Rulings of the Tax Commissioner

September 13, 2024

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

Dear *****:

This is in response to your letter in which you seek correction of the retail sales and use tax assessment issued to ***** (the “Taxpayer”) for the period September 2020 through August 2023. 

FACTS

The Taxpayer, a fabricator of vinyl fencing, decking, pergolas, screen porches, and outdoor furniture, sells finished products to construction contractors as well as lumberyards and other retailers. It also sells and installs its products for customers and performs jobs as a subcontractor for other contractors for the installation of vinyl fencing and decking. For sales and use tax purposes, the Taxpayer had been treating itself as fabricator of tangible personal property for retail sale and collected and remitted tax based on the price of the sale.

The Taxpayer was audited for the period at issue. Based on the Taxpayer’s operations, the auditor treated the business as a fabricator of tangible personal property for its own use in real estate contracts. As a result of the audit, the Taxpayer was charged use tax on untaxed purchases of tangible personal property. The Taxpayer filed an application for correction, contending that it properly classified itself as a retailer. In the alternative, the Taxpayer argues that it should be allowed a credit toward the use tax on tangible personal property provided in transactions for which it charged, collected, and remitted sales tax from its customers as permitted under newly amended legislation. 

DETERMINATION

Contractors

Generally, real property contractors must comply with Virginia Code § 58.1-610 A, which provides:

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.

The regulation that interprets this provision, Title 23 of the Virginia Administrative Code (VAC) 10-210-410 A states:
 
Tangible personal property incorporated in real property construction that loses its identity as tangible personal property and becomes real property is deemed to be tangible personal property used or consumed by the contractor. Any sale, distribution, or lease to or storage for such a contractor is deemed a sale, distribution, or lease to or storage for the ultimate consumer (the contractor), and not for resale by the contractor.

Based on the facts in this case, the Taxpayer was fabricating property for both retail sale and for its own use as a consuming contractor. Under these operating conditions, the Taxpayer would be considered to be a dual operator.

Dual Operators

Title 23 VAC 10-210-410 E addresses fabricators who operate in a dual capacity of fabricating tangible personal property for sale or resale and fabricating for their own use and consumption in the performance of real property construction contracts. This regulation provides that dual role fabricators must follow the primary purpose rule based on gross receipts in determining sales and use tax application. 

For the purposes of sales and use tax application, the primary purpose rule as applied to a dual capacity operator is as follows:

• If most of the gross receipts result from a fabricator’s sales or resales, it would purchase materials exempt from tax by submitting an appropriate exemption certificate to its vendors and would collect and remit the tax based upon the total amount for which the vinyl fencing is sold. When the fabricator withdraws tangible personal property from its inventory for use and consumption in the performance of real property construction contracts, it would accrue the tax based on the fabricated cost price of the inventory withdrawn and remit the use tax with its sales and use tax return. 

• If most of the gross receipts result from fabricating products for its own use and consumption in real property construction, a fabricator would pay sales tax on all materials at the time of purchase to all suppliers that are authorized to collect the tax. In addition, a fabricator would also be required to register, collect, and pay the tax on the retail selling price of the fabricated products sold regardless of whether tax had already been paid to a supplier. The fabricator would be permitted to purchase exempt from the tax only those materials that could be identified at the time of purchase as purchases for resale.

• If the primary purpose cannot clearly be determined based on gross receipts or materials are purchased under circumstances where it is impossible to determine the manner in which such materials would be used at the time of sale, a fabricator may apply to the Department to pay any tax directly to the Commonwealth. See Virginia Code § 58.1-624 concerning direct payment permits.

The analysis of the Taxpayer’s books and records indicated that most of the fabricated vinyl fencing, decking, pergolas, and screen porch materials were used or consumed in building or installation for customers. Based on the primary purpose test, the Taxpayer incorrectly operated as a retailer during the audit period and the auditor properly classified the Taxpayer as a contractor fabricating principally for their own use based on the primary purpose rule. See also Public Document (P.D.) 96-274 (10/9/1996). 

As a contractor fabricating principally for its own use, the Taxpayer was required to pay the sales tax to its vendors at the time of its purchases of tangible personal property consumed in its real property contracts. Instead, the Taxpayer erroneously treated its transactions as retail sales and charged the sales tax to its customers. Consequently, material purchases for which the Taxpayer did not pay the sales tax were properly listed as exceptions in the audit.

Credit for Improperly Charged Sales Tax

The Taxpayer asserts that it is entitled to a credit for the tax periods at issue in amounts greater than the use tax that was assessed. In essence, it is arguing that it has already collected and remitted sales tax, which allowed the Commonwealth to receive more tax than permitted by the existing sales and use tax statutes and regulations.

Contractor Rules

When any contractor erroneously collects sales tax from its customers, it does not eliminate the contractor’s responsibility to remit use tax on the property being installed. See Title 23 VAC 10-210-410. Under audit, if it was determined that use tax should have been paid rather than the erroneously remitted sales tax, the contractor would receive an assessment for the unpaid use tax. Because the transaction on which the sales tax was collected is a separate transaction, credit has not generally been granted against the use tax assessment. The contractor is generally entitled to a refund of the sales tax only if he can show that the tax erroneously collected was paid by him and not passed on to the customer or that the tax was collected from the customer and subsequently refunded to the customer. See Title 23 VAC 10-210-3040

The Department’s current policy only permits a credit in limited circumstances. The Department has allowed credit in a case involving a dealer that incorrectly failed to charge sales tax, but the customer remitted use tax for the transaction. See P.D. 07-68 (5/10/2007). Similarly, in P.D. 22-56 (3/30/2022), the Department allowed credit where the contractor included "estimated use tax" on its invoice, essentially charging sales tax under the wrong name, but remitted the use tax for the property consumed in the transactions on its returns. 

In P.D. 07-135 (9/4/2007), the Department reasoned that allowing a credit for erroneously collected sales tax would (1) authorize contractors to pay their use tax liability with their customer's sales tax payments, and (2) allow contractors to avoid financial responsibility for violating the requirements of Virginia Code § 58.1-610. In other words, the Department does not allow a credit based merely on the fact that the tax has been paid. Further P.D. 07-135 overruled earlier cases, including P.D. 03-87 (11/12/2003), in which a contractor that incorrectly collected retail sales and use tax from Virginia customers and had not issued refunds to such customers was permitted a credit of taxes collected and remitted against use taxes assessed in the audit. In P.D. 09-177 (11/19/2009), the Department upheld the policy established in P.D. 07-135, but permitted a credit for tangible personal property included in transactions for which the customers had assigned the rights to refunds of erroneously paid sales tax to the consuming contractor. 

Since the issuance of these determinations, legislation has impacted the contractor industry in Virginia. Prior to July 1, 2017, contractors selling and installing fences, venetian blinds, window shades, awnings, storm windows and doors, locks and locking devices, floor coverings, cabinets, countertops, kitchen equipment, window air conditioning units, or other like or comparable items were required to purchase such items for resale tax exempt and collect sales tax from their customers. In 2017, the provision of Va. Code § 58.1-610 that imposed this requirement was repealed. The Taxpayer in this case was directly impacted by this legislative change.

Law Change

Effective July 1, 2024, Virginia Code § 58.1-1812 C, as amended by the General Assembly (2024 Acts of Assembly, Chapters 113 and 128), permits the Department to allow erroneously collected retail sales tax collected by a contractor from its customer and remitted to the Department to be credited against a use tax assessment made against such contractor regarding the transaction. Virginia Tax Bulletin (VTB) 24-3, issued as P.D. 24-64 (7/1/2024), provides important information concerning the new law.

Under Virginia Code § 58.1-1812 C, when a contractor has erroneously charged, collected, and remitted sales tax on transactions in which tangible personal property was installed and annexed into real property and the same tangible personal property is rightfully subject to a use tax assessment, a one-time credit for the erroneously remitted sales tax will be permitted against the use tax assessment. The credit will be limited to the use tax assessed on the contractor’s purchase transaction of tangible personal property and will be allowed for the first offense only. In practical terms, the first offense would be the first time the issue is identified on audit. 

In order for a credit to be granted, a contractor must clearly show that the property included in transactions for which sales tax was erroneously collected and remitted was the same specific property that was incorporated into reality and subject to the use tax. However, credit will not be given in any case where the taxpayer has previously applied for and received such a credit, or in the case of a false or fraudulent action by the taxpayer with the intent to evade the proper tax. 

For audits completed on or after July 1, 2024, audit staff will be required to determine the amount of the credit, if any. Auditors will need to have access to a contractor’s complete purchase and sales records in order to verify credit for tangible personal property for which use tax should have been accrued. If complete records are not available, auditors will work with contractors to find alternative means to verify a credit. In addition, auditors will extend the application of the credit forward in order to cover all periods in which the contractor erroneously collected sales tax. The credit is limited to the applicable use tax liability for the first offense.

For assessments made before July 1, 2024, a contractor will be required complete and submit an offer in compromise request on Form OIC B-2 to initiate the process. A contractor will need to provide matched purchase and sales records, as well as, sales and use tax return detail to document its eligibility. A review of the offer in compromise may be conducted by office staff or referred to field audit staff depending on the nature and volume of the information provided. 

In the alternative, contractors can receive a refund of any erroneous retail sales tax payments remitted if they can affirmatively show that the tax has been refunded to the Virginia customer or credited to their account. The contractor will need to follow the Retail Sales and Use Tax Refund Claim Procedures available on the Department’s website. A contractor will not be eligible for both the credit under Virginia Code § 58.1-1812 C and a sales tax refund on the same transaction.

CONCLUSION

As determined by the auditor, the Taxpayer was a fabricator for its own use that erroneously charged, collected, and remitted sales tax on its transactions that included installation into real property during the audit period at issue. 

Under VTB 24-3, the Taxpayer would need to file Form OIC B-2 to initiate a claim for a credit toward its audit assessment or follow the procedures for claiming a refund for taxes erroneously collected from its customers. Because this application for correction was filed before the issuance of VTB 24-3 and requests a credit in the manner permitted under Virginia Code § 58.1-1812 C, the audit will be returned to the appropriate field audit staff to review the Taxpayer’s eligibility for the one-time credit and adjust the assessment accordingly. 

The credit will be extended to periods subsequent to the audit until the date at which the Taxpayer changed its accounting system to comply with Virginia retail sales and use tax requirements or the last day of the month following the month in which the revised audit is completed, whichever is earlier. The extension does not constitute an expansion of the audit period and is limited to the credit for erroneous collection of tax. However, a contractor and the auditor may agree to bring the entire audit forward to correspond with the extension period.

After the revision of the audit is complete, the Taxpayer will be issued a revised audit report and revised bill, if applicable, with interest accrued to date. No further interest will accrue provided the outstanding liability is paid within 30 days of the date of the updated bill.

Because it primarily fabricates products for its own use and consumption, the Taxpayer is hereby instructed to pay sales tax to its vendors or accrue and remit the use tax directly to the Department on its purchases of tangible personal property consumed in its real property contracts. In the alternative, the Taxpayer may be able to apply to the Department for a direct pay permit. If approved, the Taxpayer would file a Virginia Direct Payment Permit Sales and Use Tax Return (currently Form ST-6).

A credit for erroneously collected and remitted retail sales tax will not be available in future audits. Every contractor or fabricator should make it a practice to be aware of the law and to keep informed about changes to maintain tax compliance.
 
The Code of Virginia sections and regulations cited are available online at law.lis.virginia.gov. The public documents and tax bulletin cited are available at tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at (804) ***** or *****@tax.virginia.gov.

Sincerely,

James J. Alex
Tax Commissioner
Commonwealth of Virginia

AR/4943.F