Our audit assessed us for materials markup we billed customers, disputed our resale-exemption purchases, and applied compliance and amnesty penalties -- what can we still get corrected?

Plain-English summary

A project engineering and design contractor with one Virginia location was audited for a second time and assessed tax, penalty, and interest for two distinct problems: sales tax the contractor collected from customers but never remitted to the Department, and use tax on untaxed purchases of expenses and fixed assets. The contractor, which had already paid the assessment in full, appealed several specific issues raised during the audit.

Resale claims: partly successful, item by item. The contractor argued two disputed purchases (line items 116 and 202) were made for resale, not for its own use -- something a contractor can do when it operates in a "dual capacity" as both a real property contractor AND a retailer, buying some items tax-free because it knows at purchase time they'll be resold outside a real property contract. The contractor produced two invoices showing it actually sold those specific items and its customers paid the tax. Because the documentation held up, those two items were sent back to the auditor to be corrected.

Markup: taxable, and must be remitted once collected. The contractor billed customers for materials plus a roughly 10% markup, and charged sales tax on BOTH -- but only remitted the tax collected on the materials portion, apparently believing the markup wasn't taxable. Virginia's "sales price" is defined extremely broadly: it includes markup, overhead, profit, and virtually any other cost tied to a sale of tangible personal property, with no exclusions. Even if the contractor had genuinely believed the markup was exempt, once it actually COLLECTED tax on that amount from its customers, Virginia law required it to remit every dollar collected -- even tax collected in error.

Manufacturing exemption: denied for lack of proof and bad timing. The contractor claimed an exemption for purchases tied to a completed contract job, without specifying which exemption it believed applied. The auditor found the project's scope (conduits, brackets, wiring, lighting, receptacles, heat trace, safety showers) was tied to REAL PROPERTY construction, not manufacturing, and the contractor didn't prove the specific disallowed purchases were actually used in manufacturing. Compounding the problem, the contractor didn't obtain its manufacturing exemption certificate until over a year AFTER the contract had already been completed -- and under Virginia's real-property-contractor rule, a contractor furnishing property under a construction contract is generally treated as the end user/consumer of that property, owing the tax itself.

Penalties: no waiver on either front. The contractor asked to have compliance and post-amnesty penalties waived, arguing the long gap since its prior audit should let this be treated like a "first" audit for penalty purposes, and that it had been found sufficiently compliant on the last audit to avoid penalty. Virginia's regulations DO generally spare penalty for genuinely new issues not covered by prior audits -- but NOT on second-or-later audits, absent truly exceptional mitigating circumstances, and this contractor's issues involved long-established Department policy the contractor reasonably should have known about. It also hadn't hit the required use-tax compliance ratio this time around. On the separate 20% post-amnesty penalty (tied to Virginia's 2017 Tax Amnesty program), the contractor needed to meet several specific conditions -- including a sales/use tax compliance ratio above certain thresholds and full uncontested payment by a set 2017 deadline -- and it hadn't met all of them, so that penalty stood too.

What this means for you

Real property contractors who also sometimes sell items at retail (dual capacity)

Keep specific documentation (invoices showing the item sold and the tax your customer actually paid) for any purchase you treat as exempt-for-resale -- that item-by-item proof is what let this contractor win on two specific line items while losing broader arguments.

Any business billing customers a markup on materials

"Sales price" under Virginia law includes markup, overhead, and profit -- if you charge and collect tax on a marked-up amount, you must remit ALL of that collected tax to the Department, even if you later decide (or later learn) that the markup portion wasn't actually taxable.

Contractors facing their second (or later) audit

Don't expect a long gap since your last audit to reset penalty exposure to "first audit" treatment -- Virginia's regulations specifically withhold that leniency on second-and-subsequent audits except in truly exceptional circumstances, and unremitted COLLECTED sales tax always draws penalty regardless of audit generation.

Contractors seeking a manufacturing (or other) exemption for a completed job

Get your exemption certificate and documentation lined up BEFORE or DURING the project, not more than a year after it's finished -- and be prepared to show the SPECIFIC purchases you're disputing were actually used in the exempt activity, not just that the project generally involved some manufacturing-adjacent work.

Citations and references

• Public Document 17-156 (9/5/2017) -- the Guidelines for the Virginia Tax Amnesty Program, describing the 20% post-amnesty penalty and the specific conditions (compliance ratio, timely payment) required to avoid it on a field audit

Subject

Real Estate Contractor: Exemptions - Resale, Manufacturing; Sales Price - Materials Markup; Penalty - Compliance, 2nd Generation - Amnesty, Requirements Under Audit

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-65

Original ruling text

May 25, 2021

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

Dear *:

This is in response to your letter submitted on behalf of * (the “Taxpayer”) in which you seek correction of the retail sales and use tax assessment issued for the period July 2015 through December 2016. The assessment at issue has been paid in full. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a project engineering and design contractor with one location in Virginia. An audit resulted in the assessment of tax, penalty, and interest for sales tax collected but not remitted to the Department, and use tax for untaxed expense and fixed asset purchases. The Taxpayer contests part of the assessment and raises various issues it was not able to resolve at the time of audit. These issues are described below.

DETERMINATION

Purchases for Resale

The Taxpayer takes issue with two line items (Line item 116 and 202) on the “non-contested purchases” exceptions list and claims that these items are purchases made for resale. The Taxpayer states that it is principally a real property contractor who fabricates tangible personal property for its own use and consumption. The Taxpayer states that it also makes retail sales. The Taxpayer claims that, as a fabricator who operates in a dual capacity as described in Title 23 of the Virginia Administrative Code (VAC) 10-210-410 E, it made tax exempt purchases in which it knew at the time of purchase that the items would be resold to customers without a real property contract. The Taxpayer provides two invoices and states that these documents show that the sales tax was charged to and paid by its customers.

Because the documentation shows the Taxpayer sold the items at issue and collected the required tax, the audit will be returned to the auditor to revise the purchase exceptions list regarding the two meters for which the Taxpayer was able to provide documentation proving that the purchases were for resale and the appropriate tax was paid by its customer.

Tax Charged on Markup

The Taxpayer invoices customers for time, materials, and lump sum billing. The auditor found that the Taxpayer was charging an average markup of 10% for material costs. The invoices billed customers for tax on the material cost and the markup, however, the amount of tax collected for the markup amount was not remitted to the Department.

The Virginia retail sales and use tax is imposed on the "sales price" of tangible personal property. Virginia Code § 58.1-602 defines "sales price" as

the total amount for which tangible personal property or services are sold, including any services that are a part of the sale, valued in money, whether paid in money or otherwise, and includes any amount for which credit is given to the purchaser, consumer, or lessee by the dealer, without any deduction therefrom on account of the cost of the property sold, the cost of materials used, labor or service costs, losses or any other expenses whatsoever.

As so defined, sales price includes any amount charged as a markup for overhead expenses and other costs and profit in connection with the sale of tangible personal property. The definition makes it clear that, absent a statutory exemption, labor, service charges, or any other additional expenses are taxable when made in connection with the sale of tangible personal property.

The documentation provided by the Taxpayer (Exhibit B) shows that the Taxpayer collected more tax than it remitted to the Department. No disclosure was included on the documents provided to reference that the tax only applies to materials. Thus, the evidence indicts the tax was collected on both the material costs and the markup. Pursuant to Virginia Code § 58.1-625, the Taxpayer is required to remit all taxes it collects from its customers to the Department, even if such tax is erroneously collected.

Exemption

The Taxpayer claims that various purchases for a contract job qualify for an exemption from tax. The Taxpayer states that most of the contract job for which the purchases were made qualify for an exemption, but does not specifically cite the statutory exemption for which it believes it qualifies. The Department’s records indicate that the Taxpayer requested and received Form ST-11A from the Department on January 29, 2018. However, the contract was completed on December 31, 2016.

The auditor notes that, while some of the contract purchases qualified for a manufacturing exemption pursuant to Virginia Code § 58.1-609.3 2, the Taxpayer failed to prove that the purchases held as exceptions in the audit were used in manufacturing. The auditor notes that the scope of the project, including conduits, brackets, wiring, lighting, receptacles, heat trace, and safety showers, is related to real property construction. The exemption certificate requested by the Taxpayer states that the exemption does not apply to purchases of “materials incorporated into real property construction…” Virginia Code § 58.1-610 A provides the following:

Any person who contracts orally, in writing, or by purchase order, to perform construction, reconstruction, installation, repair, or any other service with respect to real estate or fixtures thereon, and in connection therewith to furnish tangible personal property, shall be deemed to have purchased such tangible personal property for use or consumption.

Compliance Penalty

The Taxpayer also requests the waiver of compliance and post-amnesty penalties assessed in the audit. The Taxpayer requests that the current audit period be considered a first audit for penalty calculation purposes because of the length of time between the prior and current audit periods. The Taxpayer also states that it was found to be in sufficient compliance during the previous audit period to avoid the application of penalty. The Taxpayer also states that the post-amnesty penalty should be waived because the Guidelines for the Virginia Tax Amnesty Program state the following: “Assessments issued for additional amounts due on amnesty eligible returns, provided that the liability is paid by November 14, 2017, or within 30 days from the date of assessment, whichever is later.”

Title 23 VAC 10-210-2032 8 provides the following:

Penalty generally will not be applied to audit deficiencies occurring in new areas not covered by prior audit(s), provided the application of the tax is not clearly established under existing law, regulations or other published documents of which the taxpayer reasonably should have had knowledge… The application of penalty to audit deficiencies will not be waived on second and subsequent audits for other than exceptional mitigating circumstances.

The issues in the current audit are the result of long-standing policies by the Department and are clearly established under existing law. The Taxpayer did not reach the required use tax compliance ratio to avoid penalty on this second generation audit and the Taxpayer did not provide documentation for a computation under the alternative method. Regarding the unremitted sales tax assessed and penalized in this audit, penalty is always applied in such instances because the tax was collected but not remitted to the Department. The penalty applies regardless of the generation of the audit. See subsection B 3 b of Title 23 VAC 10-210-2032.

Amnesty Penalty

The 2017 General Assembly enacted legislation establishing a Tax Amnesty program, spanning a 60 to 75 day period that was administered by the Department. The Guidelines for the Virginia Tax Amnesty Program are addressed in Public Document (P.D.) 17-156 (9/5/2017). Taxpayers with delinquent returns for amnesty-eligible periods qualified for amnesty benefits. Any tax liability that was eligible for amnesty benefits but remained unpaid is subject to a 20% amnesty penalty in addition to all other penalties. The amnesty-eligible periods for ongoing field audits is the month of April 2017 and prior. P.D. 17-156 states that the 20% post-amnesty penalty will not apply to the following:

Any assessment generated from a field audit of a business for an amnesty eligible period in cases where the audit is a second or subsequent audit of the taxpayer, provided that the Compliance Ratio is greater than 85 percent for sales tax and greater than 60 percent for use tax, no penalty has been applied to the tax deficiency, any uncontested liability is paid by November 14, 2017, and payment for any contested liability remaining upon resolution of an appeal under Va. Code §§ 58.1-1821 or 58.1-1825 is paid within 30 days from the date of the Tax Commissioner’s or the court’s final determination.

The Taxpayer has failed to meet all of the conditions mentioned above. In this case, the Taxpayer’s use tax compliance did not reach the required level of compliance and penalty was applied to this assessment. The uncontested liability was paid May 1, 2018 and the contested liability was paid July 6, 2018. Accordingly, I do not find cause to waive compliance or amnesty penalties in this instance.

CONCLUSION

The audit will be returned to the appropriate field audit staff to make the adjustments consistent with this determination. The auditor will also issue a refund for any adjustments made, with interest accrued to date, as soon as practicable.

The Code of Virginia sections, regulations 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/1687.G

Related Documents

17-156