Could construction contractors estimate Virginia consumer use tax by allocating inventory cost according to Virginia revenue?

Subject

The clients should be reporting and remitting consumer use tax on the actual cost of materials.

Plain-English summary

Two affiliated out-of-state residential contractors stored materials in warehouses and used them on projects in Virginia and other states. Because some material was blown or sprayed and unused material could return to inventory, they estimated Virginia's monthly use-tax base by multiplying total inventory cost by Virginia project revenue divided by total company revenue.

Virginia rejected that method. Va. Code §§ 58.1-602 and 58.1-604 imposed use tax on the actual cost price of property used or consumed in Virginia, and the filing statutes did not authorize taxpayers to substitute an estimated cost. Va. Code § 58.1-618 permitted the Department—not taxpayers—to estimate liability as a last-resort compliance tool.

The Department was not persuaded that project consumption was impossible to measure. It described counting full bags and weighing partially used bags as one possible method for blown-in insulation. If identical warehouse materials had different costs, the contractors could use first-in, first-out accounting.

The contractors also had to assign the local 1% use tax to the Virginia locality where each project used the materials. They were directed to begin reporting consumer use tax on the actual cost of materials.

Citations and references

• Va. Code §§ 58.1-602, 58.1-604, 58.1-606, 58.1-615, 58.1-616, and 58.1-618.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 16-74

Original ruling text

May 10, 2016

Re: Request for Ruling: Retail Sales and Use Tax

Dear *:

This is in response to your letter in which you request a ruling on whether the use tax accrual methodology used by your unidentified clients is an acceptable means for computing and reporting the use tax.

FACTS

The clients consist of two separate legal entities and affiliates, i.e. , Company A and Company B. Each operates as a construction contractor or subcontractor for new and existing residential properties. Both entities are located outside Virginia. When purchasing construction materials, they store the materials in their warehouses located in their home states. Company A's state has a temporary storage exemption for materials. Company B's state does not impose a sales tax. Each company is registered with the Virginia Department of Taxation for sales and use tax purposes.

Each company provides construction services in Virginia and in other states. When bidding on a project, each company sends an estimator to the jobsite to estimate the amount of materials needed to complete the project and to issue a quote to the customer or prime contractor.

Materials are purchased and maintained in an inventory at a warehouse. You contend that the materials are consumed in a manner that renders measuring their consumption at the time of installation as impossible. The example presented is when materials are blown and sprayed from a large container. While materials are withdrawn from a warehouse for use on a project, an excess amount of materials are not used on the project and are returned to the warehouse for use on another project, perhaps in another state.

Because the companies have no way of measuring the total amount of materials consumed on a particular project, they use an allocation methodology to determine the use tax base upon which to accrue the Virginia use tax on a monthly basis. At the end of each month, each company conducts a warehouse inventory audit to determine the total amount of materials consumed in all projects (Virginia and elsewhere), i.e. , the total inventory cost. Using actual project revenue for Virginia and the actual cost of inventory consumed in all projects, each company allocates material costs to Virginia based on the following monthly formula:

Virginia Use Tax Base = Total Inventory Cost X Virginia Project Revenue
Total Company Revenue

The current tax rate is applied to the amount determined as the Virginia Use Tax Base (the "Base") and the appropriate use tax is remitted to the Department by each company. The Taxpayer asks whether this use tax accrual methodology is acceptable.

RULING

The contention is made that the Virginia statutes and regulations do not prescribe specific guidance on the manner or methodology on which the Base shall be determined or use tax shall be accrued. I respectfully disagree.

As you correctly point out, Va. Code § 58.1-604 imposes a use tax on the "cost price" of each item of tangible personal property used or consumed in Virginia. The use tax is also imposed on the cost price of each item or article of tangible personal property stored outside Virginia for use or consumption in Virginia. Virginia Code § 58.1-602 defines the term "cost price" to mean "the actual cost of an item or article of tangible personal property computed in the same manner as the sales price as defined in this section without any deductions therefrom on account of the cost of materials used, labor, or service costs, transportation costs, or any expenses whatsoever." [Emphasis added.] As such, the Base upon which to apply the use tax should be the actual cost price of the tangible personal property purchased. For these reasons, the use tax accrual methodology used by the clients is not acceptable as such methodology is an estimate of the cost price and results in an estimate of the use tax owed.

While you contend that Va. Code § 58.1-618 permits the clients' use tax accrual methodology on a monthly basis, I must point out that such statute is a tool used as a last resort by the Department, not taxpayers, to ensure compliance with the tax laws in the event a taxpayer has failed to file a return or has filed a false or fraudulent return. Such statutory authority was never intended to replace a taxpayer's or dealer's obligation to report and remit the tax in accordance with the provisions of Va. Code §§ 58.1-615 and 58.1-616. I would also note, by citing Va. Code § 58.1-615 A, that "[e]very dealer required to collect or pay the sales or use tax shall . . . transmit . . . a return showing the gross sales, gross proceeds, or cost price, as the case may be, arising from all transactions taxable under this chapter during the preceding calendar month." [Emphasis added.] As shown above, cost price is the actual cost of an item of tangible personal property. The cited statutes do not permit the estimation of the cost price. Nor is there any other retail sales and use tax statute that expressly allows the kind of use tax accrual methodology at issue.

Because materials are blown and sprayed from a large container for residential construction projects, such facts suggest that the materials are some type of insulation materials. It is my understanding that blown-in insulation materials are typically sold by the bag and the manufacturers of such bags generally have instructions printed on the bags on how much insulation is needed based on the square footage of the area to be blown and the R-value to be achieved. Insulation bags used in a particular project can be counted as either a full bag or partially used bag. For full bags used, it should be possible to easily determine the tax based on the number of full bags used and the cost price paid for such bags. A partially used bag can be weighed and compared to the weight of a full bag to determine how much material was used. From such comparison, the cost price of the used material and the associated use tax can be computed. Applying the foregoing rationale, I am not convinced that the consumption of materials on each project is impossible to measure.

Because the materials are maintained in a warehouse, it appears that they may be commingled with the same type of materials purchased at various times in which the cost price has potentially fluctuated. In such an event, your clients may use the "first-in, first-out" method of accounting for computing the cost price of tangible personal property used in Virginia projects.

In reviewing this matter, I am also concerned that the clients’ methodology does not take into account the distribution of the local 1% use tax owed on the actual cost of tangible personal property used in specific Virginia localities in which the projects are performed. Such locality use tax is imposed by Va. Code § 58.1-606. Using the rationale provided above, the clients should be able to accurately assign the local use tax to each Virginia locality.

Based on the foregoing, I have discussed concerns with the clients’ methodology. There may be more concerns; however, those discussed above are sufficient to deny the clients’ methodology for computing and reporting the use tax. Accordingly, the clients should begin reporting and remitting the consumer use tax on the actual cost of materials as directed in this ruling.

I trust that the above has responded to your inquiry. This response is based on the facts provided as summarized above. Any change in the facts or the introduction of new facts may lead to a different result.

The Code of Virginia sections and regulation cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions about this ruling, please contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-6191367072.R