Did a federal research-and-development subcontractor qualify for Virginia's reduced BPOL rate for principal or prime contractors?

Subject

Federal R&D subcontractor did not qualify for the special BPOL rate

Plain-English summary

Virginia upheld the county's ordinary business-service BPOL treatment. The special rate of no more than $0.03 per $100 applied to a designated principal or prime contractor receiving identifiable federal appropriations for specified research-and-development services.

The taxpayer's contract with Corporation A expressly designated it as a subcontractor. Nothing showed that it was a principal or prime contractor, and Corporation A compensated it rather than the taxpayer receiving an identifiable federal appropriation.

The equal-protection challenge also failed. The taxpayer was not in a suspect class, and the ruling found a legitimate and reasonable legislative purpose in encouraging businesses to bid for and obtain qualifying federal contracts directly.

What this means for you

• Performing qualifying R&D work was not enough by itself.
• Contract designation as principal or prime contractor mattered.
• The taxpayer also had to receive identifiable federal appropriations.
• Virginia treated the subcontractor as a business-service provider at the ordinary applicable rate.

Citations and references

• Va. Code §§ 58.1-3703.1 and 58.1-3706(D)(1).
• Va. Code §§ 65.2-302 through 65.2-304; 41 U.S.C. § 52.
• Temple v. Petersburg; Graham v. Richardson; Arlington County v. Richards; Caskey Baking Co. v. Commonwealth.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 09-53

Original ruling text

May 1, 2009

Re: Appeal of Final Local Determination

Taxpayer: *

Locality: *

Business, Professional and Occupational License Tax

Dear *:

This final state determination is issued upon the application for correction filed by you on behalf of * (the "Taxpayer") with the Department of Taxation. You appeal an assessment of Business, Professional and Occupational License (BPOL) taxes issued to the Taxpayer by *** (the "County"), for tax years 2004 through 2006.

The BPOL tax is imposed and administered by local officials. Virginia Code § 58.1-3703.1 authorizes the Department to issue determinations on taxpayer appeals of BPOL tax assessments. On appeal, a BPOL tax assessment is deemed prima facie correct. That is, the local assessment will stand unless the taxpayer proves that it is incorrect.

The following determination is based on the facts presented to the Department summarized below. The Code of Virginia sections, regulations and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site.

FACTS

* (Corporation A) entered into a contract with the federal government to provide research and development services. Corporation A subcontracted out a portion of this research and development work to the Taxpayer.

The Taxpayer was originally licensed as a professional service. In October 2007, the Taxpayer contacted the County and provided a schedule of revised gross receipts. In addition, the Taxpayer requested that they be reclassified as a business service and be taxed at the reduced BPOL tax rate for certain federal contractors under Va. Code § 58.1­-3706 D 1 on gross receipts earned through their contract with Corporation A.

The County determined that the Taxpayer should be classified as a business service but did not qualify for the reduced rate imposed on eligible federal contractors. The County reclassified the Taxpayer as a business service provider and adjusted the Taxpayer's BPOL liability in accordance with the revised gross receipts. The Taxpayer contends that although it was not a prime contractor, it was a principal contractor as specified in Va. Code § 58.1-­3706 D 1. In the alternative, the Taxpayer contends that not extending the special rate for research and development services to subcontractors violates the Equal Protection Clause of the United States Constitution.

ANALYSIS

Virginia Code § 58.1-3706 D 1 provides a separate BPOL classification for:

Any person, firm, or corporation designated as the principal or prime contractor receiving identifiable federal appropriations for research and development services as defined in § 31.205-18 (a) of the Federal Acquisition Regulation in the areas of (i) computer and electronic systems, (ii) computer software, (iii) applied sciences, (iv) economic and social sciences, and (v) electronic and physical sciences... [Emphasis Added.]

Businesses eligible for this classification are subject to a BPOL tax rate not to exceed $.03 per $100 on federal funds received for eligible contracts.

The County determined that the Taxpayer was not a prime contractor as defined by the Code of Federal Regulations because it operated as a subcontractor to Corporation A. The Taxpayer contends that the County only addressed whether it was defined as a "prime" contractor. It argues that it operated as the "principal" contractor in Corporation A's contract with the federal government.

The federal statutes define prime contractor and subcontractor, but not principal contractor. See 41 U.S.C. § 52. In addition, principal contractor is not defined in Title 58.1 of the Code of Virginia . Under Va. Code §§ 65.2-302 through 304, principal contractors are clearly distinguished from subcontractors for purposes of worker's compensation. There is no other mention of principal contractors in Virginia law.

In Temple v. Petersburg , 182 Va. 418, 29 S.E.2d 357 (1944), the Virginia Supreme Court held that effect must be given to a statute if it is plain and unambiguous, and its meaning perfectly clear and definite. As such, in order to receive the special BPOL research and development classification, a contractor must be designated a prime or principal contractor. A review of the contract between the Corporation A and the Taxpayer indicates that the Taxpayer is designated a subcontractor. Nothing in the contract indicates that the Taxpayer is designated as either a principal or prime contractor, nor has the Taxpayer provided any evidence to show it is a principal contractor under federal statutes or regulations.

Further, Va. Code § 58.1-3706 D 1 requires that the contractor performing the specified research and development must receive "identifiable federal appropriations." In the instant case, the Taxpayer is compensated by Corporation A for its work as a subcontractor. As such, the Taxpayer did not receive an identifiable federal appropriation.

Equal Protection

In Equal Protection cases, classifications based upon alienage, race, or national origin are inherently suspect and subject to close scrutiny. Graham v. Richardson , 403 U.S. 365 (1971). When the classification is not suspect it is permissible if the governmental objective is "legitimate" and the classification bears a "reasonable" or "substantial" relation thereto. Arlington County v. Richards , 217 Va. 645, 648, rev'd per curiam , 434 U.S. 5 (1977).

The Equal Protection Clause of the Fourteenth Amendment to the Constitution of the United States does not forbid inequalities or exemptions in state taxation. It does not limit the state's power to make any reasonable classification of property, occupations, persons or corporations for taxation purposes. It merely prohibits inequality occasioned by clearly arbitrary action especially such as is attributable to hostile discrimination against particular persons or classes. Caskey Baking Co. v. Commonwealth , 176 Va. 170, 179, 10 S.E.2d 535, 540 (1940).

The Taxpayer contends that Va. Code § 58.1-37015 D 1 discriminates against subcontractors because it only classifies primary or principal contractors for the special research and development rate. Because the Taxpayer is a computer services contractor, it is not a member of a suspect class that is subject to close scrutiny. As such, the Commonwealth need only have a legitimate reason for limiting the classification and the classification must be reasonable.

The legislature's intent in enacting Va. Code § 58.1-3706 D 1 in 1993 was to stimulate the Commonwealth's economic recovery during a downturn in the economy. In 1992, the Joint Subcommittee issued House Document No. 37, To Study the Measures Necessary to Assure Virginia's Economic Recovery , which included a proposal to reduce BPOL rates for receipts from certain research and development contracts with the federal government as a way of stimulating economic growth. Thus, the purpose of the enactment of Va. Code § 58.1-3706 D 1 was to make Virginia more attractive to businesses that bid and obtain contracts directly from the federal government for specifically identified research and development projects. The Taxpayer has not met the burden of showing that the General Assembly's reasons for enacting the special rate are not legitimate or reasonable.

DETERMINATION

Based on the specific facts in this case, it is my determination that the County properly classified the Taxpayer as a business service that did not qualify for the $.03 per $100 rate reserved for entities designated as principal or prime contractors receiving identifiable federal appropriations for research and development services. For the contract with Corporation A, the Taxpayer is a subcontractor rather than a primary or principal contractor and did not receive identifiable federal appropriations.

If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2479597014.B