Could a pharmaceutical testing laboratory qualify for Virginia's research exemption when its work may develop or improve drugs rather than merely test samples?

Plain-English summary

A laboratory challenged use tax on equipment and supplies, arguing that its pharmaceutical and vaccine work developed new products and methods rather than merely testing client samples.

Virginia ordered further review. The available material suggested qualifying research might occur, but the taxpayer still had to prove the projects and identify property used directly and exclusively in them.

Qualifying activity versus routine testing

Basic research systematically advances scientific knowledge. Research and development transforms new understanding toward new products, improved products, or new uses. Routine sample testing for content does not qualify by itself.

The laboratory described developing and validating methods involving drugs, metabolic products, antibody reactions, and vaccine interactions. FDA reports and website material made that claim plausible enough for additional audit work.

Direct and exclusive use

Only property used directly and exclusively in the actual research process qualifies. Essential status or legal necessity is insufficient, and a single item used in both qualifying and nonqualifying work cannot receive a percentage exemption.

What this means for you

• Document the scientific objective of each project.
• Distinguish product development from routine testing services.
• Tie each claimed asset or supply to a qualifying research step.
• Do not prorate mixed-use property under this exemption.

Common questions

Q: Did Virginia grant the exemption immediately?

A: No. It ordered a documentary review and audit adjustment only for proven qualifying items.

Q: What evidence could help?

A: Contracts, work orders, proposals, customer lists, FDA information, and comparable project records.

Citations and references

• Va. Code § 58.1-609.3(5) — research exemption
• 23 VAC 10-210-3070, 10-210-3071 — research definitions and use test
• Related Virginia rulings cited: P.D. 96-43, P.D. 99-136, and P.D. 03-91

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 19-23

Original ruling text

April 8, 2019

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

Dear *:

This will reply to your letter in which you seek the correction of assessments issued to * (the “Taxpayer”) for the period March 2011 through March 2014. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer states that it partners with pharmaceutical and vaccine researchers and manufacturers to develop and bring to market pharmaceutical products. The Department audited the Taxpayer and assessed consumer use tax on untaxed fixed asset and expense purchases made during the audit period. The Taxpayer maintains that the use tax assessments are erroneous because the equipment and supplies were used directly and exclusively in exempt research activities. The Department’s auditor concluded that the Taxpayer was engaged in the periodic testing of blood and urine samples, which is an activity that does not qualify for the basic research or the research and development exemptions.

DETERMINATION

Virginia Code § 58.1-609.3 5 provides an exemption from the sales and use tax for “[t]angible personal property purchased for use or consumption directly and exclusively in basic research or research and development in the experimental or laboratory sense.” Title 23 of the Virginia Administrative Code (VAC) 10-210-3070 interprets the exemption statute. Subsection A defines “basic research” as:

A systematic study or search in a scientific or technical field of endeavor with the ultimate goal of advancing knowledge or technology in that field. The development of a tangible product or process need not occur in basic research activities. Examples of basic research activities include medical, chemical, or biological experiments conducted in a laboratory environment.

Subsection A defines “research and development” as:

A systematic study or search directed toward new knowledge or new understanding of a particular scientific or technical subject and the gradual transformation of this new knowledge or new understanding into a usable product or process. Research and development must have as its ultimate goal: (i) the development of new products; (ii) the improvement of existing products; or (iii) the development of new uses for existing products. Research and development does not include the modification of a product merely to meet customer specifications unless the modification is carried out under experimental or laboratory conditions in order to improve the product generally or develop a new use for the product.

Title 23 VAC 10-210-3071 A discusses the direct and exclusive use requirements of the exemption and states:

The exemption is limited in scope to tangible personal property used directly and exclusively in an actual research process, starting with the handling and storage of raw materials and supplies at the research facility and ending after the last step of the research process when the products of the research process are stored at the research facility. Items of tangible personal property used directly and exclusively in research include chemicals, drugs and other materials, equipment, machinery, tools, supplies, energy, fuel, and power used in these processes. An item is not considered used directly and exclusively merely because it is essential to research activities or because its use is required by law.

Title 23 VAC 10-210-3071 B addresses items that are used in both taxable and exempt research activities and states that:

When a single item is used both in exempt and nonexempt activities, it is not used exclusively in research activities and is taxable. Therefore, a prorated research exemption of the single item based upon percentages of exempt and nonexempt usage or an exemption based upon the preponderance of an item's use in exempt activities is not permitted.

The auditor toured the Taxpayer’s facilities and concluded that it was testing samples for chemical or other content and providing the test data to clients. Based on Title 23 VAC 10-210-3070 B and on Public Documents (P.D.) 96-43 (4/10/96) and 99-136 (6/10/99), the testing of samples for chemical or other content does not qualify for the basic research or the research and development exemption.

The Taxpayer states that its services are integral and necessary to developing new and improved pharmaceuticals. The laboratory develops and validates methodologies to measure pharmaceuticals, their metabolic breakdown products and their adverse reaction to biological drugs due to antibody development. The Taxpayer develops and uses unique methodologies to measure vaccine interactions. The Taxpayer cites P.D. 03-91 (11/14/03) as being on point with the facts of this case. P.D. 03-91 discusses a taxpayer that contested the Department’s audit assessment on the basis that it was developing new pharmaceutical products and improving existing products. The results of the testing and analysis performed by the taxpayer determined if the pharmaceutical product developed by its customers satisfied federal Food and Drug Administration or Environmental Protection Agency requirements. If not, the taxpayer developed changes to improve the product and obtain the necessary approval. The Tax Commissioner agreed that the taxpayer was conducting research and development because the purpose of the testing and analysis was to develop or improve pharmaceutical products.

Based on a review of federal Food and Drug Administration inspection reports provided by the Taxpayer, as well as information on the Taxpayer’s website, it appears that the Taxpayer may be engaged in basic research and research and development activities. Virginia Code § 58.1-205 1 provides that an assessment of tax by the Department is deemed prima facie correct. As such, the burden of proof is on the Taxpayer to prove that the assessments are erroneous. Keeping this requirement in mind, it is necessary to clarify and confirm that the Taxpayer’s activities qualify as basic research or research and development pursuant to Title 23 VAC 10-210-3070. For this reason, the Taxpayer should produce additional documentary evidence that establishes it is engaged in product development activities or other qualifying research activities. The documentation may consist of contracts, work orders, customer lists, requests for proposal, federal Food and Drug Administration information or similar information.

In accordance with Virginia Code § 58.1-609.3 5, and as discussed in P.D. 03-91 and Title 23 VAC 10-210-3071, property must be used directly and exclusively in basic research or research and development activities to qualify for exemption. If it is determined that the Taxpayer is engaged in exempt research activities, the Department must then identify and confirm the contested equipment and supplies assessed in the audit that were used directly and exclusively in the qualifying research activities. Those items that meet this criteria will then be removed from the audit.

CONCLUSION

A member of the Department’s audit staff will contact the Taxpayer to set up a mutually agreeable time to review additional documentation to determine the research projects and activities that qualified for exemption during the audit period. Based on this review, the audit will be revised to remove the equipment and supplies that are used directly and exclusively in basic research or research and development activities. The Taxpayer will be issued a revised audit report and the assessments will be adjusted accordingly. The Department’s records do not indicate that any payments have been applied to the audit bills. Revised bills that reflect any remaining audit liability will be issued to the Taxpayer and should be paid within 30 days to avoid the accrual of additional interest.

The Code of Virginia sections, regulations and public documents cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s website. If you have any questions concerning this determination, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

Related Documents

94-238

96-43

99-136

03-91