Rulings of the Tax Commissioner

September 18, 2024

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

This is in response to your letters submitted on behalf of ***** (the “Taxpayer”), in which you seek a refund of the retail sales and use tax for the periods October 2011 through December 2012. I apologize for the delay in responding to your letter. 

FACTS

The Taxpayer, a provider of broadband services to customers in Virginia, filed retail sales and use tax refund requests related to various equipment purchases. The Department granted a portion of the request. However, the denial of the remaining balance of the request resulted from the Taxpayer’s failure to show that it made retail sales of services as required by the existing Internet Service Provider (ISP) exemption policy. The Taxpayer submitted applications for correction citing a Virginia circuit court decision that overturned the Department’s prior policy. The Taxpayer also disputed the allocation percentage applied by the Department to its mixed-use equipment, the vendor certification form requirement, and the denial of interest paid on the refunds that were granted. 

DETERMINATION

ISP Exemption

Virginia Code § 58.1-609.6 2 provides an exemption from Virginia’s retail sales and use tax for broadcasting equipment, including parts and accessories, and towers used by commercial radio and television companies, cable television systems, common carriers or video programmers using an open video system or other video platform provided by telephone common carriers, or other entities that are under the regulation and supervision of the Federal Communications Commission. The exemption also applies to amplification, transmission, distribution, and network equipment used by wired or land-based wireless cable television systems, open video systems, or telephone common carriers. ISPs are eligible for the exemption because the definition of “amplification” under Virginia Code § 58.1-602 includes “production, distribution, and other equipment used to provide Internet-access services.” 

The Department previously interpreted the ISP exemption to require that a provider make retail sales rather than wholesale sales of services to qualify. See Public Document (P.D.) 00-18 (3/17/2000), P.D. 01-29 (3/29/2001), P.D. 13-179 (10/11/2013), P.D. 16-167 (8/26/2016), P.D. 20-80 (5/12/2020), P.D. 20-81 (5/12/2020), and P.D. 20-82 (5/12/2020). However, the Circuit Court for the City of Richmond disagreed, holding that the ISP exemption is not limited to equipment used to provide retail sales of the relevant services. See Alcatel-Lucent USA Inc. v. Virginia Department of Taxation, CL20-3591-7, (10/26/2021), published as P.D. 21-171 (5/11/2022). Accordingly, the Taxpayer’s refund claim must be reconsidered.

Mixed-Use Equipment

The Taxpayer argues it is entitled to full exemption for qualified equipment purchases because it was used exclusively for the provision of internet services. It has been the Department’s experience that equipment eligible for the exemption under Virginia Code § 58.1-609.6 2 can and has been used in services for which the exemption is available and in services ineligible for an exemption. For example, while equipment used for transmission of television signals is exempt, equipment used for transmitting telephone services is not. Because these service providers have often bundled services, the same equipment can be used to provide both services that qualify for the exemption and services that do not.

Some sales and use tax exemptions include a predominant use requirement, where the transaction is exempt so long as the tangible personal property will be used more than 50% of the time for an exempt purpose. See, e.g., P.D. 93-202 (9/27/2003). The ISP exemption does not require predominant use in an exempt manner in order for the exemption to apply. With such exemptions, when tangible personal property is used for purposes beyond the scope of the exempting language, the relief is limited to the tax attributable to the exempt purpose of the property. In other words, the tax must be prorated when the equipment is used in both exempt and taxable activities. See P.D. 88-331 (12/16/1988) 

For retail sales and use tax purposes, the proration methodology is generally based on the percentage of time the property is used in a taxable activity and the percentage of time the property is used in an exempt activity. However, when it is not possible to prorate the tax in this manner, another approach may be considered. See P.D. 13-136 (7/18/2013). The Tax Department has previously determined that the percentage of time may be calculated by using revenue derived in exempt activities versus the revenue derived in taxable activities. See P.D. 92-28 (4/20/1992), 93-229 (12/15/1993), and 96-238 (9/20/1996).

In this case, the Taxpayer maintains that its proposed time allocation percentage should be used to determine the sales tax on the mixed-use equipment, rather than the Department’s revenue-based allocation method. The Taxpayer contends that the equipment at issue is used to provide exempt activities 100% of the time. Specifically, the Taxpayer states that in order to provide uninterrupted Internet services, its mixed-use equipment is dedicated 100% of the time to the provision of Internet services. The Taxpayer further contends that the fact that a piece of equipment is performing more than one function at a time does not take away from the fact that the equipment is performing exempt activities all of the time. Based on this rationale, the Taxpayer contends that the equipment used to provide Internet services is exempt. As an alternative, the Taxpayer contends that the revenue-based allocation percentage used by the Department should be adjusted.

The Taxpayer admits that the equipment at issue is used in more than one activity. Equipment used in both exempt and taxable activities cannot be 100% exempt for sales and use tax purposes. As such, the Taxpayer’s contention that the mixed-use equipment is exempt because it is used 100% of the time to provide exempt services is without merit. The sales tax must be prorated on mixed-use equipment. However, the Department will consider the Taxpayer’s alternative allocation percentage in light of the ISP exemption policy change. 

Interest

The Taxpayer disputes the amount of interest paid on its refund. After further review, the Department agrees refund interest was understated on the initial refund and that additional interest is due to the Taxpayer. 

Vendor Certification Forms

The Taxpayer asserts that it was not required to comply with the refund guidelines published by the Department in June 2016. These guidelines require refund claimants to submit completed vendor certification forms to support the refund request. Rather, the Taxpayer contends that it provided sufficient proof sales tax was paid to each vendor, and that it is not required to provide proof the vendor remitted the tax to the Department. 

During the refund verification process, the Department’s auditors requested that the Taxpayer have its vendors complete vendor certification forms. In instances where the certification forms were not provided, the auditor reviewed the vendors’ sales and use tax filings with the Department to determine whether a refund was warranted. If the gross sales amount was insufficient to have included the value of the invoice, the refund was denied. The refund was also denied if the locality information could not be verified or if the vendor did not file a return for the month in which the transaction took place. 

In 2006, the Virginia General Assembly enacted language in the 2006 Appropriation Act (House Bill 5002, Chapter 3 of the 2006 Acts of Assembly, Special Session I) regarding the sales and use tax exemption for Internet service providers for purchases made on or after July 1, 2006. Similar language has been reenacted by the General Assembly in subsequent budget bills since 2006. See Item 3-5.04 of the 2024 Appropriation Act (House Bill 6001, Chapter 2 of the 2024 Acts of Assembly, Special Session I):

Notwithstanding any other provision of law, for purchases made on or after July 1, 2006, any exemption from the retail sales and use tax applicable to production, distribution, and other equipment used to provide Internet-access services by providers of Internet service, as defined in § 58.1-602, Code of Virginia, shall occur as a refund request to the Tax Commissioner. The Tax Commissioner shall develop procedures for such refunds.

On June 12, 2017, the Department issued Guidelines for Retail Sales and Use Tax Refund Claim Procedures (the “Guidelines”), published as P.D. 17-98 (6/12/2017). The Guidelines provide that a taxpayer must complete a Refund Claimant Return in order to receive a refund of a tax remitted to the Department by the dealer through whom a purchase of tangible personal property was made. The refund request spreadsheet and the vendor certification form must also be included with the Claimant Return. This information is used by the Department to assist in verifying the refund claimed by the Taxpayer. 

When the Taxpayer filed its initial refund request, the Department had not yet established the Guidelines referenced above. Accordingly, the Taxpayer was not required to provide the vendor certification form as part of the review of its refund request by the Department. 

Notwithstanding the foregoing, the Department must be able to verify the refund amount requested by the Taxpayer. Further, the Department must ensure that the local tax portion of the refund is allocated to the locality for which the tax was originally reported and paid. If the Department cannot verify the refund amount request or the locality, the refund cannot be granted. In this instance, transactions were excluded from the refund because it could not be verified if the sales tax was actually charged and remitted to the Department. Additionally, the Department could not verify the localities to which the sales tax was initially paid. On appeal, the Taxpayer has not proven its contention that the refund was erroneously denied. Accordingly, the transactions at issue were properly excluded from the refund.

CONCLUSION

The Taxpayer’s case will be remanded to the Department’s audit staff to reconsider the Taxpayer’s refund request in light of the change to the Department’s ISP exemption policy and this determination. Should the audit staff need additional information from the Taxpayer, the auditor will request the specific information needed and work with the Taxpayer in order to review the additional information at a mutually agreed-upon time. Once the audit staff’s review is completed, the auditor will send the Taxpayer an updated audit report and a written explanation of any changes to the approval or denial of the Taxpayer’s refund requests. 
    
The Code of Virginia sections cited are available online at law.lis.virginia.gov. The public documents 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 via email at *****@tax.virginia.gov. If you have any questions regarding the audit staff’s review of the Taxpayer’s refund requests, please contact ***** in the Office of Compliance, Field Audit, at (804) *****, or via email at *****@tax.virginia.gov.

Sincerely,

James J. Alex
Tax Commissioner
Commonwealth of Virginia

AR/3895.C