We're an electrical contractor who was assessed sales tax on the fire alarm and suppression systems we install -- but we think those systems become part of the building, not taxable personal property -- who's right?

Plain-English summary

A Virginia-licensed Class A electrical contractor performs commercial electrical work, including installing legally required life-safety systems like nonmonitored fire alarm and suppression systems. The contractor buys these systems from businesses that specialize in selling them, pays sales tax on those purchases as the end user (treating itself as a real property contractor who is the ultimate consumer of materials it installs), and then installs the systems for its own customers as part of its electrical contracting services. The Department's audit instead treated the LABOR, material markup, and permit costs tied to these installations as connected to a SALE of tangible personal property -- meaning sales tax should have been charged to the customer -- and assessed accordingly. The contractor appealed, arguing the fire alarm components lose their identity as tangible personal property once installed and become part of the real property.

The key legal question: do the installed components remain "tangible personal property," or do they become part of the building? Virginia law treats a contractor who furnishes tangible personal property under a real-property construction contract as the END USER/CONSUMER of that property (owing use tax on its own cost) -- UNLESS the property is sold separately as tangible personal property that never becomes part of the realty (in which case sales tax on the sale would apply instead). Virginia's own regulation on burglar/security/fire alarm systems draws exactly this line: installers of alarm-type devices that become "permanently affixed to realty" are treated as contractors (paying tax on their own purchases), while alarm devices that DON'T become attached to realty remain ordinary taxable retail sales.

Applying the three-part fixture test, the systems here were fixtures. Virginia's long-standing fixture test (from a 1941 case, Danville Holding, and reaffirmed in later cases) asks: (1) was the property annexed (attached) to the real estate; (2) is it adapted to/essential for the realty's purpose; and (3) did the party installing it intend it as a permanent addition? Here:

• Annexation: the fire alarm and suppression systems were fully integrated into the building's telephone lines and hard-wired into its electrical network -- genuinely attached, not just placed.
• Adaptation: these are legally required life-safety systems tied to the building permit and occupancy process -- no certificate of occupancy issues unless the system is installed, inspected by the fire marshal, and fully functional, meaning the building would be unusable for any commercial purpose without it.
• Intent: if the system becomes disabled, the building can be ORDERED CLOSED by the fire marshal until it's repaired, and the owner must report any malfunction immediately and get it fixed -- strong evidence that everyone involved intends the system to remain permanently in place and operational.

All three factors pointed to fixture treatment. Because the systems became part of the realty upon installation, the contractor -- not its customer -- was the appropriate party to pay tax (as a use tax on its own acquisition cost), not the retailer making a taxable sale to the customer. The sales tax assessment was abated.

What this means for you

Electrical, fire-alarm, and life-safety-system contractors

If the systems you install are hard-wired into a building's own electrical/utility network, are legally required for occupancy, and would force the building closed if disabled, you have a strong argument you're a real property CONTRACTOR (paying use tax on your own material costs) rather than a retailer who must charge sales tax to your customer on the installation -- consistent treatment with how Virginia already treats security and burglar alarm installers.

Businesses installing any code-required building system (not just fire alarms)

The same three-part fixture analysis -- physical integration, necessity for the building's use/occupancy, and evidence the system is meant to stay permanently functional -- can apply to other integrated life-safety or building systems beyond fire alarms; look at how deeply wired-in, code-mandated, and permanently intended the installation is.

Taxpayers whose audit treats an installed system as a taxable "sale" rather than contractor self-consumption

If your product becomes physically integrated into the customer's building in a way that would be costly to remove and is legally required to stay operational, push back on an assessment that treats the installation as an ordinary retail sale -- the fixture classification can shift who owes tax and in what form.

Common questions

Q: Does a fire alarm system have to be visibly "built into" the walls to count as a fixture?
A: Not necessarily visibly, but functionally -- here, being fully integrated into the building's telephone lines and hard-wired into its electrical network was enough to satisfy the annexation element, even without more detail about visible construction.

Q: What made these fire alarm systems "essential" to the building rather than just helpful equipment?
A: The building couldn't legally be occupied for any commercial purpose without a working, inspected fire alarm/suppression system -- no certificate of occupancy issues otherwise, which is a strong form of the "adaptation to the realty's purpose" factor.

Q: Does it matter that the fire marshal can force the building closed if the system fails?
A: Yes -- the Tax Commissioner treated that enforcement mechanism as strong evidence of the parties' INTENT for the system to remain a permanent, continuously functional part of the building, satisfying the third fixture-test factor.

Citations and references

• Danville Holding Corp. v. Clement, 178 Va. 223, 232, 16 S.E.2d 345, 349 (1941) -- established Virginia's three-part fixture test (annexation, adaptation, intent)
• Transcontinental Gas Pipe Line Corp. v. Prince William County, 210 Va. 550 (1970) -- confirmed and applied the Danville Holding fixture test in a later case

Subject

Contractors : Electrical: Real V. Tangible Property - Fire Alarm Systems

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-76

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 2013 through June 2016. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a Virginia licensed Class A contractor with an electrical specialty. The Taxpayer provides commercial electrical contracting services, including but not limited to building electrical, power systems, smart building and power management systems, and legally required life safety systems. The Taxpayer considers itself to be the user or consumer of all materials installed in the real property of its customers and pays sales or use tax on its acquisition of all such materials and supplies. As a result of the Department’s audit, the auditor determined that labor, material mark-up and permits in connection with the installation of integrated life safety systems (e.g. nonmonitored fire alarm and suppression systems) were provided in connection with the sale of tangible personal property and issued an assessment. The Taxpayer appeals, contending the application of sales tax in this instance is improper because the component materials of the life safety systems lose their identity as tangible personal property upon installation.

DETERMINATION

Installation of Integrated Life Safety Systems by Contractors

Virginia Code § 58.1-610 A provides that:

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. Any sale, distribution, or lease to or storage for such person shall be deemed a sale, distribution, or lease to or storage for the ultimate consumer and not for resale, and the dealer making the sale, distribution, or lease to or storage for such person shall be obligated to collect the tax to the extent required by this chapter.

Virginia Code § 58.1-610 D states that “tangible personal property incorporated in real property construction which loses its identity as tangible personal property shall be deemed to be tangible personal property used or consumed within the meaning of this section”.

Title 23 of the Virginia Administrative Code (VAC) 10-210-410 A provides, in pertinent part, that “[t]angible personal property incorporated in real property construction which loses its identity as tangible personal property and becomes real property is deemed to be tangible personal property used or consumed by the contractor”.

Virginia Code § 58.1-603 imposes retail sales tax on “every person who engages in the business of selling at retail or distributing tangible personal property in this Commonwealth…” “Retail sale” is defined, in part, in Virginia Code § 58.1-602 as “a sale to any person for any purpose other than for resale in the form of tangible personal property or services under this chapter…”

These principals are reflected in the Department’s regulation regarding burglar, security and fire alarm systems. Title 23 VAC 10-210-230 C provides, in pertinent part that “persons engaged in the sale and installation of… security devices…. and similar items which become permanently affixed to realty are contractors with respect to such transactions and must pay tax on all property installed or used in installation at the time of purchaser withdrawal from nontax paid inventory”. The sale of fire devices that do not become attached to realty are retail sales of tangible personal property.

In the instant case, the Taxpayer is purchasing fire alarm and suppression systems from businesses that are specifically engaged in the business of selling such systems, and paying sales tax on such purchases as the end user and consumer. The Taxpayer is then providing and installing such systems to its customers in performance of its contract for electrical services. The question then becomes whether the fire alarm and suppression systems maintain their status as tangible personal property once installed into the commercial setting, or if such systems become fixtures of the real property. If the systems are installed in such a way that they become permanently affixed to the realty, then the Taxpayer is the end user and consumer of the property and must pay the use tax. If the systems do not become attached to the realty, they remain tangible personal property and are subject to the sales tax.

Tangible Personal Property vs. Real Property Fixtures

The distinctions between real and tangible personal property have been addressed by the Virginia Supreme Court in Danville Holding Corp. v. Clement , 178 Va. C 223.232, 16 S.E. 2d 345, 349 (1941) and confirmed in subsequent cases, such as Transcontinental Gas Pipe Line Corp. v. Prince William County , 210 Va. 550 (1970). Danville Holding and Transcontinental Gas Pipe Line provide a three part test to determine if tangible personal property loses its identity and becomes real property upon installation. The three general tests are as follows: (1) annexation of the chattel to the realty, actual or constructive; (2) its adaptation to the use or purpose to which that part of the realty to which it is connected is appropriated; and (3) the intention of the owner of the chattel to make it a permanent addition to the freehold. The intention of the party making the annexation is the chief test to be considered in determining whether the chattel has been converted into a fixture.

Annexation of the Property

With respect to the first test, the court in Danville Holding found that “while… there must be actual or constructive annexation, the method or extent of the annexation carries little weight, except insofar as they relate to the nature of the article, the use to which it is applied and other attending circumstances as indicating the intention of the party making the annexation”. Danville Holding at 232. In this instance, the fire alarm and suppression systems are fully integrated into telephone lines and are hard wired into the subject building in such a way that they become part of its electrical network. Based upon the manner in which the system is installed into the space, I find that the equipment is annexed to the real property.

Adaption to the Reality

With respect to the second test, the court found that “if the chattel is essential to the purpose for which the building is used or occupied, it will be considered a fixture. Id. Here, the Taxpayer is installing life safety systems that are included in building plans requiring approval for building permits and for which no certificate of occupancy will be issued if the system is not installed, inspected by the fire marshal, and fully functional. Therefore, without such systems, the realty would be unusable for any commercial purpose whatsoever. Based upon these factors, I find that the equipment at issue is essential to the purpose for which the building is used.

Intention of the Party

The court further held that “the intention of the party making the annexation is the paramount and controlling consideration.” Id . If a fire alarm and suppression system is not in working order or is in any way disabled, then the building may be closed by order of the fire marshal until such repairs are completed. Should a legally required fire alarm and suppression system become disabled at any time the owner must report it to the fire marshal immediately and contact a licensed contractor to make necessary repairs. Based upon these factors, I find that the intention of the parties is for the fire alarm and suppression systems installed by the Taxpayer to be fully operational and remain in place at all times.

CONCLUSION

Pursuant to Virginia Code § 58.1-610 A and D, Title 23 VAC 10-210-410, I find that the Taxpayer is a commercial electrical contractor within the meaning of Virginia Code § 58.1-610 and is not engaged in the retail sale and installation of fire alarm systems as contemplated under Title 23 VAC 10-210-230. The fire alarm and suppression systems at issue are incorporated into real property upon installation. The tangible personal property components of the systems are deemed used or consumed by the Taxpayer within the meaning of Virginia Code § 58.1-610 D. Therefore, the Taxpayer must pay sales or use tax on its acquisition of all such materials and supplies installed in the real property of its customers. Accordingly, the assessment is abated.

The Code of Virginia sections, regulation and public document cited 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/1481.A