivered electronically.  

In the instant case, the denial of the Taxpayer’s refund claim constitutes an assessment for purposes of seeking an administrative remedy from the Department. Pursuant to Virginia Code § 58.1-205 1, “[a]ny assessment of a tax by the Department shall be deemed prima facie correct.” As such, taxpayers have the burden of proving that an assessment is erroneous or that a refund claim is valid.

Public Document (P.D.) 05-44 (4/4/05) sets out the Department’s minimum documentation requirements for confirming the exemption for the electronic delivery of software products. P.D. 05-44 provides that “a sales invoice, contract or other sales agreement must expressly certify the electronic delivery of the software and that no tangible medium for that software has been or is to be furnished to the customer.”  

Without sufficient proof of electronic delivery, the Department must assume that software and software updates are conveyed in tangible form and constitute taxable retail sales. The basis for this policy is Virginia Code § 58.1-609.5 1, which provides an exemption from the retail sales and use tax for the electronic delivery of computer software via the Internet provided there is no exchange of tangible personal property. To satisfy the criteria of the exemption, the records of the transaction must establish both the electronic delivery of the software and that there is no exchange of tangible personal property.

I understand that a member of my staff discussed with the Taxpayer the need for additional documentation that establishes there was no transfer to the Taxpayer of tangible personal property in connection with the software support transactions. In P.D. 15-153 (7/16/15), the Tax Commissioner allowed the exemption in a case where the transactional evidence was insufficient.  Instead, the taxpayer provided vendor information and email evidence that was acceptable in conjunction with the sales invoices submitted with the appeal. In this case, I will allow the Taxpayer 45 days to provide additional documentation that the software support payments qualify for the exemption for electronically delivered software.  The evidence may include the software contract or licensing agreement, other vendor documentation or statements and documentation from the Parent that supports the Taxpayer’s refund claim.   

VAT

The Taxpayer states that the software support charges billed by the vendor to the Parent include a VAT. The Taxpayer’s share of the VAT amounts paid to the Parent were included in the taxable measure used to calculate the use taxes reported and paid to the Department. The Taxpayer questions whether a credit for the paid VAT amounts should be applied against the use tax liability reported and paid to the Department.

P.D. 00-81 (5/11/00) addresses the allowance of credits against a sales and use tax liability for a VAT paid by a taxpayer. The Tax Commissioner ruled that a credit for VAT payments is not allowable for sales and use tax purposes. P.D. 00-81 cites Virginia Code § 58.1-611, which states, in part, that “[t]he amount of the credit shall be equal to the tax paid by him to another state or political subdivision thereof by reason of the imposition of a similar tax on his purchase or use of the property.” The statute is interpreted to limit the credit to similar taxes paid to another state or a political subdivision of a state. Because the VAT was imposed by a foreign country rather than a state or political subdivision, a credit was not allowable. P.D. 00-81 also concludes that the VAT and the retail sales and use tax are not similar taxes, which is also a requirement of the credit statute.

Based on the above, the Taxpayer’s share of the VAT payments made to the Parent are not allowable as a credit against the Virginia use taxes reported and paid to the Department.

CONCLUSION

The Taxpayer will be allowed 45 days from the date of this letter to provide  documentation to the Department that supports its claim that the software support payments qualify for exemption from the tax pursuant to Virginia Code § 58.1-609 1. The Taxpayer should contact ***** in the Department’s Office of Tax Policy, Appeals and Rulings Unit, to make arrangements for the review of the information. If no additional information is provided to the Department, the Taxpayer’s refund claims will be deemed erroneous.

The Code of Virginia sections 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 website.  If you have any questions concerning this determination or the documentation request, please contact ***** at *****.

Sincerely,

Craig M. Burns
Tax Commissioner