Could a vendor exempt sales to federal prime contractors without timely certificates, contract statements of work, or reviewable classified records?

Plain-English summary

Virginia kept the unproven federal-contractor sales in the audit but created a 120-day process for additional proof and cleared review of classified records. The vendor sold products, systems, and services to prime contractors working on classified and unclassified federal contracts.

For 31 unclassified contracts, the vendor had no resale certificates. Even a later certificate would require complete contract evidence showing whether the prime contractor resold property to the government or consumed it while providing services. Navy or Army contract modifications did not prove a direct government purchase when the prime contractor used its own credit and no complete statement of work was supplied.

The classified-sales issue was different. The vendor had refused access because the original auditor lacked security clearance. Virginia said it could not uphold an assessment when it had not furnished a properly authorized reviewer. A newly available classified-contract agent would inspect those records and apply the true-object test.

The vendor also received time to prove sales tax already paid and Florida sales. Virginia noted that the auditor's 50% property-price assumption understated tax, but limitations had expired, so no additional assessment would issue for that error.

The 20% post-amnesty penalty could be waived if the vendor timely paid the revised balance within 30 days of the updated bill.

What this means for you

• Obtain resale or other exemption certificates when federal-contractor sales occur.
• Review the complete statement of work to identify resale versus contractor consumption.
• Protect classified material while arranging access for an authorized cleared auditor.
• A government contract does not automatically make the government your purchaser.

Common questions

Q: Were the 31 unclassified sales immediately exempted?
A: No. They remained taxable pending final documentation.

Q: Could Virginia uphold classified sales without providing a cleared reviewer?
A: No; it assigned a newly available classified-contract agent to examine them.

Q: Did a Navy-issued contract modification prove the Navy bought from the vendor?
A: No. The document showed a prime contractor, not a direct purchase or purchasing agency.

Citations and references

• Va. Code §§ 58.1-202, 58.1-205(1), 58.1-216, 58.1-219, 58.1-602, 58.1-603, 58.1-623, and 58.1-1840.1(F)(1).
• 23 VAC 10-210-160(D), 23 VAC 10-210-280(A), and 23 VAC 10-210-693(C).
• Virginia Public Documents 93-161 (July 23, 1993) and 98-29 (February 20, 1998).

Subject

Tax on untaxed sales of tangible personal property: federal government contractors

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 11-146

Original ruling text

August 10, 2011

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

Dear *:

This is in response to correspondence from * requesting correction of the retail sales and use tax assessment issued to *** (the "Taxpayer") as a result of an audit for the period April 2005 through March 2008. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer provides various products, systems, and services to prime contractors who are engaged in classified or unclassified contracts with the federal government. An audit resulted in the assessment of sales tax on untaxed sales of tangible personal property made to federal government contractors and use tax on untaxed purchases of tangible personal property used or consumed by the Taxpayer.

In its protest, the Taxpayer indicated that it would like to discuss alternative methods for briefing classified contracts that the Taxpayer or a prime contractor had with the federal government. For sales to federal government contractors engaged in unclassified contracts, the Taxpayer indicated that it did not have resale exemption certificates on file for the sales assessed in the audit but was in the process of obtaining them. A staff member of the Department's Appeals and Rulings section contacted the Taxpayer to request the alternative methods to be set out in writing and to request copies of the exemption certificates referenced in the appeal. The Taxpayer subsequently responded.

DETERMINATION

Pursuant to Va. Code § 58.1-205 1, any assessment of a tax by the Virginia Department of Taxation is deemed prima facie correct. This means that the burden of proving that a tax assessment does not apply is upon the taxpayer assessed with the tax.

Sales to Prime Contractors with Unclassified Contracts

Title 23 of the Virginia Administrative Code (VAC) 10-210-280(A) interprets and supports Va. Code § 58.1-623 by explaining that the burden of proving that the tax does not apply rests with a dealer unless he takes, in good faith from the purchaser or lessee, a certificate of exemption indicating that the property is exempt under the law. The language makes clear that the dealer is required to obtain a valid certificate of exemption from the purchaser at the time of the sale. The regulation further provides that the seller must use reasonable care and judgment in selling tangible personal property exclusive of the tax, even when an exemption certificate from the purchaser may be on file.

In responding to the Department's request for exemption certificates, the Taxpayer explained that it was unable to obtain any resale exemption certificates for the thirty-one unclassified contracts in question. Although the Taxpayer had hoped to provide them, it has not as of the date of this letter. Because the Taxpayer has not met its burden of proof, I must conclude that the resale exemption is not applicable to any of the sales made in connection with unclassified contracts. Such sales shall remain in the audit.

I would also note the Department's long-standing policy that the validity of an exemption certificate is subject to closer scrutiny by the Department when it is furnished well after a sale is made. See Public Document (P.D.) 93-161 (7/23/93) and P.D. 98-29 (2/20/98). Had the exemption certificates been furnished, the Taxpayer would also need to prove that the items actually qualified for the resale exemption. Generally, this process requires obtaining a copy of the unclassified contract, from the customer so that a determination can be made as to the true object of the transaction, i.e. , whether the customer actually resold the items, or made a taxable use or consumption of the items in the performance of services with the federal government. See Title 23 VAC 10-210-693 C. As stated in P.D. 93-161, "[a] dealer cannot escape liability for sales tax based on assumptions of what a customer will do with the item sold."

Notwithstanding, I will allow the Taxpayer one final opportunity to present the documentary evidence necessary to establish an exemption for each of these sales. Such evidence should be presented to the auditor within the allotted time noted in the Conclusion section of this determination letter. After the allotted period has expired, the auditor will review any documentation presented for this issue and revise the audit and associated assessment, if necessary. The auditor will then send a revised assessment and a revised audit report to the Taxpayer.

Classified Contracts with the Federal Government

The Department has the authority to use its authorized auditors or agents to investigate any books and records of a taxpayer in order to ascertain the proper tax liability. See Va. Code § 58.1-219. If a taxpayer refuses to allow the examination of its records, the Department is authorized by Va. Code § 58.1-216 to proceed with legal action.

The Taxpayer refused to allow the Department's auditor to examine the records related to sales transactions marked as "classified" can the worksheets provided the auditor. The Taxpayer's reason for such refusal was because the auditor lacked the proper security clearance from the federal government. Because the Department was not able to furnish an auditor with such security clearance, no examination of the classified records at issue was conducted by such auditor or agent of the Department.

One of my duties in supervising the administration of the tax laws of Virginia is effecting equitable assessments. See Va. Code § 58.1-202. Had the federal government or the Taxpayer denied access to an auditor with proper security clearance to review classified records and contracts, the Department would have no choice but to conclude in the absence of evidence to the contrary that the classified sales at issue are taxable.

When the Department provides an auditor without any security clearance to review classified federal government contracts or classified sales records, I must conclude that the Department has not furnished a properly authorized classified contract agent to review the Taxpayer's records. In such instances, an assessment cannot be upheld.

Notwithstanding the foregoing, it is my understanding that the Department now has a classified contract agent with sufficient security clearance to review the classified sales records and the associated contracts at issue. Accordingly, the classified contract agent will contact the Taxpayer and arrange for a convenient time and place to review the classified records and contracts at issue. For any mixed contracts that provide for both services and tangible personal property, the classified contract agent will examine the true object of the transaction in accordance with Title 23 VAC 10-210-693 and determine the appropriate tax or exemption application.

Navy and Army Contracts

The Taxpayer indicates that several contracts are with the Navy and Army. In these instances, the Taxpayer provided the contract modifications to the auditor. The Taxpayer includes one example with its appeal. The Taxpayer claims that the customer is clearly identified as the Navy or Army and requests the associated sales to be removed from the audit.

The contract modification provided indicates that it was issued by the Navy to a contractor (not the Taxpayer). The purpose of the modification is for such contractor to furnish the necessary personnel send facilities to conduct the research effort as described in section C of the contract. A copy of section C of the unclassified contract was not provided. Unless the Taxpayer has evidence that it sold products directly to the Navy, I must conclude based on this contract modification that the purchaser of any products from the Taxpayer was the contractor and not the Navy. There is no indication in such document that the contractor was officially appointed as a purchasing agent for the Navy. It appears that the contractor was hired to conduct certain research tasks on behalf of the Navy. However, this in no way provides any conclusive evidence that the Navy was the purchaser of products from the Taxpayer or that the Navy's credit was bound directly to the transaction. As long as the contractor used its credit, such as payment via company check or credit card, the contractor is the purchaser. In the absence of the complete statement of work (SOW) for this contract and any claim for exemption, I must conclude that sales were made to the contractor and that such sales are taxable.

In conclusion, I would take the same approach for the remaining Navy and Army contracts. Generally, there should be no problem with furnishing the Department with an unclassified contract or the SOW. Without the SOW for an unclassified contract, the true object of the contract cannot be determined. For sales tax purposes, a true object test is used to determine whether the transaction (contract) is for the sale of tangible personal property or is for the sale of services. If the true object of the transaction is for the sale of tangible personal property, then the resale exemption would apply to tangible personal property purchased by the contractor for resell to the government. If the true object of the transaction is for services, then the contractor is deemed the taxable user or consumer of all tangible personal property purchased to perform its contract, unless such purchases can be shown to qualify for a statutory exemption from the tax. For more information on the true object test, see section C of Title 23 VAC 10-210-693.

Because no exemption certificate was obtained for sales related to these contracts, the Taxpayer has no good faith standing for exemption and would be required to prove an exemption. As it appears that these contracts are unclassified, any exemption claim would need to include the complete SOW for each contract and a completed exemption certificate from the customer (purchaser) indicating which exemption is applicable to its purchases. If it still wishes to contest the sales related to these contracts, the Taxpayer would need to furnish the required documentation to the auditor.

Sales Tax Claimed as Paid

The Taxpayer claims to have paid the sales tax owed on several items assessed in the audit and requests their removal from the audit. The Taxpayer identifies seven potential line items (129, 174, 176, 181, 182, 187 and 188) assessed in connection with this issue.

It is my understanding from the auditor that she was given limited access to documentation related to customers with unclassified contracts. While a few invoices were furnished to the auditor, I understand that the Taxpayer did not provide all of the invoices requested or any backup documentation needed to support such invoices, including but not limited to, purchase orders, contracts, etc. Accordingly, complete documentation needs to be furnished to the auditor in order to verify and determine the validity of the Taxpayer's sales tax payment claim.

Florida Sales

The Taxpayer claims that two sales (line items 13 and 249 of the contested sales exception list) were made within the state of Florida and are thus not subject to Virginia taxation. For the same reasons noted above, complete documentation (invoices, purchase orders, contracts, etc.) needs to be furnished to the auditor in order to verify the Taxpayer's nontaxable claim.

Sales Price

It is my understanding that the auditor assessed sales tax on 50% of the sales price of tangible personal property sold to each contractor on the assumption that 50% of the contract price was probably attributable to non-taxable services. Such assessment does not conform to the "sales price" definition in Va. Code § 58.1-602. In that statute, the term "sales price" is defined as "the total amount for which tangible personal property or services are sold, including any services that are a part of the sale, valued in money, whether paid in money or otherwise, and includes any amount for which credit is given to the purchaser, consumer, or lessee by the dealer, without any deduction therefrom on account of the cost of the property sold, the cost of materials used, labor or service costs, losses or any other expenses whatsoever." Further, Va. Code § 58.1-603 imposes the sales tax on the gross sales price of each item or article of tangible personal property sold at retail or distributed in Virginia. Thus, when tangible personal property is sold at retail to a consumer such as a contractor, the sales and use tax applies to the sales price charged without any deduction for services or any expenses related to the sale.

Pursuant to Title 23 VAC 10-210-160 D, the Department will not correct an assessment by increasing the amount of liability (except for additional accrued interest). This regulation allows the Department to make a second assessment for the portion of tax that was not assessed only if the period for assessing additional tax has not expired. Because all of the returns that were due during the audit period were timely filed, the statute of limitations for assessing additional taxes is limited to 3 years. Because such statute of limitations has expired for all of the periods covered by the audit, no additional assessment will be issued by the Department for the unassessed amounts.

CONCLUSION

The assessment is subject to revision in accordance with this determination if the Taxpayer furnishes additional documentation to the auditor and the classified contract agent, or allows examination of such documentation at a mutually agreeable location, within 120 days of the date of this letter. The auditor and the classified contract agent will contact you within 15 days of the date of this letter to arrange for the receipt and/or review of any additional documentation.

If the additional documentation is received or, made available within the allotted time, the (auditor will review it, determine whether to further revise the audit, and advise the Taxpayer accordingly. If the audit is revised, the auditor will send a revised audit report to the Taxpayer. In addition, an updated 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, 600 East Main Street, 23rd Floor, Richmond, Virginia 23219, Attn: *. If you have any questions concerning payment of the assessment, you may contact at **.

After the assessment was issued on April 23, 2010, a 20% post-amnesty penalty was applied to the assessment pursuant to subsection F 1 of Va. Code § 58.1-1840.1 because the assessment was not paid within 30 days of its issuance. Notwithstanding, because the Taxpayer timely appealed the assessment within 90 days of the date of assessment, the post-amnesty penalty may be waived if the Taxpayer remits 'the revised balance due as shown on the updated bill within 30 days of the bill date.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/14506144212.R