Rulings of the Tax Commissioner

April 8, 2019

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

Dear *****:

This will reply to your letter in which you seek the correction of consumer use tax assessments issued to ***** (the “Taxpayer”) for the period March 2009 through January 2015. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer is a utilities contractor that specializes in the replacement, rehabilitation and repair of water and wastewater systems. The Taxpayer performs this work primarily for government entities, political subdivisions and sewage and water treatment authorities. The Taxpayer repairs and rehabilitates existing water and wastewater infrastructure by providing cutting edge slip lining, polymer liners and other materials that replace the need to dig and replace pipes, manholes and similar infrastructure components. 

The Department audited the Taxpayer and assessed use taxes on various untaxed purchases, including the materials used for the replacement, rehabilitation and repair of water and wastewater piping and system components. The Taxpayer contends that the purchase of the materials used to repair and rehabilitate the water and wastewater systems qualifies for the resale exemption. The Taxpayer bases this claim on a true object analysis of the contract transactions related to the work performed for its customers.  

Alternatively, the Taxpayer requests the waiver of the use tax assessments attributable to the purchases of materials used in the performance of those water and wastewater jobs that it considers to be exempt pollution control work.

DETERMINATION

Resale Exemption

The Taxpayer maintains that it is engaged in making retail sales of the materials used to repair and rehabilitate the water and wastewater systems. As such, the Taxpayer contends the purchase of the materials that the Taxpayer subsequently transfers to its customers in the performance of the contracts are sales of tangible personal property that qualify for the resale exemption.

The Taxpayer cites the true object test, which is set out in Title 23 of the Virginia Administrative Code (VAC) 10-210-4040 D, to support the contention that it is making retail sales of the materials used to repair and replace water and wastewater systems. The true object test is used to determine whether a particular sales transaction which includes both the rendering of a service and the provision of tangible personal property is an exempt service or a taxable retail sale of tangible personal property. The Taxpayer asserts that a review of the contracts performed during the period covered by the audit demonstrates that the true object of the contract transactions with government entities is the provision or sale of tangible personal property.  The purchase of the materials then qualifies for the resale exemption, and the Taxpayer’s sales of the materials to government entities are exempt pursuant to the government exemption in Virginia Code § 58.1-609.1 4.  

Virginia Code § 58.1-610 A states:

Any person who contracts orally, in writing, or by purchase order, to perform construction, reconstruction, installation, repair, or any other service with respect to real estate or fixtures thereon, and in connection therewith to furnish tangible personal property, shall be deemed to have purchased such tangible personal property for use or consumption. Any sale, distribution, or lease to or storage for such person shall be deemed a sale, distribution, or lease to or storage for the ultimate consumer and not for resale, and the dealer making the sale, distribution, or lease to or storage for such person shall be obligated to collect the tax to the extent required by this chapter. [Emphasis added.]

To determine whether tangible personal property becomes real property upon installation or remains tangible personal property after its installation, the Department relies on the Virginia Supreme Court’s ruling in Transcontinental Gas Pipe Line Corporation v. Prince William County, 210 Va. 550 (1970), which states:

Three general tests are applied in order to determine whether an item of personal property placed upon realty becomes itself realty.  They are: (1) annexation of the property to the realty, (2) adaptation to the use or purpose to which that part of the realty with which the property is connected is appropriated, and (3) the intention of the parties. The intention of the party making the annexation is the chief test to be considered ….

In this case, the court concluded that, based on the three general tests set out above, underground gas mains, pipe lines and similar equipment became part of the realty upon installation. In support of its decision, the court also cited a similar case, City of Newport News v. Warwick County, 159 Va. 571, 166 S.E. 570 (1932), in which the court ruled that a system of underground waterworks constituted real property fixtures.  

The Taxpayer does not dispute the fact that it is a utility contractor.  The Taxpayer’s business activities, a review of the contract documentation provided and the cited statute confirms that the Taxpayer is a real property contractor with respect to the replacement, rehabilitation and repair of water and wastewater systems. The court cases cited are directly on point with this conclusion. As the contested purchases relate to the performance of real property contracts, the true object test is not applicable to the transactions at issue because the Taxpayer is not making retail sales of tangible personal property. In accordance with Virginia Code § 58.1-610 A, the Taxpayer’s purchases of materials used to fulfil the water and wastewater contracts with government entities do not qualify for the resale exemption.  

The Taxpayer should note that the Department’s policy with respect to real property contractors that perform jobs pursuant to government contracts is set out, in part, in Title 23 VAC 10-210-410 J, which states that:
 
Generally, purchases of tangible personal property by contractors in connection with real property construction contracts with the governments of Virginia or the United States or political subdivisions thereof, are sales to such contractors for their own use or consumption and contractors are subject to the tax on such transactions.  This applies regardless of whether title to such property passes directly to the governmental entity upon purchase by the contractor or if the contractor is reimbursed directly by the government entity for the cost of such property.

In summary, the contested purchases were made by the Taxpayer for its use or consumption in the performance of real property contract work and do not qualify for the resale exemption.

Exemption Certificates

In support of its contention that the resale exemption applies to the contested purchases in the audit, the Taxpayer provided copies of the Department’s government exemption certificate, Form ST-12, which was issued to it by local government entities. One Florida exemption certificate was also provided by a Florida government entity. Due to the determination that the Taxpayer is engaged in real property construction activities, the use of the government exemption certificates is invalid. The Form ST-12 is valid only when used by an actual government entity to make purchases of tangible personal property. In this case, the Taxpayer is the final user or consumer of the materials purchased for the water and wastewater jobs it performed. There was no sale of tangible personal property to which the government exemption would apply.

Pollution Control Exemption

The Taxpayer maintains that the materials purchased to perform the water and wastewater jobs for government entities and political subdivisions qualify for exemption from the tax as certified pollution control equipment. The Taxpayer states that it assumed the exemption for pollution control equipment and facilities applied to the jobs for which the untaxed materials were purchased and subsequently assessed in the Department’s audit. The Taxpayer claims that this assumption was based on the results of prior audits and that the contract work was being performed for facilities that had existing pollution control certifications.  

Virginia Code § 58.1-609.3 9 provides a sales and use tax exemption for “certified pollution control equipment and facilities as defined in § 58.1-3660, except for any equipment that has not been certified to the Department of Taxation by a state certifying authority pursuant to such section.” [Emphasis added.] Virginia Code § 58.1-3660 B provides that certified pollution control equipment and facilities include:

Any property, including real or personal property, equipment, facilities, or devices, used primarily for the purpose of abating or preventing pollution of the atmosphere or waters of the Commonwealth and which the state certifying authority having jurisdiction with respect to such property has certified to the Department of Taxation as having been constructed, reconstructed, erected, or acquired in conformity with the state program or requirements for abatement or control of water or atmospheric pollution or contamination.

Title 23 VAC 10-210-2090 interprets the exemption for pollution control equipment and facilities. Subsection C states that the exemption is not applicable until the property for which the exemption is sought has been certified by the State Water Control Board or the State Air Pollution Control board. Once a project is certified, the Department issues an exemption certificate, Form ST-11A, to contractors seeking the certification to make purchases for the exempt project. The Form ST-11A contains the name and address of the contractor, a certification date, a project completion date, the certifying agency and the name of the project. This information is necessary to insure proper compliance by contractors that perform jobs related to pollution control equipment and facilities. Without a properly executed Form ST-11A, vendors are required to charge the sales or use tax on purchases made by contractors.

Based on the clear statutory language of Virginia Code §§ 58.1-609.3 9 and 58.1-3660 and the supporting regulation, the exemption for pollution control equipment and facilities applies only in instances where certification for a particular pollution control project has been obtained from the proper state certifying authority. I understand that the auditor instructed the Taxpayer that the audit would be adjusted if pollution control certification was provided for any of the jobs in which contested purchases were assessed in the audit.  The Taxpayer did not present any such evidence to the auditor. 

The Department’s policy and procedures regarding purchases made for pollution control jobs is longstanding. The Taxpayer clearly had no basis to assume that purchases for its projects could be made exempt of the tax without obtaining pollution control certification for the jobs.  The contested purchases were properly assessed in the audit.   

Offer in Compromise

In the event that an adverse determination is issued pursuant to Virginia Code § 58.1-1821, the Taxpayer requests the removal from the audit of the items purchased for water and sewer rehabilitation and remediation projects performed for exempt government entities. The Taxpayer agrees to pay the assessment amounts that remain after the audit liability is recalculated. In addition, the Taxpayer agrees to request the necessary exemption certification for future pollution control and abatement projects. 

Virginia Code § 58.1-105 B authorizes the Tax Commissioner to compromise and settle doubtful or disputed claims for taxes. In this particular case, the Taxpayer has not shown that the assessments are doubtful. The Department’s longstanding policy and the law that supports the policy is clear that certification for pollution control projects must be obtained from the proper certifying government authority for the exemption to apply.  

The Department’s records indicate that the Taxpayer has applied for the certification of past pollution control projects and has been issued Form ST-11As to make exempt purchases for those projects.  As such, it appears the Taxpayer was aware of the requirement to apply for certification of individual pollution control projects and was aware of the responsibility to apply to the Department for the Form ST-11A needed to make exempt purchases for such projects.

Based on the above, I cannot accept the Taxpayer’s offer. I will, however, allow the Taxpayer 45 days to file for or provide pollution control certification for the projects for which purchases were assessed in the audit.  The Taxpayer must furnish the Department the certification documentation or evidence of filing for certification within this 45-day period. Otherwise, the assessments will be deemed correct and the Taxpayer will be issued updated bills.

CONCLUSION

As set out in this determination, the audit assessment of use tax on the purchases contested by the Taxpayer is correct and there is no basis to adjust the audit. The Taxpayer is advised to contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, to submit evidence of filing for pollution control certification or to submit the actual certification documentation.  

The Code of Virginia sections and regulations 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 ***** at *****.

Sincerely,

Craig M. Burns
Tax Commissioner