How did Virginia's post-July 1, 2006 government-contractor true-object rule apply to a liquid-nitrogen plant contract, subcontractors, refunds, and modifications?

Subject

Order-level true-object test for a government plant contract

Plain-English summary

Virginia treated the statement of work for a liquid-nitrogen production plant as a sale of tangible personal property. Under the government-contractor rule effective July 1, 2006, the true-object test applied to each statement of work, work order, or task order rather than automatically to the original umbrella contract.

Because the statement of work required delivery of the plant, the contractor could buy property incorporated into and resold as the plant without tax. If an order's true object instead was a service, the contractor would owe tax on property used to perform that service.

The contractor could ask vendors to refund tax paid on qualifying purchases within three years. For accrued use tax, it could amend returns within the limitation period stated in Va. Code § 58.1-1823 and explain the amendment.

Subcontractors received the same tax treatment as the prime contractor for their obligations, but they also had to apply the true-object test to each qualifying order. Contract modifications and other add-ons executed on or after July 1, 2006 were analyzed separately from the original contract.

What this means for you

• Classify each post-July 1, 2006 order by its own true object.
• Property bought for resale under a property-focused order can be exempt.
• Property consumed under a service-focused order is taxable to the contractor.
• Apply the same order-level analysis to subcontractors and amendments.
• Track purchase and return dates so refund claims remain timely.

Common questions

Was the liquid-nitrogen plant order a service contract for tax purposes?

No. Its true object was delivery of tangible personal property—the plant.

Did every future purchase under the umbrella contract become exempt?

Only purchases made for resale under the identified statement of work. Other orders required their own analysis.

How were later modifications treated?

Each add-on executed on or after July 1, 2006 received a separate true-object test.

Citations and references

• Va. Code § 58.1-1823.
• 23 VAC 10-210-693(E), (I).
• Virginia Tax Bulletin 06-4.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-180

Original ruling text

October 17, 2008

Re: Request for Ruling: Retail Sales and Use Tax

Dear *:

This is in response to your letter submitted on behalf of * (the "Taxpayer") requesting a ruling regarding the application of the government contractor emergency regulation to its contract with an agency of the federal government. I apologize for the delay in responding to your correspondence.

FACTS

The Taxpayer has entered into a contract with * (the "government entity") to provide a liquid nitrogen production plant. The Taxpayer indicates that it has already purchased some equipment pursuant to this contract. In addition to requesting a ruling regarding the application of the government contractor emergency regulation to the aforementioned contract, the Taxpayer also requests the following issues be addressed:

whether it has overpaid tax on previous purchases for this project; whether it needs to continue to pay tax on purchases made pursuant to the contract at issue;

whether its subcontractors need to pay tax on purchases made pursuant to the contract at issue; and

whether the purchase of equipment and materials, under the various contract amendments are subject to the government contractor emergency regulation.

Each issue will be addressed separately below.

RULING

Emergency Regulation Application

As a result of budget language included in the Budget Bill (House Bill 5002, Chapter 3, 2006 Acts, Special Session 1), the Department of Taxation changed its current interpretation of the "true object" test under, the Retail Sales and Use Tax as it applies to contractors doing business with the federal, state and local governments. This policy change went into effect on July 1, 2006. See , Tax Bulletin 06-4 (7/7/06).

Title 23 of the Virginia Administrative Code (VAC) 10-210-693 E provides that "[a]s of July 1, 2006, the application of the sales and use tax to all mixed contracts and indeterminate purpose contracts shall be based on application of the true object test to each individual order and not the original contract." This tax treatment applies to all orders executed on and after July 1, 2006.

Based on the documentation provided, the contract and statement of work were executed on and after January 25, 2007. Accordingly, the aforementioned policy change would apply to the contract and statement of work at issue.

Overpaid Tax

The Taxpayer questions whether it has overpaid tax on previous purchases of tangible personal property made pursuant to the contract at issue.

Pursuant to Title 23 VAC 10-210-693, the true object test is applied to each individual statement of work, work order or task order, instead of to the underlying contract. The Taxpayer must apply the true object test to each statement of work, work order or task order to determine whether the true object is for the sale of tangible personal property or for the provision of a service. If for the sale of tangible personal property, all purchases made by the Taxpayer for resale to its customer would be exempt of the tax. If for the provision of a service, the Taxpayer would be liable for the tax on the purchase of tangible personal property that was used to provide the service to its customer.

The Statement of Work (SOW) provided by the Taxpayer indicates that the Taxpayer is required to provide its customer with a liquid nitrogen production plant. Applying the true object test to this SOW, the true object is for the sale of tangible personal property to the government entity. The true object of the SOW is for the sale of the liquid nitrogen production plant. Accordingly, the Taxpayer can purchase the items of tangible personal property exempt of the -tax that will be resold to the government entity. If the Taxpayer paid tax to its vendor, the Taxpayer can request a refund from the vendor within three years of having paid the tax. Pursuant to Va. Code § 58.1-1823, if the Taxpayer accrued use tax, the Taxpayer can amend its sales tax returns within "three years from the last day prescribed by law for the timely filing of the return." The Taxpayer must provide a written statement along with the amended returns indicating the rationale for submitting the amendment to the returns.

Tax on Future Purchases

The Taxpayer also questions whether it needs to continue to pay tax on purchases made pursuant to the contract at issue.

If all purchases of tangible personal property are made pursuant to the SOW provided with the Taxpayer's correspondence, the Taxpayer would be making purchases for resale to the government entity and would not be liable for the tax on those purchases of tangible personal property resold to the government entity.

Tax Treatment for Subcontractors

The Taxpayer questions whether its subcontractors need to pay tax on purchases made pursuant to the contract and SOW at issue.

Pursuant to Title 23 VAC 10-210-693 I, "a subcontractor to a prime contractor with a government entity shall be granted the same tax treatment as the prime contractor when fulfilling its contractual obligations to the prime contractor. Thus, a subcontractor shall apply the true object test to the overall purpose of the contract, unless it contains individual orders that were executed on or after July 1, 2006, in which case the subcontractor must apply the true object test to each separate order to determine the tax application."

Accordingly, the Taxpayer's subcontractors should apply the true object test as described above to all work orders, statements of work and task orders relating to the contract with the government entity that were executed on or after July 1, 2006.

Modifications

Finally, the Taxpayer questions how the purchase of equipment and materials under the various contract amendments should be treated.

Title 23 VAC 10-310-693 E states, "For add-ons to government contracts executed on or after July 1, 2006, the true object test will be applied to each separate add-on without regard to the true object of the original contract." "'Add-ons' mean additional obligations subsequent to the execution of the original contract or order, including modifications to contracts or orders."

Accordingly, the retail sales and use tax should be applied to any modifications to the contract at issue, executed on or after July 1, 2006, in accordance with the above.

This response is based on the facts provided as summarized above. Any change in facts or the introduction of new facts may lead to a different result.

The tax bulletin and regulation 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 response, you may contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2052509020.P