Did a contractor succeed in lowering a use tax assessment by arguing the Department overestimated the taxable materials cost in its lump-sum invoices?

Subject

Audit: Contracting - Determining Material Cost

Plain-English summary

A business that operates as a "consuming contractor" -- meaning it sells and installs tangible personal property that becomes real property once installed -- was audited by the Department for the period July 2017 through December 2018. Because the Taxpayer billed customers a single lump-sum amount per job rather than separately stating labor and material charges, the auditor had to estimate what portion of each sale represented taxable materials. The auditor used a 37.73% materials percentage, a figure that came from the Taxpayer itself and matched the Taxpayer's own internal and tax-related documents. The Taxpayer appealed, arguing the real materials percentage was closer to 10% and that the tax it had already paid should cover any liability.

The Tax Commissioner upheld the assessment. Contractors are treated as the consumers of everything they install, so they must pay sales tax when they buy the materials or accrue use tax if it's unclear at purchase whether items will be resold or installed. Separately stated installation charges are exempt, but when labor and materials are billed together in one lump sum, the exempt and taxable pieces are not separated and the whole charge becomes taxable -- which is exactly what happened here since the Taxpayer used single lump-sum invoices. The Commissioner found the auditor's 37.73% figure reasonable because it was sourced from the Taxpayer's own materials, while the Taxpayer's competing 10% claim came with no documentation or evidence to back it up. Without proof, the Commissioner could not accept the Taxpayer's position, so the assessment (plus accrued interest) was upheld and payment was due within 60 days.

What this means for you

Contractors billing in lump sums

If your business sells and installs tangible personal property and bills customers a single combined price for labor and materials, expect that the entire charge -- not just the materials portion -- can be treated as taxable unless you separately state the installation/labor charge on the invoice. Va. Code § 58.1-609.5 2 only exempts installation charges that are stated separately; lump-sum billing forfeits that separation.

When the Department has to estimate your materials cost

When your own records don't break out materials versus labor, the Department's auditor may build a materials percentage from whatever internal or tax documents you've already provided. That estimate becomes the working figure for the assessment, and it will generally be treated as reasonable if it is traceable to the Taxpayer's own data.

Challenging an auditor's estimate on appeal

Simply asserting that the auditor's percentage is too high is not enough to overturn an assessment. To succeed on appeal, a taxpayer needs to bring documented proof or evidence -- invoices, cost records, contracts, or similar support -- showing what the actual materials cost was. A bare assertion of a different number, without more, will not carry the Taxpayer's burden.

Common questions

Q: Did the contractor get the assessment reduced?
A: No. The Tax Commissioner found the assessment correct as issued and upheld it in full, with accrued interest added and payment due within 60 days.

Q: Why was the entire lump-sum charge taxed instead of just the materials portion?
A: Because the Taxpayer billed one combined amount for labor and materials rather than separately stating the installation charge, the exempt installation portion under Va. Code § 58.1-609.5 2 could not be carved out, so the full lump sum was subject to tax and the auditor had to estimate the materials share.

Q: Where did the auditor's 37.73% materials figure come from?
A: The Taxpayer itself provided that percentage, and it was consistent with the Taxpayer's other internal and tax-related documents, which is why the Commissioner treated it as a reliable basis for the assessment.

Q: Why didn't the Taxpayer's claimed 10% materials figure work?
A: The Taxpayer asserted the 10% figure without submitting any additional evidence or documentation to support it, so the Commissioner could not accept that position over the documented 37.73% figure used by the auditor.

Q: Does a contractor have to pay sales tax when it buys materials, or use tax later?
A: Under Va. Code § 58.1-610 A and Title 23 VAC 10-210-410, contractors are consumers of the tangible personal property they install, so they must pay sales tax at the time of purchase, or accrue use tax on those items if it's unclear at the time of purchase whether the items will be resold or installed.

Q: Is there a way to keep installation charges exempt from tax?
A: Yes -- Va. Code § 58.1-609.5 2 exempts separately stated installation charges. But that exemption is lost when the installation charge is combined and billed as one lump sum with taxable charges, such as those for materials.

Citations and references

Statutes:

• Va. Code § 58.1-610 A (contractors as consumers of tangible personal property they install)
• Va. Code § 58.1-609.5 2 (exemption for separately stated installation charges)
• Va. Code § 58.1-1821 (application for correction of assessment / appeal)
• Title 23 VAC 10-210-410 (contractors regulation)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-11

Original ruling text

February 9, 2021

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

Dear *:

This will respond to your letter submitted on behalf of * (the “Taxpayer”), in which you appeal the retail sales and use tax assessment issued to the Taxpayer as a result of an audit for the period July 2017 through December 2018. I apologize for the delay in responding to your request.

FACTS

The Taxpayer operates as a consuming contractor. An audit by the Department resulted in an assessment of consumer use tax on untaxed purchases of tangible personal property used or consumed in the Taxpayer’s operations. The Taxpayer did not separately state the labor and material costs on its invoices. Instead, one lump sum amount was charged for each sale. To address this, the auditor applied 37.73% of the total sales price to determine the taxable materials portion of each sale. The Taxpayer appeals, contending that the material percentage used by the Department should have been close or equivalent to 10% and that the amount of tax already paid should be sufficient to satisfy any liability.

DETERMINATION

Virginia sales and use tax law generally treats businesses that sell and install tangible personal property that becomes real property upon installation as contractors. See Virginia Code § 58.1-610 A and Title 23 of the Virginia Administrative Code 10-210-410. Contractors are considered to be the consumers of all tangible personal property that they install for their customers. As such, contractors are required to either pay sales tax on all items they are installing at the time they purchase those items or accrue use tax on such items if it is unclear whether the items would be resold or installed at the time of purchase. See Public Document (P.D.) 17-139 (6/29/2017).

The Taxpayer does not dispute its classification as a consuming contractor, or that tax was not properly charged and collected based upon that designation. Instead, the Taxpayer asserts that the Department overestimated the taxable materials cost, and based upon the correct materials cost, the proper amount of use tax for the audit period has already been paid.

While the tangible personal property used by a contractor is subject to tax, separately stated installation charges are not. See Virginia Code § 58.1-609.5 2. However, exempt service charges are subject to tax when combined and billed in a lump sum with taxable charges, such as those for tangible personal property. Here, the Taxpayer’s invoices reflected one lump sum charge, subjecting the entire sale to the retail sales and use tax.

The Department’s auditor, however, attempted to separate out the taxable and potentially non-taxable charges by calculating the materials cost to be 37.73% of the total sales price. The Department’s auditor used this percentage because it was provided by the Taxpayer and was consistent with other internal and tax-related documents. The Taxpayer asserts, without providing any additional evidence, that the assessment was incorrect because the taxable materials costs were close or equivalent to 10% of the total sales price. However, I cannot accept the Taxpayer’s position without documented proof or evidence.

Accordingly, the assessment at issue is upheld. The Taxpayer will receive an updated bill, which will include accrued interest to date. Payment should be made within 60 days of the date on the bill to avoid the accrual of additional interest.

The Code of Virginia sections, regulation, and public document cited are available online at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s website. If you have any questions or concerns regarding this determination, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/2119-C