My company repairs and replaces command/communications/surveillance systems on Navy ships, including cabling and racks -- does that make me a retailer who can buy the parts tax-exempt for resale, or a consuming contractor who owes tax on them?

Plain-English summary

A contractor asked Virginia whether it should be treated as a RETAILER or as a CONSUMING CONTRACTOR when it repairs and replaces command, communication, control, intelligence, surveillance, and reconnaissance systems on United States Navy ships -- work that also involves installing cabling pathways, cabling, and metal equipment racks alongside the systems themselves. The distinction matters because of how Virginia's sales tax exemption for federal government sales works.

Virginia's government-contractor regulation (23 VAC 10-210-693) treats a contract combining both services and tangible personal property as a "mixed government contract." For these, the Department applies a "true object" test: if the real point of the contract is to SELL property to the government, the transaction is treated as a retail sale, and the contractor can buy the underlying materials and equipment tax-exempt using a resale exemption certificate (Form ST-10) -- because the SUBSEQUENT sale of that property to the government is itself tax-exempt under Va. Code § 58.1-609.1(4). But if the real point is to provide a SERVICE, the contractor is treated as the taxable user/consumer of everything it buys to perform that service, and owes tax on those purchases itself.

The Department pointed to its own earlier ruling on a similar fact pattern, P.D. 18-104, involving a government contractor that furnished and installed communications equipment on naval ships. That ruling found the temporary-storage exemption (which applies only to construction materials used in REAL PROPERTY construction) didn't apply to shipboard equipment installation, and separately found the true object of that contract to be a retail sale.

Applying the same reasoning here, the Department found that even though this contractor also performs repair labor and uses subcontracted services alongside the equipment, the true object of its contracts is to secure REPLACEMENT of the systems and their associated equipment and materials -- making the contracts retail sales of tangible personal property, not the provision of a service. As a result, the contractor can purchase the qualifying equipment, materials, and other tangible personal property intended for transfer to the federal government tax-exempt for resale, by issuing a completed Form ST-10 to its own vendors. The ruling was explicitly based only on the facts summarized (without a review of the actual contracts), and the Department advised the contractor to review its specific contracts -- current and future -- to confirm whether their true object is really the sale of property or the provision of services, since a different contract could produce a different result.

What this means for you

Government contractors performing shipboard or similar equipment repair/replacement work

If your contracts combine services (labor, repair, subcontracted work) with tangible equipment and materials, don't assume the service component makes the whole contract a nontaxable service. Virginia looks at the TRUE OBJECT of the contract as a whole -- if the point is really to deliver/replace equipment for the government, it's a retail sale, letting you buy the underlying materials tax-exempt for resale using Form ST-10.

Contractors weighing whether the temporary-storage exemption applies to equipment installation work

This ruling reinforces (via its citation to P.D. 18-104) that the temporary-storage exemption is limited to construction materials incorporated into REAL PROPERTY construction -- it doesn't extend to equipment installed aboard a vessel or similar non-real-property context.

Any contractor with multiple, varying government contracts

Don't assume one ruling covers all of your work going forward. This ruling is expressly based only on the facts described and without review of actual contract language -- review each contract's true object individually, since different contract terms could yield a different (consuming contractor) result.

Common questions

Q: When is a government contractor treated as a retailer versus a consuming contractor for Virginia sales tax purposes?
A: It depends on the "true object" of the contract -- if the real point is to sell/deliver tangible property to the government, the contractor is a retailer who can buy the materials tax-exempt for resale; if the real point is to provide a service, the contractor owes tax on its own purchases as the user/consumer.

Q: Does providing repair labor alongside equipment automatically make a contract a service contract?
A: No -- here, the contractor also provided repair labor and subcontracted services, but the Department still found the true object was equipment replacement (a retail sale), because that's what the contract was fundamentally about.

Q: Does the temporary-storage exemption help a contractor installing equipment on a Navy ship?
A: No -- per the Department's earlier ruling P.D. 18-104 (cited here), the temporary-storage exemption applies only to construction materials incorporated into real property construction, not to equipment installed aboard a vessel.

Citations and references

• Va. Code § 58.1-609.1(4) (sales to the federal government are exempt from sales and use tax)
• 23 VAC 10-210-693 (government contractor regulation; addresses mixed government contracts and the true object test, including subsection H on real property contracts)
• P.D. 18-104 (5/31/2018) (prior ruling on a government contractor installing communications equipment on naval ships; found the temporary-storage exemption inapplicable and the true object to be a retail sale)

Subject

Contractors: Mixed Government Transactions : Systems Repair and Replacement

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-135

Original ruling text

October 26, 2021

Re: Request for Ruling: Retail Sales and Use Tax

Dear *:

This is in response to your letter submitted on behalf of * (the “Taxpayer”), requesting a ruling on the application of the Virginia retail sales and use tax to government contracts involving United States Navy ships. I apologize for the delay in responding to your ruling request.

FACTS

The Taxpayer contracts with the United States Navy to repair and replace various command, communication, control, intelligence, surveillance and reconnaissance systems on Navy ships. In the performance of its contracts, the Taxpayer installs cabling pathways, cabling and metal racks in addition to the systems. The Taxpayer requests a ruling to determine whether it is considered a retailer or a consuming contractor when performing contract work on Navy ships.

RULING

The Department’s government contractor regulation found in Title 23 of the Virginia Administrative Code (VAC) 10-210-693 and Public Document (P.D.) 18-104 (5/31/2018) are instructive in this instance. Based on the information provided, the Taxpayer provides services and tangible personal property when it performs its contracts on Navy ships. Such an agreement would be considered to be a mixed government contract or a mixed transaction. See Title 23 VAC 10-210-693 B.

Relying on the cited regulation, the Department has traditionally applied a “true object” test to mixed government contracts to determine whether a government contract is for the sale of tangible personal property or for the provision of services. In accordance with Title 23 VAC 10-210-693 C, if the true object of the contract is for the sale of tangible personal property to the government, the contractor may purchase such property exempt from the tax under a resale exemption certificate, Form ST-10. The subsequent sale of the property to the government is exempt from the sales and use tax pursuant to Virginia Code § 58.1-609.1 4. However, if the true object is to obtain the provision of services, the contractor is deemed to be the taxable user or consumer of all tangible personal property used in performing such services.

In P.D. 18-104, the Department addressed the application of the temporary storage exemption for contractors to a government contractor that furnished and installed communications equipment on naval ships. The Department opined that the temporary storage exemption was not applicable and applied only to construction materials incorporated into real property construction. This is supported by Title 23 VAC 10-210-693 H which discusses real property contracts between a contractor and a government entity. Alternatively, the true object test was applied to the taxpayer’s contract to furnish and install communications equipment on a naval vessel was found to be a retail sale.

Although the Taxpayer provides repair, labor and subcontracted services in conjunction with the systems’ equipment and materials, it appears that the true object of the contracts is to secure replacement of the systems and the tangible equipment and materials associated with the systems. Consistent with Title 23 VAC 10-210-693 and P.D. 18-104, the Taxpayer’s contracts appear to constitute the sale of tangible personal property or a retail sale. Purchases of equipment, materials and other tangible personal property associated with the systems for transfer to the federal government may be purchased exempt for resale. The Taxpayer must issue a completed Form ST-10 to its vendors to claim the resale exemption on qualifying purchases for resale to the Navy as a federal government entity.

I trust that the guidance provided in this ruling responds to your inquiry. This response is based on the facts provided as summarized above, and without review of the Taxpayer’s contracts. Any change in facts or the introduction of new facts may lead to a different result.

Accordingly, the Taxpayer is advised to review its contracts to verify whether the true object of its current and future contracts with the government are for the sale of tangible personal property or the provision of services.

The Code of Virginia section, regulation and public document 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 web site. If you have any questions about this response, you may contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/3279L

Related Documents

18-104