Tax Type
Retail Sales and Use Tax
Description
Research; Testing materials; Maintenance supplies
Topic
Exemptions
Taxability of Persons and Transactions
Date Issued
07-23-1990
July 23, 1990
Re: §58.1-1821 Application/ Sales and Use Tax
Dear ****
This will reply to your letter of February 5, 1990, as supplemented by information conveyed by **** of your firm to a member of my staff during a recent telephone conversation, seeking the correction of an assessment issued in the above referenced case for the period of November, 1985 through October, 1988.
Facts
***** (Taxpayer) is engaged in the manufacture of various filters and capillary wick reservoirs. An audit of the Taxpayer produced an assessment for its failure to remit the sales and use tax on purchases of supplies used in producing samples for customer testing and the purchase of a lathe used to make parts for research and development machinery. The supplies were held taxable by the department as property used in product marketing activities and the lathe was deemed to be used only indirectly in the research and development process.
The Taxpayer contests the inclusion of the supplies in the audit, contending they are used directly and exclusively in research and development activities and therefore exempt under Virginia Code §58.1-608(3)(e) and Virginia Regulation (VR) 630-10-92. The Taxpayer further contests the penalties and interest assessed. It is the department's understanding, however, that the Taxpayer now concurs that the lathe was correctly included in the audit inasmuch as subsection G of the above regulation provides as taxable, "[e]quipment and supplies used to produce items that will be used directly in research activities."
DETERMINATION
Virginia Code §58.1-608(3)(e) provides an exemption from the sales and use tax for "[t]angible personal property purchased for use or consumption directly and exclusively in basic research or research and development in the experimental or laboratory sense." Subsection C of VR 630-10-92 includes the following activities within the scope of the exemption: (1) the development of new products; (2) the improvement of new products; or (3) the development of new uses for existing products.
Subsection D of the regulation defines the term "used directly" to mean, "those activities which are an integral part of ... research and development activities, including all steps of such processes, but not including secondary activities such as administration, general maintenance, product marketing and other activities collateral to the actual research process."
The regulation also provides that basic research and research and development do not include environmental analysis, testing of samples for chemical or other content, operations research, feasibility studies, efficiency surveys, management studies, consumer surveys, economic surveys, advertising or promotions.
It is my understanding that the transactions at issue in this case are in connection with the Taxpayer's development and production of new custom products. The Taxpayer's research and development department develops product prototypes which are then further tested by the Taxpayer's customer within the customer's test facilities only. The additional test results are then furnished to the Taxpayer for adjustments to and final development of the product for sale. The test items are not used in product marketing activities but rather are used for purposes of internal performance testing only. Samples used for product marketing purposes are produced at the Taxpayer's production facility after the final development of the product.
Based on the information presented by the Taxpayer and after further review by the department, I find that the materials worked on, equipment, machinery, tools, supplies, energy, fuel, and power used directly and exclusively in producing the test items will qualify for exemption under VR 630-10-92. However, equipment and supplies used to clean or sterilize items used directly in research activities either before or after such activities and equipment and supplies used to produce the parts for the research and development machinery will be taxable in accordance with the above regulation. The exemption also will not apply in instances where the Taxpayer modifies a product merely to meet customer specifications unless the modification is performed under experimental or laboratory conditions to improve the product generally or develop a new use for the product.
Additionally, in instances where the Taxpayer engages in a joint research and development project with its customer, only the tangible personal property purchased or leased by the entity that actually will perform the research activities will qualify for the exemption.
Further, under the provisions of Va. Code §58.1-105, I agree to abate the penalty assessed, however, I do not find basis to abate any applicable interest. The audit is being returned to the department's district office for revision in accordance with the determination reached in this letter. A new assessment will be sent as soon as practicable.
Please contact the department if you have additional questions or if we may be of any further assistance.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner