Could a federal service contractor buy video-conferencing equipment tax-free for resale to the government?

Subject

Government Contracts

Plain-English summary

A federal IT and information-services prime contractor hired a subcontractor to furnish, install, integrate, test, operate once, and provide training for video-conferencing equipment. Virginia agreed that the subcontract itself primarily sold tangible personal property because the operational service was brief and installation and training were integral to the equipment sale.

The prime contract controlled the contractor's tax treatment, however. Its purpose was ongoing life-cycle support and performance of government IT and information-service functions. Because that contract's true object was services, the contractor was the final taxable user or consumer of the video equipment, even if title passed to the federal agency.

The ruling also explained a policy change effective July 1, 2006. For later government contracts, except real-estate construction contracts, Virginia would apply the true-object test to each task or work order rather than only the overall prime-contract statement of work. That change did not apply retroactively to the 2003 project.

What this means for you

• A government customer does not automatically make a contractor's equipment purchases exempt.
• Both the subcontract and the prime contract may require separate true-object analysis.
• The applicable Virginia method can depend on when the government task or work order was issued.

Common questions

Was the video-system subcontract a property sale?

Yes. The one-event operation and other services were incidental or integral to the equipment sale.

Why did the prime contractor still owe tax?

Its federal prime contract primarily provided ongoing services, making it the consumer of property used to perform those services.

Did the post-June 2006 task-order policy change this 2003 result?

No. The ruling expressly said the change was not retroactive.

Citations and references

• Va. Code § 58.1-609.1(4), exempt sales to government entities.
• 23 VAC 10-210-693, government-contract true-object analysis.
• Virginia Tax Bulletin 06-4, task-order and work-order policy effective July 1, 2006.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-98

Original ruling text

June 27, 2007

Re: Ruling Request: Retail Sales and Use Tax

Dear *:

This is in response to your letter requesting specific guidance on the application of the retail sales and use tax to a contract between * (the "Taxpayer") and the federal government in which a subcontractor performed some of the work. The Taxpayer also asks for general guidance with other like transactions with the federal government. I apologize for the delay in responding to your letter.

FACTS

In 2000, the Taxpayer contracted with a federal government agency (Agency) to be its sole source provider of information technology (IT) and information service (IS) functions nationally and internationally. This prime contract is a cost-plus award fee contract for one base year with fourteen option years.

On occasion, the Agency requests the Taxpayer to perform a one-time special project that is outside the scope of the contract. For one of these special projects occurring in the year 2003, the Taxpayer contracted with a subcontractor to furnish, install, integrate and test video teleconferencing equipment at several Agency sites, including the provision of award ceremony operations for one event and the training of government and Taxpayer personnel on how to operate and maintain the equipment for future events. The Taxpayer contends that the taxability of the transaction between itself and the subcontractor should be determined in the same manner as individual task orders or delivery orders issued under an Indefinite Delivery/Indefinite Quantity (ID/IQ) contract or a basic ordering agreement. The Taxpayer maintains that the transaction is for the sale of tangible personal property and constitutes an exempt sale for resale to the Agency.

RULING

The Department has traditionally held that 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. The "true object" test as applied in Title 23 of the Virginia Administrative Code (VAC) 10-210-693 is used to determine whether the contract is for the sale of tangible personal property or for the provision of some service.

If it is determined that 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 its contractual services, even though title to some or all of the property may pass to the government. Conversely, if a contract is for the sale of tangible personal property, the contractor may purchase such property exempt from the tax for resale. The subsequent sale of the property to the government is deemed exempt under Va. Code § 58.1-609.1(4).

First, the true object of the subcontract must be determined. Although the subcontractor is required to operate the video teleconferencing equipment, the requirement is not continuing and is only for one event. Further, the other services furnished pursuant to the subcontract are only for equipment installation and training services, which are integral to the sale of the equipment. Because the operational requirement is of incidental scope and duration, I must conclude that the true object of the subcontract is for the sale of tangible personal property to the Taxpayer.

Next, the true object of the prime contract must be determined because it will decide how the tax applies to the Taxpayer's purchases made pursuant to such contract. Notwithstanding the work order issued, there is no indication that the prime contract is an ID/IQ contract or a basic ordering agreement. Rather, the prime contract utilizes a cost plus award fee level of effort for the purpose of evolving into a full performance-based service contract for life cycle support of all phases of certain IT/IS functions. The ultimate goal of the contract is to transition the performance of selected IT/IS functions from the government to the Taxpayer on an on-going basis. The Taxpayer is required to provide services with respect to research, development, test and evaluation, production, deployment, operations and support, and disposal for the following IT/IS functions: program support, printing, digital replication, distributed and centralized systems and services, networks, operational help desk, research, and voice and video services. Based on the Agency's stated goal and these service functions, I must conclude that the true object of the prime contract is for services.

Because the prime contract is for services, the Taxpayer is deemed the final user or consumer of the property it purchases for use in the performance of its service contract with the Agency. As such, the Taxpayer is liable for the tax on all purchases of tangible personal property made pursuant to the prime contract. Consequently, the Taxpayer is liable for the tax on the items purchased pursuant to the subcontract.

Policy Change for True Object Test

Effective on and after July 1, 2006, the General Assembly mandated a change to the Department's application of the true object test to contractors who provide services to the United States, the Commonwealth of Virginia, and any political subdivision or instrumentality thereof. Prior to July 1, 2006, the Department applied the true object test to the overall statement of work for the prime contract. Only in those instances in which a contract was designated as an ID/IQ contract or a basic ordering agreement was the true object test applied on a task order or delivery order basis. After June 30, 2006, however, the Department applies the true object test to the statement of work for each task order or work order issued pursuant to a prime contract (except for real estate construction contracts) with any of the above government entities. This policy change is not retroactive to any period prior to July 1, 2006. While this policy change has no effect on the prime contract addressed above for the periods prior to July 1, 2006, it would apply to work orders issued under the prime contract after June 30, 2006. For further details, see Virginia Tax Bulletin 06-4 (7/7/06). The Department is also in the process of issuing an emergency regulation by June 30, 2007, to further explain and implement this policy change.

The Code of Virginia section, regulation and bulletin cited are 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 ruling or would like more information about the emergency regulation for government contractors, you may contact * in the Department's Office of Policy and Administration, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-889423669R