Were two classified federal IT contracts treated as service contracts or sales of tangible property for Virginia use tax?

Subject

A provider of information technology services to various federal agencies

Plain-English summary

Virginia found that the true object of two classified federal IT contracts was the sale of tangible personal property, not services. Items bought for resale to the federal government under those contracts were removed from the use tax audit.

Contract 1 required development, delivery, installation, deployment, operation, maintenance, and training for a data supercomputer. The government was intended to obtain complete control and use of that system, while the contractor's support was incidental. Contract 2 centered on maintaining, procuring, and installing hardware and software plus integration support; the services supported the equipment.

The taxpayer also challenged individual purchases. Virginia removed ten listed items based on adequate invoices and other documentation. It kept twelve others where submitted invoices did not match the dates or amounts in the audit, records showed Virginia ship-to addresses, or the taxpayer lacked invoices and shipping documents proving that items never entered Virginia.

The ruling expressly says this analysis used the federal-contract policy in effect before July 1, 2006. It notes a later policy change in Tax Bulletin 06-4.

What this means for you

• For the historical rule applied here, the government's true object determined whether contract property could be bought for resale.
• Government control of the delivered system supported property-sale treatment even when development and support services were substantial.
• Property retained for the contractor's own use remained taxable regardless of the contract's true object.
• Audit appeals need transaction-level records matching the assessed ledger entries, invoice amounts, dates, purchase orders, and shipping destination.

Common questions

Did Virginia remove every disputed purchase? No. It removed resale property under the two contracts and ten documented items, but kept twelve purchases without adequate matching or delivery proof.

Was passing title to the government always enough? No. Under the stated historical rule, a service contractor remained the taxable user even if some property passed to the government.

Why did Virginia reject the Colorado-delivery claim for some items? The invoice, purchase order, and quotation showed Virginia addresses, and the supplied packing slip related to a different order.

Citations and references

• Va. Code § 58.1-609.1(4).
• Virginia Tax Bulletin 06-4 (July 7, 2006).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-165

Original ruling text

October 17, 2007

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

Dear *:

This is in response to your letter requesting correction of the retail sales and use tax assessment issued to * (the "Taxpayer") as a result of an audit for the period May 2002 through April 2005. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a provider of information technology services to various federal agencies involved in national security. An audit resulted in the assessment of consumer use tax on various purchases of tangible personal property.

The Taxpayer appeals the assessment primarily based upon a determination by the auditor that the true object of two classified federal government contracts, the * (Contract 1) and the *** (Contract 2), is for the sale of services. The Taxpayer contends that the true object of these two contracts is for the sale of tangible

personal property to the government. Based on additional documentation submitted with its appeal, the Taxpayer also claims that certain items should be removed from the audit because the tax has been paid, or the transactions are not taxable because the items never entered Virginia.

DETERMINATION

Classified Contracts

In considering the tax treatment of federal government contracts, it must be determined whether the contract is for the sale of tangible personal property or for the provision of services. If a contract is for the provision of services, the contractor is deemed to be the taxable user or consumer of all tangible personal property used in performing these services, even though title to some or all of the property may pass to the government. (Note: This is prior to the policy change effective July 1, 2006. See Tax Bulletin 06-4, July 7, 2006.) Conversely, if the true object of the contract is for the sale of tangible personal property, the contractor may purchase property for resale to the government under a resale exemption certificate. The subsequent sale of the property to the government is exempt from the tax under Va. Code § 58.1-609.1(4). Property that does not transfer to the government but is purchased for the contractor's use or consumption in the performance of the contract is taxable to the contractor regardless of whether the true object of the contract is for services or for the sale of tangible personal property.

Contract 1

The scope of work under Contract 1 encompasses the development, delivery, installation, deployment, operation, maintenance and training activities in support of a new data supercomputer (SDS) for operational use by a federal agency. The SDS enables government end users to process data and perform search queries of various data. Minimal operations and management support is provided by the Taxpayer during testing of the SDS and for a short term after the SDS is operational. Because the SDS is ultimately intended for the government's complete control and use, I find that the true object of the contract is for the government to obtain the SDS. The services provided by the Taxpayer are for the procurement and maintenance of the SDS and are, therefore, incidental to the sale of the tangible personal property. The audit will be revised to remove those items purchased for resale to the government.

Contract 2

The stated objective of Contract 2 is to provide for the maintenance of new and existing hardware and software, the procurement and installation of new hardware and software, and the provision of integration support. The services in Contract 2 are provided to support the equipment. Accordingly, I find that the true object of Contract 2 is for the sale of tangible personal property. The audit will be revised to remove those items purchased for resale to the government.

Miscellaneous Purchases

Based on the invoices and other documentation provided, I find basis for the removal from the audit (purchase exception list) of the following ten items:

Ø Line 5 in the amount of $631.33

Ø Line 9 in the amount of $118.56

Ø Line 12 in the amount of $1,043.99

Ø Line 23 in the amount of $17,989.62

Ø Lines 30-33 in the amounts of $47.10, $24.85, $97.22, and $15.94

Ø Lines 35 and 36 in the amounts of $14,252.56 and $3,675.19

As for the remaining twelve contested purchases, I find insufficient basis to remove them from the audit. Explanations are provided below.

The Taxpayer submits two invoices (#25410 and #25248) claiming that they are for lines 1 and 2 of the purchase exception list. I find, however, a few inconsistencies with this documentation as explained below:

1. The amounts charged on these invoices do not correspond to the taxable amounts held in the audit. (a) Invoice #25410 shows a total charge of $12,722.08, which consists of sales tax of $537.08, freight, delivery and installation of $250.00, and furniture of $11,935.00. The taxable amount shown on line 1 of the purchase exception list is $12,689.26. (b) Invoice #25248 shows a total charge of $3,216.34, which consists of sales tax of $133.34, freight, delivery and installation of $120.00, and a workstation of $2,963.00. In contrast, the taxable amount shown on line 2 of the purchase exception list is $3,272.07.

2. Invoice #25410 is dated May 10, 2004, but invoice #25248 is dated April 6, 2004. In contrast, both entries for lines 1 and 2 of the purchase exceptions list are dated for May 2004.

Based on the foregoing, it is clear that neither invoice corresponds to the taxable measures assessed in the audit. The taxable measures held in the audit were taken directly from the Taxpayer's general ledger for the selected month. For these reasons, I must conclude that invoice #25410 and invoice #25248 were not included in the audit.

* (the" Project")

The Taxpayer contests the remaining ten purchases of tangible personal property that are assessed in connection with the Project. According to the Taxpayer, the items for this project were purchased outside of Virginia and ultimately delivered outside Virginia where the property was used. The Taxpayer claims that these purchases never entered Virginia and that it has provided documentation with its appeal that unequivocally demonstrates that legal title passed outside of Virginia.

On the contrary, the evidence presented shows that some items purchased for this project were shipped into Virginia. Although removed above, the purchase shown on line 23 of the auditor's exceptions list is supported by five invoices, two of which show delivery into Virginia and charged Virginia sales tax.

Furthermore, the invoice and purchase order provided for the purchases listed on lines 49-52 of the auditor's exception list shows a 'ship to' address in Virginia. Although the vendor's sales order form lists a Colorado shipping address and is referenced on the vendor's invoice *, the invoice lists a Virginia 'ship to' address. This same invoice references the Taxpayer's purchase order *** which lists a Virginia 'ship to' address. The vendor's quotation form lists a Virginia address. The packing slip provided is for a different order as it references different sales and purchase orders and, therefore, has no bearing on the transaction at issue. Because the invoice generally establishes the written record of the transaction and absent shipping documentation to otherwise establish delivery to a Colorado destination, I find no basis for the removal of these items from the audit.

In some other instances, there is a lack of documentation to support the Taxpayer's claim. For example, the Taxpayer admits that it has no documentation with respect to the purchases listed on lines 18 through 22 and line 24 of the auditor's exceptions list. The Taxpayer claims that these purchases are not taxable because they never entered Virginia. In light of the foregoing, it is clear that some of the Project items were delivered to Virginia. Accordingly, absent a copy of the invoice or shipping documentation to establish that these items were not shipped to the Taxpayer in Virginia; I find no basis to remove these items from the audit.

CONCLUSION

The audit will be revised in accordance with this determination. A revised bill, with interest accrued to date, will be sent to the Taxpayer. The outstanding balance should be paid within 30 days of the bill date to avoid additional interest charges. The Taxpayer should remit its payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attn: *. If you have any questions concerning payment of the assessment, you may contact at **.

The Code of Virginia section cited is available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions about this determination, you may contact * in the Department's Office of Policy and Administration, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-853519159R