My company sells a bundled smart-home system -- remote video, door locks, lights, controlled through our app and network -- along with our basic monitored alarm service. Is the whole bundled charge taxable as equipment, or exempt as a service?

Plain-English summary

A security company that provides monitored alarm services for residential and commercial customers also offers an optional add-on system with smart-home-style features: remote viewing of security camera video, arming/disarming the security system, locking and unlocking doors, and turning lights off and on. The company supplies the equipment and operates it over its own network using its own proprietary software and web/mobile app; customers pay one periodic bundled charge covering the equipment and all related services. The add-on system is only available to customers who also have the company's basic monitoring service.

An audit concluded the bundled charge for this add-on system was really a sale of a "nonmonitored" security system -- fully taxable tangible personal property -- relying on Virginia's alarm-system regulation (23 VAC 10-210-230) and prior rulings distinguishing MONITORED systems (where the seller actively monitors the system, at least part-time and regularly, making the true object a nontaxable service) from NONMONITORED systems (where the customer just buys the equipment, a taxable sale). The company appealed, arguing its add-on system was actually monitored, or alternatively that its true object was a service regardless.

The Department agreed the alarm-system regulation, written before online networks, mobile apps, and software-controlled smart-home features existed, simply doesn't address a system like this one. Instead, it applied the broader "true object" test from Virginia's services regulation (23 VAC 10-210-4040(D)), which governs any transaction mixing services and tangible personal property: if the object of the transaction is really to secure a SERVICE, and the property transferred isn't critical to the transaction, the whole thing can be an exempt service; but if the object is to secure the PROPERTY itself, the whole charge (including any service component) is taxable. Where both the service and the property are critical elements, the analysis looks at the degree of customization and specific services provided.

Here, the Department found BOTH sides critical: the equipment matters because customers need it for the system to function, but the equipment is equally useless without the company's software and network access. Weighing everything -- the video recording/storage/alerting features, the ability to control locks/lights/temperature remotely, and the app/web-portal customization -- the Department concluded customers were really paying for the ONGOING ABILITY to remotely control and automate their premises (and, for video, to obtain video information), available whenever and wherever they have internet access. That's a service, not a hardware purchase, so the whole bundled charge was ruled nontaxable.

Critically, the Department distinguished this from the company's own two prior, similar rulings (P.D. 16-49 and P.D. 16-93), where the company's ongoing connection to installed equipment was much thinner -- just periodically checking that the equipment was working properly and issuing administrative reports. That limited, "keep the lights on" style monitoring supported a nonmonitored/taxable-equipment finding in those cases; the much deeper software/network dependency in THIS system supported the opposite result here. The audit assessment on these charges was removed, with a revised bill to follow for any remaining liability.

What this means for you

Security, smart-home, or IoT companies selling bundled hardware-plus-software-plus-network offerings

Don't assume Virginia's older, hardware-focused alarm-system regulation automatically governs your product if it's really a software/app/network-driven service. The broader "true object" test for mixed transactions may apply instead, and can produce a nontaxable result even for a bundle that includes real equipment -- if customers are functionally paying for an ongoing capability (remote control, monitoring, data access) rather than just owning hardware.

Businesses distinguishing their offering from the "monitored vs. nonmonitored" alarm framework

The depth of your OWN ongoing connection to the equipment matters a lot. If you merely check that installed equipment still works (like the taxpayer's own earlier rulings), expect a nonmonitored/taxable-equipment result. If your equipment is genuinely inoperable without your software and network -- and customers are really buying continuous access to that software/network -- you have a stronger case for the "true object is a service" outcome reached here.

Businesses bundling equipment and services into one periodic charge

How you bill matters less than what customers are actually buying. A single bundled charge covering hardware and services doesn't automatically become taxable just because tangible equipment changes hands -- the analysis turns on which element (the property or the service) is the real reason customers are paying.

Common questions

Q: Does Virginia's alarm-system regulation (23 VAC 10-210-230) cover modern app-controlled, network-based smart-home systems?
A: Not really -- this ruling found that regulation predates and doesn't contemplate online networks, mobile apps, and software-enabled remote control, so the Department applied the broader mixed-transaction "true object" test instead.

Q: What made this system a nontaxable service rather than a taxable equipment sale?
A: The equipment couldn't function without the company's software and network, and customers' real goal was ongoing remote control/automation and video data access -- not simply owning the hardware -- which the Department found made the true object of the transaction a service.

Q: How is this different from the company's own earlier rulings finding a taxable, nonmonitored system?
A: In those earlier rulings, the company's only ongoing role was periodically checking that already-installed equipment was functioning properly -- a much thinner connection than the deep software/network dependency present in this system.

Citations and references

• 23 VAC 10-210-230 (monitored vs. nonmonitored security system sales; the regulation the Department found didn't fit this modern system)
• 23 VAC 10-210-4040(D) (true object test for mixed transactions involving both services and tangible personal property)
• P.D. 13-108 (6/19/2013) (a seller who monitors a system part-time but regularly is providing a monitored, exempt service)
• P.D. 16-49 (4/11/2016) and P.D. 16-93 (5/20/2016) (this same taxpayer's earlier rulings, distinguished here because the taxpayer's ongoing connection to the equipment in those cases was limited to confirming proper functioning)

Subject

Alarm Systems : Mixed Transactions: Monitored, Nonmonitored; Services : Exempt Services - True Object Test

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-139

Original ruling text

November 9, 2021

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

Dear *:

This will reply to your letter in which you seek correction of the retail sales and use tax assessment issued to your client * (the “Taxpayer”), for the period July 2014 to June 2017. I apologize for the delay in responding to your appeal matter.

FACTS

The Taxpayer provides security monitoring services for both residential and commercial customers. In addition to the basic service, the Taxpayer offers an optional system (the “System”) with a range of additional features, such as the ability to view security camera video remotely, activate the security system, lock and unlock doors, and turn lights off and on. System equipment is supplied by the Taxpayer and operated over the Taxpayer’s network using the Taxpayer’s proprietary software and web portal. Customers are billed periodic bundled charges to use the System, including any additional equipment and all related services depending on the features selected. The System is not available unless the customer also purchases or already has the Taxpayer’s basic monitoring service.

As a result of the Department’s audit, the auditor concluded that the charge to the Taxpayer’s customer for the System, which includes all equipment and related services, constitutes the sale of a nonmonitored system. The auditor relied primarily on the distinction between monitored and nonmonitored systems as described in Title 23 of the Virginia Administrative Code (VAC) 10-210-230 and as applied in certain prior determinations of the Department, particularly Public Document (P.D.) 16-93 (5/20/2016). The auditor assessed the sales tax on such charges. The Taxpayer appealed, contending that the System was a monitored system or alternatively that the System’s true object was a service.

DETERMINATION

Consistent with Title 23 VAC 10-210-230, the Tax Commissioner has determined that sales of security systems constitute retail sales of tangible personal property if the customers monitor the systems. See PD 13-108 (6/19/2013). Should the seller, however, monitor the system on a part-time but regular basis, it is considered to be providing a monitored service. See id . In accordance with the regulation, the true object of a monitored security system constitutes the provision of a service, the charge for which is exempt. Likewise, the true object of a non-monitored system constitutes the sale of tangible personal property, a taxable transaction. See P.D. 16-49 (4/11/2016) and P.D. 16-93 (5/20/2016).

Because the Department’s regulation regarding security systems does not contemplate online networks, mobile devices, and software-enabled control using computers, it cannot be relied upon to address the many functions available using the System at issue. While the true object test addressed in Title 23 VAC 10-210-4040 D of the services regulation provides the underlying distinction between monitored and non-monitored systems as explained above, the services regulation also applies the true object test when both the services and property are critical elements when provided in a mixed transaction. Therefore, in this case, I believe the Department’s services regulation provides the appropriate guidance.

Title 23 VAC 10-210-4040 D addresses mixed transactions and provides the following:

In order to determine whether a particular transaction which involves both the rendering of a service and the provision of tangible personal property constitutes an exempt service or a taxable retail sale, the “true object” of the transaction must be examined. If the object of the transaction is to secure a service and the tangible personal property which is transferred to the customer is not critical to the transaction, then the transaction may constitute an exempt service. However, if the object of the transaction is to secure the property it produces, then the entire charge, including the charge for any services provided, is taxable.

The regulation goes on to state that:

In instances where both the services rendered and the property transferred are critical elements of a transaction, the degree of customization, uniqueness or specific services provided in connection with the product shall be considered in determining its appropriate tax status.

The System allows customers to perform off-site video monitoring of their premises and to control or automate certain functions remotely, such as enabling the security system, locking doors, adjusting temperature controls, controlling appliances and turning on lights. The Taxpayer offers a number of video functions with the System, including the ability to record video, store short video clips locally using a software application provided by the Taxpayer (the “mobile application”), store video in the Taxpayer’s cloud storage, view live or event-driven video on the mobile application or the Taxpayer’s website, and receive text or email alerts from the System for certain triggering events. Customers are only able to perform such activities by using the System’s hardware, software and network together, and paid a periodic bundled charge for the equipment and all associated services.

In my opinion, the equipment provided is a critical element to the transaction because the customers need such for the System to function. Likewise, the services are critical because the equipment cannot function without the Taxpayer’s software applications and access to the Taxpayer’s network. After carefully reviewing the information provided by the audit staff and the Taxpayer, in addition to the Department’s research into how the System operates, it appears that the software applications, web portal and network allows the customer to customize the user experience with the System. Therefore, the true object of the Taxpayer’s customers is the ability to remotely control and automate their premises, and in the case of video, obtain information in the form of video data. With the System, customers can perform these tasks whenever and wherever access to the internet is available. Therefore, the Taxpayer is deemed to provide a nontaxable service when it sells the System equipment and associated services to customers.

This case is distinguishable from the facts of P.D. 16-49 and P.D. 16-93 in that the taxpayers in those cases had limited ongoing connections to the tangible equipment once it was installed. In P.D. 16-49, the taxpayer merely monitored the equipment to make sure it was functioning properly and issued administrative reports. Similarly, in P.D. 16-93, the taxpayer monitored the system remotely only to ensure proper functioning.

Accordingly, the audit will be revised by the audit staff to remove the sales transactions at issue. The Taxpayer will receive a revised audit report and sent a revised bill for any remaining liability. The bill should be paid within 60 days from the date of this letter to avoid the accrual additional interest charges.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/2122.M

Related Documents

16-93

13-108

16-49